Overfunded Universal Life Insurance

[Ian Saingarm]

Hi guys, I was at an asset protection conference and one of those guru's who tries to sell you a tablet and a "program" was all about index linked overfunded insurance and I liked some of what I heard.  The idea being you get life insurance (which my wife and I like the idea of) and an investment that grows with the market and has a cash value that you can borrow against tax free for future real estate investments.  If the market has a bad year, you get the guaranteed interest rate which is low but much better than say a year like 07/08. 

State Farm had a plan where you get a guaranteed 2% and a "illustrated" rate of 3 ish percent.  For a $300k policy with a premium of $908/ month or $10,908 per year.  After 10 years of paying the premium I would have a cash value of about $107k.  It grows from there.  From year one there is a death benefit of $300k+.

I went to Farmers and they had a local "expert" who has a certification in securities which he said was unlike other firms and he said I should go with a Mutual fund liked overfunded policy with no guaranteed amount.  He suggested a fund linked to some of the American Growth Funds specifically AGTHX and says they have an average return of 13% per year, and projected we'd have a couple million dollars after "not long at all".  Sounds pretty legit right?  :-) 

American Funds

He proceeded to show me their website and a graph... which to me looked like the S&P outperformed the fund pretty easily over the last 10 years.  His response was, "its hard to see" and "its complicated" and I told him unless I'm reading the graph wrong which is entirely possible, it doesn't seem that complicated, it seems like the mutual fund underperforms the market.  Maybe the dividend reinvestment is much more powerful than I am thinking.

Here's how yahoo finance stacks them up:

Yahoo Finance

So, what are your thoughts on overfunded insurance as a tax advantage investment that has a dual purpose serving as life insurance for a family?  Where should I be looking?  I like the idea but have not found my unicorn yet.

Ian

[Ian Saingarm]

@Kent Martin @Keith Gifford

[Damien Pagano]

There are going to be a lot of people on here who are going to mention "buy term and invest the difference" because they've been fed information from Dave Ramsey and other financial entertainers that whole life or universal life is a bad "investment". But that's not your question and you're looking to have growth and liquidity, so an insurance vehicle can help you here. 

An Indexed Universal Life policy is an asset that has underlying investments (index funds), but there's also an insurance expense which is basically term each year.  Using it for what you've mentioned is an alternative source of financing that has tax advantages if done right, but the devil is in the details.  That insurance expense will increase as you age, but if you keep enough cash in the policy then that will help to mitigate that increase in cost.  If you don't keep it well funded there's a possibility in can lapse. The policy should be a non-recognition policy (they still pay interest and dividends based on your cash value amount and don't recognize any loans you have out on the policy when making these), and a mutual company would (most likely) be best since the dividends won't be taxed, and can still be reinvested into the policy.

As for the mutual funds - that's more along the lines of a variable product and there are more fees and risk than an indexed policy, plus it's difficult to consistently beat the index.  You seem like you still want it to provide a life insurance benefit, so just use caution in deciding how much risk you want this to be exposed to (risk is related to control, not always reward).

Disclaimer - I am licensed to sell life insurance and we do this exact type of investing with clients, so it can be done if set up correctly, but it's not an "off-the-shelf" type of product.  If properly designed and used, you can do very well with it.  I would look for someone who works in your area that has done this successfully.  I'm with MassMutual (we use a whole life product for this instead of an indexed universal policy), and there are some Guardian, and Northwestern Mutual policies among others that also work well for these.

Good luck in your search.

[Thomas Rutkowski]

I've got some blog posts about using life insurance cash value, not specifically an IUL, as a personal bank for investing in real estate. Since you are on BP, you may find this an interesting use of your retirement savings. Unlike an IRA, you can access the cash value in your policy every single day between now and the day you retire to put that money to work in two places at one time.

https://www.biggerpockets.com/blogs/7595-make-your...

One thing you should also keep in mind. The market-based, but principal-protected returns are only the tip of the iceberg. Account values are only number on a piece of paper. They do not put food on the table or pay bills. Because of the way you access the cash value for income--and income IS what is important--life insurance cash value will provide about 2-3 times the income of a traditional retirement savings account based on stocks or mutual funds.

If you research IUL, you will find a bunch of misleading and incorrect information. Take it with a grain of salt. The internal insurance costs in an overfunded policy outside of the surrender charge period, is less than 0.25%. The risk of a policy lapsing due to rising insurance cost is nearly impossible. 

https://www.biggerpockets.com/blogs/7595/47958-is-indexed-ul-or-whole-life-better-for-infinite-banking

If you want principal-protected returns with market performance, the IUL is the perfect tool. You know the mechanism by which interest is credited, you just won't know exactly what you will get.

If you want to know what you will get, then get a whole life policy. These come with guarantees, but the trade off is a lower return.

[Thomas Rutkowski]

Originally posted by @Damien Pagano:

An Indexed Universal Life policy is an asset that has underlying investments (index funds), but there's also an insurance expense which is basically term each year.  Using it for what you've mentioned is an alternative source of financing that has tax advantages if done right, but the devil is in the details.  That insurance expense will increase as you age, but if you keep enough cash in the policy then that will help to mitigate that increase in cost.  If you don't keep it well funded there's a possibility in can lapse. The policy should be a non-recognition policy (they still pay interest and dividends based on your cash value amount and don't recognize any loans you have out on the policy when making these), and a mutual company would (most likely) be best since the dividends won't be taxed, and can still be reinvested into the policy.

Damien - I was looking back at this thread and noticed a few errors in your response. 

1. Indexed UL does not have underlying investments in index funds. They use option hedging strategies to give the policyholder market returns without actually being invested in the market. Insurance companies use options on the underlying indices to lock in the caps and set the floor. Only Variable UL policies hold actual securities. 

Think about an option on real estate. If you paid $1000 for an option to purchase a house that is currently valued at $100,000 for $100,000, then you will capture the equity as the house increases in value. But if the house decreases in value, the option will expire worthless. All you will have lost is the amount you invested in the option. If the option was paid for from the earnings on the cash value, then the principal is intact. You get to enjoy the performance of the real estate investment without actually buying real estate. 

2. All life insurance loans are loans against the policies cash value. This is written into the insurance statutes in every state. The individual companies may declare that their loans are non-direct recognition or direct recognition. Non-direct recognition is what most real estate investors want. The cash value securing the loan continues to earn interest or dividends. This gives an investor the ability to put their money to work in two places at one time. 

Direct recognition, on the other hand, looks and smells like a loan "from" your cash value. The cash value is still there securing the loan, but the company does not pay dividends or interest on it. The investor would need to get a loan from a 3d party lender that is secured by the cash value. This is very easy to do and banks love to loan against cash value because they can get an assignment of collateral.

3. The interest credited to a UL's cash value is not taxed. The interest is credited to the cash value account. This is part of the death benefit and is not taxed unless it is withdrawn and then, only to the extent that it exceeds its basis. Just like a capital gain. 

The idea that a "mutual" company is somehow better than a privately held company is a myth propagated by the mutual companies. All companies need to make a profit. Most companies reinsure their risks with the exact same reinsurance companies, so the idea that size and ratings matter is also a myth. At the end of the day, as long as you are happy with the policy, the dividends/interest, and the agent you are working with, you'll be fine.

[Damien Pagano]

Tom, thank you for clarifying some of those things.  You are correct in terms of the mechanism of the Indexed UL, I was describing it vaguely to show the concept, and misspoke by saying indexed funds.  The idea is still the same in that it's tied to the performance of indexes rather than holding ownership of mutual funds/stocks/etc.

For the loans, the difference you described between non-direct recognition and direct recognition is what I was saying, just worded differently.  By saying that there's a "loan on your policy" with respect to direct recognition, I was not saying that the cash was taken out of the policy, but that the company does not pay dividends or interest on it.  I didn't mention that the loans are using the cash value as collateral which is great information for Ian, most people I've talked to initially think of something like a 401K loan which removes the money from your account which is different than insurance vehicles.

The tax situation for mutual companies vs stock companies is still worthy of mentioning.  He said that he wanted to use the policy as an asset for real estate but at the end of the day it's still a life insurance policy.  The point I was making is that there's a difference between the two regarding a tax implication.  I see that the way it was worded might make it look like the dividends would be taxed before being reinvested, which is not what I was implying.  If he was going to at some point (because this is still a life insurance policy) take the dividends as cash instead of reinvesting them into the policy or take distributions down the line, there could be a tax implication if it were a stock company rather than a mutual company.  And just as you said, if he withdrew more than his cost basis it would be taxed similar to a capital gain.  That's all I was referring to - my use of the word "better" is subjective to my own perception of the tax code and how I feel about it.

Ian - Tom is a great resource on here as well as a few others from different posts, give some of their material a read.  Also, if you begin to use this strategy I look forward to seeing a post in the future about how it's helped!