How policy loans work in life insurance.
A policy loan is taken against the policy’s cash value, not from the insurer’s general funds.
Under both federal tax rules and Maryland insurance principles, policy loans are not taxable income as long as the policy remains in force.
Evaluate each option.
A. Taxable income
Incorrect. Policy loans are generally not taxable unless the policy lapses.
B. Loss of tax-exempt death benefit
Incorrect. Death benefits remain income-tax free, though the loan balance is deducted.
C. Becomes a modified endowment contract (MEC)
Incorrect. A loan does not convert a policy into a MEC.
D. Reduces amount receivable upon surrender
Correct. Any outstanding loan plus interest is deducted from the cash surrender value.
Maryland relevance.
Maryland regulates policy disclosures to ensure consumers understand that loans reduce cash value and net proceeds, which aligns with fair-dealing standards.
Conclusion.
The correct effect of a policy loan is a reduction in the amount receivable upon surrender.
