It’s no secret the life insurance industry rides the waves of the latest hot product. In today’s market, that hot product is indexed universal life insurance. And with that comes a plethora of sales ideas from the life insurance companies offering IUL to help position their product in a crowded IUL market.
So, we’re all familiar with the pitch—cash-value life insurance, in general, offers tax deferral, tax-free distributions (diversifying tax rate exposure), no contribution limits based on income, no pre-591/2 distribution penalty, Roth IRA alternative, no RMD requirement, tax-free death benefit, and add LTC, chronic illness, or other riders.
(Related: Life Insurance Premium Increased 3% in 2016)
This product is often positioned as a supplemental retirement tool, adding a tax-free bucket to a retirement savings account to go along side the more traditional retirement savings resources — tax-deferred buckets, such as 401(k) plans and IRAs, and taxable buckets, such as brokerage accounts, stocks, etc. It’s also a potential source for funds to cover LTC costs in retirement. And with IUL, there’s the added pitch of no market risk.
There is no question as to the legitimacy of IUL (or any cash value product) as an accumulation vehicle and many of the sales ideas focusing on accumulation. The objective here is to address a rarely mentioned issue: the distribution phase.
Typically, when advisors have a suitable client for using IUL as an accumulation vehicle for supplemental retirement savings, they will contact their product provider/broker for illustrations. The generic illustration scenario is a maximum funding approach initially using an increasing death benefit (option 2) then switching to a level death benefit (option 1) at the optimum time. This design helps maximize cash accumulation and distributions, which is the goal.
In addition, the illustrations are run showing projected distributions which are structured as a withdrawal of funds up to the client’s basis in the policy, then switching to loans to maintain a tax-free distribution stream of income. There can be, of course, other design approaches depending on each individual client; however, this is traditionally how these scenarios are illustrated.
A majority of insurance companies focusing on the IUL and accumulation market also offer an overloan protection rider, which essentially freezes policies when loan balances exceed a certain threshold as a percentage of cash value in the policy. This inhibits the policyholder from continuing to take additional loans from the policy, preventing the policy from lapsing and creating a potentially disastrous tax situation.
Many financial and investment advisors will agree that sequence of returns is a critical element of retirement planning. There are a variety of techniques available for developing allocation strategies to help ride out the highs and lows of the market in the accumulation phase. However, the challenge of managing market volatility in the distribution phase can be quite different.
If retirement distributions begin in a stable or rising market, the client has the potential to preserve or even grow their retirement assets. If a client begins retirement distributions in a declining market, they are both drawing down on assets and selling into losses. Their retirement assets may begin to erode faster than initially planned. The bottom line is that the distribution of retirement funds must be managed carefully so a client doesn’t spend down the retirement nest egg much quicker than anticipated and potentially run out of money in retirement.