IUL and Estate Balance with Options

Courtesy of: Mutual of Omaha, Advanced Markets

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First let’s look at the concept of estate equalization, or perhaps more properly phrased estate balancing.

Many of your business owner clients want to pass their business along to family members one day. Usually, though, not all of their children want to take over the business. So using a life insurance policy to provide for those children, under the concept of estate equalization, makes a lot of sense.

But what if your client has very young children, and doesn’t know yet if any of the children will want to take over the business. Or maybe the client is a doctor or lawyer, and it isn’t clear yet whether any of the children will get the professional education and licensing necessary to take over the business. Or, maybe your client wants the option to make a living exit by selling the business. A life insurance policy still makes sense to protect against a premature death, but after selling the business, what happens to the policy and all the premiums the client paid over the years? Wouldn’t it be great if you could offer your clients that protection with options for a living exit?

At the same time business owners have a very difficult time building wealth outside of the business, even though that is one of the most important things for them to do as they prepare for their exit from the business.

IUL can provide your clients with a way to prepare for both contingencies. Here’s an example: let's say your client is a 40 year old business owner with three very young children. No one knows yet if any of the kids will be interested in taking over the business one day. Just in case one of them does want the practice, you determine that a good estate equalization face amount is $250,000. Assuming he is Standard Plus Non-Tobacco, and assuming he can move $500 a month into the policy to build assets outside the business, at a non-guaranteed crediting rate of 6.69% he would have over $200,000 in cash surrender value at age 60 and with an increasing face amount he would have a death benefit of over $450,000. At that point he should know if any of his children are interested in taking over the business. If they are, he can keep the policy. If they aren’t, and he will eventually sell the business to a third party, he can surrender the policy and  use the cash value for whatever he wants: savings, retirement supplement, travel, starting a new business…whatever. Tax consequences may result from the surrender, but he is balancing his estate while leaving himself options.
It’s nice to have options. And with our new IUL product you can offer your clients protection and options as well.

Need assistance with your advanced markets cases?

Contact Partners Advantage at 888-251-5525, Ext. 700

This is for informational purposes only.  Recommendations for financial product or financial strategies must be suitable for the individual based on their circumstances. Mutual of Omaha does not give tax advice.

Mutual of Omaha
Advanced Markets
advanced.markets@mutualofomaha.com

The advice provided in this communication is not intended or written by the practitioner to be used and may not be used by you for the purpose of avoiding penalties that may be imposed by the IRS or any other taxing authority. The advice in this communication was written to support the promotion or marketing of the transaction(s) or matter(s) addressed by the written advice. You should seek advice based on your particular circumstances from an independent tax advisor.

How Do You Measure Expenses?

By: Charlie Gipple, CLU,® ChFC® is the Senior VP of Sales & Marketing at Partners Advantage. Excerpt from “A New View on Modern Portfolio Theory: Making the Case for Life Insurance as an Asset Class”

“I understand I get a death benefit with IUL but isn’t life insurance an extremely expensive product for building retirement dollars?”

You can show your client the internal rate of return (IRR) report that many carriers have to demonstrate expenses. Many carriers have IRR reports on the death benefit and there are also carriers that have the IRR based on the cash value.

Cash value IRR

The cash value internal rate of return report basically calculates what the “net” amount of return was on the client’s premium in order to arrive at the cash value that the product generates in year 20 for example. This can be a great tool in demonstrating how the average expenses over the life of the product. This can be done by analyzing the disparity between the actual “internal rate of return” of the policy and the rate in the illustration.

Hypothetical Example

To elaborate further, before we discuss life insurance cash value IRRs, let’s use a simplified analogy. Let’s say that you had a magical “product” that had zero expenses. Assume this “product” was going to grow a client’s deposit by 6% per year from now until say 20 years from now. Without any expenses coming out of this product, what would be the true “internal rate of return” the client would recognize? It is 6%! We know this because, as mentioned, whatever the deposit/ premium is put into this hypothetical “product,” it is going to grow by 6% and not be eroded by any expenses. Therefore, 6% is the answer.

Well, what if we calculated the internal rate of return on the same product with one exception. This time we assume the product had .50% in annual expenses. Well, in this case, the internal rate of return to the client in this product would be 5.5% (6%-.50%)? In other words, if you punched in to your financial calculator what the deposit/premium was in this product versus what the year 20 value was in this product after being eroded by this .50 annual expense, magically the financial calculator would arrive at an IRR of 5.5% per year.

Now, let’s go back to talking about the life insurance illustration to make the point. We know that in our illustration, the policy is going to credit a “gross” 6%. Why? Because we told the system it will by using 6% as the illustrated rate. That does not mean that once you plug the premium payments into the illustration and the 6% illustration rate/gross rate that the cash value will actually grow by 6%, right? No, because there are “expenses” imbedded in the policy and thus the illustration.

The main expenses in IUL are what I call “The Big 3.” They are: 1. Premium Loads 2. Per Thousand Charges. 3. COI Charges. These expenses reduce cash value year after year.

How Large are These “Expenses”?

This is where the Internal Rate of Return calculators can help you put a number on the “expense drag” in the project. Rather than having the actual IRR report on my example, if you otherwise did the math on your financial calculator when I said that the client would pay $16,740 for 20 years then have around $550,000 in cash value in year 20, you would know that the “internal rate of return” would come back at around 4.65%. This is based off a 6% illustrated rate. This means that the “expense drag” averaged 1.35% (6% - 4.65%) per year. In a world where the average A Share Equity Mutual Fund is charging 1.4% (ICI.org), is 1.35% “prohibitively expensive”? It is also important to note that as the policy ages, the “disparity” between the IRR and the illustrated rate narrows. Many times the disparity can be lower than 1%.

Another thing to keep in mind is the tax deferred nature of the growth on the cash value and the tax free nature of loans from the policy. In other words, a tax free rate of return of 4.65% is actually equivalent to an otherwise taxable return of 6.94% (assuming the 33% tax bracket).

Again, these are not investments, but as you can see if optimized correctly the disparity between the IRR and the illustrated rate (expense drag) can be quite reasonable. Especially considering with IUL, you can never lose money because of a stock market decline.

Objection Rebuttal

Something you can discuss to rebut an objection is that “cost is only an issue in the absence of value.” Is the 1.35% expense worth the “value” that the client would be able to get out of this policy? The “value” they are getting out of the policy is, almost $1.3 million in distributions (harvest) on a total premium (seed) of $334,795 while in the early years having significant death benefit “leverage.” And again, the client is merely paying taxes on the seed, not the harvest. Note, if the client were to die in the early years, the IRR percentage on the death benefit would be in the hundreds.

In designing the policy with the goal to eventually take tax-free loans against the policy, it is important for the financial professional to be well-versed on how to set up and adjust the policy’s premiums and death benefit in order to minimize the COI charges. If done correctly, the client may find that the cash value in IUL is not only an “asset” that will not drop in lockstep with the stock market like other assets in a portfolio, but also the client may find that IUL can be a very cost-effective and tax-effective “asset class” relative to others.

Access the full article “Life as an Asset Class” by Partners Advantage’s Charlie Gipple Senior VP of Sales & Marketing by filling out the form below.

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For Financial Professional Use Only. Not for use with consumers.

Guarantees are backed by the Financial Strength and claims-paying ability of issuing company.

Annuities are designed to meet long-term needs for retirement income. They provide guarantees against the loss of premium and credited interest, and the reassurance of a death benefit for beneficiaries.

An income rider or benefit (sometimes called Guaranteed Lifetime Withdrawal benefit rider or GLWB rider) is an additional feature available with some annuities and generally optional and come with additional costs. Income benefits are designed to provide income options above and beyond the standard annuitization or free withdrawal features in annuities.

Pursuant to IRS Circular 230, Partners Advantage Insurance Services and their representatives do not give tax or legal advice and cannot be used to avoid tax penalties or to promote, market, or recommend any tax plan or arrangement. Encourage your clients to consult their tax advisor or attorney.

The information contained in this article is not intended to serve as tax or legal advice and is not intended to provide financial or legal advice and does not address individual circumstances.

The hypothetical investment results are for illustrative purposes only and should not be deemed a representation of past or future results. Actual investment results may be more or less that those shown. This illustration does not represent any specific product and/or service.

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