An Equity Indexed Universal Life Insurance Policy is a financial tool that is growing in popularity.
For most people who purchase an EIUL, it becomes a part of their well thought out purposeful financial plan. As only one part of a plan it must work in complementary ways to the other parts. There are four key components of an EIUL that attract folks; taxation, liquidity, death benefit and solid internal rates of returns with low variance.
EIUL’s Have Tax Advantages
Money placed in a properly structured EIUL can be accessed via policy loans without incurring a taxable event. At death a death benefit goes to heirs free on income tax, but could incur estate tax depending on what the rest of the estate looks like. This taxation benefit is what initially attracted Wall Street to life insurance causing them to develop universal life insurance. Large corporations and wealthy individuals have used this aspect of universal life insurance for their benefit since its inception in the 1970s. As the government increasingly looked to the middle class to fund its operations, taxation has become one of the biggest risks a middle class investor has to deal with. For example, look at what is about to happen if congress doesn’t get its act together this month:
- Top two tax brackets to go to 39.6% and 36% from 35% and 33;
- Capital Gains tax rate to go to 20% from 15-18%; and
- Qualified Dividend Income to go to the taxpayers regular income tax rate from 15%.
Of course no one knows what will happen, but with huge budget deficits the government must find new revenue. By placing wealth in an EIUL you eliminate this risk and cut the government out of your pocket. I have California clients that will now avoid close to 50% taxation [federal and state] on their retirement funds that they would have paid had they continued with their 401K. Even those in lower tax brackets avoid 25% or more taxation in many states. I think readers can immediately understand how this can give you Bigger Pockets in retirement.
EIUL’s Offer Liquidity
Liquidity is important to all folks and its lack is the leading cause of bankruptcy. Money inside an EIUL can be accessed without penalties or taxation. Money accessed can be critically important to real estate investors giving them time to deal with cash flow issues avoiding fire-sale situations. Once cash flow issues are dealt with the money can be put back into the policy with little financial costs unlike accessing funds from an IRA/401K or through traditional loans. Job loss is the #1 reason people cash in their retirement funds and the government penalizes these folks severely. Some folks work for companies that simply won’t allow access to 401K funds while continuing to work for that company, essentially locking out folks from their money!
Death Benefits Are Included
This is a life insurance policy at its core. The death benefit is an understated benefit. If death occurs in the earlier years of the policy then your $$ are leveraged. Most people have family or organizations that they are supporting and would want to be financially protected from their early death. Who will take over your real estate investing if you were to die? Wouldn’t it be nice to have your financial plan be completed or at least your loved one’s have cash to buy time to deal with your real estate investments no matter what age you die?
EIULS Can Provide Solid Investment Returns
EIULs get annual interest credits that are tied to a stock index with a floor and a ceiling commonly called the cap rate. After you receive the interest credit it is locked in permanently. Cap’s range from 11% to 16% at this point. Generally, the floor is 0%. So that means each year you will receive between 0% and 16% depending on the index. If the index goes negative then you get the 0%. If the index goes positive from 0% to the cap rate, that is what you receive. If the index goes up more than the cap rate then you receive the cap rate. Using historic numbers for the indexes, this strategy beats the index average by 1-2%. The power is not having negative numbers which have to be overcome. The other advantage is limiting sequence of return risk. So if you have $1M of cash value in your policy in the years before you start using it, you know you will have at least that $1M when you need it. Now it is highly unlikely that you will get double digit returns. However using historic number as a guide you should get 7.5% at the lowest to around 9%.
Now there are some costs that come along with the advantages.
A Long Term Investing Strategy
This is a long term strategy and should not be purchased by folks who have a short time horizon or who can’t keep within a plan. Expenses in all life insurance policies are taken out mostly in the early years. There are also surrender fees that go for 10-15 years if you were to decide to surrender the policy. So it is best to wait 15 years before you start taking out cash value without the intent of replacing it. When kept to death, most of the policies I structure have an overall expenses percentage of less than 1.75%, some less than 1%. This includes all expenses including insurance expenses. This can’t be understated, these policies are designed to keep for live and with this intent is how it should be bought. Those that expect to need the money before around 15 years, should not buy this product either as it needs that time to get beyond the majority of the expenses and really start to perform well.
Who Should Not Buy a EIUL
Those that have serious health issues, might not want to purchase this product. Because the IRS rules go by ratio’s I can overcome most of the increased insurance cost with correct structuring, but when the issues force us way down the rating scale we do lose some efficiency.
Finally, those that haven’t done the basics, like build up short term reserves should get their financial house in order before locking up any money in any retirement strategy.
This should be a good primer for EIULs and allow folks to decide if looking more deeply into this product is worth their time. Ultimately, the decision should be based on if this financial tool complements their current strategies and fits their financial plan. Only you can answer those questions.
Photo: Alex Proimos