WHY ADOPT THE INDEXED UNIVERSAL LIFE INSURANCE (IUL) POLICY?
Mortgages, taxes, and lower income. Life after retirement can be difficult without a proper retirement plan. Individual Retirement Accounts (IRA) seemed great when first unveiled, but quickly unraveled with many limitations. To curb this challenge, Roth IRA plans provided a profitable means for getting retirement benefits, with the ability to combine a potential for tax-free withdrawals and no required minimum distributions turning the Roth IRA into a powerful retirement income-planning tool. However, Roth IRA rules can make contributing to them, and withdrawing from them more complicated than initially thought. In fact, any client with a large IRA or 401k has a tax problem.
Enter Indexed Universal Life (IUL) insurance, an IRS approved source of tax-free retirement income – which doubles as a proper retirement plan, and a life insurance policy. The Indexed Universal Life (IUL) insurance policy, when properly set up by a licensed financial professional, offers tax advantages no other single product can provide. Indexed universal life (IUL) insurance policies are cash value policies which can be allocated into an equity index account or a fixed interest account. IUL is not unlike more traditional retirement vehicles like the Roth IRAs in that cash value accumulates tax free over time based on an equity index. However, it comes with the added benefit of unlimited contribution levels, plus life insurance. This means there are no limitations to the premiums clients can contribute annually, which makes them ideal for high net-worth individuals who desire to earn tax free income post-retirement. It also means account holders in IUL plans have a reliable life insurance policy, with death benefits paid out to stated heirs in the event of death.
When the IUL makes sense over a Roth IRA…
Roth IRA annual contribution premium is strictly capped by the IRS – $5,500 (or $6,500 for clients older than 50). For clients with high net worth of up to $116,000 ($183,000 for couples), contributing to a Roth is limited. Contribution is completely prohibited by the IRS once a clients’ income exceeds $131,000 ($193,000 for couples). As a result, benefitting from the Roth IRA for high net worth clients, requires a complicated multi-step process with rigid restrictions placed on annual contributions. Should a client wish to take a Roth distribution before the 591/2 age restriction without the occurrence of other “triggering events”, the portion of the distribution which exceeds his after-tax contribution is taxed, and the benefit accruing from the Roth IRA will be eliminated.
IUL insurance policies, on the other hand, come with less limitations. While the client has to wait for the cash value to build-up (usually over a period of 10 – 15 years) before taking tax-free withdrawals, once substantial cash value is accumulated, clients are free to begin tax-free withdrawals without the restriction of the 591/2 age policy. Withdrawals made do not have to be paid back into the policy but simply reduce the policies death benefit.
Why does it work?
Two concepts lie at the heart of the IUL. The first is the concept of the mutually-owned life insurance company. The second concept is the concept of direct recognition — or more precisely, the lack of it.
The concept of mutually owned life insurance company means that policyholders rather than corporate shareholders own the company. This ownership structure means that profits go to policyholders, as a result, boosting the returns in cash value policies, and subsidizing the cost of term life insurance policies. According to IRS Code Section 101(j) dividends paid to insurance policyholders under current tax laws are tax-free, which means after-tax returns on participating policies of the insurance company.
The concept of direct recognition, or lack of it is a little more technical, and is little understood beyond insurance circles. To properly understand it, let’s assume a client has $100,000 in cash value, and borrows $50,000 against the policy to buy a house. The insurance company only pays dividend on the cash value left after any loans are taken out – in this case, the $50,000 left in cash value. While, insurers who do not practice direct recognition charge interest on the loans, but continue paying the agreed crediting rate on the money borrowed against. Thus, when one borrows against an IUL insurance policy, one borrows from the general funds of the life insurance company, while the cash value in ones policy is used in order to secure the loan.
For IUL policies that do not practice direct recognition, you never have to repay the loan collected against your cash value. Instead, it provides you opportunity to arbitrage the difference between the minimum crediting rate on cash values, with dividends on one hand, and insurance company loan interest rates on the other, to create a source of very cheap credit. So, for non-direct recognition policies, the cost of capital to the client is the difference between the dividend rate, and the loan interest rate. Therefore, for years with unusually high dividends, the loan can become a type of free money.
The IUL policy thus provides a smart source of liquidity, without the drawbacks of credit application and heavy paperwork. This means you don’t have to pledge a collateral, and you never have to pay back the loan. The insurance company pays itself through interests, and death benefit payments, if needed. However, when loans collected against the policy are paid off, you get the opportunity to take advantage of the cheap financing again and again. It also gives room for you to enjoy the retirement plan until death, without the possibility of funds running out before that.
Provided you do not contribute more than the maximum allowable premium for the death benefits – thus, turning the policy into nothing more than a modified endowment contract – the IUL insurance policy is the best available life insurance policy.
The indexed universal life insurance also provides more tax benefits than traditional retirement accounts. It is also a great retirement plan for high net-worth individuals who can leverage the tools it presents for greater tax-free retirement benefits.
All in all, we at TailoredQuotes only believe an IUL makes sense:
- For individuals who take retirement seriously and want to add to their portfolio.
- For individuals who make too much to contribute to a Roth IRA.
- For individuals who need life insurance, and they’re not disciplined financially to contribute to a retirement vehicle.
If you’re considering an IUL, be sure that you compare illustrations from an licensed independent financial professional. Give us a call toll-free at 1-888-503-8382 or send us an email to email@example.com to show you an illustration at no financial charge to you.