Participating Loan, Wash Loan, or HELOC: Which One Should Fund the Purchase?

I treat the cash value in my policies like any other line of credit I own. When I need money for a purchase, I ask where it comes from. If I'm sitting on cash, I use the cash. If I have to borrow, the choices are a credit card, a bank line of credit, a home equity line of credit, or the policy. The policy is one more option, and I try not to think about it any differently. I laid this out in an easy guide to cash value life insurance loans, before and after retirement.

What changes the answer is the type of loan. A participating index loan, which is available on an IUL (indexed universal life), lets me reach the cash without cutting the policy's growth. A wash loan works differently. I pay interest on the loan and the policy gives me an offsetting credit that mostly covers it. It's available on whole life and IUL.

The cost of a wash loan is what you give up. Say I borrow at 2% and get a 2% offsetting credit. The cash I borrowed against now grows at 2%. If the index would have averaged 6% to 8%, I'm giving up 4% to 6% on that money. Those averages are an example and not a promise. The comparison is what matters.

So here's how I'd rank a few sources. Suppose a home equity line of credit charges 6%. If my only policy option is the wash loan at 2%, the home equity line of credit might be the better choice, because the policy keeps its full growth potential while I use the bank's money. But if I can borrow with a participating index loan at about 5%, I'd skip the 6% home equity line of credit. The rate is lower, and the growth isn't cut.

Whichever source you use, treat it like any line of credit. You pay it back, and it's available again. I don't worry about how much I've borrowed from the policy as long as I can cover the interest every year. If I reach the policy anniversary and can't cover the interest, the policy can lapse, and a lapse brings an income tax bill on the gains. A loan also reduces your cash value and death benefit while it's outstanding, so don't borrow so much that you're near the edge.

Every carrier's loan options differ, and I'm not a CPA, so the tax side goes to your preparer. Ask your agent which loan types your policy has before you plan around one.