The following article is part 2 in a 2 part series. Part 1 can be found here.
Make sure to also read “How to Use Life Insurance to Get a Tax Free Retirement and Guaranteed Income for Life“
Part 2
Up to this point, Indexed Universal Life Insurance plans are sounding quite rosy, and that’s because they are. They’re amazing for retirement savings and legacy. However, there are some things that people should be aware of before purchasing an IUL. In this article, we’ll go over everything the consumer should know and how to prepare for these kinds of plans.
Surrender charges
Let me preface this section by saying that you can take money out of an IUL at anytime without charges if you do it right. However, if you completely cancel or withdraw cash incorrectly from the policy during the surrender period, you’ll pay the surrender charge. A surrender charge is a percentage penalty that has to be paid if the policy is surrendered or cancelled within the first several years of the policy. This penalty starts at around 10 percent and goes down by about a percentage point every year until it reaches 0 at about year 10 or so.
Take Loans Instead OF Withdrawals To Avoid Taxes And Surrender Charges
I know what you’re thinking. Taking loans is a bad idea and this plan sucks. I originally thought that too until I realized 1.) You don’t have to pay back loans and 2.) Whenever you do take loans, a collateral account is automatically set up along side it to counteract the loan interest rate. For all intents and purposes, a policy loan is a tax free withdrawal, with none of the drawbacks of the loans we all know and understand in other walks of life. This method of withdrawing is also the preferred for whole life plans to avoid taxes.
Cap Rates
With IULs, you trade a portion of the upside of the market, for a guaranteed floor of 0 at the bottom, so that your policy never loses money. This set up performs better than most retirement accounts in volatile market years, and is still very competitive and secure in healthy market stretches. I digress.
The Cap on a policy is what limits the amount you get from stock market gains. These are typically 13-14 percent for most IUL plans. So if the stock market has a gain of 20 percent, you get 13-14 percent. If the stock market gains anything between 0 and 14 percent, your policy is credited whatever number that is. So a gain of 10 percent means you’ll get credited 10 percent. Market goes up 14 percent, your policy is credited 14 percent. Any amount over that, and you get the amount that cap rate is set at. So if the gain is 15 percent or higher, you only get the 14 percent. Of course, if the market is down, like say -16 percent, you lose nothing. That’s the trade-off. You trade a portion of the upside of the market over the cap rate, in exchange for protection against the down side, with a floor of zero percent.
Fees And Expenses
The fees and expenses in an IUL are fully available in the illustration report the agent provides to you. The fees include the cost of insurance, policy fees, and a premium charge during the first 10 years of the policy. Many of these fees disappear after 10 years with the exception of the cost of insurance that goes up every year, but not as much as you might think. In fact, the cost of insurance should, with a well-designed policy, represent around 1 percent of your account value. For intance, an IUL with an account value of $100,000 should have fees of around $1,000 that year. Very similar to other retirement plans account fees.
Participation Rate
A participation rate is set by the insurer and it represents what percentage of the stock market gain you’ll receive. If the participation rate is 80 percent, with a gain of 10 percent on the market, you’d get credited 8 percent in the policy. The advisers on this site work with IUL carriers with 100% participation rates only.
Dividends Aren’t Credited
The reason dividends aren’t credited in IUL policies is because the IUL is not directly invested in the stock market, but the gains in the index are credited to the policy. You have to be directly invested in the stock market to get the dividends, but then your account value is more at risk to the downside. That’s apart of the trade-off with IULs. At any rate, dividends are not guaranteed and are not always paid out, so often times, and IUL holder isn’t missing out on anything.
Commissions
Speaking of fees, lets talk about commissions, which is what agents get paid by the insurer when someone buys from us. It is no more or less expensive to buy from an agent as opposed to going direct to the insurance company. The carrier doesn’t take money out of your policy to pay us. They pay us as an affiliate and ambassador of their products.
Participation Rates, Caps, and Policy Fees Can Be Changed at The Discretion of The Insurer.
The fact that the insurance company can change things at any time is often brought up be detractors of IUL. While this may be true, the changes are typically negligible and set up so that the insurance carrier can serve more clients and make good on their guarantees. Carriers base the Cost of insurance on a prediction of mortality rates and market performance. This may cause a slight negative or positive impact on your policy based on projections and predictions. Consider the 0 percent floor guarantee. To keep that promise alive, if the market becomes extremely volatile for too long a period of time (hasn’t happened yet) or if a projection looks grim, they reserve the right to slightly change fees, participation rates, and cap rates.
Again, they make these changes so that they can make good on their guarantees and pay out claims when they are due. These changes are not always negative. Many times fees are lowered and cap rates raised. The carriers are inclined to remain competitive so that they can continue to sell policies. If word gets out that they’re not servicing their clients properly, they go out of business. They know this and are very unlikely to make changes out of greed.
The Policy Can Lapse If The Cash Value Reaches Zero
The cash value in an IUL could potentially go down to a zero balance, ruining your retirement strategy, and causing the policy to lapse (Read; end), but this is completely avoidable. Here’s the secret to make sure this never happens: max-fund the policy. If you can’t max-fund an IUL or any other universal insurance plan, it’s not the product for you. Max funding guarantees the plan will build up enough cash value to offset any expenses and last forever.
Best To Wait For Retirement Before Accessing Cash
The same logic used to prevent accessing money from your 401k or IRA before retirement, should be applied to an IUL as well. We all understand that life happens and people sometimes need access to their nest egg for various reasons. And of course, IULs will give you that access, penalty and tax free. Just make sure you don’t abuse the right to this cash. During the stage of life where you are still making contributions to your IUL plan, any withdrawals should only be for emergencies. Overall, it’s best practice not to withdraw any money until retirement.
When you get to the stage of life where payments stop, I.E. retirement, the value of the IUL account should be enough to where it grows yearly on it’s own and can sustain itself. As you know by now, some market years are better than others, and that affects the amount of cash credited to your policy. Sometimes you’ll get a lot of money in your account, sometimes it won’t grow much at all. It just depends on the interest rate credited to the account and how the stock market is performing. Your account won’t sustain a loss due to the stock market, but if you have a 0 percent return, the account still has fees, which are not too high, but should be accounted for.The best strategy to use to keep the cash value stable is to only take the yearly gain of the account, minus the expenses. This will make the policy last forever.
Not Everyone Qualifies, But Most Do
IULs are similar to other life insurance plans in that they require someone to pass a health check, as well as avocation and hobby checks, to be approved for a policy. This is so that the carrier doesn’t take on too much adverse risk. It also helps the carrier to keep the participation rates, caps, and fees stables.
So there we have it. The good and bad of IULs. Overall, the good outweighs the “bad.” Most of the “bad” here exists in every retirement account. IULs are a solid way to get rich and make your kids even richer. If you’re interested in seeing how much an IUL or other life insurance plans and annuities would cost you, hit the side or top bar for a free quote, or click this link.
Blue Crush Insurance
