Protected growth: The index product advantage

Does it seem many of your clients have targets on their backs? It might be because they do. The evolving tax environment continues to challenge high-net-worth individuals, and the challenges wrought by higher taxation, combined with fewer opportunities to protect assets, likely won’t diminish soon. You know smart planning for retirement includes diversification of assets, but it also includes looking for opportunities to diversify the taxation on these assets — will they be taxed now, later or never? This article will discuss two types of index products that can provide tax-deferred cash accumulation while offering the guarantees so many clients desire.

Index universal life insurance (IUL) may be a beneficial choice for many clients, based on their financial status and needs. Index annuities may be appropriate for certain other clients, as a modest part of an overall balanced portfolio. Before we take a closer look at these products, let’s review the highlights (or lowlights, if you will) of the tax changes that went into effect earlier this year, impacting both the market and the consumer mindset.

Taxes on the rise

In a nutshell, for 2013, taxpayers whose taxable income exceeds $400,000 ($450,000 for couples) face the prospect of a new 39.6 percent marginal tax rate, as well as higher qualified dividend and long-term capital gains rates. The combination of higher tax rates and shrinking deductions can erode income, making it even more crucial for high-net-worth clients to manage their taxes effectively while leveraging opportunities for cash accumulation and/or future income stream generation.

Clients can’t just assume that when they retire they will be in a lower tax bracket. According to the Tax Foundation, in 63 of the past 101 years, the top federal income tax bracket has been greater than the current top bracket.Indeed, the Tax Policy Center in mid-April of this year released its new estimate of tax rates through 2023 based on the 2014 federal budget proposal — and it points toward the highest federal tax rate in four decades.

As Howard Gleckman, editor of the TaxVox blog on the Tax Policy Center’s website, explained in his April 22 post, “For high-income taxpayers, the news is nearly all bad. Obama would limit the value of itemized deductions and some other tax preferences to 28 percent, limit the benefits of large tax-favored retirement accounts, adopt a version of the Buffett Rule by imposing a Fair Share minimum tax of 30 percent of adjusted gross income over $1 million (less a charitable credit), and raise taxes on estates, gifts and certain family trusts.”

Obviously, no one knows what the future holds. However, given the potential for an unfavorable tax environment, high-net-worth clients may benefit from financial products that allow for protection as well as growth. Now seems an opportune time to consider the value of index products — global IUL in particular, but also index annuities. These products may serve as solutions for the new retirement realities that clients are facing, especially given the blend of protection, flexibility and cash accumulation potential available today in certain IUL and index annuity products.

IUL: Well-suited for HNW

Let’s face it, limited opportunities exist for clients who want to allocate their resources and enjoy the prospect of income tax-free growth. The Roth IRA, for example, is often perceived as quite attractive, yet, due to income thresholds for making contributions, it’s the most unattainable option for high-net-worth clients. And the restraints may only grow tighter. As mentioned earlier, the proposed fiscal year 2014 budget, if enacted, would bar individuals from accumulating more than $3 million in IRAs and other tax-preferred retirement accounts. Time will tell how such tax reform proposals will play out, but one thing is certain: nothing is certain.

Of course, any life insurance policy can help diversify a retirement plan, but in times of uncertainty, IUL can be advantageous as an accumulation product for clients who want to maximum-fund the contract, allowing cash values to build up within it, tax deferred. With IUL products, cash values may be accessed without the type of tax penalties the client would incur for IRA distributions (prior to age 59 ½) — subject, of course, to applicable surrender charges.

IUL products also feature flexibility, with the potential to reduce premium payments temporarily or to take policy loans. If the client’s intention is to fund the policy at a certain level and that becomes unfeasible due to changing personal needs and circumstances, premium payments may be paused for a period of time or coverage can be dialed down as an alternative to using loan options to access cash values. Of course, the failure to pay sufficient premiums in a timely manner can cause a policy to lapse.

Furthermore, should the client die prematurely, the in-force IUL policy would “self-complete,” as it would provide that critical, lump-sum, income tax-free death benefit to beneficiaries. The bottom line is that, if the IUL policy is managed strategically and kept in force, its build-up and death benefit proceeds may fall into the coveted “never-taxed” column.