Variable Universal Life Offers Alternative to Term
Policies May Bolster Retirement Portfolio
BY LANCE A. PELKY
Special to the Business Journal
The original purpose of life insurance was for short-term protection for dependents of individuals who died unexpectedly before they were able to build up a sufficient nest egg to provide for the needs of their family.
If the unexpected didn’t occur, and the bread-winner lived a full life, the family would amass enough in assets to ensure its financial solvency and would eventually terminate the policy.
In addition to providing essential financial support for dependents, life insurance can also help solve some common estate planning issues by providing immediate cash at death, avoiding probate and reducing the death tax liability of the insured’s estate, if applicable. But by and large, if individuals have done an adequate job in planning for their retirement, there shouldn’t be any reason to continue paying premiums on a term life insurance policy past the age of 65.
There are many ways to successfully plan for retirement, but one of the most sensible and prudent is to obtain a variable universal life policy, a unique retirement planning tool with incredible benefits and flexibility. Variable universal life policies are considered the “bone china” of retirement planning tools simply because they are one of the finest investment products out there, and also because the death benefits can be passed on to future generations for their use and benefit.
There are a number of reasons why selecting variable universal life could bolster an investment portfolio and provide some very attractive benefits. Policyholders have great flexibility in getting their money out when they need it by borrowing the money they need against the policy’s cash value tax-free. However, withdrawals may generate an income tax liability and loans or withdrawals reduce death benefits and cash value. Policyholders can invest income tax deferred during their lifetime by paying premiums and placing contributions into variable investment options through mutual funds, resulting in growth, diversification and asset allocation.
They can own the policy during their lifetime, but also have the capability of making their children contingent owners with a choice to continue to invest tax-free during their lives, and pass on income tax-free death benefits to their heirs upon death.
In addition to offering tax-deferred growth to outpace inflation, there is the built-in flexibility of setting up a trust for heirs to receive proceeds of the policy as a loan, without liquidating it so the heirs will continue to benefit from the policy’s tax shelter capabilities.
– Legacy For Heirs
Essentially, universal life policies are excellent discount tools with great leverage, providing legacy at death to the insured’s heirs while offering significant supplemental retirement benefits. They have the potential for becoming the only savings program an individual will ever need because of their liquidity to support savings and are one of the best ways to ensure retirement with dignity.
As with any investment decision, there are certain elements to look for when considering a variable universal life policy. Try to find a policy that has a range of investment choices that can help build a successful portfolio. Additionally, the policy should have reasonable annual fees, as low as possible, and look for a low or no-load program that also has low net loan costs in case money will be borrowed out at some point. Finally, the policy can be self-managed or managed by a professional financial planner or advisor, but the most attractive policies are those with an insurer who will only work with other qualified agents.
Those who are already familiar with investing in mutual funds will notice that a variable universal life policy is similar since the investing is accomplished in much the same way, except that it is done within the wrapper of a life insurance policy. Policyholders can withdraw the principal without paying taxes and can take income tax-free distributions up to income tax basis.
They can borrow the cash value of the policy without taxation and, as mentioned earlier, can create a nontaxable living legacy for their heirs. To be effective, variable universal life must be designed properly by providing minimum death benefits with maximum deposits according to IRS guidelines. And also, as with any investment decision, there are certain risks of which individuals should be aware. But the benefits of these policies could outweigh the risks.
Proceeds from an insurance policy paid because of the death of the insured are generally excluded from the beneficiary’s gross income for income tax purposes. Tax-free income is achieved by withdrawing from the policy cash value an amount equal to the total premiums paid (cost basis), then using policy leans for the balance.
– Penalties If Withdrawal Or Loan Not Repaid
Outstanding policy loans at death, and withdrawals, will reduce the policy death benefit and cash values. If the policy is allowed to lapse with a loan outstanding, the amount of the loan in excess of cost basis will be taxable as ordinary income to the extent of the gain in the policy and may be subject to a 10 percent income tax penalty before age 59 & #733;.
On the down side, some, but not all, of the more than 1,650 variable investment options available through variable universal life programs may be watered-down clones of the originals with similar names, which can cause confusion and less than optimum performance. Another catch is that policyholders must pay taxes on profits that are withdrawn, but not on money that is borrowed.
On the upside, however, there is some risk protection that investors should be aware of as well. Money is invested in separate accounts, created specifically for variable universal life policies.
The IRS prohibits variable universal life accounts from investing directly in mutual funds available directly to the general public, and the state insurance commissioner and the Securities and Exchange Commission regulate these accounts.
Additionally, by law, money placed in these universal life accounts is not commingled with the insurance company’s general account and the cash values of the policies are not available to creditors of failed insurance companies.
What’s more, universal life loans allow the policyholder to avoid receiving IRS Form 1099s, which would otherwise reduce their Social Security payment and investment income, and trigger even more deductions for amounts tied to their adjusted gross income.
Variable products can only be sold by registered representatives and are sold by prospectus only. Variable investment options are available only as investment options in variable life insurance policies and variable annuity contracts issued by life insurance companies. They are not offered or made available to the general public directly.
Investments and variable insurance products are not guaranteed and are subject to investment risk including the possible loss of principal. The investment return on and principal value of the security will fluctuate so that when redeemed, it may be worth more or less than the original investment.
Read the prospectus carefully before sending money or investing.
Pelky is a financial adviser and the founder and CEO of Lance Pelky & Associates, Inc. of La Jolla.
