Using a Policy Loan to Fund a Donor Advised Fund Without Selling a Thing
Updated: Sep 21
A client sits down in October wanting to put $100,000 into her donor advised fund before year end. The money exists. It is sitting in a stock position she has held since 2009 with a basis somewhere around thirty cents on the dollar, and selling it means writing a check to the IRS before she writes one to the fund. The building she owns is not liquid on any timeline that matters. Her business distributes in March.
There is a third door, and most people who own a permanent life insurance policy never think to open it. Using a policy loan to fund a donor advised fund lets the gift happen this year without selling a single share, liquidating a single property, or realizing a single dollar of gain.
It is a real strategy and a narrow one. The mechanics are simple. The places it goes wrong are specific, and worth knowing before anyone signs anything.
What a Policy Loan Actually Is
A loan against a permanent policy is not a loan in the ordinary sense. There is no application, no credit check, and no approval. The cash value inside the contract secures the advance, the insurance company is contractually obligated to make it, and the money typically arrives in days. Policyholders borrowed against their contracts to the tune of $147 billion by the end of 2024, according to the American Council of Life Insurers — a large and entirely ordinary feature of how these contracts are used.
The tax treatment is the part that makes it interesting for giving. Loan proceeds are debt, not a distribution, so the money is not taxable income while the policy remains in force. You receive $100,000 in cash and report nothing. Meanwhile the policy generally continues to earn on the full cash value, which is why a well-designed contract can have money working in two places at once.
What lands in the donor advised fund is cash, and cash is the cleanest contribution there is. No appraisal, no valuation question, no sponsor deciding whether it can accept an unusual asset. The fund receives the deposit and the deduction is straightforward.
Why Cash Behaves Well in 2026
Two features of current law make a large cash gift worth thinking about differently than it was three years ago.
The 60% of AGI ceiling on cash gifts to public charities, which had been scheduled to fall back to 50%, is now permanent. Cash gets the most generous limit in the code. Appreciated securities, by contrast, are capped at 30% of AGI. For a donor making an unusually large gift in a single year, that twice-as-much headroom is the difference between deducting it now and carrying half of it forward.
Then there is the floor. Beginning this year, itemizers deduct charitable gifts only above 0.5% of adjusted gross income, and the floor lands on the first dollars given regardless of what follows. A $100,000 gift from a household with $600,000 of income loses $3,000 to the floor and keeps $97,000. The same household giving $10,000 a year loses nearly a third of it. Concentration beats habit under this rule, which is exactly why bunching several years of giving into one has become the default advice. A policy loan is one way to find the cash for the bunching year without selling the assets that were going to fund the next five.
One caution on the value of the deduction itself. Under the same law, the benefit of an itemized charitable deduction is capped at 35 cents on the dollar even for filers in the 37% bracket. The deduction is still worth having. It is simply worth a little less than it used to be, which raises the bar on any strategy that carries a cost of its own.
Whether a loan makes sense depends on your policy's loan rate, its dividend history, how much basis is in the contract, and what else you were planning to sell. Those four numbers decide it, and they are specific to you.
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When Borrowing Beats Selling
Here is the honest version, because this strategy gets oversold.
If what you hold is publicly traded stock with a long-term gain and you have AGI headroom, give the shares. Donating appreciated securities directly to your fund avoids the capital gain entirely and still produces a full fair-market-value deduction. That remains the single most efficient move in charitable giving, and a policy loan does not beat it. Anyone who tells you otherwise is selling something.
The loan earns its place when giving the asset is not available to you. Four situations come up repeatedly.
The asset cannot move. Shares under a lockup or a trading window, real estate mid-contract, a closely held interest with transfer restrictions, a position pledged against a line of credit. The value is real and the timing is not yours.
You are already at the 30% ceiling. A donor making a very large gift relative to income can hit the appreciated-property limit and still have room under the 60% cash limit. Cash from a loan fills the gap in the same tax year rather than five years of carryforward.
The gain is the point. Some positions are being held deliberately for the step-up in basis at death. Selling to fund a gift destroys exactly what the plan was protecting, and the loan leaves it intact.
The liquidity event is coming, just not yet. A business owner heading toward a sale has a planning window that closes early, often before there is any cash. A loan can fund the fund now so the charitable side of the plan is in place before a letter of intent changes what is possible.
The Four Things That Go Wrong
Every one of these is manageable. None of them is optional reading.
The interest is not deductible, and it is not deductible twice over. Interest on a personal policy loan is nondeductible personal interest, and the code layers additional restrictions on borrowing against life insurance under Section 264, including rules aimed at systematic borrowing of cash value increases. Do not model this as a deductible cost of carrying a charitable gift, because it is not one.
Unpaid interest compounds against the policy. If the loan is never repaid, the balance does not sit still. It grows at the loan rate and consumes cash value along the way.
The number that actually matters is the spread between what the carrier charges on the loan and what it continues to credit the borrowed cash value. On a well-structured whole life contract that spread is often narrow, and on some designs it is close to zero. On a policy that was never built for this, it is not. That difference is worth confirming in writing with the carrier before the loan, not after.
A lapse turns a tax-free loan into taxable income. This is the real risk. If the loan and its accrued interest eventually exceed the cash value, the policy lapses and the gain above basis becomes ordinary income — in a year when there is no cash coming in to pay the tax on it. The Tax Court has worked through exactly this fact pattern, and the taxpayer's sympathetic circumstances did not change the outcome. A policy carrying a loan needs to be monitored annually, not filed away.
A modified endowment contract changes everything. If the policy is a MEC, loans are taxed gains-first, which converts the entire premise of this strategy into a taxable distribution. Whether a contract is a MEC is a fact determined by how it was funded, and it is the first thing to verify.
There is also a quieter consideration. The death benefit is reduced by any outstanding loan. If part of what you intended for family or for charity is the benefit itself, borrowing against the policy reduces that gift to fund this one. That may be exactly the right trade. It should be a decision rather than a surprise.
Where to Start
If you own a permanent policy and a large gift is on your mind this year, four steps before anything else.
1. Pull an in-force illustration. Ask the carrier for current cash value, basis, the loan rate, whether it is fixed or variable, and MEC status. Every question above is answered on that one document. 2. Price the alternative first. Run the gift as a direct transfer of appreciated securities and compare. If the shares can move and you have the AGI room, they usually should. 3. Model the loan out twenty years, not five. The question is not whether the policy supports the loan today. It is whether it still does at 85 with no further premium going in. 4. Decide the repayment plan before you borrow. A loan repaid from a bonus, a distribution, or the eventual sale of the asset you were protecting behaves very differently than one left to compound. Both can be right. Only one of them is an accident.
A policy loan is a tool for a specific problem: the gift is right, the timing is right, and everything you own says no. Used deliberately, it turns an asset you already own into this year's generosity without disturbing anything else you built. Used carelessly, it quietly hollows out a contract your family was counting on.
The difference between those two outcomes is almost always in the modeling, and the modeling takes one conversation and one in-force illustration.
Want to know whether your policy can carry a gift this size? Let's look at the actual contract together.
Luke Lyles is a Partner at Sage & Main who works with business owners, families, and their advisors to turn intentions on paper into plans that are actually funded.
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