An Overlooked Insurance Feature: Overloan Protection Riders
by Oliver Fitch, Product Analyst
Given the current economic climate, some insureds may be seeking ways to supplement their income by using their life insurance policy as a source of cash flow. It is important to recognize that taking loans can have unintended risks, such as taking too heavy a loan, causing the policy to be in danger of lapsing. The potential taxes* due when a “loaned-on” policy lapses are not appealing, but what protections are in place? If the policy has an Overloan Protection Rider, that may help prevent the policy from lapsing. When an OLP Rider is exercised, it shuts down the policy, stops premium payments and disbursements, and freezes the policy at a set death benefit.
Each company’s Overloan Protection Rider is unique, but by categorizing the important aspects of each, we can determine what to expect.
The difference in the activation process from company to company is quite diverse. Certain companies will not send any notification at any time when the policy is near lapse, so the holder of one such policy must be vigilant in watching its status. Other companies will notify the holder when the requirements of the rider are met, or when they’re approaching that point, and only require the policy holder to respond. Finally, some companies will activate the rider automatically when the requirements are met, without any action needed. The difference in attention required by each policy is enough that it is well worth consideration.
The Overloan Protection Rider is free to add to the policy and is often included automatically. Most companies will charge between 1% and 5% of the accumulated value at activation. Other companies will charge a variable amount determined at activation.
The triggers for activating the OLP Rider vary in complexity and specifics, but the majority have at least one of the following requirements: the loan amount must be greater than a certain accumulated value (usually around 90%), greater than the initial or current death benefit, all premiums must be withdrawn, or some combination of these. The rider always has an age requirement, that is usually between age 70 and age 80, with a policy age between 10 and 20 years. To actually activate the rider, in addition to meeting all the requirements, some companies require a written request for activation, while a smaller number will activate the rider automatically upon meeting all the requirements. The specifics vary enough by product, so it is worth noting them for a particular policy.
Overloan Protection Riders are most commonly found on Indexed Universal Life and Variable Universal Life products, but they can also be found on Universal Life or even Whole Life. This rider is typically only allowed on policies that follow the Guideline Premium Test assumption, though a small handful do allow the Cash Value Accumulation Test at a higher charge.
The tax burden of an unexpectedly lapsed policy carrying a hefty loan can be substantial. Knowing the specific trigger requirements, as well as the activation process of a product, are important to keep a policy from falling into a lapsed status. In the end, it is important to understand the product while continuing to monitor the policy.
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*We do not give tax advice. Please speak to a tax advisor.