What are the tax implications of an IUL? One of the great things about an IUL is the cash you access as a policy loan isn’t income so it doesn’t trigger pesky 1099s or other notices to the IRS. Not only is there no tax liability on those loans there isn’t a bunch of reporting either. You are not selling anything. There is no gain or loss. Simply, it isn’t income so you don’t owe any income tax.
What happens to my plan if there is a downturn in the market?
Advanced IUL has built in downside protection. All Indexed accounts are guaranteed to be credited a minimum of 1% or 2% interest regardless of downward trends in the market. With some Advanced IUL plans there is a small downside risk of 2%-6%.
How do all of the fees or expenses effect my return?
These products are designed to have fewer expenses as you age, so the majority of fees are up front. Typically it takes about 5-10 years to become even with other investments and then blows right past them. The advanced IUL has a surrender charge that lasts 9 years. Remember, that is never a factor if you commit to the long-term plan.
What is my risk if the insurance company changes any of the fees that are built into the policy?
There is no denying the fact that this is a life insurance product that has mortality charges. These charges are insignificant when compared to the tax-free compounding, tax-free distribution, flexibility, liquidity and safety benefits of the product. Don’t forget about the tax-free death benefit that is paid to your beneficiary upon death. Bottom line, with these charges your tax free retirement income is still significantly higher (usually double) than what it would be in another vehicle. In order for mortality charges to go up people would have to start living shorter. The insurance company can raise mortality rates to the maximum stated in the policy based on new higher mortality tables. The companies we use have never raised any of the charges or fees in an in-force policy.
Most of our clients don’t know anything about the concept of tax-free income in retirement through life insurance products. So, we take our time explaining all the pros/cons, expenses, IRR, what can go right and what can go wrong, in addition to the fun part — estimates on how much money they might have in retirement that they don’t have to report to Uncle Sam.
Article added by Katherine Vessenes on January 9, 2013
Does an IUL affect the calculations of the parent’s assets when my children applies for college loans or scholarships? Currently parents are able to exclude cash values in insurance contracts from assets in the formulas on financial aid forms (both the FAFSA and CSS Profile) as well as on many scholarship requirements. Not only is IUL an excellent way to actually save for a college education the way it is treated on your “balance sheet” is favorable as well.
Do you have to repay the loans you take?
Yes, the loans you take do have to be repaid. The good news though is they do not have to be repaid while you are alive. Upon your death the insurance carrier will deduct your outstanding loan balance from your death benefit and pay the remaining amount to your beneficiaries as you have specified.
You showed me taking out $xx,000/per year beginning at age 65, what if I don’t need to take that much out?
Don’t take it out. Leave it in the contract and allow it to continue to grow! Alternatively you can select to take less out. Conversely if you need to take money out sooner, you can do that as well, however taking money out earlier will impact the amount you can take out later. One of the great things about the IUL design is the flexibility it offers you. The document containing the projections, called an “illustration” is simply that: a projection. It is a hypothetical scenario. You don’t have to stick to the funding or distribution plan in it (of course changes will impact the values in your contract).
What if my health changes or something bad happens to me after I get my IUL? Will my rates go up? No, absolutely not! Indexed Universal Life Insurance is a form of permanent life insurance. You are underwritten at the time you take out the policy. The insurance company can’t raise your rates just because you have a heart attack, get cancer, put on weight, start smoking, etc. in the future. This is another good reason to consider a policy while you are healthy (although you’d be surprised, IUL still works for people that aren’t in great health, ask me or another advisor that specializes in IUL to show you).
Why are some financial advisers predicting that IUL’s will produce fixed type of returns in the long term future?
Fixed like returns over time is another completely false statement. The IUL was introduced to the industry in 1997 and the product has averaged between 7.0 %- 8.5% depending on the company. During this time, fixed products paying bond like returns have been averaging between 3% – 5%. Advanced IUL has a guarantee on the cap that would make it impossible for an IUL product to have comparable returns to bonds or fixed products based on historical data. If fixed products increase like in the 1980’s, the IUL has an option to go to fixed returns at the owner’s request. You can go back and forth between indexed and fixed in any year on your policy anniversary date.
Is there a risk of the insurance company changing the interest crediting formula?
There are only two variables in the IUL contract. First, mortality charges, which we have already mentioned. The second variable is the cap. The Advanced IUL has a guarantee that the cap will never go below 10%. With that guarantee, and looking at all the historical data, 10 yrs, 20 yrs, 30 yrs, 40 yrs etc., we are looking at returns similar to stock returns rather than bond returns. With a 10% cap the historical returns are around 7%.
How reliable are the illustrations of Indexed Universal Life?
We have taken many historical segments to evaluate how this product will perform. Although we can’t predict the future, by looking at the 20 yr best, worst, and middle you can see that the IUL would not have earned less than 7%. If your Advanced IUL is structured correctly and reviewed yearly there is no reason for you not to get the returns that are illustrated. Granted, some agents and companies allow too aggressive illustrations. You want to look at illustrations that show returns lower than the historical data would show.
What is the risk of a contract lapsing and creating a tax disaster?
This is another scare tactic that is thrown out there by advisers competing against non-qualified plans. Whether it is a variable product or an indexed product, a lapse in retirement could result in a significant tax. However, the insurance companies all have a rider that would turn the policy into a reduced paid-up policy to keep that from happening.
How does an Advanced IUL compare to purchasing Term Life Insurance and investing the difference?
A program of buying term insurance and investing the difference will succeed for only a very short period of time. Typically, the Advanced IUL will pass it by in about 5-8 years. Basically, you are committing to a program of investing on a taxable basis. Take a look at the comparison we showed above when discussing mortality charges. With identical amounts of money invested for 10 years, the Advanced IUL annual retirement income was $23,400; the IRA annual retirement income was $18,963; and the taxable annual retirement income was $11,499. The taxable investment would have been even lower income if you took out term insurance premiums from the investment amount.
How does an Advanced IUL compare to a 401k or IRA?
The above referenced comparison shows you how the long term income compares. The Advanced IUL with 10 years or more time always creates more income with a similar gross return. The one advantage of a 401K is if you are receiving matched funds for your investment into the 401K from your employer. If this is the case, you want to take advantage of those matched employer contributions. It is common for an employer to match your first 6% of your 15% contribution.
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