Tag: Retirement Planning

No Roth, No Problem

Having too much income will prevent you from using a Roth IRA (Roth) to save after-tax money, and grow that money, tax-deferred, as well as use that growth, tax-free. Also, the type of income you have may prevent you from using a Roth, as contributions must be made with earned income, not income derived from dividends and other passive sources.  On top of all of this, the people who are most likely to want to maximize Roth IRA contributions, and may even use strategies like the “back-door Roth”, are likely able, and want to, make substantially higher contributions than allowed by law anyway.  For these folks, who want to enjoy tax-free growth and tax-free use of gains, well into the future, municipal bonds, don’t fill the bill; instead, the only mechanism left is the implementation of a properly designed cash-value life insurance plan. 

Cash-value life insurance has several tax advantages that can mimic a Roth IRA, except without income or contribution “limits” imposed on a Roth IRA (such as income phase-out, earned income requirement, and annual contribution limits). But selecting the correct type of permanent cash-value policy must be done with care for a variety of reasons. Firstly, there is not one type of cash-value insurance that is better than another type, each general type has a unique value proposition.  Also, the individual contract terms, carrier formation, carrier ratings, dividend history, underwriting standards, reserves, optional features and benefits, and other factors of each issuing insurance company’s contract, may play a part in your decision to use one type of insurance over another, with one particular carrier over another.  Said another way, the same type of insurance still differs from one carrier to another!

Complexities of cash-value life insurance should be explained by an experienced, licensed professional

Using permanent cash-value insurance for this purpose should be secondary, the primary purpose of the policy is to provide life insurance and it offers a panoply of benefits above and beyond tax benefits to the cash-value. 

A full understanding of:

  • cash-value crediting method
  • dividends
  • loan interest
  • direct or non-direct recognition
  • general account surpluses/obligations
  • carrier ratings
  • performance history

…along with several other items, need to be understood for all products being considered by the policy purchaser; also reviewing illustrations that can generally show the guaranteed and non-guaranteed aspects/projections of a certain type of policy. That being the case, it is most prudent to speak to an experienced, knowledgeable professional since the choice made, will have to be lived with for years into the future.

Filling the hole in a portfolio

Using permanent cash-value insurance can fill a significant hole in many people’s portfolio.  Typically, brokers advise clients on investments based on the client’s time horizon for needing to use the money, and risk tolerance.  Younger investors who want to be aggressive in their investing, may not have any “safe” money sitting on the sidelines, growing at a slower, but more stable pace, and this might prevent them from taking advantage of buying opportunities when the market has a correction; but the only significant money they have, might be tied up in securities that have lost value during the correction.  But as investors get older, many are advised to put an increasing percentage of their portfolio into bonds, or other fixed income instruments, but the issue here is that an investor would still have to liquidate securities to have the cash to take advantage of buying opportunities

Another issue is that sometimes an investment doesn’t allow for liquidating only certain segments, like just the bond portion, of the investment.  This might limit the down-side of the portfolio, but it can also inhibit the upside.  But certain types of cash-value life insurance can serve as the conservative aspect of a well-rounded portfolio, by leveraging the long-term stability typically  found in a highly rated insurance company’s general account.  Since access to the cash-value can be done without taxation, or penalty, it gives the policy holder liquidity that is difficult to achieve with regular investments, and when the tax load is considered, it makes the tax free use of an insurance policies cash-value, all the more attractive.

estate taxes life insurance

Estate Tax Recovery

Checking your exposure to estate taxes

At a minimum, estate tax and inheritance taxes can be imposed at the federal and state level, given this, individuals should check with their CPA and/or a tax attorney, regarding the potential for exposure to either of these taxes, now and what the potential may be in the future.

Most people don’t believe they have or will have assets significant enough when they die to make death taxes matter,  but most likely, your heirs and estate will be faced with some tax burden.  Also –  tax laws and rates can change over time.  

And when you’re trying to predict what will happen 20, 30 or 40 years from now — nobody knows, and only a fool would try to guess! 

A device commonly known as an ILIT (irrevocable life insurance trust) is typically used to segregate the life insurance death benefit proceeds from the insured’s estate, for the purpose of having those funds excluded from the taxable estate, and in the case of the estate incurring any tax, using those funds to pay the estate, thereby keeping the estate “intact.”

Keeping the estate “intact” is extremely important if a non-liquid asset is part, or all of the estate, the decedent may wish to pass real estate or a business that has value that subjects the inheritors to taxation, but the estate, or inheritors, don’t have cash to pay the estate or inheritance tax due. This might cause the need to quickly liquidate the asset for a fraction of its value, since the due date on the taxes owed may force a below-market sale of the asset(s).

Using permanent life insurance to manage estate tax funding

Estate tax funding issues are generally only properly addressed with permanent life insurance, and a proper plan from an experienced professional is necessary to design a coverage plan that will most likely fulfill the requirement in the distant future. There are several major considerations when doing insurance policy design for this type of estate planning, some of them are, retention limits of the carrier you and your agent choose, general account rating, booked obligations, earnings history, dividend history, trend of the assets and liabilities.

Your independent agent should be able to produce and review a VitalSignsⓇ comparison of the carriers he or she is recommending to you. In the hands of an experienced agent, the reports on the various carriers can help guide your decision to a company you think is most suitable for your goals, and alleviate future regret about the company you chose.

So if you are now, or think you may be in a position in the future, where you want to make sure you have done some planning around alleviating an estate of inheritance tax burden from your heirs, it would be prudent by engaging an experienced life insurance professional, as well as an estate attorney and/or CPA, who can take you through the first steps of developing a strategy

insurance protection

Universal Life Insurance

Flexible premium policies

A Universal Life (UL) — or flexible premium policy — is a form of cash-value policy where the cost of insurance increases every year.

Typically, this annually increasing cost of insurance isn’t noticed by the policyholder, as the initially required premium covers the cost of insurance and policy expenses in the early years of the policy. During those years the excess premium being put into the policy is accumulated as the policy’s cash-value, and the goal of the policyholder is to grow the cash-value to either offset the net amount at risk to the insurance company, or so that in the future as the cost of insurance exceeds the scheduled premium, there is excess cash value and/or growth of the cash-value, that supplements the premium to cover the increasing cost of insurance.

That is only one factor that makes universal life a lot more complicated than whole life insurance. There are three main cash-value crediting/growing methods used in universal life policies: Traditional, Variable and Indexed.

piggy bank

Traditional Universal Life Insurance

The three methods of cash-value crediting

You should first read the Universal Life article to get a general understanding of universal life insurance, and then come back to read this article.

There are three main cash-value crediting/growing methods used in universal life policies: Traditional, Variable and Indexed.

With the traditional interest crediting method, cash-value is credited either at the carrier’s current stated rate, or the minimum crediting rate as defined by that particular policy. It is useful to understand that universal life came about in the 1980s when bank interest rates were above 10%, and traditional whole life cash-value projections didn’t look attractive in comparison to a savings account or bank C.D.

While it was not uncommon to see universal life policies with cash-value crediting rates of 8% or higher, a typical provision in the policy allowed the crediting to be reduced, as the carrier saw fit, to a minimum “guaranteed” interest rate, typically 4%-5% in those days. Another component that is not generally fixed as it is in whole life insurance, is the cost of insurance, it too is changeable by the carrier up to a guaranteed maximum. So depending on the carrier, if you have an older UL where the crediting is now at the guaranteed minimum of 4% or 5%, your policy still may not perform well if the carrier has increased to cost of insurance of your policy, meaning more of your premium and possibly the already accumulated cash-value, will have to go toward servicing the increasing policy costs.

These are just a few things that make universal life a much more complicated product for the average person to own, without the perennial help from a knowledgeable agent. It should also be highly appreciated that many carriers have experienced cost of insurance increases over the years, and especially in those cases, it translated into results that did not resemble the “current” assumptions, costs, and crediting rate that was shown on the original illustrations, in many cases, forcing the policy holder to drop the policy as the costs became unaffordable.

life insurance income growth

Variable Universal Life Insurance

Mutual fund sub-accounts and variable universal life insurance

There are three main cash-value crediting/growing methods used in universal life policies: Traditional, Variable and Indexed.

The second type of crediting mechanism is the use of accounts that are tied to investments. This type of universal life is called Variable Universal Life, (VUL) in a variable universal life policy, the policy holder has the opportunity to pick from a menu of mutual fund sub-accounts, or a low risk money market account for times the policy holder wishes to take some or all of their money out of the market.

Typically, the policyholder can chose to divide their cash-value however they wish among the various investments. While this is may appear more appealing than the traditional universal life, one has to remember that their cash-value is subject to going down if there is a loss in the investments they have selected. Also, the possibility of the cost of insurance increasing, as described above in the traditional universal life, is still the case here as that is the nature of all universal policies.

However, if one has faith in their own investment acumen, they should seek out a knowledgeable, experienced agent to guide them through the various decisions that must be made when designing a variable universal life policy, and then the policy holder should stay in touch with that agent at least annually to do a policy review, and discuss possible changes that have happened with the carrier, or the policyholder.

life insurance tax free income

Indexed Universal LIfe Insurance (IUL)

Indexed universal life is the most complex type of universal life insurance

You should read the Universal Life article first to understand the basic components common to all universal life/flexible premium life insurance policies.

Indexed Universal Life (IUL) is the most complex of the three types major types of universal life.  IUL has the same attributes as the other types of UL policies, regarding the annually increasing and changeable cost of insurance, but the cash-value in an IUL is attempted to be grown through the use of options, purchased by the insurance company from a portion of the policy’s premium payment.

Policy holder "investing" explained - indexed universal life insurance

Typically, a policy will have different strategies to choose from, many of which sound like the policyholder is “investing” in a mutual fund, tied to some index. But the policyholder is not participating in a mutual fund, they are agreeing to let the carrier buy into an options strategy where the options are purchased on particular dates, and exercised on particular dates in the future, so long as they are worth exercising at that time, potentially the policyholder’s cash-value will be credited with some or all of the gain, produced by the option, if there is any.

Should the option be worthless on the exercise date, the policyholder’s cash value might not see any change caused by the purchase of the option as the balance of the premium payment, after all the charges and expenses are deducted, went into the insurance company’s general account, where over the same period of time that the option was for, the carrier was able to grow back the balance of the premium payment left in the general account as part of the policy’s cash-value, to where it would have been had no money been used to buy the option. Some policies may even promise that there will even be a sight gain of 1%-3% should the option have proven worthless; again, this “gain” is simply the interest crediting of the company’s general account, and usually when a guaranteed credit above 0% is offered, there are typically other limiting factors to how much gain will be credited should the option actually produce a profit.

Indexed universal life insurance "cap" explained

One of these limiting factors is called a “cap”, this is where the gain of the indexed option is limited to a maximum amount. As an example, say you pay your first annual premium of $1,300 about $300 of that goes to policy fees and expenses, and the cash-value is credited $1000, and in the strategy you chose, you are guaranteed a 0% loss of cash-value. Now the company’s general account is yielding 4%, so the company takes about $38 of the $1000 of the policy’s cash-value, and buys an option that can be exercised 1 year from its purchase. Why $38, because over the next year, the $962 left in the general account, is earning 4%, and will grow back to $1000 and therefore, should the option be worthless on its anniversary date, the promise of no loss will be fulfilled without any actual “cost” that would harm the insurance company’s general account. But say that $38 option turns out to return $140 when it is exercised, well if there had been a 7% cap on this particular strategy, the insurance company would credit the policy with $70 while keeping the other $70 as company profit, and since since the $962 grew back to $1000, when $70 is added to the now $1000, it looks as though the $1000 made a 7% return, as the cash-value would then be $1070. The next possible limiting factor is called a “participation rate”, this is a slightly different limiting factor on the policy’s gain.

Using a participation rate, a company might give a policyholder an uncapped strategy, but cut the participation of the gain to some percentage. So, say in the example above the option returned a total of $70, but the participation rate was 50%, the amount credited to the policy would only be $35, yielding a gain of 3.5%  to the policy’s $1000 of cash-value. The last major factor built into some strategies is the “spread” this is a declared percentage of gain that will be taken from the calculated “percentage yield” that might have been produced by the options return. So if an option made an amount that would have yielded, say, effectively 7% to the policy’s cash-value, if the spread on this particular strategy was 1%, then the policy’s cash-value would only be credited effectively 6%. 

Indexed universal life insurance options strategy explained

The last major factor particular to IUL, that affects the policy’s ability to grow cash-value through an options strategy, is point-to-point risk, this is where the day the option can be exercised, the option is below the strike price and is therefore worthless.

All of these items: cap rate, participation rate, spread, that are particular to IUL, and then the changing annually increasing cost-of-insurance, as well as the insurance company to potentially increase that, up to a maximum guaranteed level, makes an IUL a very complex product that has the most moving parts that are in the control of the insurance company of the three categories of universal life.

And while many times, an IUL is sold to a client as a vehicle which allows the policyholder to participate in the upside of the market, without the downside risk, the limits on the upside of any particular product, have to be carefully considered before deciding to use this for a cash accumulation vehicle, as opposed to simply a life insurance policy that may have a guaranteed death benefit in the end, as long as the minimum required premiums had been paid. 

When any universal life product is considered by the consumer, it is extremely important that all of the variables be understood, with a view toward the consumer’s goals, with an understanding of what may be necessary, and available to change, should the performance of any of the variables not meet the non-guaranteed expectations shown in the product’s illustration.

This is why only a knowledgeable, experienced agent should be consulted on this or any life insurance product purchase, as the consumer rarely has enough insight into these products to ask all the questions necessary to make sure they won’t regret their decision a decade or two or later. And while illustrations of cash-values can look exciting, one also has to consider the company that is issuing the product, and that company’s ability, through an examination of their assets, liabilities, portfolio rating, retention rates, number of policies in-force and several other factors, before they commit to a very long-term plan for their money.

Next Article:
  • Universal Life Insurance
Related Articles:
  • The Truth About Whole Life Insurance
  • Traditional Universal Life Insurance
  • Variable Universal Life Insurance
  • The Truth About Online Life Insurance Quotes
retire with life insurance

How To Buy Permanent Life Insurance

Selecting the right carrier is critical in permanent life insurance

Buying permanent insurance requires expert advice.  Even you think your need is very basic — like a final expense policy for funeral expenses.  Why?  One reason is that the company you choose will be apart of your life for a very long time.  So you should always carefully consider:

  • the company’s history
  • general account ratings
  • outstanding liabilities
  • number of policies in-force
  • reserve, and claims experience

…just to name a few items!

In addition to understanding the company, there is the question of which type of permanent insurance will be best for your particular circumstance and what the company’s terms are, for the type of insurance policy you are seeking.  Lastly, understanding all the “moving parts” of the policy and understanding what you, (the policy owner) have influence over and what the issuing company has control of. 

These are not small considerations, given that the policy owner’s own operation of a policy, and/or minor changes allowed by the policy, that the carrier can make, can have a dramatic influence on the direction a policy takes over the years.

Selecting the right agent to be your advocate ensures you will get the best coverage at the lowest possible cost

Many times, even small deviations from illustrated rates and values from the carrier or changes in premium payments by the policy owner can be magnified over time, possibly spelling disaster for the original intention of the policy.  And while the term “permanent life insurance” implies that it is for the life of the insured, that is not always the case!

There are many factors that can adversely affect the ability of a policy owner to ensure that their policy is actually permanent.   Some of these items are in the policy owner’s hands, others are in the carrier’s hands, and still others could be the result of the underlying terms of that particular contract.  So with any type of permanent insurance, it is extremely important to work with a knowledgeable, experienced agent