How do vul policy loans affect coverage?

Written by Hannah McCullough Insurance Researcher & Writer

A VUL loan is secured by the policy’s value. It does not create a separate pool of money that grows without consequences. The practical question is whether the policy can still support its insurance charges, investment losses, and loan balance over time.

If you are deciding whether existing coverage still fits your household, you can see your estimated rate in minutes. That estimate is separate from the policy review described below and does not predict whether a current VUL contract will stay in force.

What is a VUL policy loan?

A VUL policy loan lets the owner borrow against part of the policy’s available cash value while the policy remains in force. The insurer charges interest, and the contract explains how the loan is credited, how much may be borrowed, and what happens to the death benefit.

Variable universal life combines insurance with investment options in a separate account. The National Association of Insurance Commissioners describes variable universal life as a cash-value product whose account performance can change with the selected investments. That market exposure matters because loan risk is measured against a value that can move.

A policy loan is therefore a lien or charge against the contract, not a guaranteed withdrawal from an account. The exact mechanics differ by policy. Read the loan provisions, the current illustration, and the in-force statement together.

How can a loan change the death benefit?

A VUL loan can reduce the death benefit because the unpaid loan and accrued interest are taken into account under the policy’s death-benefit provisions. The amount is not automatically the same for every VUL contract, so the policy schedule controls the calculation.

IRS Revenue Ruling 80-132 describes a policy loan as a charge that reduces cash surrender value and the amount payable on the death of the insured when principal or interest is not repaid. A beneficiary may therefore receive less than the face amount shown when the policy was issued, especially when interest is added and the loan remains unpaid.

Check three lines on the latest statement: the current death benefit, the outstanding loan including interest, and the net amount payable at death. Ask the insurer to show how those lines change under the current loan balance and under a stress case with weaker investment performance.

Can a VUL loan make the policy lapse?

Yes. A loan can increase lapse risk when the remaining cash value is no longer enough to cover insurance charges and other policy expenses. A VUL can also lose value when its investment options perform poorly, which can make the same loan more dangerous during a market decline.

IRS guidance confirms that unpaid loan principal and interest reduce policy value and death proceeds. Combined with the NAIC’s explanation that variable-account performance can decrease, that means a loan can leave less margin for ongoing charges. If the policy cannot support those charges, its contract terms may allow a lapse, subject to any grace-period and reinstatement provisions.

Watch the policy’s net cash value, loan balance, accrued interest, premium history, and projected lapse date. A notice that asks for more premium is not the same as a guarantee that one payment will solve the problem. Request a current in-force illustration showing what happens if you pay interest only, repay part of the loan, add premium, or make no change.

What happens to the cash value and investments?

A VUL loan can reduce the value available inside the policy and leave less margin for ongoing charges. The investment effect depends on the contract’s loan accounting and the performance of the selected subaccounts, so a simple statement that the borrowed money earns a particular rate would be misleading.

The NAIC Life Insurance Buyer’s Guide explains that variable policy investments directly affect cash value and carry more risk than non-variable policies. The same guide also distinguishes flexible-premium universal life from other products, which is why a VUL owner should use the issued contract rather than a generic whole-life rule.

Consider the loan as a drag on the policy’s safety margin. Strong investment performance may make the balance easier to manage, but it does not remove the loan interest or contract charges. Weak performance can shrink the margin faster. Neither outcome is guaranteed.

Is a VUL policy loan taxable?

A policy loan is generally not treated as immediate income when received, but the tax result depends on the contract and what later happens to it. The tax analysis is different for a modified endowment contract and can also depend on prior withdrawals, premiums, and other distributions.

IRS Revenue Ruling 2009-13 applies Internal Revenue Code section 72 to amounts received from life insurance contracts and explains that taxable income on surrender is measured against the investment in the contract. The IRS also says that, in general, a policy’s cost is premiums paid less certain refunds, dividends, and unrepaid loans that were not previously included in income.

One concrete IRS example shows why the basis matters: a $78,000 surrender after $64,000 of premiums produced $14,000income in the ruling’s surrender example of recognized income. That example is not a forecast for your policy, but it shows why the contract history must be reviewed before a surrender or lapse.

If a policy lapses or is surrendered while a loan is outstanding, the result can be taxable income even though no new cash arrives at that moment. Do not calculate the tax bill by subtracting the loan from premiums yourself. Ask a tax professional to review the contract, basis, loan history, and the event that ended or changed the policy.

What should you check before borrowing?

Before taking a VUL loan, confirm the policy’s maximum loan provision, interest rate, interest-crediting method, death-benefit formula, and premium requirements. Also ask whether the policy has a grace period or reinstatement conditions and how long a notice gives you to act.

Use the current in-force ledger, not the original sales illustration. Ask for at least two projections: one with the planned loan and premiums, and one with less favorable investment performance. The projections are not promises. They are a way to see how quickly the policy could approach a lapse point.

The choice between fixed and variable loan ratesConfirm the available rate method in your policy contract. affects predictability, but no rate label by itself tells you whether the loan is affordable. The policy’s charges, investment performance, loan balance, and planned premiums work together.

How should you manage an outstanding loan?

Managing the loan starts with monitoring it on a schedule that matches the policy’s risk. Review the loan balance and interest, net cash value, death benefit, and projected lapse date after each statement and whenever investment performance changes materially.

Possible responses include repaying part or all of the loan, paying interest, adding premium when the contract allows it, or changing the policy only after reviewing the tax and coverage consequences. Each option has contract-specific costs. A licensed life insurance agent can help explain the ledger, while a tax professional should address a possible taxable event.

For a broader explanation of the interest-rate choice, read about fixed versus variable policy loan rates. The phrase is a useful starting point, but your own policy form and current ledger are the controlling documents.

What is the right next step?

The right next step is a current policy review before you borrow more, surrender the contract, or stop paying premium. Gather the in-force statement, loan history, policy illustration, and any lapse notices. Ask for the death benefit and net cash value under several reasonable scenarios.

If the review suggests that new coverage may be appropriate, you can see your estimated rate in minutes and then discuss the result with a licensed life insurance agent. An estimate is not a promise of approval or a replacement for reviewing the existing VUL contract.