IUL Cash Value and Policy Loans: How Borrowing From an IUL Works

Short answer: IUL cash value is the cash value account inside an indexed universal life (IUL) policy. FINRA says IUL “falls under the universal life insurance umbrella,” and NY DFS says that in universal life, premiums are credited to a cash value account and expenses and the cost of insurance are deducted from it. The Texas Department of Insurance (TDI) says universal life pays “Death benefits, plus a possible cash value you can withdraw from, invest, or borrow against.” Loans you don’t repay, plus interest, reduce what your beneficiaries get, and TDI says that if the cash value reaches zero, the policy could lapse.

If you’re new to these policies, start with what IUL insurance is and how it works.

How does an IUL build cash value?

FINRA says indexed universal life “falls under the universal life insurance umbrella; however, it follows a set stock index (such as the S&P 500) rather than allowing policyholders to choose their investments.” FINRA says IUL “is generally not considered a security.”

The New York State Department of Financial Services (DFS) describes how universal life works:

1. Premiums go in. “The company credits your premiums to the cash value account.”
2. Charges come out. “Periodically the company deducts from the cash value account its expenses and the cost of insurance protection.”
3. Interest is credited. “The balance of the cash value account accumulates at the interest credited.” The NAIC says interest in an IUL is “tied to external investment indexes.”

Writing about permanent life insurance, TDI says “It takes a policy years to build a cash value.” The NAIC Buyer’s Guide says “In some cash value policies, the values are low in the early years but build later on.”

Variable universal life is a different product; FINRA says it is considered a security. This guide doesn’t cover it.

Can you borrow from an IUL?

Universal life policies can allow it. The NAIC says that with universal life insurance, “Loans may be taken against the cash value.”

Washington’s Office of the Insurance Commissioner (OIC), writing about cash value life insurance, says:

• “You may borrow against a policy’s cash value by taking out a loan.”
• “If you don’t pay back the loan and the interest on it, the company will subtract the amount you owe from the benefits when you die.”
• “If you cancel the policy, the company will also subtract the loan balance from the cash value you receive.”

Before you borrow, ask the agent what the loan interest rate is, whether it’s fixed or variable, and how unpaid interest is handled. Also ask how a loan affects indexed crediting: does the borrowed amount still earn index-linked interest, or is it treated differently?

How do IUL withdrawals and partial surrenders work?

TDI lists withdrawing and borrowing as separate ways to use cash value. Writing about permanent life insurance, TDI says:

• “You can withdraw from, invest, or borrow against these savings.”
• “You might have to pay a surrender fee if you withdraw the money early.”
• “If you withdraw the entire cash value, the company might cancel your policy.”
• “If that happens, the coverage will end, and it could affect your taxes.”

For universal life, DFS says “If you surrender a universal life policy you may receive less than the cash value account because of surrender charges.” Ask how a partial withdrawal would change the death benefit. For more on these charges, see IUL fees and costs.

How do loans reduce the death benefit?

The Maryland Insurance Administration, writing about permanent life insurance, says “any loans (including interest) taken out against the policy that you have not repaid will be subtracted from the death benefit.” It adds: “The result is that your beneficiary could wind up with less than the face amount of the policy.”

Can a policy loan make an IUL lapse?

Regulators describe the pieces. Writing about permanent life insurance, Maryland says “If you take out the cash value, there may not be enough to pay premiums.” For universal life, TDI says “If your premiums are lower than the cost of insurance, the difference is taken from the cash value,” and “If the cash value reaches zero, your policy could lapse.”

Washington OIC says of universal life: “if your premiums and interest earnings are less than the cost of insurance, your account will decrease. If your account keeps dropping, your coverage will end.”

To keep track, TDI says “The company will send you a report each year showing your cash value and how long the policy might last.” Wisconsin’s Office of the Commissioner of Insurance (OCI) says the report “will also provide notice if the cash value is insufficient to fund the policy until the next reporting period,” and that if the annual report doesn’t include an illustration, policyholders can request, free of charge, “an updated ‘in-force illustration’ once a year.”

What are the tax issues, including a MEC?

This guide doesn’t give tax advice. Regulators and the statute say:

• Cash value growth. TDI says “The cash value of a life insurance policy is tax-deferred.”
• Withdrawals. TDI says “Withdrawals from the cash value are usually nontaxable until the cash value exceeds the total premiums paid into the policy,” and, writing about permanent life insurance, “if you withdraw more money than you paid in premiums, you’ll probably have to pay taxes on it.”
• Modified endowment contracts (MECs). Under 26 U.S.C. 7702A, a “modified endowment contract” is defined “For purposes of section 72,” the section of the tax code titled “Annuities; certain proceeds of endowment and life insurance contracts.” The statute covers a contract “entered into on or after June 21, 1988” that “fails to meet the 7-pay test.” A contract fails that test if “the accumulated amount paid under the contract” in its first seven years “exceeds the sum of the net level premiums” that would have been paid if the contract “provided for paid-up future benefits after the payment of 7 level annual premiums.”

Ask a tax professional whether a policy is or could become a MEC, and how loans, withdrawals, a surrender or a lapse would be taxed in your situation. See also what a max-funded IUL is.

Is an IUL life insurance with living benefits and cash value?

Writing about permanent (whole life) insurance, DFS says “It is the cash value of the policy that can be accessed while the policyholder is alive.”

Some policies also offer an accelerated death benefit. TDI says an “Accelerated death benefit option prepays some or all of the death benefit while you’re still living.” TDI also says “You can usually add features or other coverages to your policy so it better suits your needs.” Ask the agent whether a specific IUL includes an accelerated benefit, what it costs and what conditions you’d have to meet.

What to ask before you borrow or withdraw

The NAIC says the basic illustration “shows both guaranteed and non-guaranteed elements,” and, using a universal life illustration as an example, that the non-guaranteed elements are “current death benefits, current fund accumulation, and the cash value and premiums related to the current benefits.” Ask to see a loan run through both.

The bottom line

IUL cash value is the account inside the policy, and regulators say universal life cash value can be withdrawn from or borrowed against. Maryland says unrepaid loans and interest on permanent life insurance are subtracted from the death benefit, and if the cash value reaches zero, TDI says the policy could lapse. Ask a tax professional about tax treatment, including whether a policy is a modified endowment contract under 26 U.S.C. 7702A, before you borrow or withdraw.

A licensed agent can go over options with you. The licensed agents who work with us offer IUL policies: call (888) 603-7464 to compare options and get a quote, with no obligation. Here’s how calling RestAssured works.

RestAssured is not an insurance company or an insurance agency; we connect callers with independently licensed insurance agents. RestAssured doesn’t give tax or investment advice.

Frequently asked questions

Can you borrow from an IUL?

The NAIC says that with universal life insurance, “Loans may be taken against the cash value,” and FINRA says indexed universal life falls under the universal life umbrella. Ask the agent how much you could borrow, the loan interest rate and how the loan would affect the policy.

What happens if I don't pay back an IUL loan?

Washington’s insurance regulator says that if you don’t pay back a cash value policy loan and its interest, the company will subtract what you owe from the benefits when you die. Maryland’s regulator, writing about permanent life insurance, says the result is that your beneficiary could wind up with less than the face amount.

Can an IUL loan cause the policy to lapse?

Regulators describe the pieces. Maryland’s insurance regulator says that with permanent life insurance, if you take out the cash value, there may not be enough to pay premiums. TDI says that if universal life premiums are lower than the cost of insurance, the difference is taken from the cash value, and if the cash value reaches zero, your policy could lapse.

Is money from an IUL tax-free?

Don’t assume it is. TDI says withdrawals from cash value are usually nontaxable until the cash value exceeds the total premiums paid, and, writing about permanent life insurance, that if you withdraw the entire cash value the company might cancel your policy, which could affect your taxes. Tax rules, including the modified endowment contract rules in 26 U.S.C. 7702A, are complex, so ask a tax professional.

What is the difference between an IUL withdrawal and a loan?

A withdrawal takes money out of the cash value, and TDI, writing about permanent life insurance, says you might have to pay a surrender fee if you withdraw the money early. A loan uses the cash value as the basis for borrowing, with interest, and unrepaid loans reduce the death benefit, according to Washington’s insurance regulator and, writing about permanent life insurance, Maryland’s.

Sources

• Life insurance guide, Texas Department of Insurance
• Insurance (life insurance types), FINRA
• Life insurance (insurance topics), National Association of Insurance Commissioners
• Types of life insurance policies, New York State Department of Financial Services
• A consumer's guide to life insurance, Washington State Office of the Insurance Commissioner
• Life Insurance, Maryland Insurance Administration
• Consumer Alert related to Universal Life Insurance, Wisconsin Office of the Commissioner of Insurance
• Life insurance illustrations, National Association of Insurance Commissioners
• Life Insurance Buyer's Guide, National Association of Insurance Commissioners
• 26 U.S. Code 7702A, Modified endowment contract defined, Legal Information Institute
• 26 U.S. Code 72, Annuities; certain proceeds of endowment and life insurance contracts, Legal Information Institute

This article is for general education. Policy features, prices and eligibility vary by insurance company and state; your agent will explain the specific terms of any policy before you apply.