By Teresa Kuhn JD, RFC
President, Living Wealthy Financial
More and more financial strategists are acknowledging the power of life insurance as a cash flow management tool and essential component of a well-planned financial future. Unfortunately, the advent of more complex, “hybrid” insurance products, such as indexed universal life, has led to some confusion about the best type of policy one can use to ensure safe growth, lower risk, and liquidity.
My clients are well-educated about the advantages of specially structured, dividend-paying whole life insurance policies such as the ones I use. However, for those only beginning to build their financial cornerstones, a plethora of confusing new insurance options accompanied by hyperbole and often misleading marketing tactics, has them wondering if whole life really is the best option.
If you’re reading this, chances are it’s because you have either been approached by an agent touting indexed universal life as being superior to dividend-paying whole life or you’ve read an article or advertisement in a financial magazine claiming that you can get “8% returns.”
You may be seriously considering using IUL to manage your wealth because you’ve been advised by a friend or colleague that it is safe, secure, and has many advantages over anything else available.
I encourage you, before making decisions with your finances from which you might never recover, to consider some of the compelling reasons why I never recommend indexed universal life insurance to my clients (no matter what their risk tolerance) and why you should think twice before purchasing this type of policy.
It always pays to get a second, or even a third, opinion when purchasing ANY financial product. If you’ve been presented with a proposal for indexed universal life or other insurance products, call my office at (800)382-0830 and arrange for a free consultation.
I won’t try and sell you anything, but I will be able to review insurance proposals you’ve received and give you my honest opinion. I will also send you free information about other methods available for ensuring that your nest egg stays intact and grows safely and sanely.
In the meantime, please read on to learn a little more about indexed universal life insurance and why, in spite of the big commissions dangled in front of my face, I have never wanted to sell this product to my valued clients:
- The cost of insurance can go up for Indexed Universal Life insurance contracts.
In December, 2015, Investment News reported that, due to the continued pressure of low interest rates, several major insurers including AXA, Transamerica, and Voya Financial had increased the cost of insurance for some of their Indexed Universal Life policies.
While all insurance policies have costs that the policy owners pay, IUL costs are a little different as they are subject to increases at the insurer’s discretion at any time.
Owners of IUL policies can pay insurance costs from their own pockets, from the cash value of their accounts, or a combination of the two. As long as there is a positive cash value, the death benefit stays in force. If, however, policy premiums can’t be paid, the policies lapse and owners lose the death benefit.
This isn’t always explained very well (or at all) by the agent selling the IUL policy. Often internal fees are shown on illustrations at current expense levels, with no mention of the fact that the company can decide to increase them, sometimes by as much as 40%.
I could write a whole article just on this one point, but at the risk of having your eyes glaze over from too much math, let’s just say that there are many devils hidden in the details of an IUL policy and those could make for some nasty surprises when it comes time for you to retire.
- IUL defeats the very purpose of insurance by exposing you to MORE risk.
A brief history of the death of the pension plan and the rise of the IUL
Before the advent of 401(K) plans, most American workers could count on their employers to provide them with defined benefits plans, also known as pensions. These plans rewarded loyalty and hard work with the promise of a steady, predictable monthly income in retirement.
Pensions were an essential part of the corporate culture in America and in many other places in the world. In those days, it was a culture that placed a high value on taking care of employees by providing a benefit that created guaranteed future income. The risk of this benefit rested solely on the shoulders of the corporation.
All of that changed, however, in September 1980, when a Philadelphia benefits consultant named Ted Benna found an overlooked codicil in the tax code known as section 401(K).
Section 401(K) said that employees would not be taxed on income they chose to receive as “deferred” compensation, meaning money they wouldn’t use until later.
Although this provision had been passed two years earlier at the behest of bank holding companies, Benna realized that nothing in the wording of the law limited its’ application to just bankers. Using the 401(K), any company could theoretically create savings accounts in which employees could place some pre-tax money every paycheck. Employers might or might not choose to supplement this money.
Early adopters of the 401(K) claimed it would be a great way to encourage personal retirement savings and to help companies who lacked pension plans put them in place more easily.
These new “defined contribution” accounts were also seen as useful to a workforce that had begun to move from company to company more than ever. People could, in theory, be freer to leave one company for a better opportunity because their 401(K) plan could go with them.
Corporations naturally recognized these plans as a great alternative to more costly defined-benefit plans. Getting rid of defined-benefit plans and replacing them with 401(K)s invested in mutual funds seemed like a good business decision.
Even unions, under pressure by companies to agree to benefit cuts, were lured into replacing their traditional pensions with 401(K)s in the belief that their members would now be able to participate in higher returns on the stock market and have more flexibility in retirement planning.
During the period when the market prospered, employers saw an opportunity to gradually scale back their company contributions to retirement plans or replace these contributions with shares of their own stock.
These plans succeeded in saving money beyond anyone’s expectations. It soon became obvious that 401(K) plans were not going to supplement plans, as originally predicted, but were actually destined to replace them.
In 2016, only a handful of corporations continue to offer defined benefits plans and the majority of those have closed existing plans to new employees, replacing them with 401(K)s. Today, the majority of existing pensions belong to union employees, especially government employees.
The fallout from 401(K) plans…
What does this shift away from defined benefits plans mean in the long term?
Well, for one thing, it transfers ALL the risk and responsibility for retirement planning to the employee and away from the employer. Where before negative situations such as stock market meltdowns and poor interest rates were dealt with by the company, 401(K) plans rely on employees’ ability to understand and interpret trends and know exactly what their mutual funds contain. 401(K)’s assume that employees can and will manage their plans and get the most from them, especially in turbulent and confusing financial times. Most experienced wealth advisors agree, however, that that is just not happening.
Another issue which has arisen as the popularity of 401(K)s has increased is that mutual funds, one of the main vehicles used to fund self-directed plans, have become de facto witches’ brews that contain all manner of sketchy instruments masquerading as legitimate investments. Created by banks and Wall Street, these toxic bundles often consist of things such as debt, mortgages, and derivative stocks.
These suspicious “investments” are packaged together and often used in mutual funds which then wind up as choices for employee plans. Some of the mutual funds are like the “mystery meat” served in school cafeterias. No one is quite sure what is in it, no one wants to ask, and it is assumed that ladling on the gravy will hide any bad taste.
But you can’t blame employees for doing anything they can to help swallow the bitter pills of a shaky economy.
Over the past few years, employees they’ve been punished by artificially low interest rates and have seen little to no growth in their retirement plans. They are forced to search for relief and growth potential anywhere they can find it.
That’s why indexed universal life insurance, with its’ flashy marketing and alluring promises of interest rates as high as 8%, has captured the attention of many people looking for safe growth.
Retirees and pre-retirees are being sold universal life products in the hope that they can outperform a whole life policy by allowing participation in the market. Since they are now conditioned to assume all retirement planning risks themselves, many people fail to question these claims or even ask themselves if indexed universal life insurance is a very good idea at all.
When people question me about IUL, I ask them this question: “If IUL is such a sound investment strategy, why don’t insurance companies use it in their overall portfolio? “
I believe the answer to that question is that insurance companies understand that over time, the slow and steady approach will almost always outperform the market.
And, although an IUL illustrated with 8% returns each year, could potentially achieve those returns, it is highly unrealistic that the market will and can return this much year after year. This fact has insurance regulators beginning to question just how realistic many of these projections are.
Further highlighting the problems with most IUL illustrations is the proliferation of lawsuits for deceptive marketing practices now faced by companies and agents selling IULs, NY regulators in particular are investigating the sales practices of advisors who sell IULs , who “may be giving buyers overly optimistic projections of potential gains in the policies”.
Since the performance of the IUL is tied to the performance of the stock market, and since corrections in the market are a near certainty, those considering IUL must ask themselves how such corrections will affect the projected returns of their policies.
Add to that the fact that there will still be insurance costs, fees, administrative costs, etc., compounding any poor performance of an IUL in a down market.
- With IUL, you could be paying premiums for the rest of your life.
Unless you have what is called a “no-lapse guarantee” written into your IUL policy your death benefit is not guaranteed. This means that if the index performance is sub-par or costs increase (or both), you may have to increase your out of pocket premiums to keep the death benefit in force.
For most people, the death benefit is an important part of their life insurance; a way to ensure that loved ones don’t wind up saddled with financial burdens. Life insurance is also used to create or enhance legacies that will be passed on to children or grandchildren.
If this is one of your reasons for purchasing life insurance, then you need to ask yourself if you really want to be worrying about paying premiums, month after month, for the rest of your life or risk losing your insurance.
Wouldn’t it be better to have a product where you could eventually stop having to pay an insurance premium?
- IUL is often too complex.
Over the years, I have noticed a trend of financial products being built with such complexity that even those who sell them have difficulty explaining how they work. It’s almost as if these vehicles are deliberately designed to confuse consumers and keep them from asking their insurance agent too many tough questions. IUL is one the products, in my opinion, that has so many moving parts that is difficult for the average person to ask the right questions before deciding to purchase.
On the surface, IUL appears to be similar to the more familiar whole life insurance policy. Just like whole life, IUL is built around two basic components. First, there is insurance that pays a death benefit and there is a cash value account from which you can borrow money tax-free (but not interest-free) in order to pay for big ticket items such as cars, real estate, educational expenses, and retirement.
Unlike whole life insurance, however, an indexed universal life policy adds an intriguing twist – allowing you to participate in the stock market, not directly, but by purchasing an option on an index. This feature is a difficult one to explain to a consumer who is being enticed by the potential for huge interest rates they see on an IUL illustration.
The way IUL’s are credited is also difficult to grasp. Each month, cash value is credited with interest, and the policy is debited with the cost of insurance (COI) along with other policy charges and fees. As I mentioned earlier, costs can and DO go up. If the premium paid to an UL policy is greater than the cost of insurance, then the extra is credited to the cash value. If no premium payment is made that month, or a premium payment that is less than the actual expenses of the policy, then additional amounts are taken from the cash value.
There’s a lot of math to consider with an IUL, and a lot of ways in which you can become confused and even misled.
Experience has taught me that the more complicated a product is, the more that complexity favors the insurance company, rather than the consumer.
“Wouldn’t you prefer to understand the product that forms the cornerstone of your financial future?”
- IUL has “cap rates.”
One of the complicated IUL features that could come back to haunt a policyholder who is lured by illustrations of great returns is the so-called “cap rate”. Most IUL products have a cap rate built in that is often either downplayed or not mentioned at all by the agent.
A cap rate means that means if the stock market has a really great year, such as in 2013 when there was a 30% index return, your IUL contract is capped at some lower figure, often in the 10% to 15% range.
If you’re attracted to IUL because of the potential large gains, this matters a lot. Imagine if your policy had a cap of 10%. Any time the S&P 500 index returned more than 10%, all you would get is just that 10%. Given that since 1928, the S&P has had index returns exceeding this rate over half the time, you could wind up with a lot less money than if you had just made sound investments on your own.
- In some IUL policies late premiums can kill guarantees
For most indexed universal life contracts, late premiums remove any guarantees in the policy. Even if the premium is finally paid, once it is late, the insurance company is off the hook for promises they made concerning cash value amounts, guaranteed premiums, or death benefits.
In many cases, the insured may not even be aware that a premium wasn’t made on time and that their guarantees have been forfeited… until it is too late.
In the span of a 50 year policy paid monthly, which is 600 or more payments, do you think there is a likelihood that a mistake could be made by the premium payer, the post office, the bank, or the humans working at the insurance company?
- No proven track record makes IUL’s less than predictable…
The concept of whole life insurance has been around for more than 150 years while what we currently call indexed universal life has been marketed for less than 20.
This abbreviated track record means that none of the illustrations put forth by sellers of IUL have history backing them. They are, in many cases, wishful thinking on the part of an insurance company’s marketing department.
Available data from the short history of IUL indicates that actual returns for these policies are closer to those of fixed products, around 4% or less. This is a far cry from the 8% rates often found on illustrations.
Most of the time, whole life insurance comes out ahead on the guaranteed side. This gives you a lot more of the certainty which is critical in determining your income at retirement.
At some point in an IUL, the cash value gets completely depleted and, as we’ve noted previously, the death benefit goes away unless you a no-lapse guarantee written into the policy.
Do you want to trade certainty and predictability for uncertain gains?
In conclusion, I’d like to say that regardless of what financial vehicle you are considering purchasing, you should always take time to research beyond the sales and marketing materials you’ve been given by the salesperson.
Learn to ask questions that let potential advisors know that you are actively involved in charting your own financial future. If these agents or advisors are unable or unwilling to answer your questions, then you might want to think twice about proceeding.
Be sure you scrutinize all proposals and contracts carefully and get a second opinion from a financial advisor who can act as an unbiased third party. Make a list of all your options, with a side-by-side comparison of the pros and cons of each.
As you near retirement, or even if you are just thinking about doing so, you can’t count on being able to recover from any mistakes you make when you plan.
There is an incalculable benefit to critically examining each and every part of your wealth preservation strategy and doing only those things which create certain outcomes, predictable streams of wealth, and which give you peace of mind.