Matching Indexed Participating Loans vs. Traditional IUL Loans: Why the Difference Can Matter in Retirement

Most people hear the words “IUL policy loan” and assume every policy loan works basically the same way.

You build cash value. You borrow against it. The insurance company charges interest. Eventually the loan gets repaid or reduces what your beneficiaries receive.

That’s the basic picture.

But it leaves out something that can dramatically change the retirement-income math:

What happens to the borrowed money after the loan is created?

If you borrow $30,000 against an IUL and use it to buy a boat, you’ve created a $30,000 policy loan and removed that $30,000 from the strategy.

But what if that $30,000 is immediately redeployed back into the policy?

Now you still have the policy loan and its associated cost, but you also have additional loan-funded dollars participating in the policy’s indexed-crediting strategy.

That’s the concept behind the Matching Indexed Participating Loan used in our IUL JUMP Strategy.

And it’s one of the biggest reasons I tell people:

Don’t compare two IULs by looking at their cash values alone.

How you access and use those values can completely change the retirement-income calculation.

What Is a Matching Indexed Participating Loan?

A Matching Indexed Participating Loan is a policy-loan mechanism used as part of the IUL JUMP Strategy.

The simplest explanation is this:

The strategy borrows against the policy and redeploys the loan proceeds back into the same policy as additional funding.

The borrowed money isn’t being handed to the client to spend.

It’s being put back to work inside the policy.

That distinction is critical.

The loan itself is real. The loan charge is real. The outstanding loan balance accumulates.

This isn’t free money from an insurance company.

But because the loan-funded dollars are redeployed into the policy, they have the same potential to receive indexed crediting under the applicable indexed strategy as the client’s original funded dollars.

That’s where the possibility of positive arbitrage enters the picture.

Think of the Strategy as Two Buckets

This is probably the easiest way to understand what is happening.

Bucket One is your money.

Those are the dollars you’ve contributed out of pocket.

Bucket Two is the Matching Indexed Participating Loan money.

Those are borrowed dollars that have been redeployed into the policy rather than taken out and spent.

Under the indexed strategy we’re discussing, both buckets have the same indexed-crediting potential, subject to the applicable 10% cap and 0% indexed-crediting floor.

But there is a major difference between them.

Bucket Two carries the cost of the policy loan.

With the policy structure we currently use for the IUL JUMP Strategy, the applicable loan rate is currently 5%, with a contractual maximum loan rate of 6% for the applicable loan feature.

The current 5% rate is not a guarantee that the loan rate will remain 5% indefinitely.

That’s why any serious analysis should also test the strategy using the contractual maximum loan rate.

The Loan Cost Is Separate From the Indexed Crediting

This is an easy part of the strategy to misunderstand.

If the indexed-crediting result is 6.87% and the loan rate is 5%, that doesn’t mean the insurance company simply takes 5% out of the indexed account and credits the client 1.87%.

The indexed-crediting calculation and the policy-loan charge are separate mechanics.

The loan-funded dollars can participate in the applicable indexed-crediting strategy while the corresponding outstanding policy loan carries its own loan charge.

So when we talk about a 1.87% positive arbitrage in one of our historical examples, we’re talking about the modeled economic spread between those two numbers.

That’s an important distinction.

Where Does the 6.87% Historical Example Come From?

I don’t want someone to see 6.87% in an illustration and assume we just picked a number that made the strategy look good.

Here’s how the historical example we’re using was calculated.

The analysis looked at annual S&P 500 price changes from 2006 through 2020.

Dividends were not included.

That’s because the policy isn’t directly invested in the S&P 500. The client doesn’t own the stocks in the index and doesn’t receive their dividends through the policy.

Instead, the S&P 500 serves as the external index used in the policy’s indexed-crediting calculation.

For this historical analysis:

• Negative annual index changes were treated as 0% for the indexed-crediting calculation.
• Positive annual index changes up to 10% were subject to the applicable crediting formula.
• Annual positive changes above 10% were limited to the 10% cap used in the example.
• Dividends were excluded.

Applying that framework to the historical period analyzed produced a 6.87% historical average indexed-crediting result.

That does not mean the S&P 500 historically returned 6.87%.

It does not mean the policy owns the S&P 500.

And it certainly doesn’t mean the policy is guaranteed to earn 6.87% going forward.

It is a historical indexed-crediting calculation based on the specific period and assumptions being analyzed.

How Does Positive Arbitrage Work?

Now we can put the two pieces together.

In the historical example:

Historical average indexed-crediting result: 6.87%

Current applicable loan rate: 5.00%

Modeled positive spread: 1.87 percentage points

That’s the basic positive-arbitrage concept.

The Matching Indexed Participating Loan creates borrowed capital. Instead of spending that borrowed capital, the strategy redeploys it into the policy, where it has the same indexed-crediting potential under the applicable indexed strategy.

If indexed crediting exceeds the cost of the loan, that creates positive economic spread on the borrowed-and-redeployed dollars.

But there’s another side to this.

What Happens If the Index Doesn’t Credit More Than the Loan Costs?

This is the question that needs to be asked before someone gets excited about positive arbitrage.

Suppose the applicable indexed-crediting calculation produces 0% for a period.

The 0% indexed-crediting floor may prevent a negative index-crediting rate under the applicable strategy.

But the policy loan still has a cost.

If the loan is costing 5% while the applicable indexed account receives 0% crediting, you don’t have positive arbitrage for that period.

You have unfavorable loan economics.

That’s why saying, “We borrow at 5% and make 6.87%” is too simplistic.

Some periods may produce more crediting.

Some may produce less.

And the loan cost doesn’t disappear simply because the index had a bad year.

This strategy needs to be evaluated across multiple years and under less favorable assumptions.

Why Doesn’t the Client Just Pay the Matching Loan Back?

Because immediate repayment isn’t the objective of the JUMP structure.

Under the strategy we’re discussing, the Matching Indexed Participating Loan is designed to remain outstanding while the borrowed proceeds are redeployed into the policy.

The strategy generally does not plan on requiring the client to pay the applicable JUMP loan charges out of pocket every year as they accrue.

Instead, the strategy is modeled with the applicable loan charges carried forward.

The outstanding loans therefore accumulate.

That’s intentional.

But intentional doesn’t mean risk-free.

The growing loan balance needs to be monitored against cash value, policy performance, future retirement distributions and the death benefit.

What Happens When Another Matching Loan Is Created?

The old loan doesn’t disappear.

It isn’t paid off by the new loan.

The new loan is added to the strategy.

Let’s say a client has reached the point where the strategy creates a $10,000 Matching Indexed Participating Loan.

That loan remains outstanding according to the policy’s loan provisions.

Later, after another successful JUMP, the matching-loan amount might increase to $20,000.

That new loan doesn’t wipe out the previous borrowing.

The policy loans accumulate.

And the new loan proceeds are again redeployed into the policy.

That’s why understanding the accumulating loan balance is every bit as important as looking at the additional policy funding.

How Does the Matching Loan Grow?

Here’s a simplified example using a client who contributes $10,000 per year.

Look at Year 11.

The client isn’t contributing $60,000 out of pocket.

The client is still contributing $10,000 in this example.

The additional $50,000 shown comes from the Matching Indexed Participating Loan structure.

So the question shouldn’t be:

“How did my $10,000 magically become $60,000?”

It didn’t.

The better question is:

“How much of the $60,000 came from me, how much came from policy loans, what do those loans cost, and what happens to the loan balance over time?”

Now we’re asking the right questions.

Why Are Death-Benefit JUMPs Necessary?

The matching-loan progression isn’t something you can necessarily continue indefinitely inside the original policy design without considering life insurance funding and tax rules.

That’s where the JUMP itself comes in.

At planned JUMP points, the strategy seeks an increase in death benefit designed to provide the additional policy funding capacity needed while maintaining the intended non-MEC structure.

A Modified Endowment Contract, or MEC, receives different tax treatment for distributions and policy loans.

So keeping the policy within the intended non-MEC structure matters when the strategy is being designed for future access to policy values.

But increasing the death benefit isn’t just an administrative change.

The insured has to qualify for it.

You Have to Qualify for Future JUMPs

This is one of the most important limitations of the strategy.

Future JUMPs aren’t automatically guaranteed when the original policy is issued.

When an additional death-benefit increase is required, a new application for that increase must be approved by the insurance company.

Underwriting can include factors such as:

• Health
• Income
• Employment
• Financial justification for the requested death benefit
• Driving history
• Occupation
• Hazardous work activities
• Risky hobbies or extracurricular activities
• Other carrier underwriting requirements

That means someone could successfully complete several JUMPs and then fail to qualify for the next one.

Maybe they have a heart attack.

Maybe their employment situation changes.

Maybe their income drops enough that the carrier won’t financially justify the additional amount of life insurance being requested.

The strategy has to account for that possibility.

What If You Don’t Qualify for the Next Matching-Loan Increase?

This is where the structure gets interesting.

Under the JUMP mechanics we’re describing, failing to qualify for the next increase does not automatically erase the matching-loan level you’ve already reached.

Suppose you’re contributing $10,000 annually and have successfully reached a $30,000 annual Matching Indexed Participating Loan level.

That means the simplified strategy is showing:

$10,000 from you + $30,000 matching loan = $40,000 of annual policy funding.

Now imagine you apply for the next JUMP that would allow the matching loan to advance to $40,000, but you aren’t approved.

Under the structure we’re discussing, you can remain at the previously established $30,000 matching-loan level rather than automatically falling all the way back to zero.

You may then have the opportunity to apply again at a future policy anniversary.

So a failed JUMP can potentially pause the progression rather than reset the entire strategy, subject to the actual policy contract, carrier rules and future approval.

That’s a meaningful distinction.

But it’s still a risk because the future projections may have assumed that additional JUMPs would occur.

If they don’t, the eventual result can be different.

Why Is This Different From Taking a Normal Policy Loan to Spend?

Let’s go back to the boat example.

You have $30,000 available through a policy loan.

Scenario one:

You borrow the $30,000 and spend it.

The loan and its associated cost remain, but those borrowed dollars are no longer being redeployed into the policy as part of the strategy.

Scenario two:

The $30,000 is created through the Matching Indexed Participating Loan structure and redeployed into the policy.

Now the policy still has the outstanding loan and associated loan cost, but the borrowed proceeds are also participating in the applicable indexed-crediting strategy.

That’s the economic distinction.

It does not make the loan free.

It doesn’t eliminate loan interest.

And it doesn’t guarantee positive arbitrage.

But it explains why the JUMP loan is being used differently from a policy loan taken for personal spending.

How Can the JUMPs Change the Modeled Effective Result?

Now we can return to the historical example.

The indexed-crediting analysis we’ve discussed produced a historical average of 6.87% using the 2006 through 2020 period, a 10% cap, a 0% indexed-crediting floor and no dividends.

Against the current 5% loan rate, the modeled spread is 1.87 percentage points.

As successive JUMPs add additional borrowed-and-redeployed capital, the historical JUMP analysis illustrates the modeled effective result increasing:

• Year 3 JUMP: approximately 8.74%
• Year 5 JUMP: approximately 11.61%
• Year 7 JUMP: approximately 14.48%
• Year 9 JUMP: approximately 17.35%

Do not read that list and conclude:

“This IUL earns 17.35%.”

That’s not what those numbers mean.

The policy’s indexed account isn’t suddenly being credited 17.35%.

The figures represent a modeled effective result attributed to the JUMP structure under the assumptions used in the historical analysis, including the effect of successive Matching Indexed Participating Loans and the modeled positive spread.

Policy charges, cost of insurance, loan costs and other contractual expenses still have to be accounted for.

Future indexed-crediting results could also be materially different from the historical period being analyzed.

Why Can This Potentially Produce More Retirement Income Than a Traditional IUL?

This is where the loan mechanics can become more important than simply comparing two accumulation values.

We’ve evaluated certain modeled comparisons in which the JUMP structure produced approximately 40% more projected retirement income than the traditional IUL structure being compared.

That doesn’t mean JUMP automatically beats every traditional IUL by 40%.

The result is affected by policy design, funding, insurance costs, loan mechanics, crediting assumptions, retirement distributions, loan rates, longevity and other assumptions.

But it demonstrates why two IULs with similar-looking accumulation assumptions can potentially produce very different retirement-income projections.

The loan strategy matters.

What About the Up to 300% More Retirement Income Comparison?

We’ve also evaluated certain modeled comparisons where the IUL JUMP Strategy produced up to approximately 300% more projected retirement income than the 401(k), Traditional IRA or comparable tax-deferred retirement strategy being evaluated.

Again, that’s projected retirement income.

Not 300% more investment return.

And it’s not a promise that everybody who uses JUMP will receive three times the retirement income.

The modeled difference can come from several places working together:

• Additional borrowed-and-redeployed policy funding
• Successful future JUMPs
• Potential positive arbitrage
• Indexed-crediting results
• Policy-loan mechanics
• Tax treatment of the strategies being compared
• Market and sequence-of-returns exposure
• Retirement distribution design
• Policy costs
• Loan costs
• Longevity assumptions

If somebody shows you a 300% number without showing you those assumptions, you’re missing the most important part of the analysis.

The 300% isn’t the sales pitch. It’s the question.

Where did the difference come from?

What Happens to All These Loans in Retirement?

This is where a strategy that looked fantastic during accumulation can get into trouble if it wasn’t designed properly.

The loans don’t disappear when you retire.

The accumulated indebtedness still matters.

Then you may begin accessing additional policy values for retirement.

Policy values from a properly structured and maintained non-MEC life insurance policy may potentially be accessed through withdrawals to basis and policy loans without current income taxation under current federal tax rules.

But policy loans aren’t free withdrawals.

They accrue interest.

Outstanding indebtedness reduces available policy values and can reduce the net death benefit.

Too much borrowing can increase lapse risk.

And if a policy with gain and outstanding indebtedness lapses or is surrendered, taxable income can potentially result.

That’s why the retirement distribution plan has to be modeled along with the accumulation plan.

What Happens to the Outstanding Loans at Death?

Outstanding policy loans generally reduce the net amount payable under the policy according to the contract.

In favorable modeled scenarios, policy values and remaining death-benefit protection may be sufficient to account for the outstanding indebtedness while still leaving meaningful value for beneficiaries.

But that isn’t something I would promise in advance.

The eventual result is affected by actual policy performance, loan balances, distributions, charges and longevity.

Life insurance death benefits are generally received income-tax-free under current federal law, subject to applicable exceptions and individual circumstances.

What Should You Ask Before Using a Participating Loan Strategy?

If somebody shows you an IUL illustration using a participating-loan strategy, don’t start with:

“How much retirement income does it show?”

Start with:

“Show me how the loans work.”

Then keep going.

What’s my actual out-of-pocket contribution?

How much additional funding is coming from policy loans?

Where do those borrowed dollars go?

Do they continue participating in the indexed strategy?

What’s the current loan rate?

What’s the contractual maximum loan rate?

What happens if indexed crediting is 0%?

What happens if the loan rate increases?

How large does the accumulated loan balance become?

What happens if I don’t qualify for a future JUMP?

What happens if the policy performs below the illustrated assumptions?

What happens if I live longer than projected?

What happens if I take more retirement income than originally modeled?

What’s left for my family after the outstanding loans are accounted for?

Those questions tell you far more than one illustrated retirement-income number ever will.

The Real Risk Is Believing the Illustration Without Understanding the Engine

Most people considering this strategy aren’t insurance experts.

They shouldn’t have to be.

But if you’re approaching retirement, you also don’t want to wake up ten years from now thinking:

“I didn’t realize that’s how the loans worked.”

Or:

“What if we mess this up and regret it?”

For many people in their late 50s and 60s, there’s something deeper underneath that fear.

“We should be able to handle this ourselves.”

And maybe:

“I don’t want to ask my kids for help.”

That’s why the answer isn’t to hide the complicated parts.

It’s to put them on the table before you make the decision.

Make the Loan Strategy Prove Itself

At FPP Financial, we use our Retirement Math Method™ to look beyond the headline numbers.

If we’re evaluating the IUL JUMP Strategy, I want to see the entire mechanism.

Show me Bucket One.

Show me Bucket Two.

Show me the client’s actual contribution.

Show me every Matching Indexed Participating Loan.

Show me the accumulating loan balance.

Show me the loan charges.

Show me the indexed-crediting assumptions.

Show me what happens when positive arbitrage occurs.

Then show me what happens when it doesn’t.

Show me the policy costs.

Show me the future JUMPs.

Show me what happens if one isn’t approved.

Show me the retirement distributions.

Show me the projected policy values later in life.

Then compare those numbers with the 401(k), IRA or traditional IUL strategy you’re considering instead.

I don’t try to sell you on the strategy. I make the strategy prove itself with the math.

Want to See How the Matching Indexed Participating Loan Works With Your Numbers?

You don’t have to decide whether this strategy makes sense based on a hypothetical $10,000 example.

We can model it using your actual retirement situation.

We’ll look at what you’re currently saving, what you’ve already accumulated, your retirement timeline, the strategy you’re using now and the assumptions behind the alternatives.

Then we can examine where the projected retirement income is actually coming from.

No mystery.

No “just trust the illustration.”

Let the math do the talking.

Schedule Your Tax-Free Retirement Strategy Meeting

Explore More

• What Is the IUL JUMP Strategy and How Does It Work?
• What Happens If IUL Loan Rates Go Up in Retirement?
• What Happens If You Borrow Too Much From an IUL?

Disclosure

This material is for educational purposes only and is not intended as individualized investment, tax, legal or insurance advice. Indexed universal life insurance is a long-term life insurance product with policy charges, cost of insurance, surrender considerations, underwriting requirements and other contractual provisions. Policy loans and withdrawals reduce available cash value and death benefits and may increase the risk of policy lapse. A lapse or surrender of a policy with outstanding loans may create taxable income. Modified Endowment Contracts are subject to different tax rules.

Matching Indexed Participating Loans are policy loans, not free contributions, bonuses, guaranteed gains or direct investments in a market index. References to indexed crediting, historical results, positive arbitrage, modeled effective results, projected retirement income, the 6.87% historical example, the current 5% loan rate, the contractual maximum loan rate, approximately 40% more projected retirement income, or up to approximately 300% more projected retirement income are illustrative and are not guarantees of future performance or results.

The historical 6.87% indexed-crediting example described in this article is based on the historical analysis discussed for the 2006 through 2020 period using annual S&P 500 price changes, excluding dividends, and applying the stated 10% cap and 0% indexed-crediting floor. Historical results do not predict future policy crediting or performance. Actual indexed-crediting results are governed by the applicable policy terms and may be affected by caps, participation rates, spreads, crediting methods and other contractual provisions.

The S&P 500 is an external market index. An indexed universal life policy does not directly invest in the S&P 500, does not own the underlying stocks and does not receive index dividends. A 0% indexed-crediting floor does not guarantee that overall policy value cannot decline because policy charges, cost of insurance, loan costs and other policy mechanics continue to apply.

Future JUMPs and death-benefit increases are subject to carrier approval and applicable medical, financial and other underwriting requirements. A projected JUMP schedule should not be interpreted as a guarantee that every future increase will be approved. Policy-specific loan provisions, loan rates, guarantees, nonguaranteed elements, charges, death-benefit provisions and other terms should be verified against the current carrier-approved illustration and actual insurance contract.

Tax treatment varies with individual circumstances and policy status. Consult qualified tax and legal professionals regarding your individual situation.