If you own an Indexed Universal Life (IUL) policy, you may have heard about non-direct recognition loans as a way to access your cash value that's accumulating and compounding, while still allowing your policy to grow.
But what does that actually mean, and how can it benefit you financially? Let’s break it down with a simple example.
What Is a Non-Direct Recognition Loan?
We actually don't love the term "loan" because of the emotion that it can conjure up for some people, but it's how the industry refers to this too, so we want to educate you properly. A non-direct recognition loan allows you to borrow money against your IUL policy’s cash value without reducing the credited interest your policy earns. Unlike other loan structures, your entire cash value continues to participate in index growth as if no loan was taken.
Example: The Power of Positive Arbitrage
Let’s say you have built up a substantial cash value in your IUL policy and decide to take a loan on the life insurance policy of $50,000. The insurance company charges you 4% interest on this loan, but your IUL policy is earning an interest crediting rate between 6% and 9% based on index performance. Here’s how this plays out:
Scenario 1: Your IUL Earns 6%
Your full cash value (including the $50,000 you borrowed) still earns 6%.
On $50,000, this means your cash value grows by $3,000.
Meanwhile, you’re paying 4% interest on the loan, which amounts to $2,000.
Net Gain: $1,000 (Positive Arbitrage!)
Scenario 2: Your IUL Earns 9%
Your cash value earns 9% on the full amount, meaning a gain of $4,500.
You still pay $2,000 in loan interest.
Net Gain: $2,500 (Even More Positive Arbitrage!)
How the Loan on Life Insurance Policy Gets Paid Back
One of the biggest advantages of a non-direct recognition loan is that repayment is flexible. There are two primary ways the loan gets repaid:
Through Cash Value Growth – If your IUL policy’s cash value continues growing at a rate higher than the loan interest, the increase can be used to offset the loan over time. Many policyholders choose to let their cash value grow and use it to cover the loan balance.
From the Death Benefit – If the loan is not repaid during the policyholder’s lifetime, the outstanding balance is deducted from the death benefit when the insured passes away. The remaining net proceeds then go to the beneficiaries. This allows you to access funds during your lifetime without disrupting your long-term legacy planning.
Why This Strategy Works
Because a non-direct recognition loan does not reduce the credited interest on your cash value, you can continue benefiting from market upside even while borrowing. If the policy’s credited interest exceeds the loan rate, you experience positive arbitrage—meaning your money is growing faster than the cost of borrowing it.
The Bottom Line
Non-direct recognition loans are a powerful tool for accessing liquidity while keeping your money working for you. When structured properly, they can create a self-funding financial strategy that allows you to borrow at a lower rate while earning at a higher rate. Plus, the loan can be repaid through cash value increases or deducted from the death benefit, ensuring your beneficiaries still receive a significant payout.
Want to explore how this could work for your financial strategy? Let’s connect and discuss how an IUL can be a key piece of your wealth-building plan!
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