IUL Policy Loan Risks

Why an IUL is harder to read than whole life

With whole life, the growth follows a set schedule. An IUL doesn't. Its cash value is credited based on an index (like the S&P 500), but with several dials the carrier controls:

• Floor: the least you can be credited. This is usually 0% on indexed accounts (current example, as of 2026). It protects against negative index credits, but not against policy charges.
• Cap rate: the most you can be credited. If the cap is 10% and the index returns 15%, you get 10%.
• Participation rate: how much of the index gain counts. At 80% participation, a 10% index gain credits 8%. On common capped strategies participation is often 100% (current example, as of 2026). It can run below 100% on some uncapped designs or above 100% on certain high-participation accounts.

On mainstream one-year capped accounts at large carriers, caps currently run roughly 9% to 11% (current examples, as of 2026, all non-guaranteed). For instance, Prudential's Momentum IUL shows a cap near 10.50% at 100% participation; Pacific Life's Horizon IUL shows caps around 10% to 12%, plus a five-year account at about 110% participation with no cap; Nationwide shows caps roughly 9.25% to 10.75%, plus an uncapped S&P strategy with a spread near 9.00%. Some accounts are lower, higher, multi-year, or uncapped, so treat any single number as one example, not a rule.

The part that matters for risk: these terms are non-guaranteed. The carrier can change caps, participation rates, and spreads for new segments at its discretion, sometimes as often as monthly. Once a segment is created, its credited-method terms usually hold for that segment until its term ends. But the numbers in your original illustration are not promises for the segments you'll buy later. Confirm any figure against a current in-force illustration, since values vary by carrier, product, segment, and state.

The charge that never stops growing

Every premium dollar first pays the cost of insurance (COI) and policy expense charges; only what's left becomes cash value. And the cost of insurance climbs as you age. The older you get, the more the policy charges to keep the death benefit in place. COI is the main expense in a universal life contract, and it increases with the insured's attained age, which is why Wisconsin's insurance regulator tells consumers a UL policy must be monitored over time. A Nationwide VUL prospectus likewise notes that COI rates generally rise year over year with attained age.

So even in a flat market, the policy is spending money to stay alive. If contributions and crediting don't keep up with those rising charges, the policy starts draining its own cash value to cover them. This is the heart of the real lapse risk. Guardian notes that an IUL can lapse from low or negative index performance, inadequate funding, and rising cost of insurance acting together. The illustration can look stable because of the 0% floor, yet the danger comes from the interaction of weaker-than-hoped index credits, premium funding that's too low, and COI that keeps climbing with age.

Why the "floor" doesn't make it safe

IULs are sold on the floor (often 0%, a current example, as of 2026), meaning a down market won't credit you a loss. True. But the floor applies to indexed interest credits only, not to policy charges. A 0% crediting year is not a 0% cost year. The cost of insurance and charges still come out. So in a bad stretch you can have "no losses from the index" and still watch your cash value fall, because the charges kept running.

A floor protects against index losses. It does not protect against the policy's own costs.

A note on VUL: market risk plus layered fees

A variable universal life (VUL) policy is a close cousin, but it has no floor. Cash value sits in investment subaccounts, so a down market can directly reduce it. On top of that market risk, VUL cost is layered. A typical contract stacks a mortality and expense (M&E) risk charge, administrative and policy charges, the cost of insurance, the underlying fund or subaccount expenses, and any rider costs. FINRA describes M&E, administrative charges, and fund expenses as the standard layers. Current prospectus examples (all non-guaranteed and varying by product): M&E charges often run 0.00% to 0.50% on a current basis, with a guaranteed maximum commonly around 0.25% to 0.80%; underlying fund expenses roughly 0.1% to 3.4%; and administrative or policy charges around $10 to $30 per month. Confirm the exact layers against the product prospectus.

Where a loan tips it over

Now add a policy loan. The loan accrues interest, and if you don't pay it, that interest compounds onto the balance. Between rising insurance costs, possibly reduced caps, and a growing loan, an underfunded IUL can reach the point where the loan plus charges exceed the cash value. Then it lapses.

The sting is the same as any loaned policy: a lapse with a loan outstanding can make the gain portion taxable. You can owe income tax on money you borrowed and spent, with no death benefit left.

How to keep an IUL loan from going wrong

• Ask for an in-force illustration with the loan modeled. Ask to see it at guaranteed (worst-case) charges, not just the rosy projection.
• Fund it enough to cover rising costs, not just the minimum premium.
• Watch the loan-to-cash-value ratio every year, and pay the loan interest.
• Re-check after any cap or participation change from the carrier.

FAQ

Related: How Does a Life Insurance Policy Loan Work? · Direct vs Non-Direct Recognition · Policy Loan Lapse Risk

This article is for general educational purposes only and is not insurance, tax, or legal advice. Cove does not sell insurance and is not affiliated with any insurer. Any figures are illustrative and vary by policy, carrier, and state. Confirm specifics with your carrier and a qualified tax or legal professional. Last updated June 2026.