What Happens to Your IUL Policy Loans When You Die?

You’ve spent 25 years using an indexed universal life policy as part of your retirement strategy.

You’ve borrowed against the policy for retirement income.

Maybe there are also Matching Indexed Participating Loans associated with an IUL JUMP Strategy.

Now there’s a substantial loan balance.

So what happens when you die?

Does your spouse inherit the debt?

Do your children get a bill?

Does the insurance company forgive the loan?

Does your family still receive the entire death benefit?

This is something I want people to understand before they start borrowing against a life insurance policy.

The short version is this:

Outstanding policy indebtedness generally reduces the net death benefit paid to your beneficiaries under the terms of the policy.

That doesn’t automatically make policy loans bad.

But it means you can’t evaluate an IUL retirement strategy by looking only at how much money you can potentially access while you’re alive.

You also need to look at what remains when you’re gone.

Policy Loans Are Real Loans

This sounds obvious, but it’s one of the most important points.

When you borrow against an IUL, the loan isn’t imaginary.

It’s not simply an accounting trick that disappears later.

There is policy indebtedness associated with the loan.

The loan has contractual terms.

It can have interest charges.

And if the loan remains outstanding when the insured dies, that indebtedness is generally accounted for when the death claim is paid.

Does Your Family Have to Write a Check to Pay Off the IUL Loan?

Under the usual policy-loan structure, the outstanding policy indebtedness is generally settled through the policy’s death-benefit calculation rather than your beneficiaries being asked to personally repay the policy loan from their own bank accounts.

The exact claim calculation is governed by the actual insurance contract.

That’s why I prefer thinking in terms of:

Gross death benefit

versus:

Net death benefit.

The number that matters to your family is what they actually receive.

A Simple Example

Suppose that when you die, the applicable policy death benefit is $1,000,000.

Now suppose there is $300,000 of outstanding policy indebtedness.

A simplified way to understand the concept is:

$1,000,000 death benefit

minus

$300,000 outstanding policy indebtedness

equals

$700,000 net amount before considering any other applicable contractual adjustments.

That example is intentionally simplified.

The actual death claim is determined by the policy contract and the values in force at the time of death.

But it shows the basic point.

The loan doesn’t have to become your children’s personal debt for it to matter to them.

It can matter because it reduces what they receive.

So Do You Have to Repay an IUL Loan While You’re Alive?

Policy loans generally don’t work like a car loan with a traditional fixed monthly repayment schedule.

The actual policy may provide flexibility regarding repayment.

But:

“You aren’t required to make a traditional monthly payment”

is not the same thing as:

“The loan doesn’t matter.”

It matters.

The loan can accrue charges.

It affects policy values.

It can reduce the net death benefit.

And excessive indebtedness can contribute to policy instability and lapse risk.

Why Do People Use Policy Loans for Retirement Then?

Because a properly structured life insurance policy can offer a different way to access accumulated policy value.

With a properly structured and maintained non-MEC policy, policy loans generally may be taken without being treated as current taxable income under current federal tax rules, subject to the policy remaining in force and other applicable requirements.

That’s one of the reasons IUL is discussed as a potential retirement-income tool.

But I don’t like the phrase:

“Tax-free retirement income.”

Not without explaining what has to remain true.

The policy has to be structured correctly.

MEC status matters.

The policy needs to remain in force.

The loans need to be managed.

And the eventual net death benefit may be affected by outstanding indebtedness.

There Are Two Very Different Reasons You Might Have an IUL Loan

This distinction becomes especially important with the IUL JUMP Strategy.

You might have a policy loan because you took money out of the policy to spend.

Or you might have a policy loan because the borrowed dollars were redeployed back into the policy.

Those aren’t economically identical situations.

Example One: You Borrow $50,000 and Buy a Boat

Suppose you borrow $50,000 against the policy.

You take the $50,000 outside the policy.

You buy a boat.

Those borrowed dollars are no longer inside the policy working under the applicable indexed-crediting strategy.

You still have the policy indebtedness.

But the $50,000 itself is now sitting in your driveway or at the marina.

That’s a consumption loan.

Example Two: A Matching Indexed Participating Loan

The JUMP strategy uses a different concept.

A Matching Indexed Participating Loan is also an actual policy loan.

But instead of taking the proceeds outside the policy and spending them, the proceeds are redeployed into the same policy as additional funding.

That gives us two conceptual buckets:

Bucket One: client-funded dollars.

Bucket Two: borrowed-and-redeployed Matching Indexed Participating Loan dollars.

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 Bucket Two carries the applicable loan cost.

Here’s the Simplified JUMP Funding Example

Suppose the client contributes $10,000 per year.

By Year 11 in this simplified example:

$10,000 comes from the client.

And:

$50,000 comes from the Matching Indexed Participating Loan.

Total annual funding shown:

$60,000.

The client didn’t write a $60,000 check.

And the additional $50,000 wasn’t free money.

It was borrowed and redeployed.

The JUMP Loans Accumulate

This matters enormously when we’re talking about death benefits.

When you move from a $10,000 matching-loan level to $20,000 and later $30,000, the later loan activity doesn’t simply erase the previous outstanding loans.

The policy indebtedness accumulates.

That means I don’t want someone showing you only:

“Look how much additional funding is going into the policy.”

I also want:

“Show me the outstanding policy indebtedness.”

Both sides belong in the conversation.

What Does the Matching Indexed Participating Loan Cost?

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 isn’t guaranteed to remain at 5%.

During the JUMP accumulation design, the strategy is modeled with the applicable loan charges carried forward rather than requiring the client to pay those charges out of pocket each year.

That doesn’t mean the charges vanish.

They remain part of the economics that need to be tracked.

Why Would Carrying Those Loans Make Sense?

Because the JUMP loan proceeds are redeployed into the policy.

Under the applicable indexed strategy, those borrowed-and-redeployed dollars retain indexed-crediting potential while the corresponding loan carries its applicable cost.

If the credited result exceeds the loan cost, that can create positive economic spread.

If it doesn’t, the spread can be unfavorable.

That’s the tradeoff.

The 6.87% Historical Indexed-Crediting Example

The historical example we’ve been using examines annual S&P 500 price changes from 2006 through 2020.

Dividends are excluded because the policy isn’t directly invested in the S&P 500 and doesn’t receive the index’s dividends.

The example applies the strategy’s 10% cap and 0% indexed-crediting floor.

Negative annual price changes are treated as 0% for purposes of the indexed-crediting calculation.

Positive annual changes above 10% are limited to the 10% cap used in the example.

Under those assumptions, the historical period produced a 6.87% average indexed-crediting result.

That isn’t the historical return of the S&P 500.

It isn’t a guaranteed policy return.

And it isn’t a forecast.

Then Comes the 1.87% Modeled Positive Spread

Using the historical indexed-crediting example and the current applicable loan rate:

6.87% – 5.00% = 1.87 percentage points of modeled positive spread.

If indexed crediting were 0% while the applicable loan cost were 5%, the economics would move in the opposite direction for that period.

Positive arbitrage isn’t guaranteed.

That’s why I don’t want to see the loan balance at death modeled under only favorable assumptions.

There Are Really Two Loan Phases to Watch

With JUMP, I think it helps to separate the strategy into two phases.

Phase One is accumulation.

Matching Indexed Participating Loan proceeds are being borrowed and redeployed into the policy.

Phase Two is retirement.

Now additional policy loans may be used to provide cash for living expenses.

Those retirement dollars leave the policy because you’re spending them.

By later retirement, the policy may therefore have indebtedness associated with both the accumulation strategy and retirement access.

That’s why the death-benefit calculation matters.

What Happens If You Die Early in Retirement?

Suppose you retire at 65 and die at 70.

You may have taken only a handful of years of retirement distributions.

The policy may still have a substantial net death benefit.

Now compare that with someone who lives to 95 and has used policy values for 30 years.

The amount of outstanding indebtedness can be very different.

That’s why I don’t want one death-benefit number.

I want to see it at multiple ages.

70.

80.

90.

95.

What If You Live Much Longer Than Expected?

This is where retirement-income planning gets difficult.

Living longer is a good thing.

But financially, longevity creates pressure.

You need more years of income.

More years of potential policy loans.

More years of policy charges.

More years of loan costs.

And more years in which actual indexed-crediting results can differ from the illustration.

So when someone shows me a policy designed to provide retirement cash flow, I want to see what happens if the client doesn’t die on schedule.

Can Your IUL Loan Ever Get Too Large?

Yes.

This is why policy monitoring matters.

Policy loans reduce available policy values and generally reduce the net death benefit.

Large amounts of indebtedness can also increase lapse risk.

If the policy approaches a point where the remaining values cannot adequately support its charges and indebtedness, action may be needed.

That could include reducing future distributions, repaying some indebtedness, adding premium if permitted and appropriate, or considering other policy-management options available under the contract.

The correct response comes from the actual policy numbers.

Why Lapse Is Different From Death

This distinction is critical.

If the insured dies while the policy is in force, the death claim is generally processed under the contract, with outstanding indebtedness reflected in the net benefit payable.

If the policy lapses while the insured is still alive, the outcome can be very different.

A policy that lapses or is surrendered with gain and outstanding indebtedness can potentially create taxable income.

And you could have a tax obligation without receiving a new pile of cash at the time of lapse.

That’s why:

“The loan will just come out of the death benefit someday”

isn’t a complete retirement strategy.

The policy has to stay healthy enough to get there.

What About the 0% Floor?

A 0% indexed-crediting floor doesn’t solve the loan problem.

The floor applies to the applicable indexed-crediting calculation.

It doesn’t mean overall policy value cannot decline.

Policy charges still exist.

Cost of insurance still exists.

Loan costs still exist.

If indexed crediting is 0% while the applicable loan rate is 5%, the policy can experience unfavorable loan economics for that period even though the indexed-crediting calculation didn’t go below zero.

Is the Death Benefit Still Generally Income-Tax-Free?

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

But that doesn’t mean beneficiaries automatically receive the original headline death-benefit amount regardless of outstanding policy indebtedness.

That’s why I want to know the:

Projected gross death benefit.

Then:

Projected policy indebtedness.

Then:

Projected net death benefit.

That’s a much clearer legacy conversation.

Should You Try to Leave the Largest Possible Death Benefit?

Not necessarily.

Maybe your number-one goal is maximizing what your children inherit.

Then preserving more net death benefit could be a major priority.

Maybe your children are financially independent and your priority is creating more retirement cash flow for yourself and your spouse.

Then you may intentionally be comfortable using more policy value during your lifetime.

Neither goal is automatically right or wrong.

But you need to know which one you’re solving for.

Retirement Income and Legacy Can Pull in Opposite Directions

This is the emotional part of the decision.

You spent decades saving.

Part of you thinks:

“We saved this money so we could enjoy retirement.”

Then another part of you thinks:

“I still want to leave something meaningful to the kids.”

Those goals can compete.

More lifetime distributions can mean less remaining legacy.

Less lifetime spending can preserve more for heirs.

The right balance isn’t found in a slogan.

It’s found by showing both outcomes.

What Does This Have to Do With the Up-to-300% Retirement-Income Comparison?

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

But I don’t want you looking at that number alone.

If one strategy produces dramatically more projected retirement cash flow, ask:

What happened to the legacy?

How much policy indebtedness existed at death?

What was the projected net death benefit?

What assumptions were used for indexed crediting?

What loan costs were modeled?

How many JUMPs were assumed?

What happened if a JUMP wasn’t approved?

How long did the client live?

What happened in unfavorable crediting periods?

The 300% isn’t the sales pitch.

It’s the question.

Show me exactly where the difference comes from.

What About Approximately 40% More Than a Traditional IUL?

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

Again, that’s not guaranteed and isn’t universal.

And if you’re comparing two IUL designs, don’t stop at retirement income.

Compare:

• Policy values
• Policy charges
• Loan mechanics
• Outstanding indebtedness
• Projected retirement distributions
• Policy durability
• Gross death benefit
• Net death benefit

That’s a real comparison.

What If You Don’t Want the Loans to Reduce Your Legacy So Much?

Then that needs to be part of the design.

Maybe you take less retirement income.

Maybe you monitor and repay some indebtedness when appropriate.

Maybe the policy is funded differently.

Maybe you decide a certain minimum projected net death benefit should be protected throughout retirement.

Maybe you use other retirement assets during certain years rather than automatically borrowing from the policy every year.

The point is that the policy doesn’t need to be managed with one rule for 30 years.

Retirement changes.

The strategy can be reviewed as it does.

The Question I’d Ask Every Year in Retirement

Not:

“How much can I borrow?”

Instead:

“What happens to the policy if I borrow this amount?”

Show me the projected value.

Show me the indebtedness.

Show me the net death benefit.

Show me the policy at 85.

90.

95.

Then make the withdrawal decision.

This Becomes Personal When You’re Thinking About Your Kids

Most people aren’t trying to die with the biggest spreadsheet.

They want to enjoy retirement without creating a mess for the people they love.

You may be thinking:

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

You spent your adult life taking care of yourself.

“We should be able to handle this ourselves.”

And when someone proposes a strategy involving decades of policy loans, there’s another thought sitting underneath the conversation:

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

That’s exactly why I want the death-benefit side of the strategy modeled before retirement begins.

You shouldn’t have to choose between enjoying your money and blindly hoping something is left.

You should be able to see the tradeoff.

How We Evaluate IUL Loans and Legacy at FPP Financial

At FPP Financial, we use our Retirement Math Method™.

If an IUL is being considered for retirement income, I don’t want only the income column.

Show me the client contributions.

Show me the Matching Indexed Participating Loans.

Show me the accumulated policy indebtedness.

Show me the current applicable loan rate.

Then stress-test the contractual maximum.

Show me lower indexed-crediting assumptions.

Show me the retirement distributions.

Then show me the policy at age 70.

80.

90.

95.

Show me the projected gross death benefit.

Show me the projected indebtedness.

Then show me what the beneficiaries are projected to receive after the indebtedness is accounted for.

Now compare that with the retirement-income strategy you’re already using.

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

So, What Happens to IUL Policy Loans When You Die?

Outstanding policy indebtedness generally reduces the net death benefit payable to your beneficiaries under the policy contract.

Your beneficiaries generally aren’t simply handed the full headline death benefit while the insurance company forgets the outstanding loans.

And the loans generally aren’t turned into a personal bill that your children suddenly have to pay from their checking account.

The policy’s death claim accounts for the indebtedness according to the contract.

That’s why policy loans can be useful without being free.

You can potentially use policy value while you’re alive.

But borrowing changes the policy.

And the more you borrow, the more important monitoring becomes.

Don’t look only at:

“How much retirement income can this create?”

Also ask:

“What does the policy look like after I’ve taken that income?”

That’s the number your family eventually lives with.

Want to See Both the Retirement Income and the Legacy?

If you’re considering an IUL for retirement, we can model both sides of the strategy.

We’ll look at your contributions, JUMP progression, Matching Indexed Participating Loans, loan costs, projected retirement distributions, policy durability and projected net death benefit.

Then we’ll compare the results with the retirement strategy you’re already using.

Don’t just believe the income number.

Make the strategy prove what happens while you’re alive and what remains when you’re gone.

Let the math do the talking.

Schedule Your Tax-Free Retirement Strategy Meeting

Explore More

• What Happens If You Borrow Too Much From an IUL?
• Can an IUL Lapse in Retirement?
• What Is a Matching Indexed Participating Loan?

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 are actual policy indebtedness and are subject to the terms of the insurance contract. Outstanding loans and applicable loan charges generally reduce available policy values and the net death benefit payable under the contract. Actual death-claim calculations are determined by the policy terms and values in force at the insured’s death. Policy loans may also increase lapse risk.

Matching Indexed Participating Loans are policy loans, not free contributions, bonuses, guaranteed gains or direct investments in a market index. The JUMP strategy is modeled with applicable loan charges carried forward during the accumulation design rather than requiring the client to pay those charges out of pocket each year. This does not eliminate the economic cost of borrowing or guarantee that policy values will be sufficient to support future indebtedness.

Policy values from a properly structured and maintained non-MEC policy may potentially be accessed through withdrawals to basis and policy loans without current income taxation under current federal rules, subject to applicable requirements. A policy that lapses or is surrendered with gain and outstanding indebtedness may create taxable income. Modified Endowment Contracts are subject to different tax rules. Life insurance death benefits are generally received income-tax-free under current federal law, subject to applicable exceptions.

References to the $10,000 annual contribution example, JUMP progression, 6.87% historical indexed-crediting example, 1.87 percentage-point modeled positive spread, current 5% loan rate, 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 policy performance, positive arbitrage, policy durability, funding capacity, net death benefit or retirement income.

The historical 6.87% indexed-crediting example described in this article is based on the historical analysis discussed for 2006 through 2020 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 performance. 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. Policy charges, cost of insurance, loan costs and other policy mechanics continue to apply. Positive arbitrage is not guaranteed, and periods in which indexed crediting is below the applicable loan cost can produce unfavorable loan economics.

Future JUMPs and death-benefit increases are subject to carrier approval and applicable medical, financial and other underwriting requirements. Future JUMP approval is not guaranteed, and failure to complete a planned JUMP may materially change projected policy values, indebtedness, death benefits and retirement-income results.

Policy-specific loan provisions, loan rates, guarantees, nonguaranteed elements, caps, participation rates, spreads, crediting methods, policy expenses, MEC testing, lapse provisions, death-benefit provisions and other contractual terms should be verified against the current carrier-approved illustration and actual insurance contract. FPP Financial does not provide tax or legal advice. Consult qualified tax and legal professionals regarding your individual circumstances.