August 2013

Page 38

LIFE

Indexed UL is Not a Fad I ndexed life insurance products aren’t for all clients, but they could be a good choice for a client who is investing for the long haul. By Michael C. Staeb

M

any advisors are under the mistaken impression that indexed universal life insurance (IUL) is a fad that eventually will founder and go the way of first-to-die and credit life insurance. What those individuals fail to consider is IUL’s flexibility. Like all universal life products, IUL has flexible premiums as well as death benefits that are not as easily accessible in other products. It is also the only general account product that has interest crediting linked directly to stock market performance without actually being invested in the market. IUL always will be relevant (whether we’re in a bull market or a bear market) and theoretically can be linked to the indexed price of anything. To quote Bobby Samuelson, an industry expert on IUL, “When times are bad, people just want return of capital and, when times are good, people want return on capital. The great thing is that IUL gets both.” Indexed life insurance is not for everybody, but it’s not for the elite either. An ideal client for IUL is someone who has a steady income stream and who is looking to maximize tax-preferred retirement savings vehicles. Most important, any client buying IUL needs to understand it is a midterm to long-term play, generally at least 10 years, and ideally 20 years or longer. First of all, I don’t claim to be a retirement planning expert. That said, I believe a strong possibility exists that we will experience substantially higher taxes over the next 25-50 years. Today’s top income tax bracket is the lowest it has been since the Great Depression (with the exception of 1988-1992). With an unsustainable national debt, higher taxes should be viewed as inevitable. Between that and

36

the tax treatment of various savings vehicles, the following order of maximizing contributions (where available) is what I recommend to my clients: [1] 401(k) with employer matching: I tell my clients to contribute only what is needed to maximize the employer matching. This is free money, so don’t pass it up, even if it’s taxable. Employers who match 401(k) contributions most commonly do so dollar-for-dollar up to 3 percent of salary. If matching is not dollar-for-dollar, it may still be worthwhile, but consult a retirement planning professional to maximize the match effectively. [2] Roth individual retirement account (IRA): Even with a low contribution

limit, a Roth IRA offers 100 percent tax-free growth and distributions. For higher income earners, the availability of a Roth phases out above $112,000 for individuals and $178,000 for joint returns (for 2013). However, I tell my clients that if they qualify for a Roth, to max it out while they can! Don’t forget that after five years, Roth IRA holders, regardless of their age, have penalty-free access to principal. For your 1099 contractor and business owner clients, you effectively can create an account with 401(k) level contribution limits and Roth tax treatment. Talk to a retirement planning professional.

[3] Cash value life insurance: This enjoys taxation almost identical to a Roth IRA but with no specific limit on the amount put in each year. It seems common that in the day-to-day activities of helping our clients with their diverse needs, we unintentionally can leave out some of the key benefits of cash value life insurance. The obvious benefits are tax-deferred growth and income taxfree death benefit. Often not explained to clients are the tax-preferred distributions (effectively tax-free with proper planning and an overloan protection rider), no “contribution” limit and creditor protection when individually owned (varies by state).

InsuranceNewsNet Magazine » August 2013

IULs are still relatively young as far as life insurance products are concerned. It is vital to choose a carrier with a long-standing reputation of doing well by their insureds and policy owners. Obviously, with IULs still the newbies of most carriers’ product offerings, it’s not always easy to compare carriers based solely on how long they’ve been in the IUL market. With IUL being primarily a cash value accumulation product, it is prudent to consider the carriers’ history of cash accumulation products in general, whether that is through whole life, current assumption UL or variable life products. If the carrier has a long history of strength in those types of products, even if the carrier may not be offering them today, that is a good indicator it is diligent in designing an IUL product offering. Ignore for a moment the difference between one IUL product and another. Think only of the concept of the product. IUL is not a risky product. Downside protection and upside potential is an appealing value proposition. What’s not to like? But with anything that initially sounds attractive, there is a tradeoff. Let’s look objectively at how these products work. One of the most common questions I’ve heard as IULs have grown in sales and popularity is: “How does an insurance company afford the return potential that it offers?” A common misconception is made when answering that question. Explaining the trade-off of earnings above a cap rate is not an accurate answer. Life insurance companies offering these products are actually buying call options from an investment firm or bank that offers options on the index to which the carrier is linking their indexed crediting, most commonly the S&P 500. Call options, put simply, are the insurance company buying the right to purchase the stocks at a given point in the future, but at today’s price and only up to a specific amount of growth (12 percent for example). This is a win/win situation for all parties