Not every type of cash value life insurance will allow you to withdraw from the cash value. An indexed universal life (IUL) insurance policy does allow for cash withdrawals but what if any, are the tax ramifications? The tax treatment of IUL cash value is what makes it such a powerful investment tool.
The Typical IUL
First of all, let’s start by stating that an IUL can be viewed as an investment vehicle with life insurance attached to it, rather than the other way around. In fact, many financial and insurance professionals will recommend selecting the lowest death benefit possible since the fees for the policy are based on the death benefit and not the cash value account. Additional term coverage can be used to make sure that you have ample life insurance coverage. To many of our clients, this fee basis alone makes an IUL a favorable choice over mutual funds.
The IUL is setup to allow the policyholder to invest a periodic premium into the policy. A small portion goes toward the cost of the life insurance. The balance is deposited in a cash account that earns interest based on the index selected. Although the options available depend on the insurer and the product, the available index options are typically:
* The S&P 500
* The S&P MidCap 400
* The Dow Jones Industrial Average
* The NASDAQ 100
* The EURO STOXX 50
* The Russell 2000 Index
* Multi Index (A blend of the S&P 500, Russell 2000, and the EURO STOXX 50)
With many policies, you can choose to allocate premiums to the indices listed above in any combination, or you can choose to allocate to the fixed account. The fixed account generally pays interest at around 3% to 4%. This amount will fluctuate but most policies will guarantee around 3%.
The index credit is added to your cash account on the index crediting date, which is normally the business day that falls on or immediately after the index period’s end date. The policy will typically have a floor rate (minimum guaranteed) interest credit, participation rate (the amount of earnings the company will credit to the cash account), and a cap rate that limits the amount of earnings that will be credited during the index period.
Accessing the Cash in Your IUL – how does IRS define tax treatment of IUL cash value
Now to the good part of the story. Unlike an IRA or 401(k), the Fed has placed no limit on the amount of money you can contribute to your IUL. As a result, your cash account can accumulate significant earnings early on. As the policy’s cash account builds up, there is no tax liability to be concerned about because the earnings inside the policy are tax-deferred. When the account has accumulated a significant amount of cash, and you want to start accessing the money, the policy will allow you to take income tax-free distributions. That means more spendable cash for you. Imagine a retirement without a tax liability. You can access the cash for any reason by taking tax-free loans or even partial surrenders that are also tax-free. This method of withdrawing the cash creates a tax-free method of supplementing your retirement plan while still having the tax-free death benefit for your surviving loved ones.
Accessing your cash through living benefits
Another way to access your cash in an IUL policy is through the living benefits. Many of indexed universal life insurance policies that we sell have critical illness coverage, chronic illness coverage, and terminal illness coverage. You can read more about this in another post about living benefits found here. Basically, you can accelerate the death benefit for certain types of catastrophic events or illnesses that prevent you from performing the simple activities of daily living.
You’re in Control
Indexed universal life insurance allows the owner to remain in control. Yes, this is life insurance, but it certainly has some of the characteristics of an investment. You have access to your cash account at any time and for any reason without the tax consequences that most other investment products have. There is no limit on the amount of your investment. You can change your death benefit, premium amount, and premium payment frequency.
High earners and the tax treatment of IUL cash value
High earners who have become frustrated with other inflexible traditional investment products that are heavily regulated and high risk are perfect candidates for the IUL. Although the IRS does not allow you to roll over existing retirement plans into your indexed universal life insurance policy, many today are using Indexed universal life as a supplemental retirement plan. Would you rather be taxed on the seed or the harvest?
To get immediate advice about IULs from a reputable insurance professional, contact Ogletree Financial Services by completing the form on the left of the page or calling 1-800-712-8519.