Although Indexed Universal Life is not an investment, it does offer many long-term benefits including permanent life insurance coverage for your family, tax protection, and safety from stock market volatility. In this episode of Money Script Monday, Brian explains why you may want to consider an IUL for a portion of your retirement portfolio if you're concerned about tax and risk diversification.

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Video transcription

Hi, welcome to another episode of Money Script Monday. My name is Brian Manderscheid.

Today, I want to answer the question, "Is indexed universal life a bad investment?"

Well, first, I want to be very clear that indexed universal life or IUL is not an investment.

It's a long-term savings vehicle. It's a life insurance policy that has cash value growth that's tied to the stock market index, but it is not an investment.

What I want to do is talk about, is IUL something to consider for your long-term savings goals withinside your retirement plan?

To do that, I want to talk about the characteristics of investments. What are investments?

Second, how an IUL policy may fit withinside your retirement plan and, lastly, the importance of how an IUL is structured.

Characteristics of Investments

First, let's talk about the characteristics of investments. What is an investment?

Really, when you invest, you're taking capital, whether that's up front or over a period of years, and you're basically putting this capital to work with the pursuit of profit, whether that's interest, income or appreciation.

It's important to note when this capital is not withinside a Roth IRA or Roth 401(k), the gains, appreciation, income, interest, can be exposed to taxes, whether that's capital gains or ordinary income.

Now, how do you invest? Well, you can basically choose investments based on your risk tolerance and your long-term goals, whatever those goals may be.

If you choose higher-risk investments, like stocks, for example, you have more upside potential over the long run, but you also have a higher chance of loss.

By taking more risk, you may be exposing yourself to reduced values. In order to offset those values, you can choose lower-risk investments, like bonds, for example.

Now, with these lower-risk investments, the trade-off is you have lower return potential, but you also have the lower chance of loss.

Now, with investing, it doesn't have to be one or the other.

Modern portfolio theory suggests that we should basically diversify our retirement plan with a mixture of fixed assets or bonds and stocks in order to help reduce the risks that are associated with long-term planning.

You can see in this example a 60/40 portfolio. Basically, you don't want to put all your eggs in one basket, and you can diversify with both stocks and bonds.

Indexed Universal Life

How does that tie in the indexed universal life?

Well, again, I mentioned indexed universal life is not an investment and that with an investment really you employ capital with the pursuit of profit.

With an IUL policy, really, we use this policy for the pursuit of protection. And what type of protection does IUL policies, what does it offer?

First and foremost, unlike term insurance, an IUL policy offers permanent life insurance coverage for your family, for maybe your business or even your favorite charity.

It also offers a tax protection, meaning that the contributions that you fund into the policy are protected from taxes, whether that's on the accumulation, whether that's on the distribution when properly structured or on the death benefit.

Now, it'll be an income-tax-free death benefit that is a value greater than your account value that will be transferred onto your heirs.

If you're concerned about taxes, IUL policies are definitely a great fit.

Lastly, the other protection feature that it offers is protection against stock market losses.

With an IUL policy, the way it works is you have growth potential of an underlying index like the S&P 500. You're not going to receive all the gains.

There'll be some sort of limiting factor, like a cap rate or participation rate, but the trade-off for that cap rate is an annual floor of generally 0%.

When the stock market does really well, you're going to capture the stock market gains up to a limiting factor.

If stock market has a negative value, you're going to receive a 0% floor, you're not going to have any losses, and your previous gains will be locked in.

Now, I mentioned the idea of diversification, and really where IUL fits is tax and risk diversification.

Basically, you're putting your money in a vehicle that is protected against taxation and protected against stock market losses.

We view IUL not as a instead-of product, but instead of a in-addition-to, meaning that by adding IUL to your overall retirement plan, it adds additional protection against those key things, taxation and stock market losses.

So, again, we addressed characteristics of investments and how IUL may fit withinside your plan.

Importance of Structure

Let's move on to the importance of structure.

Now, to go back to the original question, is IUL a bad investment, or I guess a better way to phrase it, is IUL worth considering or is it a bad vehicle to put your money?

Well, to answer that question, we have to first talk about how an IUL is structured.

The way we structure an IUL policy is we always want to buy the least amount of death benefit that the IRS will allow.

The reason being, a lot of the fees of policy expenses, the cost of insurance, the surrender charges, are based off of the death benefit you purchase.

So, if you purchase the least amount of death benefit that the IRS will allow.

That means only a small portion of your premiums will go to life insurance expenses and fees and the rest will go to cash value growth that will basically provide you with those tax benefits and the risk benefits.

You also want fund up to the maximum premiums that the IRS will allow.

There are limits such as a seven-pay MEC, guideline annual premium, and guideline single premium.

If you fund over and above the seven-pay MEC limit, your policy would actually be classified as a modified endowment contract, meaning that you're going to lose some of the tax favor treatment that the IRS has bestowed upon life insurance policies.

So, it's really important to work with a qualified advisor who is looking out for your best interests and constructs these policies appropriately with the least amount of death benefit and fund right up to the guidelines without going over.

It's also important that you live up to your end on the bargain as well.

One of the great features of IULs is that they're flexible in design, meaning that you can fund up to the maximum premium, you can fund to the minimum premium to just cover the policy expenses, you can miss and make up premiums.

Sometimes that flexibility can create disaster where if you're not funding the premiums, the maximum premiums, what that means is your policy will not be performing efficiently and more of those premiums and cash value will go to costs and less to cash value growth.

So, again, it's crucially important not only to work with a qualified advisor but also set a policy up with an adequate amount of unding that you can comfortably afford without going over your budget.

Today we answered the question, "Is IUL a bad investment?" It's not an investment. It's a life insurance policy meant for protection.

If you're concerned about tax and risk diversification, having a vehicle that will protect against those negative risks, you may want to consider an IUL for a portion of your retirement portfolio.

Thank you very much. We'll see you next time.

The information presented here is not specific to any individual's personal circumstances. These videos are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials or may change at any time and without notice. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstance.

S&P 500 is an unmanaged index of the shares of 500 widely held, predominantly large capitalization, U.S. exchange-listed common stocks. The index results neither include dividends reinvested nor reflect fees and expenses. Investors cannot invest in any index directly. Guarantees provided by insurance products are backed by the claims paying ability of the issuing carrier.

Investment advisory services offered through LifePro Asset Management, LLC, a registered investment adviser. Investments involve risk and are not guaranteed. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy will be profitable or equal any historical performance.