Much has been said about Indexed Universal Life and its impact and growth over the last several years in the life insurance industry.Through the first three quarters of 2018, it represented 24% of overall individual life sales and 65% of total universal life sales*. Many industry experts have weighed in on the product mechanics, costs, benefits and features, and although these are very important, this paper sets out to examine a few of the common uses of a maximum-funded Indexed Universal Life (IUL) policy, while also offering some caution in certain circ*mstances where IUL may not be the most appropriate product choice in the array of financial product options.
First, let’s define what a “maximum-funded” IUL is.IUL is a permanent life insurance policy that builds cash value by crediting interest based on some external index strategy.Because it is a permanent UL policy, there are an infinite amount of ways to fund such a policy.That is, as defined by the insurance company, a client could pay a minimum premium to simply cover policy expenses and prevent the policy from lapsing from year to year, or she could pay a “maximum” premium as allowed by the IRS to take advantage of the favorable tax treatment of permanent life insurance, or anywhere in between.For purposes of this paper, we’ll examine the max-funded scenario.
Income Replacement
Income replacement is one of the primary reasons that clients purchase life insurance. Further, there are two core elements of any life insurance policy, including IUL, that make it attractive from an income replacement standpoint – leverage and tax-efficiency.Using an oversimplified example, if a client pays $1 and can leverage it to $100 in the event of a premature death, AND that $100 can be paid income tax-free to the beneficiary, this can be a good deal from a financial standpoint.The $100 can be used to replace the income lost because of the premature death.
Where IUL might not be the best fit as a solution for income replacement is in the instance where a client wants to protect his family with life insurance and might not have the current ability to pay for a max-funded IUL policy.To properly fund the IUL, it might require an outlay of $4 to create $100 of benefit, but for a term policy the outlay might be $1.So, if the client is on a tight budget, you might see strong consideration for the term policy instead of the IUL.In either case, there is still significant leverage and tax benefit.
Retirement Income Supplement
Most financial experts will agree that a predictable stream of sufficient income is vital to the success of a client’s finances in retirement.While growth and accumulation are important during your working years, creating income you can’t outlive becomes more important during your retirement years.IUL can be a useful product and play an important role in retirement.During your working years, your IUL’s cash values have grown and accumulated, and now in retirement you may be able to take income tax-free distributions from this policy to supplement your other sources of retirement income.It is important, however, to consistently monitor the IUL to ensure that it has enough value to continue to support the income being distributed to the client.One idea might be to use this retirement supplement IUL policy as a “backstop” in case your other retirement accounts don’t perform as intended, or if you are looking to reduce your income tax situation in a particular year.IUL offers flexibility to take income from the policy on an “as-needed” basis and doesn’t require you to take a consistent, static amount each month or year.
Because of an IUL’s ability to produce income tax-free distributions, it might be easy for a client to consider the thought of, “Well, why don’t I put all my money in this IUL?”Though tempting, it is generally not sound advice to suggest a client put all of their eggs in one basket.There are other financial products that exist that can be layered in with IUL to create tax-efficiency and even guarantees for the client.The scope of this paper won’t cover these other products, however.
Life Insurance for the Living
Up to this point, we’ve covered two of the most common uses for IUL – income replacement and supplemental retirement income.Another aspect of most IUL policies that demonstrates how useful IULs can be are the living benefit riders or provisions that exist.These give the client the ability to use part or all of the policy death benefit for purposes of chronic, critical or terminal illness.Since IUL is still a life insurance policy first, these benefits aren’t typically the primary driver of a purchase, however, they give the IUL additional flexibility and provide the client with more options to actually use the policy during her lifetime.
The chronic illness benefit, in particular, has become a popular “living” benefit in the industry.This is no surprise since the cost of long-term care continues to increase and the options for insuring against this cost have become limited in the traditional long-term care insurance space. However, buying an IUL solely for the purpose of mitigating long-term care or chronic illness risk, or thinking that an IUL is the only financial product that a client needs in order to handle this risk, would be a misstep.Certainly, IUL can provide a chronic illness benefit, however, it is generally recommended to consider alternative products as part of an overall strategy to cover the long-term care risk – not just IUL.
Other Potential Uses for Max-Funded IUL
Income Replacement
Retirement Income Supplement
Living Benefits
Estate Planning / Wealth Transfer
College Planning
Business Planning
Premium Finance
If a financial product existed that could provide a leveraged benefit and income tax efficiency in the event of premature death, chronic illness, heart attack, cancer, stroke, terminal illness and could provide income diversification to supplement a retirement plan, perhaps it could be part of a client’s plan both during their working years and through their retirement years as well.Maximum-Funded IUL may fit the description of this dynamic product, and it may be very useful when positioned properly.It’s not the only tool an advisor should have in his bag and it’s not always the answer, but it may certainly have its place in certain client situations.
* – https://www.limra.com/Posts/PR/News_Releases/LIMRA__Total_Individual_Life_Insurance_New_Premium_Increases_in_the_Third_Quarter_2018.aspx
Disclosure
The content within this document is for informational and educational purposes only and does not constitute legal, tax or investment advice. Customers should consult a legal or tax professional regarding their own situation. This document is not an offer to purchase, sell, replace, or exchange any product. Insurance products and any related guarantees are backed by the claims paying ability of an insurance company. Insurance policy applications are vetted through an underwriting process set forth by the issuing insurance company. Some applications may not be accepted based upon adverse underwriting results. Some types of permanent insurance may require consistent premium payments, or the policy may risk lapsing. Unpaid policy loans decrease future death benefits paid to beneficiaries. Excessive policy loans may cause the need for future premium payments. If a contract lapses due to excessive policy loans or if a customer chose to surrender their policy, one may be subject to tax payments for policy loans that exceeds the premiums paid. Excessive premium payments may cause the policy to become a modified endowment contract. Policies classified as modified endowment contracts may be subject to tax when a loan or withdrawal is made.
