The more I study the intricacies of Indexed Universal Life (IUL), the more I find it the golden egg of the financial world. This is particularly true when you introduce “Compared to What?” which I’ll present further down in this Blog.
The opportunity to couple valuable policy death benefits with cash values credited with interest rates equivalent to a high percentage of S&P returns is, of course, one of its key lynch pins. The floor of a 0% guarantee to insulate against negative yields is another.
Provided the policy is not a modified endowment contract (MEC), the icing on the cake is the opportunity to access cash values by way of participating loans. Traditionally, the rule has been to use tax free withdrawals up to cost basis (basis being the sum of premiums paid) and then switching to tax free policy loans once cost basis has been exhausted.
The advent of participating policy loans is a real game changer and dictates their use from the get-go as the preferred way of accessing cash values for, say, tax free retirement cash flow. Such loans add a serious level of interest rate arbitrage, often associated with foreign currency transactions but previously unrelated to life insurance transactions.
It only works well if the loan interest rate charged by the issuing insurance companies is guaranteed for the life of the policy. ?If you can borrow against accruing cash values at a guaranteed rate of say, 5%, and the cash values securing the loan can still participate in a share of S&P returns (guaranteed never to be lower than 0%), you then have the following benefits of 21st century life insurance:
Policy cash values accrue free of income tax;- Policy loans are free of income tax;
- Cash values securing loans participate in the selected index;
- Policy death benefits are free of income tax.
There is nothing in the financial world quite like this package of benefits.
Caution: ?You and your clients must manage the amount of policy loans to be sure the policy contains sufficient residual (unborrowed) cash value to prevent a lapse of the policy as that event could trigger taxation of all policy loans in excess of cost basis. Some life insurance companies have sophisticated concierge units whose purpose is to assist policy owners in the management of policy loans.
Case Study #1
Let's look at “Compared to What” mentioned previously. No financial product is good or bad in the abstract. Real value is determined by comparison to reasonable alternatives.
Case Study #2 (The Amazing Impact of Participating Loans)
Elizabeth Rand, age 40, is Board Certified orthopedic surgeon specializing in sports injuries. She is evaluating a $3.6 million IUL illustration at 7.50% compared to buying 30-year level term and investing the difference.
Click here to review the details of her term vs. permanent comparison from the InsMark Illustration System. As you can see on Page 2 of the illustration, even with an extraordinarily low assumption for the term premium and a side investment fund earning 7.50%, the “difference” of term “term and invest the difference” runs out in year 28 (her age 68).
Participating Loans: With Case Study #2, you can really see the impact of participating loans. Notice in Column (9) on Page 2 of the illustration that policy loan activity of $120,000 a year begins in year 21 of Column (4). As you might expect, cash values begin to decline in Column (9). The yearly decline gradually slows until year 34 (age 74) when it turns upward while still supporting ongoing policy loans of $120,000 a year. For example, by year 40 (age 80), the cash value increase exceeds $43,000 from year 39; by year 50 on Page 3 (age 90), the cash value increase exceeds $184,000 from year 49; and by year 60 (age 100), the cash value increase exceeds $642,000 from year 59. This is the power of participating loans.
Note: In the InsMark Illustration System, you can compare IUL with taxable, tax exempt, tax deferred, and equity accounts. (They all lose -- significantly so when participating loans are illustrated.)
If you are licensed for the InsMark Illustration System and would like to review the menu prompts we used for this analysis, please email us at bob@www.robert-b-ritter-jr.com, and we will get the Case Data file (Workbook) right out to you. Be sure to ask for the Workbook for Blog #36: The Magic of Indexed Universal Life.
Click here to learn more about the InsMark Illustration System. You can also contact Julie Nayeri at julien@insmark.com or 888-InsMark (467-6275). Institutional inquiries should be directed to David Grant, Senior Vice President - Sales, at dag@insmark.com or 925-543-0513.
Note: In Blog #37 next week (January 23, 2014), we’ll compare how and why Dr. Rand intends to use the IUL illustration in Case Study #2 in this Blog as the funding instrument for a deferred compensation arrangement.
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