What Insurance Agents Don’t Tell You About Indexed Universal Life (IUL)
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Indexed universal life (IUL) is a popular investment, thanks to aggressive marketing. Before your clients succumb to the high-pressure sales tactics, here’s a cautionary tale based on another lifetime purchase decision – buying an engagement ring.
Before my wife and I got engaged, I was on a mission to find the perfect ring, not only for her, but as a symbol of love to pass on to future generations as part of our family tradition. At the time, I didn’t know where to start, where to go for advice or ultimately who to trust with this extremely important life decision. I started my quest at a fancy big-box jewelry store where I was greeted by well-dressed salespeople who were friendly and very eager to make a sale. They insisted it was wise to overspend, stretch my budget and buy the biggest ring I could possibly afford. Uncomfortable with my initial interaction with the jewelry sales world, I decided to reach out to a trusted family member for advice. From there, I was referred to a jeweler who this person had used and recommended throughout the years. I met with this jeweler, and he gave me a thorough education on diamond quality, discussed what I was comfortable spending and explained how jewelry is typically sold. He explained a concept called buying wholesale versus retail. He said big-box jewelry stores add a significant mark up or margin that is built into the retail price to cover the expenses of the elaborate building, plentiful staff, additional overhead, marketing costs and ultimately profit.
You pay more when buying retail.
His business model was completely different. He sold his diamonds at wholesale pricing with limited margin. He was able to do this with lean overhead, repeat business and consistent referrals through word-of-mouth marketing. He even told me when I got the ring insured, it would appraise for roughly double what I paid for it, which turned out to be true.
I bought the ring, she said “yes” and we’re going on 10 years of marriage with two lovely daughters. We’ve purchased two additional pieces from him and referred countless friends and family.
Why is this at all relevant to the topic of indexed universal life (IUL)?
IULs are sold at retail pricing, often by eager insurance agents desperate to make a sale. In addition to the retail pricing, IUL can be sold the wrong way for the wrong person. The common pitch with IUL is to use it for tax-free, supplemental retirement income offering high rates of return and absolutely no stock market risk. Who wouldn’t want tax-free retirement income, while enjoying both high rates of returns and no risk?
If you think that is too good to be true, you’re right.
Despite what some insurance agents will tell you, not everyone needs permanent life insurance (or life insurance for that matter). Recently, I’ve watched far too many cringy You Tube and TikTok videos where “internet famous advisors” pitch IUL as the magic pill that will instantly replace all your other retirement vehicles and make you wealthier than you can imagine. The reality is a well-balanced retirement plan is all about diversification, time, and patience. For clients looking to tax diversify, I highly encourage them to max out their Roth 401(k)s (if available) and Roth IRAs (if under the income phase out) before considering IUL. A properly structured IUL becomes a tax-free alternative only after all those other sources have been fully maximized.
IUL is often structured the wrong way. The advisor sets up the policy more for their benefit, less for the client’s. Since most insurance agents aren’t acting in a fiduciary role, this practice is acceptable, if not encouraged, by the various layers of distribution all getting a cut of the commission. The life insurance agent is paid based on the amount of base-death benefit purchased. The greater the base-death benefit, the greater the agent’s commission and resulting upfront client fees in form of per-thousand expenses and surrender charges. Just like the first jewelry salesperson I encountered, the insurance agent may try to get you to stretch your budget or sell you a greater amount of base coverage, thus resulting in a greater agent commission.
Not all insurance agents are bad or out to get you. I’ve worked with hundreds if not thousands of agents throughout my career and the large majority are outstanding people who care about their client’s wellbeing. These good agents will instead build the IUL inside of a more comprehensive plan often involving other outside investments and structure the IUL policy with the least amount of life insurance the IRS will allow while funding premiums right up to the non-modified endowment contract (MEC) limit. That reduces the agent commission and initial upfront expenses, thus maximizing the potential for cash-value growth. But those good insurance agents are still selling you an IUL at retail pricing. After all, they need to make a living and feed their family.
How would one buy an IUL at wholesale pricing?
The trick is to work with an agent who will structure the IUL with not only the least amount of life insurance the IRS will allow, but also the lowest base or commissionable amount of life insurance the insurance carrier will allow. In the insurance industry, this structure is called a “term blend.” Essentially, you are buying non-commissionable insurance, which reduces the commission to the agent and in turn lowers the internal expenses to the consumer. Not all carriers allow term blends on their IUL products. For those that do, the maximum term blend (think commission reduction) is typically between 75% and 90%.
To provide some context, I will build four different scenarios for the same client inputs. I will use a 45-year-old male, preferred non-tobacco health, $50,000 in premium for 10 years and a 5% initial illustrated rate. These aren’t specific recommendations and are used to illustrate the IUL internal cost structure, the impact expenses have on cash-value growth and commission incentive to the agent.
- The first design uses a middle-of-the-road-cost IUL but uses a bad design built with more death benefit than the minimum.
- The second design uses the same middle-of-the-road-cost IUL and is instead structured with the minimum IRS amount of life insurance.
- The third uses a lower cost IUL with the minimum amount of life insurance.
- The fourth uses the maximum efficient wholesale design, using a lower cost IUL, least amount of death benefit and the lowest possible agent commission.
Sample scenario: 45-year-old male, preferred non-tobacco health, $50,000 10-year pay , 5% initial illustrated rate projections are non-guaranteed and for illustrative purposes only
Designing and buying the IUL wholesale significantly reduces the internal policy charges and increases the cash-value growth potential for the consumer. It does lower the commissionable premium to the agent, but ultimately a maximum-efficient-wholesale IUL is all about delivering the maximum value to the consumer, not to the agent. Also, as I previously mentioned, IUL is not for everyone and should only be considered for the appropriate client and structured the right way.
Does reducing the agent commissions and internal expenses make IUL the right vehicle?
It depends. Clients considering IUL should have a need for permanent life insurance. Likewise, the mortality expenses are based on the risk of the insured. These policies work better for younger, healthier clients. Even with a maximum-efficient-wholesale IUL, the policy expenses are still front loaded, making it a poor short-term vehicle that works best over a longer time horizon. As previously mentioned, clients should max out their Roth 401(k) and Roth IRA prior to implementing IUL as part of their overall retirement plan.
Additionally, while buying a max-efficient-wholesale IUL is better than buying one retail, an IUL still has limitations that other retirement vehicles don’t have. While IUL policies provide a 0% annual floor, the tradeoff is a limiting factor on upside growth, such as a cap, participation rate or spread. While the 0% floor limits market downside during down years, the cap limits the upside during good years. Indexed strategies vary widely from company to company, with some carriers delivering better client returns than others.
Most importantly, the renewal-rate integrity of the insurance carrier is vital. Some life insurance companies have a history of offering higher cap or participation rates for new customers but do an inadequate job maintaining those rates for in-force clients. Other carriers treat new customers and in-force clients equitably. The provisions for accessing cash value through policy withdrawals and loans may also differ, with some carriers offering more favorable provisions than others. Lastly, the guarantees are based on the insurance carrier’s ability to pay those benefits, so working with a highly rated company is critical. Essentially, carrier selection is as important as IUL product design.
Just like some jewelers have high overhead, some agents rely on high-cost, inefficient and antiquated marketing systems involving postcard mailers and dinner seminars. These events can easily cost the agent between $6,000 - $8,000, creating a huge incentive to make high commissions to offset the marketing expenses and make a return on investment. When you get that mailer for a free steak dinner, remember that nothing is free and think to yourself, “Do I want to buy retail or wholesale?”
My advice is to be on a quest for true value and for those you can trust for your financial advice. After all, you may stumble upon a vehicle that may appreciate in value by multiples over your lifetime leaving a long-lasting legacy for future generations. Those contemplating IUL should work with a highly trained independent advisor, preferably a fiduciary, who can offer more than just life insurance.
Brian Manderscheid is an Investment Advisor Representative with LifePro Asset Management located in San Diego, California. He has had an extensive career in the financial services industry and has been analyzing indexed universal life policies since 2007. Brian is passionate about helping clients with achieving their financial goals by using thoughtful, well-balanced strategies involving risk and tax diversification.
Brian can be reached at LifePro Financial Services, Inc., 11512 El Camino Real, Suite 100, San Diego, CA 92130. Telephone: 888-543-3776, x3269. Email: [email protected].
Investment advisory and financial planning services offered through LifePro Asset Management, an SEC Registered Investment Advisor. Registration does not imply a certain level of skill or training. Investments involve risk.
This material is intended for educational purposes only and is not intended to serve as the basis for any purchasing decision. Guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company. The hypothetical example is shown for illustrative purposes only and is not guaranteed. The characters in this example are fictional only. Your actual experience will vary. Remember to consider your client’s individual circumstances and objectives when discussing their specific situation.
Additional premium payments may be required to keep the policy in force. Withdrawals are generally income tax-free, unless the withdrawal amount exceeds the amount of premium paid. Tax laws are subject to change. Clients should consult their tax professional.
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