Indexed Universal Life Insurance Pros And Cons- Is IUL Good Or Bad

So, is indexed universal life insurance good or bad? That is what we're going to be talking about today with the pro and con list. This is Matt Decker with Leverage Wealth Management. So right up front, I just want to let you know that I'm trying to be as objective as possible in going through this list of pros and cons so that you can determine whether or not indexed universal life insurance is a good thing for you or a bad thing for you. This is not a sales pitch in any way, shape, or form. In fact, I start most of my videos saying this. I end nearly all my videos saying this. Indexed universal life insurance can be the best thing that you own. It can also be the worst thing that you own. It all depends on what you're trying to do and how the policy is structured. But let's save that for the actual pro and con list. We're going to start with the pros. The first pro with indexed universal life insurance is that the fees are actually inverted. What I mean by that is think of it as an upside down triangle, an upside down pyramid. It's front loaded for the first eight to 12 years. It depends on the policy that you're purchasing and exactly what you're trying to do with it and some of the riders that you may or may not use. But these policies actually charge you more in fees while your account values are smaller. It's a front loaded contract. Now what that means is that over the life of the contract, let's say 30 to 50 years, you actually end up paying much less in fees. In fact, you might pay less than what you'd pay to a money manager if it's structured the right way. If it's structured the right way, your average fees can actually be comparable to a low cost index fund. Now again, the caveat there is that it has to be designed the right way and that goes back to my initial comment, it can be the best thing you own or the worst thing that you own. A lot of it depends on how it's done. If it's properly designed, you can actually see your fees in terms of your cost of insurance reduce over time. Now it's based on annually renewable term. We'll get to that in a second because you'll notice that fees are in both columns. It's a pro and it's a con. More on that later. Another pro of the index universal life insurance is going to be the tax benefits. Now if you're dealing with an insurance agent that's got some fancy sales pitch and he's got a bunch of slides and all the lingo sounds super sexy and really good and it sounds too good to be true, chances are they're hammering on the tax benefits. So what are the tax benefits? Well it is true that money does accumulate inside index universal life insurance policies on a tax deferred basis, meaning you do not pay taxes on your gains from year to year inside your life insurance policy. You can also access money income tax free through policy loans in an index UL. That is true. You can do that. Another pro is that the income that comes out of your index universal life insurance contract is not going to count towards taxing of your social security benefits. It's also not going to count towards surcharging your Medicare premiums. So those two things are huge benefits, especially if you're a high earner or if you've done a great job saving for retirement and you're going to have a lot of income, either from qualified accounts or maybe even from a pension. So that can be a huge deal. Money does pass income tax free to your beneficiaries and heirs through the death benefit. That's a big deal. It's true that there's also no cap on how much you can put in. There's no 59 and a half rule and there are no income limits. Now juxtapose that to the Roth IRA, which has some similar tax benefits that the index universal life insurance contract does, but it comes with caps on how much you can put in. It is subject to the 59 and a half rule and there are income limits in terms of contributing to a Roth IRA. Now again, let's just set aside back to our Roth convergence for the moment because that's a whole nother topic, but those are the tax benefits of an index universal life insurance policy. They are pros to IUL and they do really work that way. Money accumulates tax deferred, money comes out income tax free, money passes income tax free, all beautiful things. Another major benefit of these index universal life insurance policies is the way that you earn money and the way that you take it out. Under loans and arbitrage, really what we're talking about here is that when you take money out of an index universal life insurance contract through the use of a policy loan, you might hear the word loan and think that's a con. Well, there's a reason that it's in the pro list. The reason it's in the pro list is because let's assume for a second that you're going to be charged 5% to take money from your life insurance contract. It's a loan. There's a charge. Let's say it's 5%. We're choosing five because that's widely available at many different carriers. They're going to charge you 5% to take out your money, but they're going to leave your money in the indexing accounts inside the life insurance policy. Let's talk about some real numbers. Let's assume that you have a million dollars in your index universal life insurance contract and you decide to take a half million dollar loan. They're going to charge you 5% on the half million dollar loan, but they're going to leave that half million dollars in the index. Let's assume the index goes up 10% that year. So they're charging you 5% on a half million dollars and you earned 10% on a million dollars. So this loan actually earned you money in that year. And that's why it's considered a pro because you have the opportunity for what's called positive arbitrage, earning money on the money that you're loaning yourself. Now that can work against you as well, which is why loans is also in the con list, but more on that later. In terms of crediting, you've heard a lot of the buzzwords, zero is your hero. It's an elevator with no down button. You can go up, you'll never lose money. It's true that index universal life insurance policies have a 0% floor and do not contain an element of market risk. You do not lose money because the market goes down. There are still fees, but you do not participate in market losses. Some of these index accounts also allow for uncapped gains, meaning you can capture the entire index gain without any caps and still have a 0% floor. And the major benefit of these two things is that, well, not the major benefit, but a major benefit is that throughout the life of the contract, you actually do not need to adjust your investment allocations because your risk tolerance throughout the life of the contract is virtually unchanged because you don't have to worry about market losses. You also do not have to adjust your target returns like you would have to do in a managed account or investing in the stock market. A 30-year-old invests differently than an 80-year-old. A 30-year-old can experience losses. In most cases, an 80-year-old cannot. With the IUL, you don't have to worry about that, therefore you don't have to adjust the way that you invest your money inside the contract. And lastly, and certainly this is not an exhaustive list, but lastly for this video, these new life insurance policies have something called living benefits. Now what that means is you can actually use these life insurance policies while you're alive. We talked about one instance of that, which is the tax-free income aspect, but you can also access your death benefit early for things like critical illness. Now when I say critical illness, what I'm actually saying is things like heart attack, stroke, cancer, burns, paralysis, all types of major illness events, you can actually access your death benefit early to help pay for medical bills when something like that happens. You can also access your death benefit early for things like long-term care episodes. And if you're terminally ill, let's say you've been given two years or less to live, most insurance companies nowadays are going to give you your death benefit early so that you can live the next two years of your life however you want to live it, spend your death benefit now while you're alive and not wait until you pass. So those are living benefits, those are relatively new, and it's a huge benefit of these index universal life insurance contracts. Now that's it in terms of this video for the pros. I want to talk about the cons because I want to do a really good job of dialing in on exactly what you have to lose inside these index universal life insurance policies. And before I go into the actual con list, I want to make this one overarching point. Most of these cons are directly related to how your policy is designed, meaning if you design the policy the right way, the things that you see in both lists are going to be a pro for you. If the policy is designed the wrong way or you're working with somebody that doesn't know what they're doing or is out to benefit themselves and not you in the form of making as much commission as possible, if you're working with one of those people, the things that you see in both lists are going to turn out to be a con for you. So most of these cons are directly related to how your policy is designed, more so than the policy itself. Let's start with fees. So a poorly designed policy done by a really bad agent can absolutely destroy, demolish, burn down your universal life insurance contract. No doubt about it. What a bad agent is going to do is they're going to juice their commission, which is going to hurt your long and short term policy performance. Why is it going to do that? It's going to do that because it's going to increase the fees. A bad agent is going to design a policy so that the fees actually don't increase over time. Because remember, these policies are built on something called annually renewable term. If your policy is designed the right way, that can be a good thing. If it's designed the wrong way, it can be a terrible thing and your fees are going to increase over time exponentially. Another major con of the index universal life insurance contract, and this actually has nothing to do with how it's designed. It has everything to do with the company itself. They can change their cost of insurance. Now the caveat on that, if they change their cost of insurance, they have to do something called proving adverse mortality, meaning they have to go to their state commissioner wherever they're domiciled and they have to prove to the state insurance commissioner that they have what's called adverse mortality, meaning they followed all the rules. They gave insurance to the healthy people. They charged unhealthy people the right premium increases, so on and so forth. They followed all the rules and they just happened to insure too many people that got in car accidents that year and they experienced what's called adverse mortality. They paid out more than they should have from an actuarial standpoint. Their math was good and it was just, think of it as bad luck. They did nothing wrong. It was just bad luck. Now only three carriers to this date, to my knowledge in the index universal life space, have had to increase their cost of insurance. All of them were bad carriers. I don't believe any of them at the time were A rated. So that just goes to show you that the carrier you're choosing plays a big role. Cost of insurance can change by choosing a good carrier. You can mitigate that risk. Another con on the index universal life insurance policies is interest rate risk. Now what we mean here is that if interest rates go down, these policies will actually perform worse because most of the policy provisions are tied to interest rate performance. So if interest rates are declining, these policies are going to perform worse. The next con on our list is performance risk. We have no guarantee on how these policies are actually going to perform from year to year because they are linked to the market. So some people would have you believe that these are guaranteed or they're positioning it as a guaranteed return or a safe return. It certainly is safer than investing in the market, but that doesn't mean that the numbers you're seeing on the paper are any more or less likely to happen because it's totally based on the performance of the index. In most cases, it's the performance of the S&P, which brings us to our next point on performance risk. These policies, specifically the S&P, do not include dividends. What you're actually doing is you're trading the 0% floor for the dividends and the upside. So these policies oftentimes will have a cap. Let's say that the cap is 12%. So if the S&P goes up 20, you're not going to get 20. You're going to get, in this case, 12. If the S&P is down 30, you're not going to get minus 30. You're going to get zero. So there's always a trade-off. In this particular case, you are not getting any of the performance from the S&P dividends, which can add up to a decent amount. The next thing I want to talk about is crediting. So the caps on these policies are not guaranteed, but again, they're tied to interest rates. So what you should expect is a good carrier doing things by the book, not cutting corners. If interest rates go up, their caps will go up. If interest rates go down, their caps will go down. Now why is that a con? It's a con because that's something that you can't really account for. These are trust me products. So if you're working with a bad carrier, this is a big time con because you better believe their caps are going to fluctuate wildly. It's not as much of a con with a good carrier, but certainly it's something that's out of your control. You cannot control what your caps are going to be because they are tied to interest rates. I also want to hit on loan provisions. So most IUL carriers have several loan provisions, but the reason that this is a con is because some carriers have really bad loan provisions or they're extremely inflexible. Other policies give you no indication of what they're going to charge you to access your money in the future. That's called an uncapped variable loan rate. So a lot of those policies are sold and they're sold because today in historically low interest rate environments, an uncapped variable loan rate seems to pose no risk. In the future, it poses a huge risk. So you have to be really careful when picking an IUL carrier to know what the loan provisions are on the contract and make sure that they're favorable. One way that you can conceptualize loan provisions in the form of a con, think of a 30 year fixed mortgage versus a three in one arm. In today's interest rate environment, you'd much rather have the 30 year fixed mortgage because interest rates are low and you can lock it in for life versus a three in one arm where you have no idea what the interest rate's going to be once it gets into that adjustable rate period. Some of these IUL policies are selling quote unquote three in one arms when it comes to their loan provisions. So you need to know that. And last but not least, and again, not an exhaustive list. This one's probably most important. These indexed universal life insurance policies typically do not have early liquidity. These should be a long term play, not suitable for short term plays. Okay. So if you've done any reading on infinite banking, bank on yourself, be your own banker. There's all kinds of different Kool-Aid drinkers out there talking about basically living your life out of a life insurance policy. It's a bad idea. Okay. It doesn't work. These policies are not designed for early liquidity or early access to income. Most of these policies also carry heavy surrender charges during those first 10, well, let's say eight to 12 years. So that's a huge con of the index universal life insurance policy. You cannot count on this policy for short term income needs. Okay. So that's my pro and con list. Of course, it's not exhaustive. It's impossible for it to be exhaustive. But in order to kind of bring this video to a conclusion, I want to just call your attention to a couple questions. Because if you can answer these questions, you'll know whether or not an index universal life insurance is quote unquote good or bad. So here are the questions. What are you trying to accomplish with this index universal life insurance policy? The answer to that question is extremely important because it's going to tell us how your policy should be designed. And if it's designed the wrong way, guess what? It's probably bad for you. Okay. What's your time horizon? Because if your time horizon is say in the next one to three years and you're putting a ton of money into an index universal life insurance policy, it's probably a bad thing for you because these are not short term time horizon plays. Of course, there are always exceptions to the rule. Just take this as a general rule of thumb. Do you have discretionary income? Guess what? If you don't, you shouldn't be putting money into an index universal life insurance policy. What's your risk profile? Well, if you're an extremely risky investor, guess what? This is not going to give you the same risk profile as investing in international stocks. It's also not the same risk profile as someone who's only comfortable with CDs. So you have to understand what your risk profile is to know if this is good or bad. And most importantly, is your policy designed the right way? If your policy is designed the wrong way, it's probably going to be a source of great pain for you over the long run. If your policy is designed the right way and it's not a short term time play and you do have discretionary income and you're looking for something that carries this risk profile, guess what? This can be one of the best things that you own. But just simply saying it's good or bad doesn't make much sense to me. You have to understand what you're trying to do, what the purpose of the policy is. Do you understand how it works? Is it designed the right way? Are you funding it the right way? Those answers to those questions are going to determine whether or not an index universal life insurance policy is a good thing or a bad thing. Now, if you have an index universal life insurance contract and you want to know if it's structured the right way, you can reach me one of two ways. You can email me at matt at leverage wm.com or you can go to my website leverage wm.com slash contact dash us. I can tell you if your policy is designed the right way as long as you can answer the questions that you see on the screen. If you can tell me what the purpose is, if you can tell me what your time horizon is, if you have discretionary income and you know what your risk profile is, I can tell you if you have a policy that's going to do what you want it to do. Before I let you go, I'm going to show you the effect of a policy done the right way versus a policy done the wrong way just to nail this point home. So we're going to look at the difference between two carriers, one done right, one done wrong. So this is a Minnesota Life contract. Minnesota Life is not a bad carrier. I am simply manipulating the numbers to design one wrong and design one right so that you can see the difference in income when done right versus wrong. So this one is designed wrong. I'm not manipulating the crediting rates. I'm simply manipulating my commission and a few other policy provisions. So this is a 45 year old male preferred plus $20,000 going in for 20 years and we're going to take out lifetime income. Our lifetime income done the wrong way is $43,000 a year tax free with no market risk for life. A good salesman could make a sales pitch off of that because it still relatively works. But look at how much better it could be. Again, same thing, $20,000 a year, 45 year old male preferred plus, the interest rates are the same. The only difference is that I designed it the right way and my income went from $43,000 all the way up to $77,000 a year. We're talking about a difference of $34,000 a year tax free for life forever. What a huge difference in designing the policy the right way versus the wrong way. But here's the kicker. If you can't answer those questions that we talked about on the screen, this right here could be bad for you depending on what you're trying to do. Because if your goal is maximum short term liquidity in year three, well guess what? You don't have the money that you put into this contract in year three. So this would be a bad policy for you. It all comes down to what are you trying to do? I hope that this has been helpful. Again, if you have any questions at all, you can reach me at matt at leveragewm.com or go to my website leveragewm.com slash contact-us, fill out the form, I'll get in contact with you that way. Like this video, subscribe, share it with your friends and hang out with me in the comments.