Pros and Cons of Over-funding Life Insurance
Here at Life Insurance Think Tank, we are fortunate to work some of the best and brightest life insurance and legacy planners in the country. Moreover, we are in such a unique and exciting position because we get to learn every day from some of the best in the business financial professionals in the life insurance arena. Recently, we started asking some of our top financial professionals to submit articles or educational pieces that have helped their clients so that we could put them on our blog and help ever more people out there searching for life insurance education.
This week we received an incredible article from Cal Burgess, owner and founder of About Universal Life, that is titled, “Why Over-funding your life insurance policy could be a smart move.” Check out the full piece below.
With the financial turmoil over the last 4 years, many retirement plans of Generation X are still in the red. Generation X is the first generation in US history that will be approaching the golden years without any sort of guaranteed income. Outside of a deferred compensation plan, over 90% of working Americans have zero guarantees with respect to their retirement income planning. Meaning that those currently concerned about the baby boomer epidemic (which is paving the way to social security’s demise) might want to take a second look at our next underfunded generation 30 years from retirement. 30 years out looking back could easily make our current retirement crisis seem infantile. What’s a possible solution to this dilemma? Generation X can start by taking a closer look at their life permanent life insurance policy.
Outside of a term life insurance policy, permanent life insurance can give a policy owner the capability of accumulating funds with absolute guarantees. Guarantees like never losing principle to unanticipated drops in the market. One popular life insurance vehicle that can protect against a roller-coaster market is an indexed universal life (IUL) policy. Why? With an IUL policy you can grow your cash value without being exposed to volatility. You can also have the capability of withdrawing funds from the policy that are exempt from federal income taxes, if properly structured.
IUL policies allow your funds to grow unaffected by market volatility. Since funds deposited into these vehicles are not securities, they don’t lose value when the market goes south. Instead, the insurance company bares all of the risk of the policy owner in exchange for a capped return. Insurance companies are able to do this by underwriting all policy owners, thus increasing the chance of each policy owner reaching expected mortality tables. The philosophy being, the longer the policy owner lives the higher probability the policy owner will continue to make deposits. This is a win-win for both parties.
Outside of being able to grow your funds exempt from volatility, an IUL policy can be set up as an income planning vehicle exempt from federal income taxes. This can be done in 1 of 2 ways. The first way is to make withdrawal from the policy during the accumulation phase. In an IUL policy the principle must be withdrawn prior to any accrued interest becoming a taxable event. The second way to withdrawal funds exempt from federal income taxes is through a policy loan. Assuming that the IUL policy has been structured as a non MEC (modified endowment contract), the policy owner has the capability to take a loan against the cash value. Interest is charged on the loan and is only deemed payable upon death. Since the policy owner is taking a loan against their own cash, monthly installments to repay the loan are discretionary. Otherwise the loan is repaid at the death of the policy owner, leaving the loan balance to be subtracted from the cash value. Think of it as the death benefit squaring the balance, while the remaining death benefit is dispersed to the beneficiaries of the contract.
Investors are using this approach as a supplemental income stream to offset the threat of rising taxes while protecting their net income against rising federal income taxes. Today the highest marginal tax rate is 35%. Historically the highest average marginal tax rate is over 60%. When considering how much debt we have incurred over the last 4 years it doesn’t take a genius to figure out federal tax rates have nowhere to go but up. How soon that happens remains to be seen. In the mean time investors are redirecting their funds to these vehicles in anticipation of rising federal income taxes. What is your contingency plan to expected volatility and rising federal income taxes?
Before you decide to absorb any more risk within your retirement plan, you may want to take a second look to an IUL policy. You may be disappointed at the results of your retirement plan (assuming your fortunate enough to have one) over the last 10 years. With an IUL policy you will have the comfort of knowing you will never have to make up you losses due to a volatile market. This is a philosophy that investors will continue to embrace with open arms. What do you think your portfolio would look like today if you could have skipped over every market downturn over the last 10 plus years?
Currently permanent life insurance contracts are the only financial vehicles that can allow for tax advantaged withdrawals while bypassing any market downturns. This is all the flexibility Generation X will need in order to adapt to an unprecedented evolving market.