Life insurance is not the first thing that comes to mind when thinking about ways to save for retirement. Most people recognize the need to protect their family in the event of an untimely death, but they do not do an actual needs analysis of what the loss of a breadwinner or stay-at-home partner costs. This article will teach you about the flexibility, vast possibilities, and potential benefits of an indexed universal life insurance policy.
The Case for Life Insurance
I do want you to consider all of the alternative uses for life insurance, but first I need to make the basic case for its existence. At its core level, life insurance is a safety net for your loved ones in case you are not here to take care of them financially, provide estate liquidity, and pay for costs associated with a death, such as paying off debts and funding future college costs and taxes. Much like car insurance protects us in case of an accident, life insurance protects us in case of an unexpected passing. The difference is that you may never get into a car accident, but unfortunately at the present time death is an inevitability. Life insurance gives you the ability to keep the promises that you have made to your family.
Why Indexed Universal Life Insurance?
Indexed Universal Life Insurance (IUL) is a permanent life insurance policy that builds cash value by tracking a market index. Up to about twenty-five years ago, you only had a couple of options, term or temporary insurance, whole life, and regular or variable universal life. Term is temporary; you pay a premium and it covers the cost of a death benefit (and nothing else) for a set number of years. In the case of permanent policies (Whole Life, Universal Life, Variable Universal Life), you pay a monthly premium and some of it goes towards the cost of insurance, and the rest goes towards a savings component that builds cash value.
Whole Life is basically permanent term insurance, with a fixed premium that guarantees coverage through age 100 and a guaranteed cash value. Universal life introduces some flexibility into the mix, where you can pay a flexible premium (more in the beginning and less in the end or vice versa), and adjust your death benefit accordingly. Both allow you to build cash value that earns a guaranteed minimum interest rate. But, Variable Universal Life was introduced as a way to invest that excess premium in separate accounts, similar to mutual funds. Neither the cash value nor coverage was guaranteed, but it gave you the opportunity to earn stock market returns in a tax-deferred vehicle while protecting your family.
The IUL is an extension of this idea, but you are not invested in the market. The excess premiums instead purchase options of an index that tracks the performance of the market. The beauty of this concept is that the insurance company guarantees 100% downside protection. You will never lose any money on your cash value due to market losses, but you are capped on the high end. So if your investment is tracking the S&P 500 and it goes up by 15%, and your cap is 9%, you will only earn 9%. But, if the S&P is slashed by 50% you will be completely shielded from those losses.
The Many Uses
Indexed Universal Life is particularly useful when it comes to saving for retirement. If you fund premiums at an adequate level and have enough time to earn compounding returns from the market index, the cash value that has been growing all those years can be used for policy loans to produce a tax-free cash flow. This allows you to take a loan out every year in retirement and fund the lifestyle you’ve always imagined. When you pass away, the policy loans will be deducted from your death benefit and the rest will go to your heirs.
In retirement, the two biggest risks you face are taxes, as higher taxes will consume a bigger portion of your retirement income, and market sequence of returns, the chance that the economy turns and as you withdraw money your nest egg is depleted too quickly. IUL as a supplemental retirement strategy completely eliminates these risks. The IUL loans are not taxed and the cash value cannot decrease due to the stock market! This can provide years of stable income in retirement and take the stress off of your risky assets.
Another strategy is to use the IUL as a way to help your kids save for college. Relying on the same principles of tax-free growth and complete downside protection, the accumulated cash value can provide funds for education or any big life purchases. If you start a policy when your kids are young and healthy, the cost of insurance is low, and therefore more will go towards building cash value. After 15 or so years when it is time to go to college, you borrow policy loans to offset this expense. Unlike other college savings plans, such as 529 plans or Coverdell Education Savings Accounts, IUL funds will never count towards FAFSA and your child’s eligibility to receive financial aid. And if your kids want to ‘discover themselves’ first, it doesn’t even have to be used for college (like a 529 plan)! In fact, it could be used for any other purpose in life, such as paying for a wedding, putting a down payment on that first house, or even letting it ride to fund their own retirement in the next generation!
Don’t forget, first and foremost this remains a life insurance policy. So, God forbid, if anything were to happen along the way, you always have protection for yourself and your loved ones.
Closing Thoughts
Life insurance is a societal need that we should all address. But apart from the piece of mind it brings you in the ability to keep the promises you have made to your family, this is not its only use. If funded properly, life insurance can provide tax-free cash flow in retirement that will never lose value if the market turns. It can even help put your kids through college. Mission Critical FPI specializes in developing unique strategies to plan for your future. Give us a call today.
