Anyone familiar with investing through a universal life wrapper?

[Chewbacca 7,788]

So here's the scenario.  I have $750k of term life insurance through 2031.  Have been thinking about getting more (and for a longer term - I'll only be 57 in 2031).  I also just sold my share of a business and am figuring out what to do with the proceeds.  Just started a new company as well, so I have enough risk in my life.  I don't need my assets to hit home runs (that's what the business is for), I would prefer they stay safe and make smaller gains.

 

Was recently approached by an acquaintance who sells life insurance and he is marketing a universal life wrapper where you invest.  You have no downside but you will participate when the market goes up, up to a maximum of somewhere around 10-12%.  I'm probably screwing some of the mechanics up, but basically how it works is they take the interest the account generates and buy options with it.  If the market goes up, you collect the $ from the options.  If it goes down, the options are worthless but you do not lose any principal.  The fees for the first 10 years are high, but everything in there is tax free (you can 'loan' yourself money out of the plan and never pay it back) and it provides a guaranteed death benefit as well.  Seems like it could be a decent component of my portfolio, give me the additional life insurance I want, and be a safe place to put money until retirement.  But I can always pull money back out if I need it.  The fees seem to be the biggest downside.

 

So what say you, Surly?

[ShaggyBevo RIP 3,868]

Everything I’ve read is the no down part is a huge stretch.

If your net worth is $10 million or more then it can be a tax strategy but I haven’t revisited that post tax cut  

You're looking at 80% fees on the front end.  

Edited September 17, 2018 by ShaggyBevo RIP

[Chewbacca 7,788]

Everything I’ve read is the no down part is a huge stretch.
If your net worth is $10 million or more then it can be a tax strategy. 

In what way is it a stretch?

[ShaggyBevo RIP 3,868]

^^^

it is stock market or other investment related. 

 

Edited September 17, 2018 by ShaggyBevo RIP

[Robin Masters 122]

Why not just do this yourself? What are they investing your money in to make the money for the options? Ask and you will probably run into the baffle them with bullshit approach. Reality is they are investing your money in something that yields 4% and giving you 3% and to get that 4% in a 3% market they are taking on some risk.  Totally safe until it isn't, type of risk.
DIY it. Buy some CD's or short term bonds,  at a handful of banks or brokers, to spread the blow up risk around. Then take that profit and buy calls yourself, or cough, Tesla puts, cough.
Upside, you have the money, not some faceless corporation where you didn't read the fine print and your friend the salesman didn't either, and even if you and a team of lawyers did read it, you might still miss something because it's written by a bigger team of lawyers specifically to make you miss stuff.

[TwiceHorn 31,653]

I don't know all the ins/outs/whathaveyous, but the conventional wisdom on those is that the investment component is easily beaten with a couch-potato-type portfolio, especially considering the fees.

There is the advantage of tax-free loans, but there's something in it where you have to pay the piper, I just don't remember what it is.

I believe, also, that a portion of it (I believe part is considered an annuity and part paid-up life), is exempt from creditors, too.  And there is an estate-planning aspect to it, as well.

I am given to understand that it can make sense in certain scenarios, particularly high-wealth people.

[Bernard 879]

If you want insurance, buy insurance. If you want to invest, invest. Don't mix the two.

Bernard

[NeverMarryAStripper 22,000]

If I’m not mistaken, the loans will have to accrue interest. If none of the principal or accrued interest is repaid, eventually the total could exceed your cash value. In that case you would have a taxable deemed distribution on the original principal and all of the accrued interest.

 

[ShaggyBevo RIP 3,868]

7 hours ago, NeverMarryAStripper said:

If I’m not mistaken, the loans will have to accrue interest. If none of the principal or accrued interest is repaid, eventually the total could exceed your cash value. In that case you would have a taxable deemed distribution on the original principal and all of the accrued interest.

 

Because it is 'insurance' there is no tax on it which is why has some value for high net worth individuals(>$10M) as a tax strategy. 

[NeverMarryAStripper 22,000]

Earnings within the policy and death benefits paid from the policy are non taxable. However, if the policy loans and accrued interest exceed the cash value of the policy it can trigger a lapse in the policy. If this happens distribution of the policy’s cash value to repay the loans and accrued interest will be taxable.

[luke duke 6,420]

The more complicated the investment, the more likely the little man gets screwed.

[TwiceHorn 31,653]

12 hours ago, NeverMarryAStripper said:

If I’m not mistaken, the loans will have to accrue interest. If none of the principal or accrued interest is repaid, eventually the total could exceed your cash value. In that case you would have a taxable deemed distribution on the original principal and all of the accrued interest.

 

That's the piper part I was thinking of.  Also, at death, I believe, the loans are netted against the death benefit/cash value(unclear which, guess it depends on the existence of a death benefit) with interest, so that "free" lifetime money isn't free to your heirs at least.

I have looked at this in two contexts, for myself being hit up by the John Hancock/NW Mutual recent grad types and in a "second-to-die" policy for my parents that is somewhat similar in operation, but almost exclusively for estate planning purposes.  It made  more sense in the second to die context, in which, IIRC, the assets of the deceased are plowed into a similar account for benefit of the second-to-die and then disbursed as tax-free insurance proceeds at the death of the second to die, thus avoiding estate taxation for amounts over the exemption.

 

I think its @Reagan1k that is very knowledgeable on this stuff, particularly as concerns high-net-worth types.

[conVINCEd 21,474]

16 minutes ago, NeverMarryAStripper said:

Earnings within the policy and death benefits paid from the policy are non taxable. However, if the policy loans and accrued interest exceed the cash value of the policy it can trigger a lapse in the policy. If this happens distribution of the policy’s cash value to repay the loans and accrued interest will be taxable.

This.  I had a little whole life policy that my grandfather got me when I was a kid.  Got to the point where the dividends paid the premium.  I got in a tough spot in college that I didn't want to tell anyone about, so I took out a loan and forgot about it, as I had never had to pay the premium myself, and like most college students, my address changed frequently, so I wasn't receiving the notices.  15 years later, the interest due passed the dividends paid, and I had to make a choice.

[52-80 19,276]

14 hours ago, TwiceHorn said:

I don't know all the ins/outs/whathaveyous, but the conventional wisdom on those is that the investment component is easily beaten with a couch-potato-type portfolio, especially considering the fees.

There is the advantage of tax-free loans, but there's something in it where you have to pay the piper, I just don't remember what it is.

I believe, also, that a portion of it (I believe part is considered an annuity and part paid-up life), is exempt from creditors, too.  And there is an estate-planning aspect to it, as well.

I am given to understand that it can make sense in certain scenarios, particularly high-wealth people.

 

14 hours ago, Bernard said:

If you want insurance, buy insurance. If you want to invest, invest. Don't mix the two.

Bernard

i straddle on this side of the fence.  checked out some private "pension" plans the local banks offer here and its all these ultra-complex financial products intermingled with life insurance, with tax advantage components, growth components, and 100s of restrictions and stipulations. 

 

doing some crude financial modeling, one's better off with a bog standard post-tax account assuming 6-8% earnings, and better liquidity.

 

like he said... insurance is insurance, investment is investment.

[Reagan1k 3,024]

My first statement is that any financial instrument is simply a tool - no different than a hammer or screw driver.....they each serve purpose, and just because a screw driver cant drive a nail doesn't make it a poor tool, and vice versa....nothing is inherently good or bad as long as it is applied as the right tool for the right job.

Any of the variable insurance policies can have a place in an overall financial plan if applied to an area of need for high(er) net worth individuals with ample free cash flow.  

The main thing is to identify if you will likely need (or want)  permanent life insurance coverage.....if you will not need or want life insurance coverage long term (into and past your late 70's and you have a 20+ year time horizon it may be worthy of consideration.    Basically you are participating in a portion of the upside of the market and are insulated from the downside risk.  You'll have a participation rate (percentage of the upside you capture)....Market goes up 20% in a year and you may be capped at 12%.  Market goes up 7% and you participate in the full 7% (minus admin fees and charges which are more than a standard mutual fund).  Market declines by 10% and your account balance is unaffected.

The KEY is to be in a position to significantly over fund it....paying much more than the minimum premium so that your paid in capital subject to the growth provisions far exceeds the annual cost of insurance that will be charged against premiums (along with fees).  This way you build up a sizable war chest of capital in the policy during the early years that grows in lock step with market gains.  

Loans are tax free (until/unless the policy lapses and then you pay income tax on the value of loans less your cost basis in the policy) and you can chose to repay principal and interest or just interest.  Death benefit (minus loan balance outstanding if any at death) is also tax free.

Here's a typical scenario where it works......high income, lots of free cash flow, fully funded qualified retirement plans (maxed 401(k)) and a portfolio of after tax investments and cash reserves.  You need more life insurance and need / want it to be there regardless of age when you die (need to balance inheritance, provide liquidity for a business buy-out, provide for a disabled child, etc....). If you buy term and invest the difference, at some point term premiums become untenable and you can't afford it. 

Instead, consider a variable universal life or other hybrid policy.  Dump a bunch of (excess) cash into it over the early years when the the cost of insurance is lowest and build up a capital balance that's growing at "market type" returns.

As the cost of insurance increases over a couple/few decades, your extra premiums have grown to a point in the account balance where they can offset / pay for that cost of insurance without you coming out of pocket with much or any new premiums (actual returns dictate this).

Young, not much excess cash, need a lot of insurance now and early in asset building - Not your tool.

Excess cash you want to work for you, need/want death benefit payable for the duration, need flexibility in financial / estate planning...something to consider.

I'll add some more thoughts later....fire away with questions (disclaimer -I'm not in the industry and have no fish to fry in the discussion)

 

[Reagan1k 3,024]

edit...3rd paragraph .......if you will not need or want life insurance coverage long term

[TwiceHorn 31,653]

So it sounds like it might be a good place for a large lump sum, if you have the need for the insurance?

[Reagan1k 3,024]

Lump sum, yes....but spread over 7 years...there are provisions in the tax code that strip away the benefit of tax free loans if you "single pay" a policy...you can do it but loans lose that special treatment because the policy becomes a "modified endowment contract" instead of a life insurance policy - in the eyes of the IRS.

Normally you'd have to spread the premiums over a minimum of 7 years to maintain all the favorable tax treatment of life insurance.

Here's a real life snapshot ....49 year old...wants life insurance for "life" to help with estate goals and has a $2mil term policy expiring at age 50.  Converts the policy to a variable universal life and decides on a $50k premium....can pay more or less but that is the goal and what present cash flows allow for the time being.  Policy is now 5 years old...there is $350k in the account and the cost of insurance and fees are running at about 1.7% of the current cash value....Plan now is to still put in between $25k and $50K per year going forward.  Policy rider says death benefit is face amount plus cash value at death.  A few more years of premiums and decent market returns will keep the policy afloat indefinitely.  If cash runs short or temp liquidity is needed...loans are there if necessary 

Great tool for business key-man / split dollar or buy-sell agreements - Split dollar plans are cool for established businesses with plenty of free cash flow BTW.

[TwiceHorn 31,653]

And I guess it makes a lot of sense to convert funds into life insurance death benefit when it's enough money that you're looking at $0.55 on the dollar estate taxation?

Edited September 19, 2018 by TwiceHorn

[Reagan1k 3,024]

12 hours ago, TwiceHorn said:

And I guess it makes a lot of sense to convert funds into life insurance death benefit when it's enough money that you're looking at $0.55 on the dollar estate taxation?

True statement-  valuable for estate tax planning even though TODAY fewer and fewer estates are taxed.  

But, permanent insurance is more typically useful to provide liquidity at death when an estate may be relatively cash poor on balance - let’s say you will leave an estate to two heirs but most of it will be in property or a private business that one heir doesn’t want to liquidate.  Permanent insurance can provide a pool of cash at death to balance the inheritance so that one heir gets cash equal to the property/business interest that the other heir wants to keep.

Other uses-  permanently disabled child /dependent,  split-dollar employee or owner  benefit in a small business,  buy-sell agreement between partners or to buy out a surviving spouse and leave a business intact for a child without impacting future cash flows- list goes on.

It is not useful for someone who needs insurance in a basic planning scenario when they aren’t flush with excess cash. It is not a “better” deal than traditional retirement plans.  

Permanent covergae uses the cash value buildup as a sinking fund to offset the higher mortality charges later in life.

Trading dimes today for dollars at death anytime.... vs term which trades a penny or two today for dollars during a specific period normally up until your 70’s. 

Edited September 19, 2018 by Reagan1k

[TwiceHorn 31,653]

Most excellent explanations, thanks. Don't believe it's something I would want or need, but having bumped up against it a couple of times, wanted to understand it better. 

[gsoda3 3,284]

On 9/18/2018 at 11:43 PM, Reagan1k said:

Lump sum, yes....but spread over 7 years...there are provisions in the tax code that strip away the benefit of tax free loans if you "single pay" a policy...you can do it but loans lose that special treatment because the policy becomes a "modified endowment contract" instead of a life insurance policy - in the eyes of the IRS.

Normally you'd have to spread the premiums over a minimum of 7 years to maintain all the favorable tax treatment of life insurance.

Here's a real life snapshot ....49 year old...wants life insurance for "life" to help with estate goals and has a $2mil term policy expiring at age 50.  Converts the policy to a variable universal life and decides on a $50k premium....can pay more or less but that is the goal and what present cash flows allow for the time being.  Policy is now 5 years old...there is $350k in the account and the cost of insurance and fees are running at about 1.7% of the current cash value....Plan now is to still put in between $25k and $50K per year going forward.  Policy rider says death benefit is face amount plus cash value at death.  A few more years of premiums and decent market returns will keep the policy afloat indefinitely.  If cash runs short or temp liquidity is needed...loans are there if necessary 

Great tool for business key-man / split dollar or buy-sell agreements - Split dollar plans are cool for established businesses with plenty of free cash flow BTW.

@Reagan1k that's a great explanation, thanks.  i'm 38, have 30 year terms for my wife and myself expiring when we're 65.  been looking into IULs to supplement that death benefit (we have kids).  in that illustration, at what point would you be taxed on the distribution?  is it if you take out a loan for an amount greater than your cash value?  i'm confused about that part.  

[troph 24,916]

@Reagan1k I agree great explanation. I’ve never heard a sales pitch on these where they explained why I would and wouldn’t want the product. Thank you for the straight forward discussion. Much pos rep. 

[kmac30 416]

If the policy lapses, matures or is surrendered the distributions will be taxable. You will get notice when the values become an issue with options. Biggest concern with loans on policies are usually the policy lapsing.

[tx 3 putt 77,671]

life insurance companies are cash cows, think about that. then think about it again 

[TwiceHorn 31,653]

1 hour ago, tx 3 putt said:

life insurance companies are cash cows, think about that. then think about it again 

Actuaries are pretty good at their jobs.

[Nice Guy Eddie 13,536]

Slightly off topic. My belief is that life insurance should be to replace lost income, for your dependents, upon your death and not about leaving money to kids when you’re in retirement. Since I’ve seen commercials where insurance companies try to sell life ins to old people as inheritance for their adult children, that only reinforces the idea that it’s bad for retirees to buy life ins, or retain it from earlier in their life.

instead of that premiums, just drop the money in stock accounts. I don’t see how you won’t come out ahead with this practice.

maybe some old people should have life insurance if they live check to check and need burial money. But once again, why not just deposit that premium money in a bank account instead AND refuse to touch it.

And I’ve only heard investment/insurance plans hyped by people that sell it. There is not one tax or personal finance expert that endorse it. Zero.

Edited March 25, 2021 by Nice Guy Eddie

[kmac30 416]

Well, I wouldn’t go that far. Hybrid life insurance/long term care can be a better deal than straight up long term care (think car insurance - use it or lose it). Also, the basis for this thread, LIRP, can be a benefit. Everyone’s situation is different and saying that something is bad for everyone is short sighted.

I just had a client die who was 92. She had a life insurance policy that we almost dumped a few years ago. We did the math and keeping it made more sense than using the premium for investments. To be clear, I did not sell her the policy. It was paying for itself for many years and it was about to lapse unless a premium was paid.

[gsoda3 3,284]

On 3/24/2021 at 7:49 AM, kmac30 said:

If the policy lapses, matures or is surrendered the distributions will be taxable. You will get notice when the values become an issue with options. Biggest concern with loans on policies are usually the policy lapsing.

if a policy lapses that means the cash value goes to zero right?  would you still get distributions after that? 

[deadshank 24,653]

Aren't there pitmasters with upcoming BBQ joints around that are offering great returns on invested capital?

Give them a try!

 

[Nice Guy Eddie 13,536]

2 hours ago, kmac30 said:

Well, I wouldn’t go that far. Hybrid life insurance/long term care can be a better deal than straight up long term care (think car insurance - use it or lose it). Also, the basis for this thread, LIRP, can be a benefit. Everyone’s situation is different and saying that something is bad for everyone is short sighted.

I just had a client die who was 92. She had a life insurance policy that we almost dumped a few years ago. We did the math and keeping it made more sense than using the premium for investments. To be clear, I did not sell her the policy. It was paying for itself for many years and it was about to lapse unless a premium was paid.

Yes, probably it was worth keeping up with premiums at 92. But it was a bad decision to continue to pay those premiums 27 years earlier at age 65.  But I know sales people will say "you never know when you're going to die" which isn't a valid explanation.

[gsoda3 3,284]

Yes, probably it was worth keeping up with premiums at 92. But it was a bad decision to continue to pay those premiums 27 years earlier at age 65.  But I know sales people will say "you never know when you're going to die" which isn't a valid explanation.

What should a 40 year old do then?

[Nice Guy Eddie 13,536]

59 minutes ago, gsoda3 said:

3 hours ago, Nice Guy Eddie said:

Yes, probably it was worth keeping up with premiums at 92. But it was a bad decision to continue to pay those premiums 27 years earlier at age 65.  But I know sales people will say "you never know when you're going to die" which isn't a valid explanation.

What should a 40 year old do then?

What I mentioned above. If you have dependents that would need to replace your income for a certain # of years, you should have life insurance. Very few 65 years old meet that condition. Perhaps if they are the guardian of their underage grandchildren, or perhaps if they care for a special needs adult child. If the latter is the case, unfortunately they didn't do the best job planning as that should have already been taken care of.

[gsoda3 3,284]

What I mentioned above. If you have dependents that would need to replace your income for a certain # of years, you should have life insurance. Very few 65 years old meet that condition. Perhaps if they are the guardian of their underage grandchildren, or perhaps if they care for a special needs adult child. If the latter is the case, unfortunately they didn't do the best job planning as that should have already been taken care of.

I have life insurance, more than enough to cover any needs. It's a term 30 that expires when I'm 65. What should my next priority be? Is it life insurance for years 65 and onward? Is it an IUL with a medical care benefit rider? Our work doesn't have a 401k but my wife and I both have IRAs.

[Nice Guy Eddie 13,536]

12 hours ago, gsoda3 said:

14 hours ago, Nice Guy Eddie said:

What I mentioned above. If you have dependents that would need to replace your income for a certain # of years, you should have life insurance. Very few 65 years old meet that condition. Perhaps if they are the guardian of their underage grandchildren, or perhaps if they care for a special needs adult child. If the latter is the case, unfortunately they didn't do the best job planning as that should have already been taken care of.

I have life insurance, more than enough to cover any needs. It's a term 30 that expires when I'm 65. What should my next priority be? Is it life insurance for years 65 and onward? Is it an IUL with a medical care benefit rider? Our work doesn't have a 401k but my wife and I both have IRAs.

After maxing out your IRA, I would look at putting as much as possible in brokerage accounts. At least recreate what you could save if you both were in a 401k plan.

And for your current IRA, I would look at a Roth IRA if your incomes allow it. Your current taxes go up but not that much. Let that money grow for 30+ years and withdraw tax-free!

 

[Celery Man 21,022]

thinking of 65 and onward, wondering if long term care insurance starts to become the need or if that is considered not to be a good buy

[Nice Guy Eddie 13,536]

6 minutes ago, Celery Man said:

thinking of 65 and onward, wondering if long term care insurance starts to become the need or if that is considered not to be a good buy

I'm interested in long term care insurance too but my understanding is that it's becoming too expensive for most. Or you have to buy it early and pay premiums for a long time before you realistically will use it. aka still expensive but spread over decades.

[conVINCEd 21,474]

14 minutes ago, Celery Man said:

thinking of 65 and onward, wondering if long term care insurance starts to become the need or if that is considered not to be a good buy

Prepare your anus.  My personal experience tells me that when it starts to go downhill it happens pretty quickly.  

[66BUFF 2,566]

1 hour ago, Nice Guy Eddie said:

I'm interested in long term care insurance too but my understanding is that it's becoming too expensive for most. Or you have to buy it early and pay premiums for a long time before you realistically will use it. aka still expensive but spread over decades.

Long term polices were a steal in the late 90's early 2000's.  Insurance companies got their pricing fixed and prices jumped. 

[Reagan1k 3,024]

Wow - blast from the past.  
 

Catching up on this.  @gsoda3   If you pull out policy loans from permanent insurance, they are not considered income at that time or any time in the future as long as the insurance contract stays in force and you either pay the loans back or cooperate and die with the coverage in place.  If the policy lapses prior to death, and you have loans outstanding, you have a tax bill dropped in your lap.  
 

As for what to do if relatively early in life with adequate term insurance and a long time horizon - the general answer would be to fund 401(k) and / or IRAs to the fullest extent allowed, then save as much as one could post tax in low fee and tax efficient investments (index funds or etf’s in a schwab or fidelity account for example).  

Permanent insurance is useful in strategic situations, but not nearly as often as it is sold.  It’s not a bad product, in and of itself even though a lot of people feel somehow righteous in declaring it so.  But, Unless you have a unique situation with dependents or health issues or just have so much excess cash flow that you want to do some estate or charitable planning... it’s probably a low priority for you. 

Both sides of that same coin-  the guys who pushed permanent insurance at every turn vs. the guy who thinks it’s criminal in all cases.  Neither is right. 
 

Pick the right tool for the right job and know what the tools are built to do....beyond the sales pitch or anti sales pitch. 
Personal finance is 90% personal and 10% application of product.  You have to identify the goals and needs and then Pick the tools and techniques to get you where you want to go-  then stick to the plan!!!!!!!!!   keeping in mind that that’s also ever changing.  
 

On the long term care deal, there is some merit in the 50+ crowd looking at taking a thin sliver of assets each year and putting them in a hybrid life / LTC policy.
Unlike straight LTC insurance, there is what amounts to a return of premium and then some in the form of the death benefit if you don’t use the LTC.  
Its an intriguing concept because as was mentioned above, straight LTC insurance is incredibly expensive and the hybrid policies let you lock in a cost and benefit with at least some guarantees on the back end.  Worth a look if you have assets to protect and cash flow to pay for it. 
 

 

[SquishMitten 10,453]

What should a 40 year old do then?

Wife and I each have $2m policies that term out when our youngest will be 16. We picked the term based on the second kid’s age so the math isn’t quite right for the third kid. We have them solely for the purpose of income replacement. Once they’re not entirely dependent on us, we figure they’ll be fine. $2m (or $4m if we go together) should be plenty to throw me a good shindig and supplement them through college for anything not covered by their 529s and any other inheritance going their way so I don’t have any intention of getting a new term or whole life policy.