As pertains to IUL, duplifunding is the process of borrowing against the cash value and using some or all of the proceeds to make a premium payment to the policy. In other words, using participating loans, a person might be able to take a policy loan at 4% to 6% and within a few days - or even simultaneously with some insurance companies - turn around and use the proceeds of the loan to make a premium payment that may earn 7% to 10% (leverage). Other types of loans will not work for this purpose. Also, special attention is needed to assure that any additional premiums made do not turn the policy into a modified endowment contract (MEC), or that too much of such borrowing may render the policy vulnerable to lapsing during years when the index strategy returns a zero gain.. The insurance company can tell you just how much you can pay at any point in time as a "maximum non-MEC premium".
The policy won't earn 7% to 10% every year. In some years it will grow at 0% on the investment side (and a negative rate when factoring in cost of insurance, expenses, and interest on any existing loans). In other years the policy may grow at a 10% to 20% pace, even after considering COI's and other expenses. Over a large number of years, studies of past performance for certain uncapped strategies would indicate such outcomes. As a general rule, one should never allow total loans to exceed 70% to 80% of the total cash surrender value of the policy at any time. This can help protect the policy in those years that do not produce positive index returns. We recommend working with our affiliated company, Plan Trackers, Inc., to protect against getting into trouble, and also to optimize IUL performance.
The effects of cost of insurance (COI) and policy expenses will lessen over time. The expenses as a percentage of the policy's Account Value, as well as cumulative premiums, will reduce dramatically as the policy ages - especially after the policy is greater than 10 years old. While the annual COI will increase each year when expressed on a "per thousand" basis of actual "at risk" death benefit, a properly structured policy will see the COI become less and less significant when compared to the policy Account Values over time. This is especially true if you contribute maximum non-MEC premiums and design the policy using the guideline premium test (GPT) as the definition of life insurance - especially when using IUL for retirement.
So, the bottom line here is creating the leverage or "spread" that is positive - say 3%. Would you rather earn 3% on a thousand dollars or earn 3% on ten thousand or even a million dollars? (Back to IUL Table of Contents)