Policy Loans — How They Work, and What They Cost

The policy loan is the mechanism the whole strategy turns on, and it is also the one most frequently described inaccurately. This page describes it accurately, including the parts that are inconvenient.

Who actually lends the money

You do not borrow from yourself. The insurer advances capital to you and takes your policy's value as security. That is a loan, from a company, on contractual terms, and it charges interest.

The popular framing — that you become your own source of financing and pay interest to yourself — is a metaphor for a function, not a description of the cash flow. Interest on a policy loan is paid to the insurer and becomes part of its general revenue. Any benefit that returns to policyowners does so indirectly, through the pooled performance of the participating account, at the discretion of the board, and it is not traceable to your particular loan. The book states this plainly because the alternative is a claim that cannot be supported.

Why access is different

What a policy loan genuinely offers is not free money. It is access on terms that do not depend on anyone's opinion of you. There is no application, no credit assessment, no stated purpose, and no committee. The contract already obliges the insurer to advance against the value that is there. That availability does not vary with your employment status, your credit file, or conditions in the credit market — which is precisely when ordinary access tends to disappear.

That is a real and substantial advantage. It is an advantage in access and control, not a claim of superior returns, and the distinction matters both factually and legally.

Repayment, and the danger inside the flexibility

The insurer imposes no repayment schedule. You may repay quickly, slowly, or not at all. This is the strategy's most attractive feature and its most dangerous one, and the book treats it as both.

Unpaid loan interest accrues. Accrued interest is added to the loan. The larger loan then accrues more interest. Left alone for long enough, the loan can approach the policy's value, and a policy that lapses with a loan outstanding does not simply end quietly — it can trigger a tax bill in a year when there is no cash to pay it. The discipline that makes the flexibility safe is not optional; it is the price of the flexibility.

The tax rule people miss

Under section 148 of the Income Tax Act, a policy loan is a disposition. Where the loan proceeds exceed the policy's adjusted cost basis, the excess is a taxable gain in the year received. Adjusted cost basis is not the same as the premiums you have paid, and it declines over time — meaning a loan that would have been fully sheltered in year eight may not be in year twenty-five.

This is not a reason to avoid the strategy. It is a reason to take advice from an accountant who understands how these policies interact with Canadian tax rules before borrowing, rather than after. Anyone who describes policy loans as simply tax-free, without qualification, is describing the United States or is describing nothing.

The effect on the death benefit

While a loan is outstanding it reduces the death benefit that would otherwise be paid, along with the cash value available for further borrowing. The policy continues to operate under its contract during the loan period, but the obligation sits against it until it is cleared.

What to take from this

The insurer lends, not you. Interest is real and is paid to the insurer. No repayment schedule is imposed, which is a freedom that requires discipline rather than replacing it. Section 148 can make a loan taxable. And the loan reduces the death benefit until repaid.

Understood properly, the policy loan is a genuinely useful instrument. Understood loosely, it is the fastest way to damage a policy that took years to build.