Brian Manderscheid

The life insurance industry heavily promotes and focuses on the idea of using Indexed Universal Life (IUL), or other cash value life insurance policies, for a supplemental tax-free retirement income stream or even to “become your own bank.” However, in recognition of Life Insurance Awareness Month, I want to present a concept using Indexed Universal Life for the purpose of life insurance.

This strategy involves the use of a Premium Deposit Account to fund an Indexed Universal Life policy, with an optional future return of premium through a tax-free withdrawal, not a loan. A huge advantage is that in addition to having all premiums essentially reimbursed, the policy still provides a life insurance death benefit for their beneficiaries or supplemental funds for long term care (LTC) expenses. To demonstrate the efficiency of this strategy, I will first explain the steps and process involved, then provide a client case study to illustrate the scenario and share the projected client benefits.

First, let’s establish common ground with our current, post-pandemic, economic
environment. During the pandemic, a substantial amount of liquidity was pumped into the system through various stimulus packages. As the economy slowly reopened, the combination of significant liquidity and supply/demand imbalances caused a severe spike in inflation. In response, the Fed-raised interest rates climbed at one of the fastest paces in history to slow the economy and subdue inflation, bringing us to today.

While this interest rate cycle is negative for borrowers looking to take out loans, it has been great for savers looking to put money aside for the future. However, some weakening pockets of the economy and early stages of deflation indicate the potential chance for interest rate cuts, with experts anticipating reductions at the September FOMC meeting. The deadline for rate decreases is tight, unpredictable, and impactful. In anticipation of these rate decreases, we find many people are rushing to lock in today’s high interest rates through long term CDs, longer term bonds, or annuities. This brings us to a strategy that allows a policyholder to lock in rates and have their premiums reimbursed down the line, all while enjoying the benefits of an IUL.

The strategy begins with a one time lump sum premium to the insurance company without creating a Modified Endowment Contract (MEC). The insurance company then uses a portion of the lump sum to fund the first-year premium payment and places the remaining portion into the Premium Deposit Fund (PDF). The PDF is essentially a holding tank for the remaining premiums of the policy and a way to systematically fund the remaining premiums.

In light of today’s higher interest rate environment, the insurance company offering this PDF holding tank recently increased the discount rate to a non-guaranteed six percent. The actuaries at this specific insurance company who recently launched their new IUL product and raised the PDF rate acknowledge the fact that this rate is non-guaranteed and subject to change. However, it is likely the last lever they would pull, meaning they would most likely adjust cap or participation rates first and for people who purchased the policy today, and that the six percent rate may potentially last throughout the PDF period. Likewise, the discount method works differently from an interest rate in that the discount credits are highest at the end of the period instead of the beginning. Lastly, the PDF discount credits are taxable as ordinary income, and the owner will receive a 1099-INT.

To demonstrate this concept in more depth, I put together an example case study that will aid in understanding just how effective this strategy can be. For this scenario, the policyholder is a 50-year-old woman in great health who recently lost her husband a little over a year ago. Fortunately, her husband had life insurance. With the life insurance proceeds, she was able to pay off debt, do some home remodels, and shore up her liquidity needs. At the time she didn’t want to put the additional proceeds in the stock market and expose her money to significant risk. She knew interest rates were high roughly a year ago and she purchased a one-year CD for $250,000. That CD is coming due and she’s looking at options to better achieve her financial goals and potentially lock in today’s high rates for longer.

As for her financial goals and situation, legacy is her number one goal and she is in a solid position from a retirement income standpoint. She saw the power of life insurance with her husband who passed, and she wants to make sure her two kids are taken care of and she can leave financial assets behind for them. In addition to receiving her husband’s 401k upon his passing, she is contributing to her own 401k at her employer. However, she anticipates needing additional income in the future to help supplement her current retirement plan. Lastly, the only other missing piece of her financial plan is she doesn’t have a dedicated source or pool for potential future long term care (LTC) expenses. She doesn’t necessarily want an ongoing premium payment to pay for LTC insurance but wants to have funds dedicated for long term care should she need it down the line. Now that we’ve established her financial goals and standing, let’s apply the PDF approach laid out in the beginning to see how effective it is as a financial solution for this particular client.

In this example we recommended funding a one-time premium payment of $250,000 from the renewing CD using the Premium Deposit Fund. Based on the six percent non-guaranteed discount rate, the PDF funds premiums of $32,044 for a 10-year time frame. A total of $320,443 in premiums paid using a one-time $250,000 contribution. The policy was illustrated with the least amount of death benefit the IRS would allow to maximize how much premium will go towards cash value growth and minimize the underlying insurance fees and mortality expenses. The initial death benefit we purchased was just under half a million dollars using an increasing death benefit. A switch to level with a maximum face decrease was illustrated in policy year 11 to further squeeze down the mortality expenses.

While this is not set in stone, we illustrated the ability to take a tax-free withdrawal (not a loan) of $250,000 at age 65. To reiterate, she funds a one-time contribution of $250,000 into the PDF with $320,000 of projected premiums and takes a tax-free withdrawal of a portion of her cost basis of $250,000 at age 65. She is not locked in to taking that withdrawal amount, but we talked about the various options for her retirement at the time. Maybe it’s using the withdrawal to cover a down payment to purchase a rental property, or it’s an investment account with diversification of stocks and bonds, or maybe it’s even an immediate annuity to provide guaranteed lifetime income. Those options are open, and we’ll discuss those once we get there.

In the meantime, let’s look at the projected illustrated values of the remaining cash value and death benefit. These values are projected, non-guaranteed, and based on a six percent illustrated rate without any bonuses to show a true six percent projected return. At age 65, there’s roughly $258,000 in the remaining cash value in the policy after making her $250,000 tax free withdrawal, which again, she does not need to pay back in the future because it is not a loan.

At age 85, that projected cash value is over $750,000 and can be used for a long term care pool, whether she withdraws the remaining roughly $70k of cost basis or takes fixed or participating loans. She can also use the Chronic Illness Accelerated Death Benefit rider if she is unable to perform two of six daily living activities. Assuming the remaining funds are never used for long term care or any other purposes, there is an illustrated death benefit of over $1,000,000 at age 90 which can provide the legacy she’s looking to bestow upon her kids for the next generation.

I stress-tested this scenario by looking at the minimum rate of return required for the $250,000 tax-free withdrawal that refunds her paid premiums, excluding additional premiums from the PDF discount rate, and provides a death benefit to age 100. At a 2.60 percent projected growth rate the remaining death benefit after the $250,000 withdrawal was roughly $217,000 and sustained at that level through age 100. Keep in mind this insurance carrier is currently crediting a 5.40 percent one-year fixed rate.

To summarize, we believe the overall interest rate environment is heading lower from its current levels due to the expected Fed rate cuts, whether it’s later this year or next. This likely reduced rate environment will impact everything from online savings rates, money market accounts, CDs, annuities, and even life insurance products. Clients and prospects may like the idea of locking in today’s high rates for longer prior to these expected cuts. If interest rates do stay higher for longer, that will be a positive situation for the insurance carrier’s general portfolio which should help support cap and participation rates for IUL and dividends for whole life.

If you like this concept, there is a client friendly video you can share with your clients or prospects. Registration on LifePro.com is not required to view this video, but if you choose to, we can create a branded page complete with your company information that the shared video will be on. I encourage you to check out the growing library of 300+ education financial videos to help your clients see the value of your services and yourself as their trusted advisor.

https://www.lifepro.com/Blog/how-to-fund-an-iul-and-get-your-premium-back.

In 2022 everything went perfectly wrong for investors. With inflation running at 40-year highs and the Fed raising interest rates at its fastest pace ever, the S&P 500 lost almost 20 percent, which was the worst performance since 2008 when it was down roughly 38 percent. Historically, bonds perform inversely to the stock market which helps absorb stock market losses in down years within a diversified portfolio. However, even intermediate-term Treasury Bonds, long considered a safe haven, were down double digits at -10.6 percent. This was the biggest decline on record dating back to 1926. This prompted articles and debates on whether the long standing 60/40 portfolio was dead or if it is still viable.

While many investors suffered one of the worst loss years in recent memory, indexed universal life sales set a new record in 2022 with a total of $2.7 billion in sales, up 10.9 percent from the previous year. The influx of sales could be attributed to many factors. For instance, investors and retirement savers may be looking for lower risk vehicles to build and distribute wealth. Or they may gravitate towards the potential tax savings IUL provides on growth, access, and transfer. Maybe it’s due to the constant 24/7 marketing through social media channels. Nonetheless, IUL sales have continued their upward climb over the years and are no longer a “fad product” in the life insurance marketplace.

When I obtained my life insurance license in 2006 there were mostly only off brand carriers offering IUL with the big players stating they would never get involved. Since then, most of those carriers, including just about all the big names excluding a few career shops, now offer IUL as part of their product portfolio. So, what changed about IUL sales between the “wild, wild west” days of 2006 and where we are now? Well, I vividly remember IUL illustrations with 10 percent+ illustrated rates and variable loan spreads at almost five percent with some carriers. With these assumptions you can make an inferior product not only illustrate well but look better on paper than just about any financial vehicle out there. Luckily for all parties involved, this is not the case anymore.

Since then, there have been three rounds of AG-49 attempting to curb illustration abuses and mischievous sales practices. But there is always room to grow, and we can still improve how we provide the proper information to the consumer so they can make an educated decision on if using an IUL to supplement retirement is beneficial for them. The purpose of this article is to examine the issues surrounding the use of an IUL as a retirement supplement, what alternatives are available, and if/when IUL should be considered.

Right Vehicle, Wrong Fit
When coaching clients and advisors, the first question I ask when considering an IUL is, “What is the life insurance need?” The industry focuses so heavily on building and accumulating cash value, while often losing sight of the fact that an IUL is a life insurance product at its core. Clients looking at an IUL policy as a retirement supplement must have some basic need for life insurance first. This could be protecting income while working, debt or mortgage protection, or estate planning.

Far too many times I have seen advisors pitch IUL as an alternative to a 401k to clients who are not married, do not have kids, or do not own a home. I have also seen IUL policies put in force for clients who are severely health rated, which adds a significant amount of higher expenses to the policy and makes it much less suitable to use as a retirement supplement. Additionally, IUL policy expenses are front loaded, making it a poor option for older clients looking for income in a handful of years. Unfortunately, these advisors also fail to mention other tax-free options that may be a better fit, some of which I will expand upon later.

IUL should instead be offered to clients who are healthy, have higher income/net worth, have a need for life insurance, can fund premiums out of cash/bonds or cash flow for a minimum of five, preferably 10, years and have a longer time horizon.

Poor Design, Front Loaded Expenses
Assuming the client has the life insurance need, the next step is to ensure the IUL is structured correctly. Far too many times I see advisors “target fund” accumulation IULs to increase their commission at the detriment of their client. You see, the front loaded “per thousand expenses” and surrender charges are based on the initial base death benefit purchased which, in turn, calculates the target premium (or commission). When using IUL as a retirement supplement it is imperative to structure the policy at maximum efficiency. This entails designing the IUL with the least amount of life insurance the IRS will allow, funding right up to the IRC guidelines, and managing face option switches or reductions when allowable. Failure to do so can make the IUL one of the worst performing vehicles in a client’s retirement plan.

Designing an IUL at maximum efficiency does not give it an automatic pass as a viable option for a client to consider. Policy expenses from carrier to carrier vary wildly, with some carriers offering lower expenses while others are significantly higher. To demonstrate this, I ran illustrations through two different insurance companies offering accumulation IUL with the same client inputs. For this example, I used a 45-year-old male, preferred non-tobacco health, $50,000 annual premiums for 10 years, minimum increasing death benefit, switch to level in year 11 with a reduction to the minimum face amount.

Carrier A had cumulative expenses through age 85 of $125,028.

Carrier B had cumulative expenses through age 85 of $582,820, over four times higher internal expenses for the same exact scenario.

While Carrier B did have other features that Carrier A did not have, the fact remains if the underlying index does not perform as illustrated the carrier with the higher fee drag loses.

The Consolidated Appropriations Act of 2021 did provide some relief to IUL expenses by reducing the minimum IRS death benefit required per the level of premium funding. Nonetheless, IUL fees in general are front loaded with both low cost and higher cost carriers. Due to these front-loaded expenses, an IUL purchaser may not even break even on a surrender value (walk away) basis until after policy year seven or longer, even with a maximum efficient design and lower expense IUL.

IUL Swiss Army Knife, No Alternatives Given
In addition to the IUL design itself, it is essential the IUL is built within a comprehensive, holistic financial plan instead of looking at the IUL in a vacuum. Recently I have watched far too many cringy IUL pitches on TikTok or YouTube. These “internet famous” social media advisors seem to focus less on reliable and accurate content but more on sensationalism, views, and likes. I recently watched an advisor call an IUL policy a “501k” in a blatant attempt to misrepresent the product and make it sound like a government approved retirement plan.

Wild claims I’ve seen include: IUL policies will average double-digit returns without any loss or risk; IULs are far better than your 401k, even if you’re getting a match; IULs were previously secrets that only the wealthy were able to obtain but are now available to everyday folks like you and I; IULs will easily beat the stock market in the long run; and, ditch the old “never put your eggs in one basket” approach and instead put all your eggs in an IUL. The list unfortunately goes on.

The commonality in all these compliance departments’ nightmare sales pitches is the sentiment that the IUL is the “magic pill” that will take you from not having money to a wealthy multimillionaire retired on a yacht that is anchored on your own private island. But an IUL is not a get-rich-quick scheme and should not be portrayed as such. Also, IUL should never be viewed as an “instead of” vehicle. It should be correctly viewed as an “in addition to” vehicle.

Clients seeking tax diversification from taxable and tax-deferred vehicles should instead look at all the tax-free options available to them. Rather than putting all their eggs in an IUL, clients should instead consider Roth IRAs, Backdoor Roth IRAs, Roth 401ks, Roth IRA conversions, and an IUL for the right situation.

For example, if a married couple is younger than 50 and under the Roth IRA income phase out limit, they can contribute a total of $13,000 per year to Roth IRAs. Assuming both spouses also have Roth 401ks at their employers, they can contribute another $45,000 between the two. That is $58,000 annually this hypothetical couple can stock away into tax-free vehicles. Additionally, they may have a down income year for any given reason, which could open the opportunity for Roth IRA conversions if they have enough cash or cash flow to pay the taxes.

For higher income or net worth clients who have maxed out the above tax-free sources, the IUL provides that “next best” alternative for tax-free planning. Of course, assuming the IUL is set up with a highly rated carrier who has a strong track record of renewal rate integrity, done so for the right person, and designed correctly with a lower expense carrier.

Lastly, something we have not yet touched is the idea of “under promise and over deliver.” The current NAIC illustration model projects IUL values and loan arbitrage with constant and level returns. The reality is clients will get zero percent returns in bad years, causing their cash value to go backwards if they do not pay premiums. Or they may get potentially double-digit returns in good years. And, of course, everything in between.

Rather than illustrating the maximum client benefits that the insurance carrier software can provide, we instead recommend dialing down the assumptions. This could be through reducing the illustrated rate, reducing the illustrated income, or a combination of the two. While this may make your IUL illustration less competitive when compared to other advisor run projections, remember it is not about the illustration! Instead, it is more about creating realistic expectations with the potential to exceed them in the long run. While we can’t guarantee performance, one thing I can guarantee is you will actually make more sales, have more satisfied clients, and get more referrals if you under promise and over deliver.

Summary
With the rockiness we have seen in the stock market, the potential for an upcoming recession, the national debt crisis, and the Tax Cuts and Jobs Act sunsetting in 2026, IUL is positioned well for a continued rise in sales. My word of caution, however, is to make sure we continue to build the IUL industry the right way. This involves using IUL the right way for the right person. That includes selecting an appropriate IUL carrier emphasizing actual client performance and policy expenses, utilizing IUL as a part of a complete and holistic financial plan involving other tax-free vehicles, and providing realistic expectations and a clear explanation of benefits.

This material is intended for educational purposes only and is not intended to serve as the basis for any purchasing decision. Premium rates vary by a number of factors, including carrier, product, client health and age, and a number of other factors. Remember to consider your client’s individual circumstances and objectives when discussing their specific situation. Guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company.

Investment advisory and financial planning services offered through LifePro Asset Management, an SEC Registered Investment Advisor. Registration does not imply a certain level of skill or training. Investments involve risk.