How To Manage Your Cash Value Life Insurance Policy in Retirement
Updated: Jun 10
I was on a webinar the other day, and the presenter, whom I really respect, was saying that "Indexed Universal Life is the worst policy to use for retirement income" compared to his preference of a limited-pay WL.
Now, is he right? And if so, does that mean that no one should buy an IUL for retirement income purposes? Going up Mount Everest (the accumulation phase):
If you are in the accumulation phase, the IUL can be one of the best policies you can use... as long as it is being max-funded. If you are paying LESS than maximum, it will NOT deliver the income stream you'll really want.
This entire article is based on max-funding either a whole life OR an IUL. Minimum-funded policies are not appropriate for this kind of planning. But for a big difference between IUL and WL - if you minimum fund a whole life, you're guaranteed your coverage. If you minimum fund an IUL, you have very little to no guarantees at all. That's the nature of the flexibility of Universal Life policies. If you have one, stay in touch with a competent agent who will help you manage your policy and maximize its potential for you.
However, because IUL can have a higher accumulation value over WL... we'll make some simple assumptions:
- Whole Life @ 65: $1,000,000
- IUL @ 65: $1,250,000 (25% higher balance).
Which one wins? I made up these numbers, but the IUL can win over a whole life policy because of the potential of indexed interest over time. (And no, it won't happen every year.) Policy Illustration concerns: I do have concerns about how IUL policies are illustrated. They assume that long-term "average" returns will happen EVERY year. That won't happen. However, it's also true that when the index does max-out to the cap, it won't show up on the illustration. So, there's give and take on both sides.
Going DOWN Mount Everest (the decumulation phase):
This is where the argument takes hold. Assuming a level death benefit, and a 0% interest year... that year will have 0% gain and a cost of insurance charge against the remaining balance.
This means that you have a little less of a balance to compound and rebound the next year. Now, if this happens year over year... it can be an issue. The stock market in 2000, 2001, and 2002 all had negative years... so it is possible.
But the IUL had a higher balance at age 65!!!
And that's where it can all still work.
Take the whole life policy: For $1,000,000 in cash values with a loan distribution rate of 6% ($60,000), the original balance will continue to grow as though it hasn't been touched (aside from loan interest charges). The policy will generally last about 5-6 years beyond anticipated life expectancy. If you do less, it'll last longer.
For the IUL policy: For $1,250,000 in cash values... I wouldn't do a 6% loan strategy. I'd probably do about 5% ($62,500) or less, and the original balance will continue to earn (or not) as though it hadn't been touched (aside from loan interest charges and attained age cost of insurance). Again, the IUL policy may also last about 5-6 years beyond anticipated life expectancy. If you do even less, the policy will last longer. By the way, for the illustration purposes, the IUL probably won't be illustrated quite that rosy. It'll probably illustrate closer to the whole life - per the illustration. Why? Mandated legal requirements in the illustration. But there is the potential (as is also true for the WL) that the balance can be higher.
Keep in mind that for every 0% year, the cost of insurance charged for the net amount at risk (the difference between the cash values and the death benefit) will be based on the insured's age at the time.
The net result... is about the same. That $60,000 loan against the whole life... OR the $62,500 against the IUL... will have the same tax treatment per the current tax code.
They just have to be managed a bit differently... that's all.
IUL vs Limited-Pay WL: Yes, IUL is technically a "forever pay" policy, depending on funding. However, the IUL can lower the death benefit to help contain ongoing costs of insurance charges. Just be sure it doesn't turn the policy into a MEC. In this way, you can simulate the policy being more like a limited-pay whole life... but we just cannot say "it's paid up".
Who is liable for the costs of insurance on an IUL vs a limited-pay whole life?
During the premium paying years, the liability is on the contract owner and payer. (Try not paying on a whole life policy after the first 5 years - it'll cancel just like any other policy.)
Whole Life: After the premium paying years, for whole life, the liability is on the insurance company. They assume the liability for earning enough on that portfolio to afford the ongoing growth and eventual death benefit.
Indexed Universal Life: You can lower the death benefit, but the liability of the costs of insurance is always on the policyholder. The trade-off is... there's typically a higher total benefit compared to whole life - with similar assumptions.
Should we replace the IUL for a whole life policy? No, it would NOT make sense to do a 1035 exchange from the IUL to whole life. You just need to know how to properly manage it. For the sequence of returns, a lower loan distribution rate would need to be factored in.
Why is this important? It's important because many insurance agents have their preferences. (Some have drunk the "kool-aid"; that's when they can't back up why they believe what they believe.) I don't believe in unnecessary policy replacements when all that's required is a different approach to policy management to net about the same results.
A couple of big considerations: - Accumulation Values: Notice the numbers I used in my example above: $1 million in Whole Life vs $1.25 million in Indexed Universal Life. That's a 25% higher balance that you'd HAVE to have to equate to the whole life policy.
- Loan Distribution Rate: I lowered the loan distribution % from 6% to 5% to offset the ongoing costs of insurance, particularly when there's no return in a given year. Yes, IUL can *work*... but it's far more efficient (and nearly guaranteed) to simply do it with a whole life insurance contract.
Another point: All the profitability on these IUL contracts... goes into the general investment account and is part of the whole life dividend performance of the same company!! Now, would you rather profit from other people buying less guarantees... or would you rather be the one potentially "holding the bag" and keeping the risks of your plan?
A Note about Variable Universal Life or Variable Life policies: These policies are invested directly in securities (referred to as "sub-accounts"). The problem with these policies, is that every time you request a loan against these securities, the equivalent amount of securities is liquidated and put into a fixed interest segment in the policy. You don't get to have the market returns in these variable policies as you would with whole life or indexed universal life.
My Bottom Line on this article: I will sell what *I* like, because I like it and I like the companies that issue the contracts I like. That doesn't mean that other policies are "bad" or "inferior". It does means that I have preferences, yet I am also skilled and knowledgeable in managing various kinds of policies. I don't necessarily have to replace a policy in order for someone to do business with me (although if it's under-funded, it's certainly fair game).