By Julian Guilfoyle, Cooper& Adel Financial
Universal life insurance policies can be an excellent tool to accomplish a wide variety of objectives. Some people are intrigued by the large death benefit that generally accompanies these policies. They may purchase the life insurance to transfer wealth down to their children or replace income lost at first death for the surviving spouse. Others like the flexibility of being able to use the cash value of the policy to pay premiums if they are unable. Most, however, inevitably run into a very difficult conundrum, pay astronomical premiums, or have their policies lapse and lose the death benefit.
The possibility of universal life policies lapsing increases as people age. It occurs because insurance companies credit interest and deduct expenses. From an interest-crediting standpoint, interest can be added to the cash value of a policy through a fixed, indexed, or variable rate.
A fixed rate is determined by the insurance company and generally will have some minimum rate that is always credited to the cash value of the policy.
An indexed crediting option is based upon an index (for example the S&P 500) and its’ returns. These policies can get very complicated because policies differ on how they credit interest to the cash value. For instance, a popular choice is to have the policy compare the S&P 500 to the previous year. If the index has gained in value, interest credited to the cash value will reflect the gain (beware there are often “caps”, or maximums, on the amount the insurer will credit). If the index has reduced in value, generally the insurer will credit no interest to the cash value, however the “loss” in the index will not reduce the cash value.
A variable crediting method will track subaccounts (stocks and/or bonds) that the investor chooses. This method carries a higher risk than fixed or indexed methods because the investor can lose principal due to market losses.
The second half of this equation is determined by how the insurer deducts expenses. Each policy and company treats these costs different, so anyone contemplating the purchase of a universal life policy should consult with a licensed professional. However, as a general rule, the investor should expect a cost of insurance charge (which rises as you age), and other charges (such as maintenance) and fees.
One can start to see the problem that can arise. If the combined charges, expenses, or cost of insurance exceed the interest credited, the investor sees a loss in cash value. Should this cash value ever reach zero, the policy lapses and the client loses their death benefit. This usually occurs when people have aged considerably (as compared to when they began the policy) and to make matters worse, they may, at that time, be considered uninsurable and unable to purchase another policy.
I believe the best way to view a universal life policy is term insurance with a cash value that the investor can access. That way, should a policy lapse, the investor is not dependent upon their death benefit to solve major problems (i.e. a substantial loss in income at first death). The only available alternatives are either paying increasing premiums or surrendering the policy for the cash value. However, as Ellen E. Schultz recently wrote in a Wall Street Journal titled “Insurance Can Cut Your Taxes”, investors have a fourth option. Should the investor decide to complete a no-tax transfer (1035 exchange) into an annuity, all of the growth up to the original premium will be tax-free. For example, I invest $50,000 into a universal life policy with a death benefit of $250,000. After ten years, the cash value of the policy is only $25,000 and I realize most likely this policy will lapse during my lifetime or I have a change in financial goals (maybe my kids are no longer in college or the mortgage is satisfied). Should I transfer this life insurance policy into an annuity, the first $25,000 in growth can be withdrawn or will pay to my beneficiaries income-tax-free. This is because investors can write off the losses in an annuity, however the same tax treatment does not apply for life insurance.
While this strategy can certainly be beneficial to investors, it is imperative that the investor’s entire legal and financial plans are reviewed and taken into account when making any recommendations. If you have any questions or concerns regarding an existing life insurance or annuity policy, or would like to discuss the recent law changes in Ohio or the federal government, please contact our office for a free consultation.
To see the full article, click the link below.
http://online.wsj.com/article/SB10001424127887324784404578145362537922992.html
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