David Julian

In my finance classes growing up I was taught the benefits of diversification in my retirement assets. My basic high school understanding was that you need diversity in your portfolio with multiple stocks, bonds and mutual funds so that you can manage the different types of risks that go along with investing. What I did not learn at that time was that there is a product out there that fits perfectly with the most common retirement vehicles. The product that is perfect for retirement diversification is fixed indexed universal life insurance (IUL). There are three retirement unknowns that IUL can help manage.  Those three retirement unknowns are the uncertainty of when you’re going to pass away, market volatility and future tax rates.  

How long will my retirement be?
We will start with the biggest unknown we have in life which is not knowing when we will pass away. The death benefit that goes along with life insurance is obviously the reason that most people purchase life insurance in the first place. Since we don’t know if we’re going to pass away in the first year of retirement, or the 30th year, it is always nice to know that there will be a benefit there for our beneficiary as long as the life insurance contract is still active. However, there is one caveat for IULs that are properly structured for retirement income. In a properly structured IUL policy we are using the premium to purchase the lowest amount of death benefit possible.  I’ll show an example so we can see how this works. In this example we have a client that is 45 years old and can pay a $10,000 premium each year into an IUL until age 65. This illustration was run at a modest six percent, and at age 65 we are expecting $28,682 of retirement income.1  As you can see from the summary in Table 1, even though we are minimizing the amount of life insurance, there is still a very significant benefit-between $300,000 and $550,000 from ages 55 to 95-that can be used either for your surviving spouse in retirement or for legacy planning.

Let’s look at a scenario where the client passes away too soon-at age 65. If both the husband and wife had significant work history, you would assume that both would have a significant Social Security benefit as well. If they both had a Social Security benefit of $2,000 a month, they would estimate that they would receive about $48,000 a year of inflation adjusted income annually. The issue, however, is if one of them passes away that number gets reduced by half for the rest of the survivor’s life. It becomes likely in this scenario that the death benefit, in our example, an extra $558,033 at age 65, will be the difference between the survivor having enough money in retirement or running out of money. I also ran a hypothetical scenario where the survivor had $750,000 of retirement assets and needed $80,000 of annual retirement income, and the conclusion was that the survivor would run out of money at age 84 without that life insurance benefit and would only have their lone Social Security benefit left for income.2

When will the market have its next significant decrease?
The second reason IUL can be a perfect product for retirement diversification is to hedge against market volatility. The current popular strategy to hedge against this retirement risk is to have a percentage of your portfolio be in bonds, maybe something like a 70 percent stock and 30 percent bond split if you’re nearing retirement. The two issues with this are that you are still likely to have a significant loss when there is a market crash, and you are not maximizing your returns when the market rebounds-unless you have learned how to time the market. 

Many clients think of the bond portion of their fund as risk free.  However, there is still the risk of losing money, as well as other risks, especially in this rising interest rate environment. With IUL we know that when the market does go down we will have a floor on the index return, commonly zero percent. This means that if there is another 2008 scenario you can have a zero percent return when the market tanks, and hit a cap on returns as the market rebounds (a common IUL cap of the S&P 500 is currently around 12 percent, although there are many different index allocations with varying caps and strategies).

Let’s look at how a client may be able to use the mix of market exposed products in conjunction with an IUL. There is market risk at any time in retirement, however the risk is highest at the beginning of retirement as you begin to take income. If there is a market downturn at the beginning of a client’s retirement it would significantly decrease the chance that they will have enough money in retirement. The good news is, with an IUL you can hedge against this risk. If there were a market crash you can simply increase the income from the IUL for a period of time, since the IUL has the floor of zero percent and won’t take the significant decrease.  At the same time you can wait to take income from your market exposed accounts until the market has rebounded. 

What are the future of tax rates?
The third way an IUL can be a suitable product for retirement diversification is that it can help with tax risk. Although it seems like taxes are currently high, the current tax rates are below historical averages. With the national debt nearing $20 trillion, the signs are pointing to taxes going up in the future. Although we don’t know future tax rates, it’s always good to have some strategy since this is a future unknown retirement variable. 

One of the most popular retirement vehicles is a tax-deferred account, such as a 401k, where the taxes are paid at distribution. It is not uncommon to find a soon-to-be-retiree whose only retirement vehicles are their tax-deferred 401k and their Social Security benefit, or someone who follows the 80-120 rule when it is time to look into 401k audits. There are a few issues with this. Let’s assume our example couple from before has their $48,000 from Social Security and would like $100,000 in total income-so they take a withdrawal of $52,000 from their 401k.  I’ll use a 25 percent marginal tax bracket for easier calculations. On the $52,000 withdrawal they would only receive $39,000 and would pay $13,000 in taxes. This is already a bad start, but it gets worse. Since the 401k withdrawal counts as “Provisional Income” (half the value of the Social Security income plus other taxable income) $8,300 of the $48,000 of Social Security income will be taxed and they’ll only receive $39,700 of that income.3  This means in total they received $78,700 of income instead of the $100,000 they thought they were receiving.

Now we’ll look at that same example with an IUL involved. The clients still have the $48,000 from Social Security, but now they also have $28,682 of income that is tax free from the loan in an IUL.  Now the clients only need to take $23,318 from their 401k to seemingly get this same $100,000 income. With the lower 401k distribution we have lowered their tax rate. I’ll use their new marginal tax rate as 20 percent, but currently it would be even lower than that. With this tax rate, they are paying $4,663 in taxes and are receiving $18,654 as income. What about the taxation of the Social Security benefits? We now estimate that they owe $1,764 in taxes on the Social Security income, which means they are able to keep $46,236 and their total income is $93,572-or $14,872 more income each year that they use this strategy. I realize that my calculation above is a little unfair since I’m using after tax dollars in the IUL premiums while the 401k is tax-deferred in this example. We were, however, able to drastically reduce the amount of taxes paid out of the Social Security benefit and increase the amount of after tax income. 

As we’ve seen from these examples, IUL can be an integral piece of your client’s retirement diversification because it can help with longevity risk, tax risk, market risk and overall product diversification.  Having the ability to use the different strengths of common retirement products and the IUL at the correct time can help manage the risks of retirement and keep your client prepared for the unknown. 

References:

1. Illustration is an Allianz Life Pro+ Fixed Index Universal Life Insurance Policy illustration.
   
2. In this hypothetical scenario I assumed a 6% return on investments and a 1.5% cost of living adjustment and inflation on Social Security and necessary income.
   
3. You can view how Social Security benefits are taxed at this link – https://www.lifepro.com/MyLifePro/Financial-Calculators/Social-Security/SSI-Tax-Calculator

Congratulations! You did it! You helped your client start an indexed universal life (IUL) insurance policy, which will give their family tax-free death benefit protection. The new policy will also help diversify their retirement plan by building the policy cash value, without market risk, that can be used for tax-free retirement income. It looks like everything is perfect, but actually there is still a big potential problem.  For the policy to work as it’s designed the client must follow the plan, which means annual reviews are a must—not only for their plan, but for your business as well.

Stats show that about 11 percent of all life insurance policies will lapse in the first year, and overall each year an average of 4.5 percent of policies will lapse.¹  These may seem like low percentages.  But if you looked at 100 policies that started this year, there would only be about 35 policies in force after twenty years.  Indexed universal life policies can be useful in the near future, but most of the time, if the plan is executed properly, these are long term financial vehicles that will be used for the rest of the client’s life. 

Since the long term success of these plans is so important, I’m going to go over three tools to make annual reviews successful for you and your clients.  First, I’ll go over key items during the sales process to set up the future annual reviews. Second, I’ll go over the annual review itself, including helping the client understand their annual statement and easing any concerns they may have. Last, I’ll go over how to look for further opportunities and get referrals.  

Let’s go over what key points are during the sales cycle so that the annual reviews are easier and there are no surprises to the client.  I’ll be describing an annual review for an indexed universal life policy, however many of these ideas can be used for other types of policies as well.  There are many items to go over during the sales cycle.  These are just the main points that will help you in your future annual reviews.

The most important item to go over is to let your client know that IUL policies are usually long term solutions and the client needs to be patient and stick to the plan. How often do we look at an illustration and only focus on a few key parts such as the premium, the rate of return, and the income and cash value? These are very important, but there are a few parts of the illustration at which we need to take a closer look. 

We should start by looking at the costs each year. It’s common for an IUL to have higher costs upfront and lower costs in the later years.  For example, an illustration for a max funded IUL for a 45 year old male paying $10,000 in premium per year to age 65 has $23,594 in costs over the first 10 years, but only has $11,250 in costs from age 65 to 75.²  This cost structure is different than most financial vehicles where the cost is usually a percentage of the total assets with higher costs in its later years.  This is why it’s beneficial to compare the costs of an IUL to other alternatives over the long run. 

Next, we should discuss the assumed interest rate used in the illustration. Even if you are conservative and run the illustration at a six percent indexed interest rate, you still need to express to the client that this scenario of a six percent return every year is obviously not going to happen.  There will be years where the market goes down and you’ll receive a zero percent interest rate, and years where you may hit the cap of your interest rate. Letting them know about this variability, as well as looking at some historical returns and seeing which return assumption they are comfortable with, will help you with whatever returns actually occur.  

The next item to go over are which allocations we are going to select. This should start with a discussion of the client’s goals and their risk tolerance. From the client’s goals and risk tolerance we can suggest an allocation. Our suggestion is to create a diversified allocation, since in any given year one index may outperform another. Then, in the annual review, you can reassess the client’s goals and risk tolerance to see if the allocations need to be adjusted. Also during the annual reviews you can analyze any cap or participation rate changes that may affect their allocation. 

This last item is a simple thing to do during the sales process.  Hold on to the issued illustration so that it can be referenced during the annual reviews.  We will use this illustration to make sure the client is on track and that they will stick to the plan in the future.

Now that we’ve discussed the main points to go over during the sales cycle, let’s move on to after the policy is in force. While the annual reviews are important, it’s also important to stay in front of your client throughout the year—whether it be more frequent meetings, sending them important financial news or just sending them birthday or holiday cards. This will insure that you stay on their mind and will increase the chance that they’ll want to do an annual review with you. 

It’s now time for the annual review. To start the meeting you should continue to build rapport with the client, discuss how their year has been and listen to what the client may have on their mind. If this includes concerns that the client has, make sure you mark those down so that they can be addressed. We’ll ask some specific questions later, but begin the meeting by having a casual conversation with the client and listening to them.

Next we’ll want to go over the annual review statement from the insurance carrier or any annual report that was created. Preferably, we’ll have a report that will include both the current numbers from the insurance carrier and the numbers from the issued illustration so that we can make sure that the plan is being executed. 

First, we’ll make sure that all the premiums were paid as expected. If not, what was the reasoning?  It is true that in an IUL you can have flexible premium payments, but the client must know that this will affect the overall plan if the premiums are not paid as expected. The next items to look at are the costs, the actual return rate and the interest credited. If these are better than projected you’ll have no problem going over these numbers, but how should you explain when the policy has a zero percent return?

The good news is that you’ve already set up for this scenario by letting your client know that this is a long term solution, the costs were expected to be higher upfront and we will experience variability in the returns.  Even though we’ve set this up, it’s still tough when the client has paid $10,000 in premiums and the annual statement says $7,718 after the first year. This is where you can take a look at the issued illustration and show your client what was expected. The issued illustration at a seven percent return has the accumulation value as $8,316, so yes we are behind schedule but it’s not the end of the world and we were expecting to have less than our premium amount. You can also explain to your client that this first year return is the least significant return year out of any year. The reason for this is that there is only one year of premium in the policy. This seems obvious but let’s look at the numbers behind this. In our same example of a 45-year-old paying $10,000 of premium a year until age 65, a seven percent return would give an estimated interest credited of about $598.  Compare this to year 20 where a seven percent return would result in an estimated $26,297 interest credited. This number is 44 times greater than the first year return. The last items to compare from the annual statement and the issued illustration include the current death benefit, surrender value and costs over the last year.

The last step is to look for any further opportunities either from that client or by obtaining referrals. You should start by having some needs assessment questions that you go through each year. A few of the popular questions include:

• Why did you purchase the policy in the first place?
• Have any of those reasons changed at all?
• Do you want to change the beneficiaries of your existing policy?
• Have there been any major changes to you or your family’s health?
• Have you had or do you expect any major changes to your expenses?
• Have there been any major income changes or has there been any inheritance?

There are definitely more questions to add, but these are an excellent start. Another important item to discuss are any additional services with which you may be able to help them. Especially as they get closer to retirement age, they may need more help with managing their retirement. Since you have helped them throughout the years, they will come to you for these services.

Then, we have the process of getting referrals from your clients. I don’t see this as “asking for referrals” but more like you helped this client with their retirement planning and the client might know some friends or family that you can help in the same way. Since you have shown the client your value and let him or her know about your services, they will be more likely to refer a qualified prospect. How much can getting referrals add to your business? Let’s say you’re able to get five new clients each year and your average target premium is $10,000. If you hold an annual review each year with all your clients and are able to get a referral from one out of ten,  in the tenth year, instead of only having five new clients, you would have twelve and an extra $70,000 in your pocket that year. 

I hope by reading this you realize the power of the annual review process. Not only will you be able to help the client execute the plan that was created, but it will help the relationship with the client which is necessary for your business as well. I urge you to start doing annual reviews with all of your clients for their benefit and for yours.

Footnotes:
1 – 2012 U.S. Individual Life Insurance Persistency Study, LIMRA and Society of Actuaries. https://www.soa.org/Research/Experience-Study/Ind-Life/Persistency/2007-09-US-Individual-Life-Persistency-Update.aspx 

2- The illustration was from an Allianz Life Pro+ illustration.