With the stock market’s continued ups and downs, and interest rates still sitting at near historical lows, there are many clients who are likely left wondering how they may be able to supplement their retirement income sources.
The good news is that there may be a product that fills the niche between being too risky and “too fixed.” This middle ground is indexed universal life insurance.
In addition to offering death benefit protection, a potential advantage of owning indexed universal life (IUL) insurance is that the policy may be used for receiving a tax free retirement income. While the policy’s cash account is being built up, these plans can also provide several advantages over other types of permanent life insurance options.
A long-term planning option
While IUL provides many of the same protections as do other permanent life insurance policies, these policies can also include more flexibility, as well as some additional advantages.
Some of the benefits that can found by choosing IUL include the following:
- Tax-free death benefit. Certainly, one of the biggest benefits of life insurance is that the death benefit proceeds are free from federal income taxation to survivors. This can allow beneficiaries to use the full face amount for paying off debts, replacing the decedent’s income, or any other need that they see fit. Also, because life insurance proceeds pass directly to a named beneficiary, these funds aren’t held up in costly, and time-consuming, probate proceedings.
- Tax-deferred growth of cash value. Permanent life insurance policies also allow the funds inside of the cash or investment component to grow on a tax-deferred basis. This means that funds have the opportunity to grow on an exponential basis, versus if the gain were taxed each year.
- Additional growth potential. With IUL, policy holders can obtain additional growth potential in their cash account. This is because the funds are benchmarked off of an underlying index (or in some cases, more than one index). In doing so, interest is credited to the account based upon the market performance, but without the downside risk of loss of principal.
- Protection of principal. Many IUL policies will protect policy holders’ principal from underlying market losses. Due to an annual “reset” feature, cash value gains can be “locked in” each policy year, and they can never be lost due to future market losses. This essentially means that policy owners can participate in market growth, but they cannot lose principal in the event of a market downturn — almost like the best of both worlds.
- No minimum age requirements to participate. Though most types of qualified retirement plans require that participants be a certain age to participate, there are typically no minimum age requirements for purchasing IUL. This can allow individuals to start saving early. There are also no minimum age requirements for cash value withdrawals, so these plans can also offer flexibility when it comes to taking funds out of the plan as well.
- No mandatory RMD (required minimum distribution) requirements. Likewise, there is no requirement to start withdrawing funds from an IUL policy once a policy owner reaches age 70 1/2 as there is with qualified retirement plans. This means that the funds that are inside of an IUL policy may remain in the account, continuing to accumulate on a tax-deferred basis
Considerations before diving in
Prior to taking the plunge into an IUL policy, one needs to consider factors that can help narrow down who may be a good fit for an Indexed UL policy. First, these plans will typically work better when used with larger face amounts, as the smaller policies really don’t offer much advantage over the traditional form of UL.
Also, clients need to be aware that the cash in their account won’t be allowed to grow on an infinite basis. And in many cases, the amount of growth may not even be the same as the percentage of the underlying index growth.
This is because insurers will typically place a cap on the amount of participation that policy holders can partake in. For instance, if the policy has a participation rate of 80 percent and the underlying index rises by 10 percent in a given year, the policy holder’s cash will increase by 8% (10% X 80% = 8%).
The Bottom Line on IUL
Although indexed universal life insurance isn’t ideal for all clients, these policies do provide much flexibility and death benefit protection, while also offering the ability to take part in market growth. Some have even deemed IUL policies as a nice “middle ground” between fixed universal life policies and the more risky variable UL.
So, while these plans may not be viable for all, they could be a nice consideration for those who are seeking the growth potential of variable life, yet the security that comes with a fixed UL policy, in addition to an alternative way to supplement income in retirement years.