Indexed Universal Life Policy Loans
Indexed Universal Life (IUL) insurance is a unique type of life insurance that has many important features. One of the key benefits of owning this type of policy is the ability to access funds from its cash value without having to pay income tax. This is done through IUL policy loans. Some people have also used this very same benefit to live off 100% of the cash value produced from their IUL policy during retirement.
You can access the cash value account in your IUL policy without incurring income tax through a policy loan. Why? IRS provisions on IUL policies allow you to take out a loan and not have to pay any income tax on it. In fact, you can even decide whether or not to repay the loan.
Some people might wonder if IUL insurance is right for them. When structured properly, loans could be one of the most important features of an IUL for the right person. But before you purchase this type of insurance policy, learn more about how it works to ensure that it is right for you.
Different Types of IUL Policy Loans
When you have cash surrender value in your IUL policy, you can take a loan against it. Here are some options you have:
- Partial Withdrawals – This is not a loan. When it comes to IUL policies, there’s an option to partially withdraw cash value for tax-free purposes. There is a chance that you will permanently lower the death benefit on your policy if you withdraw a partial amount. You can withdraw cash to your basis in the policy. This amount is not taxable. If you withdraw interest that was earned, you will be taxed on that amount.
Partial withdrawals are subject to a minimum amount and a surrender charge if applicable. When it comes to the specifics of this, you should refer to your policy for more information.
- Variable Interest Rate Loans – In the 21st Century economy, people like to get loans against the value of their insurance policies. Particularly popular are variable rate loans, which have an interest rate determined by a published monthly average. This average is usually Moody’s Corporate Bond Yield Average as published by Moody’s Investor Services, Inc.
The rate of interest will never be higher than the maximum variable loan interest rate. That rate can change at each policy anniversary based on the current published monthly average.
Variable-rate loans offer an interest rate that can change over time. Although the rate will fluctuate based on the Index Selections or Fixed Account, the loaned portion of your cash value continues to earn interest as if a loan has not been taken. Since the loaned amount continues to earn interest, your cash value will continue to grow inside your policy.
- Fixed Rate Loans, standard loans or wash loans – for a more conservative approach, standard loans are available. When taking a loan from your policy using the standard loan, your funds will only grow at the fixed account interest rate. Your standard loan rate is also charged at the same rate. That is why this loan option is sometimes called a wash loan. There is no cost to borrow from your policy since the amount you borrow will only earn the fixed account rate. This rate is usually between 1.5% and 4%.
- Fixed participating loan – Fixed participating loans are kind of a mix between variable loans and fixed loans. They allow your cash value to continue to earn interest based on your chosen interest allocation, but the interest rate charged will be higher than the normal fixed loan rate. Most carriers currently charge around 5% for the fixed participating loan. Not every carrier has this option but it is becoming more popular.
How Much Can You Borrow from an IUL Policy?
How much you can withdraw (borrow) from a life insurance policy depends on the insurer, but the maximum policy loan amount is generally 90% of the cash value but no minimum amount.
Taking out a policy loan doesn’t mean you’re taking some cash out of your life insurance policy. In fact, when you take out a policy loan you’re borrowing from the insurance company, and only using your cash value as collateral. This is significant because your cash value remains in the life insurance policy and continues to accumulate interest.
Your monthly repayment is flexible. That said, if you fail to pay the annual interest that is usually fixed or variable, the interest will go onto your outstanding. This is normal and a great reason for borrowing. The loan doesn’t need to be paid back while you are living because the insurance company will pay the loan off at your death and the remainder will go to your beneficiaries.
Overloan Protection Benefit
A major concern about long-term loans is the compounding interest. If you have a loan that stretches over many years the balance can seem very large.
Always make sure that your policy contains the overloan protection benefit. This feature guarantees that your policy will not lapse due to a loan that becomes too large.
Make sure you monitor your policy once you start taking loans. Once a year at your policy anniversary is plenty. Although borrowing money from your policy might seem like a viable option in the short term, it can lead to problems if you borrow too much or fail to make interest payments.
Pros and Cons of IUL Policy Loans
IUL insurance policy loans are the biggest reason that the policy is so attractive. You have access to your money with no loan application, just a quick call to your advisor and you should have a check within a week.
Pros:
- You’ll be able to borrow against your life insurance policy with no credit check or proof of income. You’ll just need to prove your identity, which is necessary for all loans.
- Life insurance collateral loans can be a quick and easy solution to get cash when you need it, such as for an emergency medical expense. Alternatively, they can act as a bridge while another loan application is going through the approval process.
- Once you’ve decided to retire, your IUL cash value can serve as a source of tax-exempt income that will help to offset your tax liability associated with traditional retirement investments.
- Your IUL insurance policy can be an excellent alternative if you are not sure whether you’ll need the money for a short or long time. You won’t have to pay back the loan. Borrowing from your life insurance policy is an excellent way to get access to cash whenever you need it, with no interest, no repayment requirement, and no income tax liability.
Cons:
- If your outstanding loan balance plus unpaid interest exceeds your cash value, the policy could lapse unless you have an overloan protection feature.
- Outstanding loan balances and interest will be deducted from the death benefit when you die.
- If you have a policy without the overloan protection feature and your policy lapses with an outstanding loan, that amount could be taxable to you.
