Brian Manderscheid

With all of the recent government tax and spending proposals, some of which may be signed into law in some form or another, the concept of tax advantaged growth and supplemental tax-free retirement income from a properly structured indexed universal life is certainly continuing to gain steam. Of course, coming out of a major pandemic, prospects and clients also can better see the value of owning life insurance. As a 15-year veteran in the indexed universal life space I can tell you that today there is no shortage of IUL products in our industry. Each tend to fit inside a particular niche, whether that is accumulation-focused, death benefit protection or even living benefits such as chronic and critical illness. Out of the roughly three dozen indexed universal life products, there are a handful, maybe just two, of top tier IUL’s that excel in the cash value accumulation space.

However, you can have the best IUL in the marketplace, and if it’s not structured within the best interests of the client with the minimum amount of life insurance that the IRS will allow, funding right up to the maximum Internal Revenue Code guidelines, it could actually be a poor addition to a client’s overall financial plan. It’s important advisors work with a qualified independent marketing organization who can shop around insurance companies to find the best product for a client’s situation, are leaders in the IUL space, and can set these up correctly.

One of the best, top-tier, accumulation focused IUL policies is actually one you may have never heard about. The reason being it’s a proprietary product only available to a select group of high-quality organizations and their respective advisors.

First, to backtrack to 2015, and again to 2020, there were two different regulations that were put in place to help minimize the illustrated values and loan proceeds of IULs. This was an attempt to get rid of some of the abusive sales practices in our industry, all of which were great steps for prospects and consumers alike. However, some insurance carriers reacted by making this great product more confusing, introducing various bonus options (some guaranteed while others being non-guaranteed) and adding significantly higher policy costs to an already somewhat expensive product.

Really their goal was to provide the best looking illustration and ledger to the prospect in hopes of winning the “illustration war.” The company I want to focus on today did things the exact opposite. Rather than focusing on the best looking illustration, they took the path of focusing on the best long term consumer value. To do this they’re not relying upon bonuses to provide the value. Instead they’re focusing on a simple design, low policy costs, high uncapped performance, loan flexibility and a proven history of high renewal rates.

This insurance company has one of the lowest policy costs in the industry, and to highlight that, the premium load is only 5.5 percent. The reason I point this out specifically is that premium loads have increased substantially with some of these new generation IUL products. Those premium loads are used to cover state premium taxes, the cost of bonus features, even profitability for the insurance company and of course advisor commissions.

This company has also updated their IUL product with the updated 7702 guidelines. January 1, 2021, the IRS updated the 7702 guidelines which dictate the level of life insurance that needs to exist in order to receive all of the tax benefits permanent life insurance provides. Resultantly, insurance companies were able to update their products and basically reduce the amount of life insurance that must exist for the dollar of premium funding. The benefit for this IUL is they’ve already updated it with the new 7702 guidelines which further reduces the life insurance cost structure. Additionally, they’re a highly rated insurance company. They have a 96 Comdex. Comdex is a 1 to 100 score, and 96 is one of the top ratings for a life insurance company offering an indexed universal life.

Let’s next talk about the fact that it’s a proprietary product with proven performance. Now, to give you an analogy, there are other low cost IULs in the industry, but think of them more like a Prius. You’re going to have the efficiency and high miles per gallon, but you are not going to have the horsepower or performance. This IUL not only has the efficiency in the low policy expenses, but it also has the performance upside. So think of this IUL more like a Tesla, where you have the efficiency of the electric engine but you also have a high amount of horsepower.

To do this, this product has three different uncapped index strategies all with participation rates greater than 100 percent. Let’s say the underlying index provided a 10 percent return and your participation rate was 125 percent. Your client would receive a 12.5 percent rate of return with no cap or upside limit. They also have three different index crediting segments: A one-year, a two-year, and a three-year, all with impressive 30-year lookback returns. As we know, past performance doesn’t predict any future results. While the averages look great, they look at past index data and current participation rates. We don’t know what the next 30 years of index data will look like and what participation rates will be. The low interest rate environment may continue to cause a drag on the insurance companies’ general portfolio yields causing participation rate pressure.

30 Year Average: One-year segment 7.55 percent, two-year 8.18 percent, and the three-year 10.63 percent.

Again, all very strong returns, but I’d take that with sort of a grain of salt considering we don’t know what the next 30 years will look like. The way these indexed allocations are structured is that the insurance company can provide higher cap and participation rates based on the cost of the options. These options and derivatives are based on the volatility of the underlying index and the time length of the index segment. Longer indexed segments essentially allow the insurance company or investment bank to offer greater cap or participation rates.

However, there is some risk with longer-term segments. Let’s say you have two really good years where the underlying benchmark is having a solid run. But a bad third year comes along that may potentially wipe out all your gains for the entire three-year segment. One way we mitigate against that is a very diversified approach. We recommend allocating a third into each of these indexed segments. Not only are we diversifying allocations, but we are also diversifying time. One key differentiator of this IUL is that it provides partial index credits for three reasons: Monthly deductions, withdrawals and death. With most insurance companies, if your client dies halfway through the segment, their beneficiaries are not going to receive an index return. With this policy, let’s say you’re two years in on a three-year segment and your client passess away. Their beneficiaries will still receive proportionate credit for the time they were in that index segment. Again, not only are we recommending diversifying the indexed strategies, but we also have a feature in this IUL to help mitigate against some of the risk of longer-term segments.

Lastly, loan types and rates are crucially important for a top-tier accumulation IUL. The way these policies work is you’re not actually withdrawing money from your life insurance policy, you’re merely taking a loan from the insurance company with your life insurance cash value and death benefit as collateral. Additionally, the amount you borrow from the insurance company continues to earn index returns in the contract, which can be quite substantial. The way to win with an accumulation IUL policy is to have low borrowing costs from the insurance company and high upside on the index.

This insurance company has three different loan types. A fixed loan (net wash after 10 years), an indexed loan and a variable rate loan. The index loan has a contractually set guaranteed rate of 4.75 percent. No matter what happens with interest rates, the insurance company can never charge more than that stated rate in the contract. The variable loan works a little differently, as the rate is based on the Moody’s Corporate Bond Yield Average, which as of right now is historically extremely low.

You may ask yourself, what happens if interest rates increase with a variable rate loan? Well, that is going to increase the variable loan rate. However, there is a cap in this policy of one percent over and above the fixed rate, which is similar to a moving target. The fixed rate currently is 3.25 percent, so one percent above that creates a current 4.25 percent cap. The nice thing about this IUL is it allows for the ability to switch loan types once per year. Hypothetically if your variable rate loan starts to exceed 4.75 percent you can switch loan types to the index loan and lock in that 4.75 percent rate. The nice thing again is this insurance company gives you the flexibility to decide that.

To summarize, this proprietary IUL offers a simple, low cost design, high indexed upside performance and great loan options with plenty of flexibility. To top it off, it’s offered by a highly rated carrier that has plenty of experience in the IUL market place. Our high net worth and high-income earning clients are looking for solutions to mitigate current and future taxation. If you aren’t delivering this message, they will surely be hearing it from someone else.

There are three things that are certain in life: Death, taxes and tax law changes.

In December of 2017 the Tax Cuts and Jobs Act (TCJA) was passed creating a limited window of opportunity to pay taxes now at possibly the lowest tax brackets of our lifetime. There were many significant changes to the individual income tax laws including reforms to itemized deductions and the alternative minimum tax, increased standard deductions and child tax credits, and lower marginal tax rates across all brackets. The intended results for the lower income tax rates for individuals and businesses was to spur economic growth and create new jobs. The unintended consequences may very likely be higher federal debt levels and higher future income tax rates-especially for higher income earners. As the law stands today the individual income tax reductions end December 31, 2025, and will sunset in 2026 to the pre-TCJA levels from 2017. This assumes of course another administration doesn’t impose legislation to repeal the TCJA and put in place a new set of tax laws. This would once again spur another round of tax resolution marketing from accountants in order to find clients that need their taxes done correctly and legally.

So what does this mean for us?
Specifically addressing lower tax rates, this may cause traditional retirement accounts such as 401(k)s and IRAs to become less favorable. This will automatically spur the need for tax-resolution-services as people will want to understand where they stand in terms of their tax accounts. The reason being that 401(k)s and IRAs are specifically designed to defer income for today’s tax dollars with hopes of withdrawing contributions and gains at a lower tax rate in retirement. With a lower tax rate today the implied benefits of upfront tax savings would be reduced. For example, let’s assume a married couple 50 or older earning $200,000 and contributing $20,000 towards a 401(k). This couple would have been in the 28 percent tax bracket pre-TCJA and a 24 percent tax bracket currently. The impact is that the “tax savings” on the 401(k) contributions would reduce from $5,600 to $4,800-which is more than a 14 percent reduction. Something critical to point out is that in both situations we really aren’t saving taxes, but instead merely deferring taxes to a future date with an unknown tax rate. Essentially we are kicking the can into an unknown future where tax rates may in fact be higher. If you want to find out more about the art of taxes, you might want to ask someone this like tax accountant NYC any questions you might have on taxes.

With the tax rate drop and uncertain future tax rates, Andy Friedman of the Washington Update believes retirees should plan for something called “tax volatility.” Andy, a former tax attorney and current keynote speaker, stated investors “should maintain liquidity in both taxable and tax-deferred accounts and in tax-free investments. That way they can withdraw funds from one or the other depending on whether it makes sense to pay taxes that year (and if so whether to pay at ordinary income or capital gains rates).” Friedman adds, “Preparing for tax volatility allows an investor to take advantage of tax changes, whichever way they might go.”
Andy Friedman’s comments echoed what we at LifePro have been saying for years. Due to future tax rate uncertainty, our clients should add “tax diversification” to their overall comprehensive retirement plan by making sure they have an adequate mix of dollars inside their taxable, tax deferred and tax free buckets. Make sure clients are properly diversified in various asset classes (stocks, bonds, real estate, annuities, life insurance, etc.). Why not take the added step to also diversify tax types? Financial experts across the country are making similar statements-the TCJA could mean vehicles like Roth IRAs, Roth 401(k)s and indexed universal life may be more appropriate for some investors.

What do industry experts anticipate?
Experts are saying the income tax deduction from a 401(k), or traditional IRA, provides less value in a low tax rate environment, particularly when the deferred income may be taxed at higher future tax rates. While we can’t be certain tax rates in the future will be higher, we can look at data from the best and brightest who believe we as a nation are on an unsustainable path with trillions of dollars in debt coupled with trillions in unfunded future liabilities.

Another popular keynote speaker, David Walker, former Comptroller General of the US and head of the GAO for a decade, stated government debt “is not just a financial issue. This is not just an economic issue. This an ethical and a moral issue. We are mortgaging the future of our kids and grandkids at record rates.” Walker, essentially the top accountant for the US Government, has intimate knowledge of our government’s spending, budget and debt. In fact, he once said “we are heading to a future where the U.S. Government will be forced to either cut spending by 60 percent or double federal tax rates.” Regardless of what the current or future administrations propose, they are all inheriting the same math problem in which there are limited solutions: Spend less, increases taxes, or some combination thereof.

What can we do as advisors?
First, we must educate our clients about the importance of tax diversification by making sure we are not neglecting the tax free bucket. We can start to fill up the tax free bucket either by converting existing IRA assets towards Roth, contributing to a Roth IRA or Roth 401(k), or funding an indexed universal life policy. There isn’t a clear one-size-fits-all plan and it depends on each client’s individual financial situation. Clients who are heavy in traditional IRAs and have adequate cash accounts to pay the tax bill may benefit the most from strategic Roth IRA conversions over the next seven years during the TCJA lower tax rate window. One popular strategy is to convert up to the room left in your current marginal bracket. For example, a married couple with a $50,000 AGI can convert almost $29,000 and stay within the 12 percent bracket without jumping up to the 22 percent bracket. For clients who haven’t yet accumulated a significant pre-tax retirement account balance, or have limited cash accounts but have the ability to redirect cash flow, may be better off contributing to a Roth IRA, Roth 401(k) or indexed universal life.

Of course there are income phase outs on a Roth IRA and contribution limits on both the Roth IRA and Roth 401(k). Indexed universal life combines the tax deferred growth and tax free access of cash value with an income tax free life insurance death benefit. Additionally, the cash value growth is not directly invested in the stock market. Instead the growth is based on the price change of an external index, such as the S&P 500, with a limiting factor such as a cap or participation rate. The trade off on the upside limit is a zero percent annual floor protecting the cash value from negative market performance.

As for funding indexed universal life we always want to make sure to buy the absolute minimum death benefit the IRS will allow and fund up to the Internal Revenue Code guidelines. By doing so we can minimize the mortality expenses, which in turn will maximize cash value growth potential. A common structure is to design the IUL policy with the minimum increasing death benefit with a seven year or greater funding period, paying up to the maximum premium limit and switch the death benefit to level once the client is permanently done funding. We call this a “long pay” design as the client has the ability to fund premiums for a longer period of time. We generally use a long pay design for cash flow funded cases where we want the flexibility of being able to choose how long we want to fund. A second common structure is to design the IUL policy with the minimum level death benefit and fund up to the seven-pay premium until we fill up the Guideline Single Premium (GSP), which generally takes about five years depending on the age, gender and risk of the insured. Additionally, with this strategy we can reduce the death benefit down to the minimum cash value corridor after the cumulative Guideline Level Premium (GLP) crosses over the Guideline Single Premium (GSP). We can also use a “short pay” design since our goal is to fund the policy as quickly as possible. We generally use a short pay design for asset funded cases where the client has existing assets and wants to fund those into an indexed universal life policy for the tax favored treatment and competitive returns while eliminating the downside market exposure.

What’s next?
While the TCJA has reduced individual income tax rates for the next seven years, we must look at the bigger picture. Just like a client who is stuck in the repetitive debt cycle, we as a country must first come to terms with our current situation and then act decisively. As advisors we also share some of this burden. It is not just our job, but it should be our mission, to help educate our clients and prospects on the importance of tax volatility and tax diversification. Just like David Walker, we believe we have an ethical and moral obligation to share this information with as many people as possible in hopes that we can help lead them down the right path. More than ever our clients are looking for certainty, clarity and confidence in these uncertain times-which only you can provide.