Companies for indexed universal life insurance provide a variety of allocation strategies to help ride out the highs and lows of the market in the accumulation phase.  However, there should be concerns about overly aggressive illustrated rates of return and substantial buckets of income via withdrawals and loans during the distribution phase for retirement purposes, which if not watched carefully can cause major issues and derail any policy in the future.

Typically, when using IUL as an accumulation vehicle for supplemental retirement income purposes.  The illustration approach to accomplish maximum overfunding (within MEC guidelines) uses an increasing death benefit (option 2 – face amount plus annual accumulated cash value increases) then switching to a level death benefit (option 1 – face amount only) at the optimum distribution time.  This design helps maximize cash accumulation and distributions, which is the goal.

In addition, the illustrations are run showing projected distributions which are structured as a withdrawal of funds up to the client’s cost basis (premiums paid into the policy), then switching to loans to maintain a tax­free distribution stream of income.  There can be, of course, other design approaches depending on the individual’s personal situation; however, this is traditionally how these scenarios are illustrated.

A majority of insurance companies focusing on IUL and the accumulation market also offer an overloan protection rider, which essentially freezes policies when loan balances exceed a certain threshold as a percentage of cash value in the policy.  This inhibits the policyholder from continuing to take additional loans from the policy, preventing the policy from lapsing and creating a potential tax situation.

GETTING CASH OUT OF YOUR POLICY, E.G. INDEXED UNIVERSAL LIFE OR ANY UNIVERSAL LIFE INSURANCE POLICY

For the insured / owner getting cash out of an IUL policy can feel like entering an administration maze.  Hopefully not a financial nightmare.  If retirement distributions begin in a stable or rising market, the client has the potential to preserve or even grow their retirement assets.  If a client begins retirement distributions in a declining market, they are both drawing down on assets and policy values are reducing.  Their retirement assets may begin to erode faster than initially planned.  The bottom line is that the distribution of retirement funds must be managed carefully so a client doesn’t spend down the retirement nest egg much quicker than anticipated and potentially run out of money in retirement.

I mention this because, similar to the challenge of managing the sequence of returns in traditional investment / retirement account during the distribution phase of retirement, the same careful management in the distribution phase-out of an IUL cash value life insurance policy is a necessity.  If not properly managed and the policy lapses, the client will receive a 1099 representing the taxable gain in the policy and be hit with a tax nightmare.  Remember policy withdrawals and loans are extinguished at death with the remainder of the policy paid to a designated beneficiary.  The idea is to just take enough and make sure the policy remains in-force through the end of life.