L.I.F.T.: Using Life Insurance as a Financial Tool to mitigate taxes |

Investors frequently reach out to us for fresh ideas in investing. When you say the word, “Insurance,” some people may roll their eyes, check their watch or find their attention going elsewhere. However, what most people may not know is that there are ways to leverage life insurance not for the death benefit, which you do get, but to take advantage of the tax code, specifically article 7702, where you can grow assets tax deferred over time. When you are ready, you can take it out of the account by loaning yourself the money. Because it is considered a loan rather than a taxable withdrawal from an account, you are not taxed on the funds. Wait, did someone say “Tax free money?” Let’s start with the basics…

What is an IUL?

IUL stands for Indexed Universal Life insurance. It is a type of permanent life insurance policy that combines elements of both traditional life insurance and investment savings. With an IUL policy, a portion of your premium goes towards providing a death benefit to your beneficiaries, similar to traditional life insurance. However, the distinguishing feature of an IUL policy is that the cash value component is tied to the performance of a market index, such as the S&P 500. The interest credited to the cash value of an IUL policy is usually based on the positive movement of the chosen index, subject to certain limitations like a cap or participation rate. This means that if the index performs well, the policy’s cash value can increase. Conversely, if the index performs poorly, the policy’s cash value may not grow as much or could even decline (due to the cost of insurance, not stock market performance). In short, if you have a floor of zero, you cannot lose the money. You have a cap up to 9% or 12%, depending on the company. If the market goes down, you don’t lose a dime. If the market goes up, you get up to 9 % or 12% of market participation. Your account either is flat (in a down market) or it goes up (in a good market). IUL policies offer some potential benefits, such as the opportunity for cash value growth and a death benefit for your beneficiaries. They also provide flexibility in premium payments and the ability to access the cash value through policy loans or withdrawals. However, it’s important to carefully consider the fees, charges, and potential risks associated with IUL policies, as they can be complex financial products. 2. How long have IULs been around? Indexed Universal Life (IUL) insurance policies have been available in the market for several decades, although they gained more popularity and widespread adoption in the early 2000s. The specific date of their introduction may vary depending on the insurance company and the specific features of the policy. The development of IULs can be traced back to the concept of Universal Life (UL) insurance, which was introduced in the 1970s as a variation of traditional whole life insurance. UL policies provided flexible premium payments and adjustable death benefits, offering policyholders more control and options compared to traditional policies. Indexed Universal Life policies emerged as a further evolution of UL policies. The first IUL policies introduced the concept of tying the cash value growth to the performance of a market index, providing potential for higher returns compared to traditional UL policies. Since their introduction, IULs have undergone refinements and enhancements to their features, including adjustments to caps, participation rates, and various other policy provisions. Insurance companies continue to innovate and introduce new variations of IUL products to meet the evolving needs of consumers. It’s worth noting that while IULs have been available for some time, insurance regulations, market conditions, and policy offerings can vary across different countries and regions. Therefore, the specific availability and popularity of IULs may differ based on the geographical location and the insurance market in question. 3. How does an IUL leverage article 7002 of the tax code? Indexed Universal Life (IUL) insurance policies are designed to meet the requirements outlined in Section 7702 of the Internal Revenue Code (IRC). Section 7702 sets certain guidelines for the tax treatment of life insurance policies and distinguishes them from investment vehicles. To qualify as life insurance under Section 7702, an IUL policy must meet two main criteria:

Cash Value Accumulation: The policy must have an adequate amount of death benefit relative to the premiums paid to ensure that it is primarily a life insurance policy rather than an investment vehicle. This requirement is commonly referred to as the “cash value corridor test.” The cash value growth within the policy is subject to limitations to ensure that it remains within the boundaries defined by Section 7702.
Tax-Advantaged Status: The cash value growth within the policy must accumulate on a tax-deferred basis. This means that policyholders are not required to pay taxes on the growth within the policy as long as it remains within the policy. This tax advantage allows the cash value to grow more efficiently compared to taxable investment accounts.

By meeting the guidelines set forth in Section 7702, an IUL policy can provide tax advantages to policyholders. The cash value growth within the policy is not subject to annual taxation, allowing for potential tax-efficient accumulation of funds. However, it’s important to note that there may be tax implications upon policy surrender or withdrawal, and policyholders should consult with a tax professional for specific advice related to their individual circumstances. It’s worth mentioning that tax laws can change over time, and it’s essential to stay updated on any revisions or amendments to Section 7702 or other relevant tax provisions. 4. Why invest in an IUL? There are several reasons why someone might consider purchasing an Indexed Universal Life (IUL) insurance policy. Here are some potential benefits that may appeal to individuals:

Death Benefit Protection: Like other life insurance policies, an IUL provides a death benefit to your beneficiaries in the event of your passing. This can provide financial protection and support for your loved ones.
Potential Cash Value Growth: The cash value component of an IUL policy has the potential to grow over time, based on the performance of a selected market index. If the index performs well, your cash value can increase, providing a source of potential savings or supplemental income.
Tax Advantages: The cash value growth in an IUL policy accumulates on a tax-deferred basis, meaning you don’t have to pay taxes on the growth as long as it remains within the policy. This can potentially allow for tax-efficient accumulation of funds.
Flexibility in Premiums: IUL policies generally offer flexibility in premium payments. You may have the option to adjust the amount and timing of your premium payments, within certain limits. This can be beneficial if your financial circumstances change over time.
Access to Cash Value: IUL policies typically allow policyholders to access the cash value through policy loans or withdrawals. This can provide liquidity in case of financial emergencies or other needs. However, it’s important to understand the potential impact on the death benefit and any associated costs.
Diversification Potential: The cash value in an IUL policy is linked to the performance of a market index, which allows for potential diversification. This means that if one investment performs poorly, other investments within the index may compensate for it.

5. Why do they call an IUL the “Rich man’s Roth?” The phrase “the rich man’s Roth” is sometimes used to describe Indexed Universal Life (IUL) insurance policies due to certain similarities they share with Roth individual retirement accounts (IRAs). Here are a few reasons why this analogy may be made:

Tax Advantages: Both IUL policies and Roth IRAs offer tax advantages. The cash value growth within an IUL policy accumulates on a tax-deferred basis, similar to the tax treatment of earnings in a Roth IRA. Additionally, qualified withdrawals from a Roth IRA are tax-free, while policyholders can potentially access the cash value of an IUL policy on a tax-free basis through policy loans or withdrawals.
Higher Contribution Limits: Roth IRAs have contribution limits set by the IRS. In contrast, IUL policies generally do not have contribution limits, allowing individuals with higher incomes or substantial assets to potentially contribute more money into the policy compared to the annual contribution limits of a Roth IRA.
No Income Restrictions: Roth IRAs have income limitations that determine eligibility for contributions. High-income earners may be restricted or ineligible to contribute directly to a Roth IRA. However, there are no income restrictions when it comes to purchasing an IUL policy, making it accessible to individuals with higher incomes.
Estate Planning Benefits: Both IUL policies and Roth IRAs can offer estate planning advantages. They can be used as tools to pass on wealth to beneficiaries while potentially minimizing taxes. IUL policies, in particular, provide a death benefit that can be passed on to heirs on a tax-free basis.

However, it’s important to note that while the phrase “the rich man’s Roth” highlights certain similarities, IUL policies and Roth IRAs are distinct financial instruments with different features, benefits, and considerations. IUL policies are primarily life insurance policies with an investment component, while Roth IRAs are retirement savings accounts. Each has its own advantages and limitations, and the choice between the two should be based on individual circumstances, financial goals, and risk tolerance. 6. Why would you NOT want to buy an IUL? While Indexed Universal Life (IUL) insurance policies offer certain benefits, there are also potential drawbacks and considerations that may make them less suitable for some individuals. Here are some reasons why you might not want to buy an IUL: Complexity: IUL policies can be complex financial products. Understanding how the cash value growth is calculated, the limitations or caps on returns, and the various fees and charges associated with the policy can be challenging. If you prefer simplicity or have difficulty understanding complex financial products, an IUL may not be the best option. Lower Returns in hot markets: While an IUL offers the potential for cash value growth based on the performance of an index, there are often limitations in place. These limitations can include caps on returns, participation rates, and spread or margin charges. These factors can potentially limit the overall growth potential of the policy compared to investing directly in the market. Costs and Fees: IUL policies typically come with various costs and fees, including insurance charges, administrative fees, and mortality and expense charges. These fees can reduce the overall returns and cash value growth of the policy. It’s important to understand and evaluate the costs associated with an IUL policy before making a decision. Risk of Underperformance: If the chosen index performs poorly or experiences negative returns, the cash value of the policy may not grow or could even decline. While some IUL policies offer downside protection or minimum guarantees, the potential for underperformance is a risk to consider. Surrender Charges and Policy Lapse: If you decide to surrender or cancel an IUL policy early, you may be subject to surrender charges, which can be significant, especially in the early years of the policy. Additionally, if you’re unable to maintain premium payments, the policy may lapse, resulting in the loss of the death benefit and potentially triggering taxes on any gains. Potential Alternatives: Depending on your financial goals and circumstances, there may be alternative options to achieve your objectives. For example, if your primary goal is investment growth, you might consider separate life insurance and investment accounts that can provide more flexibility and potentially better returns. It’s important to thoroughly evaluate your individual financial situation, risk tolerance, and goals before deciding whether an IUL policy is the right choice for you. Consider consulting with a financial advisor or insurance professional who can provide personalized advice based on your specific needs and circumstances. 7. How do I know if an IUL is right for me? Determining whether an Indexed Universal Life (IUL) insurance policy is the right choice for you requires careful consideration of your individual financial situation, goals, and risk tolerance. Here are some steps you can take to help assess whether an IUL is suitable for you:

Evaluate Your Goals: Consider your financial objectives. Are you primarily seeking life insurance protection for your beneficiaries, or are you also looking for potential cash value growth and tax advantages? Clarifying your goals will help you determine if an IUL aligns with what you want to achieve.
Assess Your Risk Tolerance: IUL policies offer the potential for cash value growth based on the performance of an index, but they also come with limitations and risks. Consider how comfortable you are with market volatility and the potential for lower returns during periods of poor market performance.
Review Your Financial Situation: Assess your current financial situation, including your income, expenses, savings, and other investments. Ensure that you have a solid foundation in terms of emergency savings, retirement accounts, and other key financial areas before considering an IUL policy.
Understand the Product: Familiarize yourself with the features, terms, and mechanics of an IUL policy. This includes understanding how the cash value growth is calculated, any limitations or caps on returns, fees and charges, and potential surrender penalties. Consider seeking guidance from a financial advisor or insurance professional to help you understand the details.
Compare Alternatives: Explore other financial products and strategies that may help you achieve your goals. This could include traditional life insurance policies, term life insurance combined with separate investment accounts, or other investment vehicles. Compare the benefits, risks, costs, and flexibility of these alternatives with an IUL.
Seek Professional Advice: Consulting with a financial advisor or insurance professional who has expertise in life insurance and investment products can provide valuable guidance. They can help assess your specific financial situation, evaluate the pros and cons of an IUL, and provide personalized recommendations based on your needs and objectives.

Remember that everyone’s financial situation and goals are unique, so what may be suitable for one person may not be the best option for another. Taking the time to carefully evaluate your circumstances and seeking professional advice can help you make an informed decision about whether an IUL is right for you.