INDEX UNIVERSAL LIFE INSURANCE
Protecting Your Own Future as Well as Your Family
This is the third and last in a series of posts about how “Index Based Interest Crediting” works in different products. The first article, Part I, focused on the general way Index Based Interest Crediting works. It appears on my blog at https://www.scottfbarnettconsulting.com/howtogetmore1443/ The second article, Part II, focused on how Fixed Index Annuities operate in addition to the Index Based Interest Crediting. It appears on my blog at https://www.scottfbarnettconsulting.com/get-stock-market-goes-lose-anything-stock-market-goes-part-ii-deferred-fixed-index-annuities-2/
“Index Universal Life Insurance” (“IUL”)provides another way to grow a retirement account using the powers of life insurance. Historically, “Universal Life insurance” is, without more, a way to grow the cash surrender value in your policy. This method relied on the investment performance of the life insurance company to provide additions to your cash surrender value. They have features of flexibility in paying premiums based on need and your current circumstances. However, folks wanted to avoid the volatility of the stock market, yet still have growth for their cash surrender values that was better than simple interest calculations provided.
So, many life insurance companies created “Index Universal Life Insurance” using Index Based Interest Crediting described in my prior articles as an alternative. Part I gives an in-depth explanation. A short one is this. Your policy looks to stock market indexes (such as the S&P 500) as a benchmark for calculating interest to be added to your cash surrender value. If the index goes up, you get more interest on top of any guaranteed interest. However, if the value of the index goes down, nothing is taken away from your cash surrender value. This is because your money is not invested in the market index or the stocks it includes. That would subject you to value swings. What you placed in the policy and the interest earned in prior periods resulted in cash surrender value increases. It stays regardless of what happens to the benchmark index.
WHY WOULD I WANT INDEX UNIVERSAL LIFE INSURANCE?
- BETTER GROWTH. The Cash Surrender Value build up in an Index Universal Life Insurance policy can be substantially better than in other safe investments not subject to market risk. For example, Certificates of Deposit (which many consider the safest place for money) offers little interest nowadays. Each year’s Certificate of Deposit interest is subject to income taxation and, without more, is subject to claims of your creditors. The buildup of cash surrender value inside a life insurance policy is tax-deferred. Plus, you can be allowed take it out tax-free when you retire.
This is a way to buy death benefit coverage you may want or need for your family. And that is important. But most people use Index Universal Life Insurance as a way to build up what can be an income tax-free retirement account.
- SAFETY. Life insurance companies are highly regulated by the State Insurance Commissioner. This includes regular audits. Also, companies must set aside a reserve that assures payments of benefits to policy holders.
Further, in Florida and many other states, cash surrender value inside a life insurance policy is not subject to the claims of your creditors.
HOW CAN INDEX UNIVERSAL LIFE INSURANCE BE INCOME TAX-FREE?
The tax law allows you to borrow money from your life insurance policy cash surrender value without taxation. That is because the “Loan” does not trigger a tax. So, when you reach retirement age it becomes possible in a properly created and maintained life insurance policy to “borrow” your retirement income from yourself. The death benefit is the source of paying back the borrowed money.
Caution is needed to do this properly. If not done properly, a situation might occur when you have to pay tax on all the money you “borrowed” at one time. So, proper planning is critical. However, with proper planning, this can work very well.
Also, a proper life insurance policy allows your beneficiaries to receive the death benefit income tax-free. This is a standard benefit of life insurance also.
FEES AND COSTS
Life insurance has normal fees and costs. These apply also in Index Universal Life Insurance policies. They include Mortality Costs. This is the insurance companies charged for providing death benefits to your beneficiaries. There are other administrative charges as well
So, you want to watch your account in case the growth turns out to be low. The charges from the insurance company could eat at your cash surrender value. However, there are common methods to deal with this situation. The death benefit might be lowered, for example, which lessens future costs.
Companies issue “illustrations” of how your account, including the impact of fees and charges, might do over the coming years. Regulators are setting up new standards on how these illustrations can work. This is so what you are told you “might” expect is “reasonable”. In the past, some companies suggested the Index Based Interest Crediting could grow more than many found reasonable. When the illustrations did not “come true”, some policy holders complained, and rightfully so.
Therefore, if you are considering an Index Universal Life Insurance Policy, make sure the “illustrations” of potential future performance meet these new standards.
SUMMARY AND CONCLUSION
Billions of dollars are placed in instruments that offer Index Based Interest Crediting every year for the past several years. Why? After experiencing stock market downturns of close to 50%, people planning for retirement no longer wanted market volatility.
They want safety now. There is an old saying in investing, “The return OF capital is more important than the return ON capital.” Index Based Interest Credit applies that principle. Guarantees and how they work mean you will not lose your money from market losses.
Whether you are considering a Fixed Index Annuity (with the added feature of an Income Rider) or an Index Universal Life Insurance Policy (with the value of tax-free retirement income); it is important to evaluate them carefully. Does what you are considering suit your purposes and needs? Are illustrations reasonable where given?
There is much written on Index Based Interest Crediting and the products that use them. A lot of analysis is available about how they performed in fact.
With all that has been said, most loudly by the people who have place billions of dollars in them, Fixed Index Annuities and Index Universal Life Insurance are well worth considering. Many consider them an essential element of retirement planning.
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