An indexed universal life policy, or IUL, lets you borrow against its cash value. On LIFE Pod Ep 91, while walking through an illustration with Carlo Viqueira, James spent a stretch on how those loans work, and it lines up closely with how a line of credit works.
Most carriers offer two kinds of policy loan. A fixed loan charges a set rate. A participating index loan, sometimes called an indexed loan, charges a loan rate while the borrowed money stays in the index account and keeps getting credited. Some carriers add a variable loan tied to a loan account they manage. Carlo compared it to a line of credit, where you either have a fixed rate or a variable rate. The difference is timing. Most carriers let you hold one type at a time and only switch on your policy anniversary, which is the yearly date your policy started. You can't switch in the middle of a year, because people would jump to whichever type looked cheaper once they saw how the index was doing. James said his own carrier is an exception and lets him hold both types at once, which gives him more room to protect returns.
The indexed loan is where the upside and the risk both sit. On James's policy the loan rate is 5%, and that rate is set by contract. What the borrowed money gets credited is not. He's had years where he borrowed at 5% and part of that money was credited 14%, so he earned on money he'd borrowed. He's also had a zero year, where the index credited nothing and the full 5% was his cost to borrow. Illustrations assume the indexed loan comes out ahead by about half a point, so a 5% loan is shown with about a 5.5% credit. That gap is not guaranteed, and the more loans an illustration shows, the better that assumption makes the policy look.
The fixed loan works differently. On some policies you borrow at one rate and the borrowed amount is credited at a slightly lower rate. After about ten years it can become a wash, where Carlo gave the example of paying around 2% and being credited around 2%. At that point it acts much like a withdrawal, but it is still technically a loan.
That's why James models retirement income the way he does. He illustrates indexed loans for the first ten years and then switches to fixed loans. It shows less income than the maximum the software allows, and he thinks it's more realistic. When a client actually reaches retirement, he looks at how the policy has done over the last 10, 15, or 20 years. If it's been beating 5%, they use indexed loans. But ten years into taking income, the loans are big and the cash value has been drawn down, and switching to fixed then means every year some credit offsets the loan interest, instead of risking a full year of interest cost with no credit at all.
Two more pieces show up in the illustration. You can also withdraw money instead of borrowing it, and withdrawals up to your basis, meaning the premiums you've paid in, generally come out tax-free. Above that, you'd owe tax. And an overloan protection rider, which is an add-on to the policy, keeps the policy from lapsing if you borrow too much. The carrier keeps a small death benefit in place until you pass away, so you don't lose the policy and you don't get a tax bill on top of it. For most carriers the rider can be used starting at age 75, and for some it's 65.
Policy loans reduce the cash value and the death benefit until they're repaid, and index credits above the floor are not guaranteed. James is a licensed insurance broker, not a CPA, attorney, or registered advisor, so check the tax side with your own tax professional. If you're looking at an IUL illustration with loans in it, ask which loan type it assumes and whether it switches from indexed to fixed at some point.