Written By — David Shafer
Most financial products need to be properly structured to get the best performance. EIULs are especially needy in this matter. If there is an Achilles heal in EIULs it is that most insurance agents don’t have the experience to structure them for the best performance. Add in the fact that many insurance companies are more interested in attacking other company’s products than in educating their agents and you have a troubling problem. Real estate investors understand this, because they have seen the massive amount of RE investment failure over the last couple years due to folks not knowing what they are doing in the real estate world.
Each individual has a slightly different need and slightly different circumstances to build from. For the point of this post, I will assume that the client has the ability to max-fund the EIUL and is looking for tax free retirement income or tax free money to their heirs. Universal life insurance has much flexibility built into the product which allows us to consciously keep expenses down and performance up.
Five policy premiums are scheduled to be made one year apart. Generally these payments are equal although sometimes the first or last premium can be different. For the point of discussion let’s say that the client puts $30,000 in each premium moving a total of $150,000 into the policy. The face value can be either set up as level or as increasing and can be changed at any time on an annual basis. We set up the initial face value as option B or increasing value. This allows us to keep the face value at the smallest possible. The smaller first year’s face value keeps the expenses from insurance lower during the premium load period, adding to the performance. It also lowers the amount of commission being paid and the overall premium charges. However, you don’t want to leave it on option B for the life of the policy because the insurance costs would start to eat you alive when you reach your late 70s. So after the last premium is paid [year 5], you switch to a level face value. Now depending upon the actual performance and how long you have the policy, you more than likely would have the ability to move the face value down at around year 13. The company will tell you how low you can move it, based on the IRS corridor regulations. This would reduce your insurance expenses even more. However, if the performance has been excellent during that first 12 years it is possible that the corridor rules will force the face value of the insurance to actually increase. This is a good sign as it means your cash value has gone up rapidly. The point being is that you can manipulate the face value to your benefit but have to abide by IRS corridor rules.
There is one exception. If at any point you get a poor health diagnosis you would then move to an increasing face value situation to increase payout at death.
When you get to retirement age and you want to start pulling out your tax free income you need to make a couple of decisions. How much? What type of loan? Again a call to your agent or the company will help you establish how much you should pull out. It will be dependent on how much accumulation you have and how long you plan on pulling out cash.
The way you access the cash value is through “loans.” These loans are considered return of premiums and therefore are considered tax free. There are two different types of loans available with several different permutations of each. The fixed rate loans are either offered at a particular rate or offered as a “wash loan.” A wash loan is one where the loan rate is matched to the interest paid. The Minnesota Life fixed rate loan cost you .1% each year. In other words what you earn is .1% less than what you pay in interest. This is the safest way to get your income. However, ML allows you to switch freely [up to two times a year] between the fixed rate and a variable rate loan. Variable rate loans are tied to the Moody’s published corporate bond rate. Here you get the full interest crediting that you would normally get and pay that variable rate. Historic data indicated a 1-2% advantage for the interest crediting over the variable rate. In other words if the variable rate is 7.5% and the interest credited from the index is 12% you get the difference or 4.5%. If the interest credited is 0% then you pay the full 7.5% that year. Critics of the variable rate loan point out that in the 1970s the Moody’s corporate bond rate went to 12% and that could repeat itself causing for losses. They usually point to some variable products that go negative to put fear into people. I agree that a variable rate with a variable product that could go negative is risky. But Minnesota Life has eliminated that risk by allowing you to switch to a wash loan at any time. So if interest rates go high you can make one phone call and switch to a wash loan. Minnesota Life is the only company that allows that much flexibility in loans.
Finally, there are two riders that I put on policies. Both are free from ML. The first allows you to access up to 75% of your face value if you get a poor diagnosis. This can be a great deal if you get cancer or other diseases early on. You can use the money to get alternative treatments, take your family around the world or any other use you can think of. The second rider makes sure your policy will not lapse. If at any point you have pulled out so much cash that the insurance costs can’t be covered going forward, this benefit clicks in, and freezes the face value [minus policy loans], guarantees the policy will extend to your death, but doesn’t allow for any more cash to be pulled out. This way the policy and the tax benefits are kept alive.
As you can see there are several issues that need to be thought out to maximize the performance of an EIUL. Much of the fear mongering about EIULs surrounds poor planning and under educated agents. However, when structured to the client’s advantage, EIULs perform well and does exactly what it claims to do. Provide tax free income and a decent internal rate of return. Next week I will take actual policy illustrations and demonstrate the costs and internal rate of return received.
BawldGuy Here: Man, do I know how to pick ‘em, or what?
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