Do Your Clients Know About Variable Universal Life?

There are some misconceptions about those who are highly compensated. One of the most prevalent is that they have more choices in life than those who are paid less money. Unlimited choice is what wealth supposedly brings. That’s where the misconception comes in.

The irony is that many executives with significant income have exactly the same life goals as many of the rest of us. However, they have little use for the traditional qualified methods of investing retirement money, primarily because available qualified plans have no significant impact on the retirement lifestyle that highly compensated individuals envision.

Think about itdo your clients want to take a step down in lifestyle at retirement because they have been so fortunate up to that point? While the answer “yes” would be a modest, it would also be mythical.

The truth is that highly compensated individuals can be severely limited in the number of qualified financial tools that allow them to save large portions of money for future goals, if they want investment growth opportunity and tax advantages. And, these very goals are the cornerstone elements of nonqualified executive benefits. The development of concepts, such as split dollar, 162 bonus, supplemental executive retirement plans, and deferred comp plans were built on the premise highly compensated individuals need investment vehicles that allow them the opportunity to save in flexible and tax-advantaged environments.

Still, the most overlooked aspect for some of your clients in the executive market is also the simplestvariable universal life products.

For some affluent investors, VUL may fill the void rather neatly, because it allows highly compensated executives to achieve the same advantages that others get through their qualified plan. However, many in the affluent market do not even know the option of VUL exists, until an advisor educates them.

Accumulate

A VUL product is designed to be useful for exactly this type of client by providing many critical features. In addition to the death benefit, accumulation and eventual income distributions are the predominant ones. As with any registered security, however, there is risk involved. The suitability of accumulating money in any such product can only be considered on an individual case basis. For those who understand the concept of risk and reward, VUL can be the financial solution that levels the playing field for highly compensated individuals.

The first characteristic you should consider is whether your client has all, or most, of their current life insurance needs taken care of in other types of productsperhaps term, perhaps general account universal life with guarantees. What they get with VUL is the ability to appropriate large sums of money to retirement while purchasing the lowest amount of death benefit possible through the utilization of variable subaccounts. This approach to designing a VUL can maximize the accumulation of cash inside the product. And typically, these subaccounts will include high profile retail names that your client associates with the current mutual fund industry.

In variable life products today, clients can allocate their money among subaccounts, including fixed accounts, to acquire the suitable mix of investment risk and return for their particular needs.

Because this is life insurance and your clients probably won’t want to risk the real-life coverage to the equity markets, you can likely help them insulate their policy by allocating the necessary costs and charges for the life coverage to a fixed account. Another popular feature of contemporary variable products is the ability to designate the account from which these charges are drawn, such as the fixed account. By using this strategy they have, in effect, “term and invest the difference.” During the premium paying years, only those monies not needed to carry the cost of insurance go to the variable subaccounts.

The time value of money indicates that getting funds into any vehicle sooner, and in larger amounts, allows for greater compounding given favorable investment experience. Along those lines, your client will likely fund this variable policy heavily and for a short duration of time. This accomplishes a number of things. It allows the time value of money to work harder inside a tax-favored vehicle. It also allows your clients to complete their out-of-pocket commitment sooner and move on to other life goals.

When utilizing this approach, the minimum death benefit in relation to the funding allows the contract to begin with the lowest amount of costs associated with death benefit. Most software platforms allow the illustration to show the minimum death benefit that keeps the policy from becoming a modified endowment contract. This is crucial so that the tax advantages of the product aren’t compromised. Applying an increasing death benefit may allow a lower death benefit to start off, and provides the room to get the money in without the policy becoming a modified endowment contract. Another benefit to this is that the increasing death benefit in many policies, if left on, will provide a greater return to heirs when the policy pays at death.

In many cases, once the premium duration is over, it is likely that your clients may want to designate a variable account from which to derive insurance costs. This is because it is possible to get a higher return from these than they will from the fixed account. And because the policy will now generate its own premium in this way, your clients would likely benefit from using an account that generates these dollars faster. Remember, any dollar generated in a life contract is tax deferred. Any dollar that never leaves the contract is tax-free. Now your clients are paying for their life coverage with tax-free dollars.

As with any equity instrument, investment results can be favorable or unfavorable. Values will rise and fall with the underlying values in the variable subaccounts. It’s up to you to determine the suitability issues that are present with your client and a variable product.

The final point about accumulating in this way is perhaps the most important. The amount that your clients can apply to this concept is limited only by the amount of life insurance they qualify for. And if they are going to fund heavily in relation to the death benefit, they may run out of money to apply before they run short of death benefit available.

Distribute

When it comes time to retire, or tap the cash for other reasons, your clients can access the values in their contract in an extremely tax-favored way. Under current tax provisions, and when designed properly, your clients are allowed to withdraw their basis in an amount annually, or all at once. There is no tax consequence to this, provided it starts after the 16th year. The Internal Revenue Code contains provisions that make withdrawals prior to the 16th year taxable if they reduce any benefits under the contract (IRC 7702(f)(7)). If a distribution is desired prior to year 16, it may be advisable to consider a loan rather than a withdrawal.

Once the basis has been drawn out, your client may access the values for an extended period of time by taking loans from the values. Loans, under current tax law, are not reportable as income, and therefore, are not taxed. Very few clients understand this. The power of demonstrating it to them is impressive. When designing these presentations and illustrations, keep in mind that you must always allow for cash value to continue to exist so that the contract is in force at death. If the policy lapses prior to death, and after a large distribution stream, it is taxable as income.

Still, when designed properly and assuming favorable market experience, the distributions available beyond basis can provide impressive values.

Pass On The Wealth

If your clients are going to experience a lifetime of success, they may very well have the need to, or more likely, the desire to pass this wealth on to children or grandchildren.

Most investment vehicles have tax consequences that are less than favorable for passing wealth to the next generations. In some cases, tax impacts can reduce values to heirs by as much as 70%. That is not the case with life insurance.

When owned properly at death, the highly appreciated variable life product will pass income tax-free to heirs. It may also pass estate tax-free. No other investment vehicle can accomplish this.

Costs

As with any financial product or registered security, there are costs involved. Many contemporary financial advisors recommend the use or avoidance of certain categories of financial products without consideration of costs related to specific situations. Like any other purchase your clients make, costs of particular products must be considered against each other and in light of your clients’ specific goals. There are no blanket answers to which type of product is beneficial or harmful based solely on the costs involved. And all products will have a cost associated.

Remember, if you use a VUL and designate costs to be drawn from a money market subaccount, or a guaranteed interest division, you are insulating the death benefit from the equity market. You, in effect, have the concept of buying term and investing the difference. Most software will allow you to illustrate the breakdown of costs in the policy. By doing so, you can isolate those costs attributable to the death benefit coverage as well as the money going to variable subaccounts. This is helpful in comparing products and funding scenarios for your client.

Achieving Equality

The evolution of variable products is never ending. The latest designs incorporate high early cash values, and some even provide death benefit guarantees more efficiently than they have in the past. Each component has its place in the executive benefit market.

What you?ve seen here is a vehicle that almost without restriction, allows your clients to designate large sums of money, inside virtually any executive benefit plan, toward their life goals in a tax-favored vehicle. When designed correctly, it can provide a stream of tax-free distributions from accumulated values in variable accounts managed by highly recognized and regarded money managers. In addition, some degree of creditor protection is available to your clients depending on the specific state provisions. If your clients decide to pass the wealth on, they can do so with greater efficiency than any other financial instrument available. Chances are your clients do not know they can do thisuntil you educate them.

This strategy may not work for all your clients, but it may for some. You are the expert on your clients and their financial objectives. There is risk involved in investing in a life insurance product, and it is advisable to be upfront with your clients about that risk. Even when you deal with the most sophisticated client you have to stress the obvious. If the investment experience is poor, then they will likely not achieve their financial goal without additional funding. Even though that’s a risk with any financial product it needs to be part of the process in every case. It becomes essential that you do annual reviews with your clients to monitor performance and adjust investment allocations to maximize return according to your clients’ goals and the trends in the equity markets.

Douglas Campbell is senior vice president and national sales director, life products, of Jackson National Life Distributors Inc., Denver, Colo. He can be reached via e-mail at douglas.campbell@jnli.com.


Reproduced from National Underwriter Edition, June 11, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.