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An Unanticipated Recommendation

Written By: Cal Burgess | Retirement Servicing Group

A few months ago I made a recommendation to a referral (now a client) regarding an indexed universal life policy. His financial goals were straight forward; he wanted to protect his money from rising federal income taxes while protecting as much of his money from market risk as possible. When we met, I could tell that he was frustrated with the performance of his portfolio and was skeptical about other financial vehicles that he entertained. After about an hour of assessing his financial position, he made it clear that he was concerned about rising taxes and a lingering recession. I recommended that a potion of his portfolio be redirected to an indexed universal life policy (IUL).

When the recommendation was made, he leaned back in his chair and said “Cal, I’m not concerned about leaving a death benefit behind. My intentions are to find a financial vehicle that will help me throughout my retirement years”. I responded “I understand. With this vehicle you have the opportunity to protect your money against volatility while protecting your income from Federal income taxes”.

IUL policies are in essence an overfunded life insurance policy that can protect your money against both volatility and federal income taxes, while simultaneously protecting your loved ones with a tax free death benefit. Furthermore, your cash value will grow tax deferred under the umbrella of the insurance contract. These benefits of cash accumulation are unlike any other financial vehicle available.

IUL policies allow you to accumulate interest based upon a market index like the S & P 500. This predetermined market index acts as a guide to determine how your cash will grow. Insurance companies can do this because IUL policies are not securities, but instead are safe money instruments exempt from any market volatility. Since the insurance company is baring all of the risk, the amount of interest a policy owner can earn is capped. This being the trade off for exempting your money from market risk. Even with a capped upside, the cash value growth has outperformed the stock market by an alarming rate over the last decade.

Permanent life insurance policies can also allow for withdrawals exempt from federal income taxes. These tax free withdrawals can be structured in one of 2 ways (assuming the policy is not a modified endowment contract). The first way is to withdraw your principle balance before any interest is due. IUL policies follow an accounting method known as FIFO (first in first out). If properly executed FIFO allows the principle to be withdrawn without causing a taxable event. This is one of the main reasons why many businesses are adopting IUL as a vehicle to pay expenses with. The business can eliminate unnecessary taxable events by simply depositing more money (principle) into the policy then they take out, which insures no interest is withdrawn. The second way to withdraw funds in an IUL policy exempt from Federal income tax is by taking a loan against your cash value. With this approach the insurance company charges interest on the loan that is deemed payable upon the policy owner’s death. The policy owner will usually take this approach when funds have been accumulating for several years, followed by several years of withdrawals. Many investors use this approach for either retirement planning or college planning. When the policy owner passes, the loan amount is subtracted from the death benefit, and the remaining funds are then passed to the beneficiaries of the contract.

IUL policies are being actively pursued by investors as a supplemental income planning tool. Many are using this strategy as a contingency plan to an unpredictable stock market. Investors can take advantage of withdrawals exempt from federal income taxes, grow their funds tax deferred, and have the capability to receive a moderate return without subjecting any of their money to market volatility. This is why IUL will continue to be pursued by businesses and investors alike within uncertain economic times.

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Note: Any information in this blog is not and should not be construed as investment advice.

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