IUL policy design and selection involves a multitude of factors. It should be done once and done right!
Indexed Universal Life (IUL) is a complex financial instrument masquerading as an insurance product, and it is an excellent choice for retirement planning. However, a number of factors are involved in picking a top-performing IUL in the market and in putting together and maintaining an IUL investment.
Commit and stay the course: An IUL investment that is meant for asset growth is typically overfunded in the first 5-10 years with no further investment required. Hence, it is important to stay the course with the premium payments in order to achieve the planned growth.
IUL is a lifetime investment vehicle: With IULs used for retirement planning, the investment horizon is 10-20 years before you can start taking income. Income is taken by way of a policy loan. Loans are tax-free and need not be paid back.
Be aware of cancellation penalties: The initial surrender charges are high to discourage people from getting in and out of an IUL policy in quick succession. IUL investments are meant for the long-term. Surrender charges typically end after the first decade of investment.
Understand the tax consequences: IUL investments grow tax-deferred and income taken tax-free. But, if the policy is cancelled, the earnings will be taxed as ordinary income with an additional 10% tax penalty. An IUL policy can be safely closed out without any tax consequences after age 75 by triggering the OLP (Over Loan Protection) rider.
Know your living benefits: IUL is a permanent life insurance policy that provides tax-free death benefit to your beneficiaries. However, it also provides living benefits that may be harder to grasp. When, for example, an IUL holder is diagnosed with a terminal illness and has less than a year to live or with a permanent chronic condition, a discounted value of the death benefit may immediately be utilized. Other IUL benefits are captured in our blog “IUL Benefits.”
Review the policy annually: Two components of IUL warrant an annual review, index strategy and loan options. Both are tied to your market outlook and risk tolerance. An aggressive approach could entail selecting an index like the S&P 500 with a spread (points deducted off the top of an index return) for investment growth, and using an alternative / participating loan to take income. A more conservative approach could mean going with a volatility-controlled index with a cap or even a fixed interest rate (typically ≈2.5%) option, and using a non-participating wash loan for income. Review IUL performance against a benchmark in our blog “IUL vs. S&P 500 Performance.”
Here are my priorities for picking an IUL:
- Favorable health rating
Getting qualified for the best risk class based on your current health is the most significant factor in determining your cost of insurance. Hence, it is important to start early. Ideally, get your IUL done in your 30s when you can still qualify for the best risk class.
- Variable loan option
There is a positive arbitrage to be had between loan interest and index credit based on past market performance. Our blog “Mechanics of IUL” explains why this is the case.
- Best in class index strategy terms
Index options and crediting methods (cap, participation and spread) vary widely between IULs. This is the most significant factor that affects performance. You can find more information in our blog “IUL / FIA Credit Strategies and Capital Preservation Explained.”
- Stability of non-guaranteed rates
It is important to review the revision history of non-guaranteed rates such as index cap / participation / spread rates, loan interest rate, etc.
- Nice bonus
Sometimes referred to as Persistency bonus, this rate (typically 0.1-1%) enhances the market index credit and is applied after investing for a certain period (typically starting from Y11-16).
- Low cost
Review cost summary report to ensure that the total cost is in line with other top-performing products in the market. To keep the costs low, part of the insurance coverage can be provided through a Term rider. Please refer to “IUL costs” for a comprehensive list of all IUL costs.
- Living benefits
This can be important for those at risk for chronic conditions like diabetes or heart disease. But, policy Cash Value should be exhausted first before tapping into living benefits.
- Being a mutual company
Mutual companies are owned by its policy owners rather than stockholders, and hence are considered to be more equitable.
- Last but not least: a consultative agent!
IULs are complex financial instruments. Picking a top-performing product in the market takes quantitative rigor and ability to conduct original research. We have illustrated the different phases of an IUL investment in our blog “How IUL Works.”
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