An IUL, when it is designed and maintained as a long-term investment vehicle, is a powerful retirement income generator as well as a savings account that can serve as a buffer resource to meet unexpected expenses.
Indexed Universal Life (IUL) is a complex financial instrument masquerading as an insurance product, and it is an excellent choice for retirement planning. Let us walk through the investment phases which an IUL product involves.
The first phase is the premium payment. In our example, a 45-year old male with good health invests $15K a year for 10 years. IUL policies are typically overfunded in the first 5-10 years. Investment grows tax-deferred and tracks the S&P 500 index return with a 5% spread (points deducted off the top of an index return), but with principal protected. It means that the policy earns the S&P 500 rate of return minus 5 points or 0%, whichever is greater. This index credit strategy is just one of many offered by IULs, some more conservative, others more aggressive than the 5% spread we used in this example. For more on credit strategies, refer to “How Index Crediting Works” and “IUL / FIA Credit Strategies and Capital Preservation Explained.” This model uses the actual 50-year S&P 500 returns from 1969 to 2018.
IUL has two accounts: Cash Value (CV) and Accumulation Value (AV). CV is the money available to the policy owner at any given time. AV is more for internal accounting and it can be higher than the CV either because of surrender charge, which typically applies during the first 10 years of the policy, or when a loan is taken. AV is the sum of the CV and the loan balance. A deeper dive on this topic can be found in “Mechanics of IUL.”
In the second phase, the policy value is simply allowed to grow. This growth period is 10 years in our example, at the end of which the CV and AV balances stand at $392K. In the third phase, income is taken by way of a policy loan. Loans are tax-free and need not be paid back. There are two types of loans: wash loans and participating loans. Wash loans charge a near 0% interest rate but the outstanding loan balance does not earn any market credits. Participating loans charge a fixed interest rate (5.6% in our example) but the outstanding loan balance continues to earn market credit along with the rest of the CV balance. The use of participating loan in this example resulted in a net positive interest credit of 1.5x the loan charges. Any new loan amount and the accruing loan interest reduce CV, while the market credit grows CV.
The example scenario posits a cumulative tax-free income of $1.8M taken over 30 years as $60K of annual income. At the end of phase three, almost all of CV except ≈$0.5M has been used up. Any remaining CV will go to the beneficiaries as a tax-free death benefit, when the insured passes away. The annualized IRR over the 50-year period is 9.6%. The key benefits of an IUL investment are summarized in “IUL Benefits.”
Not all IULs are made equal, however. It takes considerable market research and numerical analysis to pick a top-performing IUL policy. You can find more information about this in “IUL Policy Design Considerations.”
We specialize in tax-free retirement strategy and investments such as IUL, Annuity and LTC. Prefer a quick and complimentary consultation? Just email us at Karthik@FinCrafters.com