Too Many Loans Out On A Policy? An Overloan Feature Could Help
A special “overloan provision” can provide real comfort and assurance to producers and their clients who plan to access their policy values at some time in the future.
This article discusses how such a provision can work in a variable universal life policy. But first, well review the problem the feature addresses.
This problem is the one that occurs if a policyholder takes too much money from the policy, creating a situation in which the owner must deposit more funds, take other policy management steps, or lapse the policy altogether.
Heres the background: A prominent application of universal life and VUL products enables such contracts to favorably grow account values. If the product is a non-modified endowment contract (non-MEC), the owner can also access these values on an attractive basisi.e., have the policys value distributed to the policyholder free of immediate recognition of income tax if certain rules are followed.
The general approach, when accessing these values, is to withdraw the basis first and then switch to policy loans (which, as you may recall, are not considered distributions subject to income tax).
However, since it is highly desirable for a life policy having a sizable loan to remain in force until the death of the insured, the policy needs to be managed properly. If the loan grows to the point where it equals the policy maximum loan, the policyholder has little, if any, net equity in the policy and the contract will be terminated.
Termination will trigger a taxable event that could far exceed the available cash, with very negative results to the client. The entire gross cash value must be recognized as gain, yet there is minimal or no real cash to pay the resulting tax. And, of course, death benefit protection, or what was left of it, then will have entirely disappeared.