How are policy loans treated for tax purposes in life insurance?

Policy loans are considered to be a loan taken against the cash value of a life insurance policy. For tax purposes, this loan is treated as a debt incurred by the policyholder. This means that the amount borrowed does not trigger a tax event or are seen as taxable income. Instead, the policyholder can access the funds without an immediate tax consequence.

It's important to understand that as long as the policy remains in force and is not surrendered, the loan balance is simply a liability. The policyholder is expected to repay the loan with interest, but if the policy is maintained, the loan does not count as taxable income.

When a policyholder takes a loan against their life insurance policy, the amount they withdraw does not result in taxation, hence it is viewed simply as a reduction of the policy's death benefit and cash value until it's repaid or until the policy lapses. If the policy lapses, the outstanding loan can potentially be treated as taxable income, but the loan itself remains a debt until that occurs.