Don’t Buy an Indexed-Universal Life Policy Until You Read This

What changed about IUL sales since 2006? I vividly remember IUL illustrations with 10%+ illustrated rates and variable loan spreads at almost 5% with some carriers. With these assumptions, you can make an inferior product appear attractive and look better on paper than most financial vehicles. Of course, we know if it sounds too good to be true, it probably is. Luckily for all parties involved, this is not the case anymore.

Since then, there have been three rounds of actuarial guidelines (AG-49) to curb illustration abuses and mischievous sales practices. But there is always room to grow, and the life insurance industry still needs improvements on how it provides the proper information to the consumer so they can make an educated decision on using an IUL to supplement retirement. The purpose of this article is to examine the issues surrounding the use of an IUL as a retirement supplement, what alternatives are available, and if/when IUL should be considered.

Right vehicle, wrong fit

When helping clients, the first question I ask when considering an IUL is, “What is the life insurance need?” The life insurance industry focuses heavily on building and accumulating cash value, while often losing sight that an IUL is a life insurance product at its core. Prospective buyers looking at IUL as a retirement supplement must have a basic need for life insurance. This could be protecting earned income while working, debt or mortgage protection, or estate planning.

Far too many times I have seen advisors pitch IUL as an alternative to a 401(k) to clients who are not married, do not have kids, or do not own a home. I have also seen IUL policies put in force for clients who are severely health impaired, which adds significantly higher expenses to the policy and makes it much less suitable as a retirement supplement. Additionally, IUL policy expenses are front-loaded, making it a poor option for older clients looking for income in a handful of years. Unfortunately, these advisors also fail to mention other tax-free options that may be a better fit, some of which I will expand upon later.

IUL should be offered to individuals who are healthy, have higher income/net worth, have a need for life insurance, can fund premiums out of cash/bonds or cash flow for a minimum of five or preferably 10 years, and have a long horizon.

Poor design, front-loaded expenses

Assuming the individual has the life insurance need, the next step is to ensure the IUL is structured correctly. Far too many times I see advisors “target fund” accumulation IULs to increase their commission at the detriment of the consumer. The front-loaded “per-thousand expenses” and surrender charges are based on the initial base death benefit purchased, which in turn determines the target premium (or commission). When using IUL as a retirement supplement, it is imperative to structure the policy to achieve maximum efficiency. This entails designing the IUL with the least amount of life insurance the IRS will allow, and funding it right up to the IRC guidelines, and managing face option switches or reductions when allowable. Failure to do so can make the IUL one of the worst-performing vehicles in a retirement plan.

Designing an IUL at maximum efficiency does not give it an automatic pass as a viable option. Policy expenses from carrier to carrier vary wildly, with some carriers offering lower expenses while others are significantly higher. To illustrate this, I analyzed two different insurance companies offering accumulation IUL with the same client inputs. For this example, I used a 45-year-old male, preferred non-tobacco health, $50,000 annual premiums for 10 years, minimum increasing death benefit, and switching to level in year 11 with a reduction to the minimum face amount.

• Carrier A had cumulative expenses through age 85 of $125,028.

• Carrier B had cumulative expenses through age 85 of $582,820, over four times higher internal expenses for the same exact scenario.

While carrier B did have other “features” that carrier A did not, if the underlying index does not perform as illustrated the carrier with the higher fee-drag loses.

The Consolidated Appropriations Act of 2021 did provide some relief to IUL expenses by reducing the minimum IRS death benefit required per the level of premium funding. Nonetheless, IUL fees, in general, are front-loaded with both low-cost and higher-cost carriers. Due to these front-loaded expenses, an IUL purchaser may not even break even on a surrender value (walk away) basis until after policy year seven or longer, even with a maximum efficient design and lower expense IUL.

IUL Swiss army knife, no alternatives given

In addition to the IUL design itself, it is essential the IUL is built within a comprehensive, holistic financial plan, instead of looking at the IUL in a vacuum. I have watched far too many cringy IUL pitches on TikTok or YouTube. These internet-famous social media advisors focus less on reliable and accurate content and more on sensationalism, views, and likes. I watched an advisor call an IUL policy a “501(k)” in a blatant attempt to misrepresent the product and make it sound like a government-approved retirement plan.

Wild claims I’ve seen include: IUL policies will average double-digit returns without any loss or risk; IULs are far better than your 401(k), even if you’re getting a match; IULs were previously secrets that only the wealthy were able to obtain, but are now available to everyday folks like you and me; IULs will easily beat the stock market in the long run; and ditch the old “never put your eggs in one basket” approach and instead put all your eggs in an IUL. The list unfortunately goes on.

These compliance departments’ nightmare sales pitches share the sentiment that the IUL is the “magic pill” that will take you from not having money to a wealthy multimillionaire retired on a yacht that is anchored on your own private island. But an IUL is not a get-rich-quick scheme and should not be portrayed as such. An IUL should never be viewed as an “instead of” vehicle. It should be viewed as an “addition to” vehicle.

Those seeking diversification from taxable and tax-deferred vehicles should instead look at all the tax-free options available. Rather than put all your eggs in an IUL, consider Roth IRAs, backdoor Roth IRAs, Roth 401(k)s, Roth IRA conversions, and IUL for the right situation.

For example, if a married couple is under the age of 50 and under the Roth IRA income phase-out limit, they can contribute a total of $13,000 a year to Roth IRAs. Assuming both spouses also have Roth 401(k)s available at their employers, they can contribute another $45,000 between the two. That is a total of $58,000 annually this hypothetical couple can save in tax-free vehicles. Additionally, they may have a down income year for whatever reason, which could open the opportunity for Roth IRA conversions if they have enough cash or cash flow from outside sources to pay the taxes.

For high-income or net-worth clients who have maxed out the above tax-free sources, the IUL provides that “next best” alternative for tax-free planning. Of course, that assumes the IUL is set up with a highly rated carrier who has a strong record of renewal rate integrity, done so for the right person and designed correctly with a lower expense carrier.

Hope for the best, plan for the worst

We have all heard the phrase: Past performance does not predict future results. But insurance companies and agents use back-tested performance on “volatility-controlled” indexed strategies to justify high illustrated rates. Knowing what happened in the stock and bond markets over the last 20 years, it is easy for insurance companies to create synthetic index strategies that would have performed well. But I have been tracking actual returns for these volatility-controlled strategies for years and some have consistently underperformed relative to their illustrated back-tested performance.

The National Association of Insurance Commissioners (NAIC) illustration model projects IUL values and loan arbitrage with constant, level returns. The reality is IUL purchasers will get 0% returns in bad years, causing their cash value to decrease if they do not pay premiums due to life insurance expenses. Or they may get potentially double-digit returns in good years. And of course, everything in between may happen.

I recommend that prospective IUL purchasers do their due diligence to uncover the actual policy performance along with the renewal rate history of the insurance carrier. This will provide a more realistic expectation of the performance clients have received and how the insurance carrier treats its policyholders.

Lastly, ask your advisor for illustrations at various rates to stress test the IUL. If the projections meet your financial goals at a lower illustrated rate (5%, for instance, instead of the 6% or 7% that may have been presented) there may be merit in considering the policy.

Summary

IUL policies designed at maximum efficiency do have advantages as supplemental, tax-free retirement vehicles. But this requires using IUL the right way for the right person. That includes selecting an appropriate IUL carrier emphasizing actual client performance and policy expenses, utilizing IUL as a part of a complete and holistic financial plan involving other tax-free vehicles, and providing realistic expectations and a clear explanation of benefits.

Insurance agents selling IUL can make large commissions on these policies, which is a conflict of interest. Ask your advisor how they get paid if you purchase an IUL policy through them. Work with a fiduciary fee-based or fee-only advisor for a more objective and holistic point of view.

As the adage goes, just because it is on the internet does not mean it is true. Enjoy your social media scrolling, but also be mindful of a TikTok-famous “financial advisor” pitching a retirement miracle pill or secret tax-free investment that could be lurking on a screen near you. In a world where we have excessive amounts of information readily available at our fingertips, it is vital to ask the right questions and work with a trusted financial professional to achieve your retirement goals. Likewise, the pillar of any good financial plan is diversification. Diversify among not only asset classes to hedge market risk but tax types against tax risk.

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. Policy loans and withdrawals will reduce available cash values and death benefits and may cause the policy to lapse or affect any guarantees against lapse. 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. In the event of a lapse, outstanding policy loans in excess of unrecovered cost basis will be subject to ordinary income tax. 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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