What are Indexed Universal Life Insurance Loans?

Permanent life insurance policies, such as indexed universal life (or IUL), have two primary components. These include 1) a death benefit, and 2) a cash value. The funds that are inside of an IUL policy’s cash value will often grow over time – and when there is a sufficient amount of money in that component, the policy holder may wish to borrow from the cash value.

There are three types of loans that may be available through an IUL policy. These include the following:

Fixed – If a policy holder has a fixed loan, he or she will borrow funds against the IUL policy, and the insurance carrier will charge a certain rate of interest on the borrowed amount. For each dollar that is borrowed against the policy, the insurance carrier will put the same amount of cash value into a collateral account. In doing so, the insurance company can guarantee that the collateral account will earn a rate of return. This return will be based upon how the company has invested those funds.

Indexed – With an indexed loan on an IUL policy, the funds that are borrowed will continue tracking the policy’s underlying index. Because there can be greater risk exposure to the insurance company with an indexed loan, the interest that is charged to the policy holder will usually be higher than that on a fixed loan.

Variable – A variable loan will also allow the funds that are borrowed to track the policy’s underlying index. But in this case, the interest rate on the loan will be variable – and it is usually tied to an index that can fluctuate up and down over time.

While the borrowed funds are not required to be paid back, it is important to note that when the insured passes away, any amount that has not been repaid (plus interest) will be deducted from the amount of the death benefit that is paid out to the beneficiary.

One of the key benefits to owning an indexed universal life insurance policy is the ability to access funds from your policy’s cash value without having to pay tax. This same benefit can also allow you to use as much as 100% of the cash value your policy has accumulated.

There are several types of loans that are available with an IUL policy. These include:

Fixed loan:
With a fixed loan, you can borrow funds against your IUL policy, and the insurance company will charge a set interest rate on the amount that you’ve borrowed. For each dollar that you have borrowed, the insurance carrier will put the same amount of policy cash value into a “collateral” account. The insurance company will then guarantee that this collateral account will earn some rate of return.

Indexed loan:
If you take an indexed loan, the dollars that have been borrowed will continue to track the underlying index(es), rather than being allocated to a collateral account. The collateral against your loan will still be subject to the movement of the underlying index(es). In most cases, the interest rate that is charged by the insurance company on an indexed loan will be more than the interest that is charged on a fixed loan.

Variable loans:
A variable loan will have some similarities to an indexed loan, whereby the borrowed funds will still track the underlying index(es). However, the interest rate that is charged by the insurer on a variable loan can frequently be lower than that of an indexed loan, because the insurance company is not held to a guaranteed rate. These loans can, however, charge a higher rate of interest than a fixed loan, as the collateral is typically in a vehicle that is riskier than cash.

Factors to Consider When Taking a Loan from an IUL Policy
It is important to note that IUL policy loans and withdrawals will reduce the available cash value and death benefits. These same events could also cause the policy to lapse, which could also cause all previous loans and withdrawals to be considered as taxable income, or affect guarantees on the to policy lapse. Also, additional premium payments may be required to keep the policy in force. In the event of a lapse, outstanding policy loans that are more than unrecovered cost could be subject to ordinary income tax.

In the event of a lapsed policy, loans are not typically classified as income tax; however, withdrawals or partial Surrenders are subject to income tax. If taken before age 59 ½, a 10% federal tax (“early withdrawal”) penalty may apply.

Is IUL the Right Choice for You?