A policyowner borrows from a whole life policy using the policy loan provision. Which statement about this loan is correct?

Why C is correct

The policy loan provision lets the policyowner borrow against the policy's cash value, which serves as collateral for the loan. Interest accrues on the outstanding balance, and if it is not repaid, the balance plus interest is deducted from the death benefit or the cash value when the policy is settled. Policy loans are not taxable events because they are treated as loans rather than income, and no credit underwriting is required because the cash value fully secures the borrowing.

Why the other options are wrong

• A) Policy loans require no credit check; the loan is secured entirely by the policy's cash value, which makes the risk to the insurer minimal.
• B) Policy loans are generally not taxable; taxation arises only on surrender or withdrawal of amounts that exceed the owner's cost basis.
• D) An unpaid loan reduces the death benefit by the loan balance and interest but does not automatically cancel the policy.

Memory hook

Borrow from yourself: the cash value is the collateral and the death benefit is the security.

Why A is correct

A policy loan is secured by the cash value. Interest accrues on the outstanding loan balance; if the loan plus interest grows to equal the cash value, the policy will lapse because there is no longer collateral securing the debt. Upon lapse, the outstanding loan is treated as a cash distribution, and any amount received in excess of the policyowner's cost basis (premiums paid) is taxable as ordinary income under IRC Section 72.

Why the other options are wrong

• B) Loans are not paid off by dividends; a dividend is a return of surplus in participating policies, unrelated to loan balance.
• C) The death benefit is reduced by any outstanding loan at claim time, not increased.
• D) Loans are never forgiven; the insurer collects the outstanding balance from the death proceeds or upon lapse.

Memory hook

Loan plus interest eats the cash value like rust; when it hits zero, the policy dies and the IRS wants its share.

Why A is correct

A policy loan is a borrowing from the insurer using the policy's cash value as collateral. The policyowner may borrow up to the available cash value, and interest accrues on the loan. If the loan is not repaid before death, the outstanding loan balance plus accrued interest is deducted from the death benefit paid to the beneficiary; if the loan and interest exceed the cash value, the policy may lapse. Because the loan is collateralized by the cash value, no credit check is required, and a loan is generally not a taxable event under federal income tax rules.

Why the other options are wrong

• B) A policy loan is secured by the cash value of the policy. It is not based on the insured’s credit score, and no credit underwriting or qualification is required beyond the available cash value.
• C) A loan is not a taxable distribution, and the death benefit is reduced only by the outstanding loan balance plus accrued interest. It is not reduced dollar for dollar by the full amount borrowed beyond that.
• D) A policy loan does not require surrendering the policy as repayment. The policy remains in force, and the loan operates as a lien against the cash value while coverage continues.

Memory hook

Policy loan = borrow against your own cash pile. Unpaid balance plus interest is docked from the death benefit.