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
{ 10 comments… read them below or add one }
EIULs, especially for those clients with at least a 20 year horizon love this approach. It’s not for everyone, as you point out, Dave, but those for whom it makes sense, it rocks.
Are these contracts contractually guaranteed not to lapse under these income strategies? I’ve heard that because of the variability of cash values and rising mortality costs in these contracts that there is risk to an income strategy that exceeds what you could otherwise get with guarantees with a straight whole life contract.
I will add to what Mike asked … and dig a little deeper.
What happens if a policy holder reaches retirement and begins taking distributions and either the stock market (or underlying index in the EIUL) stays flat (no return) or if the policyholder lives to age 99?
My understanding is that both scenarios can present very dire circumstances to the policyholder.
Mike and Kevin, thanks for your thoughtful questions. I think both the questions are aimed at the same concepts so I will answer them together. There is much propaganda and misunderstanding regarding this.
First, every policy I sell I put on a rider called an “overloan rider,” which prevents the “dire circumstances” referred to by Kevin [most but not all companies have this option]. There is no initial cost to this rider, but if in the later years of this policy so much cash is taken out of the policy that the insurance expense can no longer be covered this rider is initiated. The policy is then frozen at current death benefit and guaranteed at that death benefit until the insured dies.
This prevents an accidental surrender of the policy which could trigger an tax event.
Permanent life insurance is structured differently from term insurance specifically to handle the increasing insurance costs as you age. Universal life insurance added flexibility on both premium and death benefit to whole life policies. This flexibility is important and one of the main reasons the policies work so well for retirement income. It is easier to see this with an entire illustration in front of you, but I will give an example of how this works from a recent illustration I created for a client. UL when structured for minimum life insurance and maximum cash value build up allows for the death benefit to adjust both up and down during the life of the policy. Following IRS guidelines you have to have a “corridor” between the cash value build up and the death benefit. But, the theory behind permanent life insurance is that you pay a premium that is more than the costs in the early years, that extra builds up and is used to lower the amount of actual life insurance you are paying for [this is different than the death benefit]. If you had to actually pay for the insurance costs at upper ages the costs would be astronomical as the odds of dying approach 100%. Here is an example from a 32 year old man:
After year one there is $530,000 in death benefit, but $14,000 in accumulated value. So this person would be paying insurance costs on the difference or $516,000. The cost is $238. Going to age 65, the accumulated value has gone up to $1.4M, so IRS rules has forced the death benefit up to $1.8M. So at age 65 he is paying for $400,000 of insurance at a cost of $3,000. But remember he is getting interest credit on $1.4M at this point, so it only takes a small interest credit to cover the $3,000. Now this clients starts to take distributions from the policy and the death benefit starts to decrease as a result. So at age 80 he has $1M in accumulated value and a death benefit of $1.16M. So he is now only paying for $160,000 of insurance at a cost of $4,900. But he is still getting an interest credit on the $1M of accumulated value. As the policy goes forward the minimum corridor is maintained. So, if there is no or a small interest credit in any given year, then the death benefit goes down more to account for that and the distribution.
Add in the flexibility for the amount of distribution which gives you the ability to be more or less aggressive with your distributions without having to worry about cost of insurance issues.
I know this might seem confusing, but it becomes clearer when you look at a complete illustration and can see the interplay between accumulated value, death benefit, and cost of insurance. The bottom line is that the policy is designed to render distributions, but not have large cost of insurance during old age.
One other comment on the comparison to whole life. Whole life is designed to maintain death benefit for life. That is what it does best. EIULs are designed to maximize cash value and provide distributions. That is what it does best. The internal rates of return inside EIULs, using historical data, indicates that EIULs will get around 2 what the best whole life IRRs will get. If death benefit is what you want to guarantee then whole life is your product. If cash value build-up and distributions is your intent, then EIULs [not Variable Universal Life which is a different animal] works best.
Sorry, in the next to last line I left out the word “times.” The line should read, “The internal rate of return inside EIULs, using historic data, indicates that EIULs will get about 2 times the best whole life IRRs will get.”
As I have stated in other responses to blog messages – financial plans … and as David’s lengthy response here illustrates … the purchase of life insurance is a complicated topic. Determining the AMOUNT and the TYPE (term versus whole life versus any form of universal life) involves many complex issues. Most consumers would be best served by discussing these issues at length with a qualified financial professional.
But I have to take issue with one point. You state that the investment strategy within the EIUL “beats the index average by 1-2%.” Why then do investors or indeed just a mutual fund follow this strategy? Why shouldn’t I just take 95% of my retirement funds and buy bank CDs or Treasuries (the safest investments) and then take the other 5% and buy options on various stock market indexes? You claim that this results in beating the indexes by 1% or 2%.
Kevin, I would agree with you that you should make careful consideration before purchasing any financial instrument. But, EIULs aren’t really that tough to understand if you take the time and have an agent willing to help you. If one can master real estate investing, then they can understand EIULs.
Your comment on “beating the index” misunderstands what I was saying. The interest credit that has a 0% floor and a cap rate between 13-16% beats the actual index by 1-2%.
The interest crediting strategy was created by the insurance companies based on their investing portfolio that includes mostly fixed rate securities and some european style options [along with other types of investments]. Your ability to mimic an insurance companies investing is limited by your level of investing sophistication, size of portfolio, experience, risk management, etc. Insurance companies are some of the best large scale investors out there and I for one do not think I am as experienced or have the same economy of scales and sophistication as they do. Nor do I have the time on a daily basis. But, even if you could mimic them in a personal account, you would have the taxation issues I talked about in the post.
The simple truth is that EIULs have been around for over 15 years now, through the bad times and a little of good times, and have worked as advertised. That should be what counts, right? Actual evidence of what works and what doesn’t. Just like Real Estate investing, actual evidence of what works and what doesn’t is the guide. At least that is how I look at it.
This post and the comments, followed by Dave’s replies are the perfect illustrations of why he’s an integral part of my team. Simply awesome.
I’m financial consultant and sell life insurance. I’m also a real estate investor. Real estate and permanent insurance integrated together properly can be a fantastic blend of protection savings and growth. I’m personally inclined though towards minimizing risk in my insurance planning. I like guarantees and never having to unwind a bad situation for a client. No one’s come back to me after owning whole life for 20yrs and wants to cancel it because its too conservative. I have plenty of risk and growth potential in my real estate side; I don’t need risk in my life insurance. So I’m partial to straight whole life as reservoir for profits. There’s no magic pill there either; no single product or single strategy is “the” answer for anyone. It’s really the careful coordination of financial strategies in such a way that it makes one financially bullet-proof that’s what matters most.
Mike, couldn’t agree more.
But I am a little confused about your use of the word risk.
You seem to imply that an EIUL is more risky than whole life.
If this is what you are saying, then I disagree with this sentiment.
Whole life is designed for stability of death benefit with guarantees of the death benefit.
EIULs are designed for maximum increase of cash value with guarantees attached to cash value build up.
WL companies declare a dividend or an interest credit at the end of each year which varies depending on how well the companies investments did that year.
EIULs give an interest credit based on an index movement that comes from the companies investments.
Ultimately, both are dependent upon the investment returns of the company.
Universal life has flexibility of premium payments as well as death benefit. This is what makes the ability to increase performance well above what most life insurance has traditionally given [ie whole life].
I don’t see the increased risk in EIUL over WL? In fact, I think because EIULs have more flexibility, they provide easier ways to manage any inherent risk.
Ultimately, it goes back to what do you want to accomplish with the insurance contract.
Pass on a fixed amount to an heir or produce a tax-free income stream? One should use the right tool for the job.