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IUL is trending

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Recent surveys show that sales of indexed universal life insurance products are trending right now, and while client interest in using indexed universal life as a retirement income source is stronger than ever, heightened regulatory scrutiny is similarly on the rise. As a result, ensuring that this type of product is suitable for your particular client is critical to avoiding a potential headache down the road. While some advisors may think that they know all they need to know about indexed universal life, today’s rapidly evolving market environment has created an enhanced need for advisors to not only know the ins and outs of the product features, but also whether an indexed universal life insurance product is the right fit for the individual client’s retirement planning needs.

Indexed universal life as retirement income

Indexed universal life insurance policies are cash value life insurance products that are tied to a specific stock index — such as the S&P 500 — and provide returns based upon a formula that is tied to market performance. These policies often come with both an earnings cap and an earnings floor, so that, for example, the policy might earn no more than 10 percent, but no less than two percent, meaning that the policy can continue to grow even in an economic downturn.

See also: The value of cash value life insurance

Once the cash value has built up to a substantial level — over a period of years — the client can begin taking tax–free withdrawals to fund retirement, regardless of whether he has reached the age at which penalty–free withdrawals from a traditional retirement account become permissible. If the client dies prematurely, the policy, of course, still offers the traditional life insurance death benefit that will be paid out (also tax–free) to the policy beneficiaries.

In three separate instances, a community spouse had purchased a Medicaid compliant annuity so that his spouse, a nursing home resident, could qualify for Medicaid. Because several counties in Ohio had decided to treat Medicaid compliant annuities as impermissible asset transfers even if those annuities satisfied the strict federally mandated criteria, the Medicaid applications were denied.

As popular as indexed universal life insurance has become, the client must have the ability to maintain the policy over a relatively long term — at least ten years — before reaping the benefits of the product as a retirement planning vehicle. The cash value of the policy will grow as premiums are paid in, but it takes several years before the value of the policy will exceed the level of premiums actually paid.

Further, many indexed universal life insurance policies contain surrender charge provisions that can last for ten years or more and can reduce the built–up cash value of the policy if the client becomes unable to pay the premiums. Similarly, mortality charges apply based on the client’s age and health, and must be deducted from the contract’s value over time. As a result, indexed universal life is most suitable for relatively young clients who have at least ten years until retirement. This ensures that the client has the necessary funds to continue paying premiums on the policy and that the policy cash value will have accumulated to a sufficient level.

The regulatory environment

Tied to the recent surge in the popularity of indexed universal life insurance, both state regulators and the National Association of Insurance Commissioners have begun investigating whether the sales practices employed in connection with these products are permissible. As a result, it is important that advisors understand the complexities of the product in order to provide clients with an accurate picture of the investment. While these products do provide downside protection, the earnings cap limits the growth potential so that, over time, investment gains are often more comparable to a bond investment than a stock market investment.

Further, in some cases, the insurance company that issues the policy retains the right to change both the mortality charges and the formula that governs the way interest is credited to the client’s account, so it is crucial that the client understands the fine print before purchasing the policy.