Whether one is classified as a resident alien (permanently resides in the U.S.) or non-resident alien (has their primary residence in a country other than the United States), international clients face a number of complex financial planning challenges that could be addressed by the prudent use of a U.S.-based life insurance policy.
Some of their specific concerns are confidentiality, international wealth diversification, political and economic instability, legal protections, currency risk and forced heirship. However, they also have the same needs as many U.S. clients with regards to income protection, buy-sell / key man planning, legacy planning, estate equalization and wealth protection. Then tie in the U.S. gift and estate tax exemption along with the lack of an unlimited marital deduction for a non-citizen spouse and you have a very unique set of circumstance that requires careful planning and understanding.
A U.S. Indexed Universal Life (IUL) policy has a number of features and benefits that make it an option to seriously consider. The biggest benefit is the ability to couple a death benefit along with cash value to provide for maximum flexibility.
How does an IUL work?
An IUL, as with any life insurance policy, offers a death benefit, and also the potential to accumulate cash value, providing a possible additional source of potential income during the life of the policyholder.
Interest on an IUL is credited to the cash value at a rate based, in part, on the performance of a market index. The crediting methodology involves a cap and/or participation rate established by the insurance company, which determines the maximum rate of interest. The insurance company also determines a minimum interest rate, also referred to as “the floor.”
For a domestic IUL, the most widely used index is the S&P 500®, with some companies now also using the Russell, Dow Jones and NASDAQ indexes.
Other IULs may use global indexes or a combination of indexes. Some of the global indexes used are the Hang Seng Index or the EURO STOXX 50®.
An IUL can offer a balance of risk and reward.
While the performance of an index is used as part of the interest rate calculation, the IUL is not an investment in the equities market. There may be times when the change in an index is greater than the cap rate established by the insurance company. In this case, the interest crediting rate will be less than the change. This will also occur if the participation rate is less than 100%. On the other hand, the guaranteed interest rate will never be lower than the policy’s floor. So even if the index has declined during the interest rate period, the cash value does not lose money as a result of the downturn.
What are the advantages of an IUL?
There are a number of advantages to an IUL:
- Once interest is credited to an Index Account in an IUL policy, it is locked in and will not be taken away due to any negative index performance.
- The policy can be structured so that the death benefit can increase over time based on any increase in the cash value. This can be an important feature if there were a need for additional life insurance at a time when health problems or age might make buying more coverage costly or even unattainable.
- Once the cash value is sufficient, it can be used to serve a variety of needs, whether personal or business related.
There are tax advantages as well:
- Any growth in the policy’s cash value is tax-deferred.
- Cash value may be accessed income tax-free through withdrawals, up to the cost basis, or through loans, as long as the policy stays in force and is not a modified endowment contract.
- The cash value in a life insurance contract is not currently reportable under FATCA.
There is an additional advantage for a non-resident foreign national.
A non-resident foreign national (also known as a non-resident alien) can still enjoy the same advantages of an IUL that a U.S. citizen or resident alien/green card holder enjoys – the U.S. income tax-free accumulation of cash value and the U.S. income tax-free access to the cash accumulation value via policy loans.
However, a non-resident alien has an additional advantage that applies to any U.S. life insurance owned by a non-resident foreign national:
- The life insurance policy on the life of and owned by a non-resident alien is not considered U.S. situs (legally located) property and is, therefore, not subject to U.S. estate tax.
There are some restrictions that also need to be considered.
To apply for the insurance, the client generally must have a legitimate connection (nexus) to the U.S., such as owning a home or having assets in the U.S. The application, the medical exams and delivery of the policy must be done in the United States and the premiums must be paid from a U.S. bank or financial institution. In many cases, the client must also have a U.S. address or P.O. Box to receive premium notices.
For many international clients, the advantages to a U.S. IUL policy can be very attractive. As always, it is important that the client consult with his or her financial planning, tax or legal advisor before making any important financial decisions. Each client’s individual situation and goals need to be considered to determine whether or not an IUL would be an appropriate addition to the overall financial plan.
For more information on working with foreign national clients and their life insurance needs, visit Transamerica’s Foreign Nationals Connections website. You can also follow the author on Twitter @BurkeTravis.
The discussion regarding index universal life (IUL) insurance is just a broad overview of how some of the features of this type of policy work. It is not intended to represent any specific policy offered by Transamerica companies or any other insurance company. Transamerica Life Insurance Company (“Transamerica”) and its agents and representatives do not give tax or legal advice. This material and the concepts presented here are for information purposes only and should not be construed as tax or legal advice. Any tax and/or legal advice you may require or rely on regarding this material should be based on your particular circumstances and should be obtained from an independent professional advisor. This does not consider the impact of applicable state laws or the laws of another country.