How to Take a Loan From an Indexed Universal Life Policy (Without Wrecking It)

One of the biggest advantages of an indexed universal life (IUL) policy is that its cash value is not locked away until death. Handled correctly, you can borrow from your own policy — tax-free — and keep the death benefit for your family. Handled carelessly, a policy loan can quietly hollow out the coverage you paid for. Here is how to do it right.

How a Policy Loan Actually Works

When you borrow from an IUL, you are not withdrawing your cash value — you are borrowing from the insurance company and using your policy as collateral. Your cash value keeps earning indexed interest the whole time. In most modern policies, the insurer simply charges loan interest (commonly 4–6% annually) against your loan balance instead of requiring payments from you.

Because loan proceeds are not income, you pay no income tax when you take the loan — even years after the policy has grown. This is the tax treatment that makes IULs attractive for supplemental retirement income.

The Two Types of Loans

• Standard loan: the insurer charges loan interest (say 5%), and your cash value continues earning the full indexed credit. In rising markets, you may net a positive spread.
• Wash or Participating loan: the loan interest rate is matched to the rate credited on the borrowed portion, so the loan effectively costs you nothing — a favorite feature for policyholders taking regular income.

Four Rules for Borrowing Safely

1. Never borrow more than about 70–80% of your cash value. Going past the collateral limit can make the policy lapse with a large taxable gain — the worst possible outcome, and it can happen with a single unnoticed letter.
2. Have a repayment plan for income use. Loans used for occasional needs can sit unpaid; loans meant to replace paycheck income usually need deposits back into the policy to stay healthy.
3. Watch the policy every year. Ask your advisor for an in-force illustration showing how long the policy lasts with your current loan. A healthy policy can run decades; an ignored one can lapse in 8–10 years.
4. Know the death-benefit trade-off. Any unpaid loan plus interest is deducted from what your beneficiaries receive. Some policies let you pay loan interest only, keeping the death benefit largely intact.

A Realistic Example

Suppose your IUL has $120,000 of cash value and a $400,000 death benefit. You take a $40,000 wash loan at 65 to supplement Social Security. Your cash value keeps growing on the remaining $80,000, you owe no tax, and as long as the policy stays within collateral limits, your family still receives roughly $360,000-plus — rather than the loan being taxed as income first, as it might be if you surrendered the policy outright.

When a Policy Loan Makes Sense — and When It Does Not

Loans shine for supplemental retirement income, emergency funds, or education costs, especially when you want tax-free access without disturbing other investments. They are a poor fit if you cannot monitor the policy, if the loan would exceed safe collateral levels, or if you need the full death benefit untouched for a specific estate goal.

Considering a policy loan, or wondering whether an IUL fits your retirement plan? Buckalew Financial Services reviews policy loans and in-force illustrations for Florida residents every week. Call 813-863-5917 before you sign anything — an hour of review is cheap insurance against a lapsed policy.