Policy loan

A policy loan is the usual way to draw cash from a funded indexed universal life (IUL) policy while it stays in force. The insurer that issued the policy is the lender and the policy is the security, so it is separate and different from a Lombard loan, a loan from a bank secured against assets pledged to it.

How it works

The policyholder can borrow up to a maximum set in the policy, a share of the cash surrender value. Some insurers lend from year one, others from year two.

• Interest. Charged at the policy's loan rate, and paid each year or added to the loan.
• Loan type. A fixed loan moves the loaned amount into a loan account credited at a set rate. A participating loan leaves it in the index account.
• Repayment. Any amount, at any time. Paying the interest, or part of the loan, keeps the balance and the interest on it lower.
• Death benefit. Any loan and interest outstanding at death are deducted from the death benefit. Repaying the loan restores it in full.
• Surrender charges. These apply to withdrawals, so a loan is the usual route to cash in the surrender charge period.

The loan and interest must stay within the cash surrender value. Unpaid interest compounds while the cost of insurance rises with age. If the loan reaches the cash surrender value and no payment arrives within the grace period, the policy lapses, and in some jurisdictions a lapse with a loan outstanding creates a tax charge on the gain.

Direct and non-direct recognition. These terms come from participating whole life, where direct recognition adjusts the dividend on borrowed cash value and non-direct recognition pays it as if there were no loan. In IUL, a fixed loan works like direct recognition and a participating loan like non-direct recognition.

Worked example

Illustrative figures, not a forecast. On a policy with a level death benefit of US$2,000,000, the policyholder takes a fixed loan of US$100,000, charged at 6% a year with the loaned amount credited at 4.75%.

• Interest paid each year: US$6,000 charged, US$4,750 credited, a net cost of US$1,250. The loan stays at US$100,000, and the death benefit payable is US$1,900,000.
• Interest added to the loan: after 10 years the balance is about US$179,100, and the death benefit payable is about US$1,820,900.

In an international IUL

Standard loan rates are variable and reset each anniversary: one contract quoted 5.25% in 2026, with the net cost capped at 1.25% a year. The policy is usually held by an offshore trust or company, so trustees or directors sign the loan request and receive the funds, for retirement income, property, business capital or school fees. A bank can also lend against the policy as a Lombard loan.

Common questions

Is a policy loan the same as a Lombard loan?

No. A Lombard loan is a loan from a bank, secured against assets pledged to it. A policy loan comes from the insurer itself, against the policy.

Do you have to repay an IUL policy loan?

Repayment is the policyholder's choice, and any balance left at death comes out of the death benefit. The loan and interest must stay within the cash surrender value, which annual reviews track.

Is a policy loan taxable?

It depends on the policyholder's tax residence; in many countries a policy loan is not a taxable event. In the UK, where an international IUL is taxed like an offshore bond, a loan made by the insurer, or by arrangement with it, to a UK-resident individual who would be taxed on a gain on the policy, or to UK-resident trustees, or at either's direction, is treated as a part surrender (Income Tax (Trading and Other Income) Act 2005, section 501). It counts towards the 5% a year allowance (5% of each premium a year, for up to 20 years), as a withdrawal does, and unpaid interest added to the loan counts as a further loan.

Go deeper: IUL policy loans and loan or withdrawal compared.