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.
There are a lot of questions about IUL insurance coverage and cash value. This article is going to look at the tax implications of IUL cash value and how you should manage your policy.
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?
Should You Buy an IUL Policy?
Deciding which kind of life insurance policy is best for you can be confusing. There are several factors you will need to consider to ensure you have the best coverage to fit your needs.
The first thing you should consider is why are you purchasing life insurance? IUL is not for the average American who is simply wanting to get life insurance protection for their family. If you want to protect your family with the most affordable option, IUL is not right for you. Instead, go shopping for a term insurance policy.
If you’re new to the insurance or investing market, then IUL probably won’t be the best option either. IUL plans are not the simplest form of life insurance, and they can be a confusing product to manage. Unless you have some working knowledge of both life insurance and indexed investing, you should probably choice another insurance option.
Getting Cheaper Life Insurance
One reason a lot of Americans don’t have life insurance is because they assume it’s too expensive. In most situations, it couldn’t be further from the truth. There are several ways you can get affordable life insurance protection.
One way is to cut out any tobacco you use. If you’re a smoker or use chewing tobacco, then you’re going to pay much higher rates for your insurance plan. Smokers have a higher risk of being diagnosed with various types of cancer or suffering from a heart attack. The insurance company is going to offset the risk by charging higher rates. Smoker are going to pay at least twice as much for their life insurance compared to non-smokers. Cutting out tobacco can save you thousands of dollars every year on your insurance coverage.
The best way to get lower premiums is to compare dozens and dozens of companies before you find one. Every insurance company has different medical underwriting and ways they calculate premiums. The quotes you get could vary wildly. Depending on the company, you could spend hundreds more than you have to.
Working with an Independent Insurance Agent
When you’re shopping for life insurance, either an IUL plan or one of the other options, it’s important you find the best company for you. Every insurance company is different, and all of them have various benefits. When it comes to IUL, each company is going to have a different take on their policy.
There are over 6,000 insurance companies on the market, and a good portion of those offer IUL policies, which means you could spend days researching companies and calling agents. Instead of wasting your precious time, let one of our independent insurance agents do the work for you. We know shopping for life insurance can be a confusing and overwhelming process, especially when you’re shopping for a complex IUL policy. It’s our job to help you navigate the insurance waters and connect you with the perfect policy.
Unlike a traditional insurance agent, we are independent agents, which means we work with dozens and dozens of highly rated companies across the nation. If you’re looking for IUL life insurance, we can decide which company will give you the best coverage at the most affordable rate.
You never know what’s going to happen tomorrow, which means you shouldn’t wait another day to get the insurance protection your family deserves. Regardless of what kind of life insurance plan you buy, it’s important you have the coverage they need. If you have any questions about IUL or the other options available, please contact one of our agents today. We can answer those questions and connect you with the best possible plan available.
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. Our agents have years of experience working with all types of clients and plans across the country.