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The Problem with Indexed Universal Life Insurance – Debunked
There are plenty or articles available that list the myriad of perceived “problems” with Indexed Universal Life Insurance (IUL). However, a lot of the issues raised are in large part due to a lack of understanding or due to a conflict of interest with the person pointing out the negatives of Indexed Universal Life. The following article will address why this is and why the so called “negatives” of Indexed Universal Life are not what they seem.
Indexed Universal Life - Debunking the Lies and Misconceptions
My good friend's wife has had medical problems for years. The symptoms she experiences are typically joint pain and fatigue.For years they've gone to doctor after doctor seeing a variety of “specialists” in various fields of medicine.
My friend finally concluded the following: In almost every scenario in which they sat down with a doctor to discuss the possible cause and remedy, the field in which the doctor specialized, was surprisingly always the solution.
In other words, if they went to a neurologist, the problem was neurological (as was the costly cure). If they went to a spine specialist, the problem was spinal. If they went to a orthopedic surgeon, the problem was related, and the solution was orthopedic surgery.
Our society is full of specialists, and when we look at problems we tend to see things from our own perspective.
So what does this have to do with life insurance?
I mention this because the same skewed perspectives impact those of us in the financial industry. People that are experts in mutual funds, will likely know a ton about their products, and will defend them mercilessly against their financial competitors.
Likewise, those that offer investments in real estate will likely defend their products as well, proclaiming the advantages of passive income.
And obviously those that offer life insurance will tend to know their products better than others and will defend them like the rest.
With this in mind, I want to explain how those outside the life insurance industry will criticize our products and how they can be very wrong in doing so.
Ultimately you owe it to yourself to get a broad perspective on your financial products. Do your research and talk to professionals that you trust. I will almost always recommend talking to brokers as opposed to talking with in-house agents because I think you should get unbiased advice.
Think about it for a minute. Who do you want to talk to the most when shopping for life insurance, the guy that has 3 options from 1 company, or the guy that has 30 options from 10 companies? The broker will always give you a broader view of the product landscape, and that plays to your benefit when you're shopping around.
Addressing the Biggest Critique of Indexed Universal Life
Alright, let's jump right in and address the biggest critique of an Indexed Universal Life policy. If you look long enough you'll find articles about Indexed Universal Life policies that give horrendous examples of balloon premium payments that are $10,000 to even $50,000 a year.
How in the world can responsible citizens of our great nation be selling such things? Here's the truth of the matter. It is a virtual guarantee that your cost of insurance will skyrocket when you get old. And I am not at all surprised by premiums that are in this range. WHAT?! You read that correctly. I am not surprised by these premiums. And here is why:
Think about level term life insurance for a minute. It's a simple concept. You pay an insurance company a premium over a term of years that guarantees level premiums and that if you die during that period, the company will give the beneficiary a specific amount of money. Simple. The older you are, and the longer the term, the higher the premium payment. A typical owner of a 20 year term policy may pay $10,000 over the life of the policy for as much as $1,000,000 in coverage.
So how does the insurance company make any money?
The insurance company makes money because the majority of the policies expire without having to pay out a death benefit. Based on the actuarial tables that every insurance company uses, the policies are offered to make more money than they pay out. That is how all insurance works (for the most part).
But what about the crazy high premium payments?
Let's stick with Term Life Insurance for a minute and assume you could get a 30 year policy for a 65 year old man. The cost of this insurance would be astronomical. Why? Because the odds of the man dying before the term expires are incredibly high.
Most men die before reaching the age of 95. So a 30 year policy for a 65 year old man would have a high chance of paying out a death benefit. Therefore the company would require that the premium be high enough to offset their risk.
This is essentially what is happening inside an Indexed Universal Life policy as the insured reaches the age of 70. The premiums become much higher because the company knows that the insured is more and more likely to die in the coming years.
So why would anyone buy one of these policies?
Here is the solution that is never mentioned by those that don't offer insurance products. Are you ready? You can reduce your Cost Of Insurance (COI) as you get older by changing how your policy is structured, AND you can do this without incurring additional fees or lapsing the policy.
In order to change how your policy is structured you just need to call your insurance company and ask them to reduce your death benefit. It's that simple. This can typically be done over the phone, and does not require any approvals or medical tests or questionnaires.
But why have the insurance if I don't get the death benefit?
I mentioned in 5 Incredible Elements of Indexed Universal Life Insurance some of the benefits of an IUL that are beyond the death benefit. You can also read about the Indexed Universal Life Insurance Pros and Cons. But I want to point something additional out regarding an index universal life insurance vs 401k plan.
401K vs Indexed Universal Life
If you invest in a 401k and Term Life Insurance you are doing a couple things. You are safeguarding your family while you are young so that they will provided for in the unlikely event that you die before retirement. You are also preparing for your retirement with your 401k.
The two financial products work separately to provide safety while you are young, and income protection when you are old. As you approach retirement age, your Term policy will likely expire and you will rely on your retirement to provide for your family if you die. This same methodology is followed with an IUL with some variation.
With an IUL you can lower your death benefit gradually, so you don't have to have $1,000,000 coverage one day and zero coverage the next.
Or if you prefer you can lower your death benefit drastically in one day. It's up to you how you want to structure it.
What if you don't do anything?
If you choose to leave your policy alone well into retirement, you will gradually see your premiums go up and up. When you are well into your retirement years your premiums will be so high that you will not be paying anything into your retirement and your cash value will be decreasing to pay for the Cost Of Insurance.
Would you ever want to do this?
Perhaps. If you knew you only had a short period of time to live, you might choose to keep the coverage intact because you knew the death benefit would be right around the corner.
However, for most people they will want to reduce their coverage and just keep the policy in place until death.
At the time of death the insurance may only be for $10,000 or some small amount. Your state laws will dictate what minimums (if any) are allowed and you can talk to your insurance company about those limits.
So even though you may be 90 years old and still paying for your IUL policy. The insurance company may only be insuring you for $10,000, and the rest of your premium is going to your indexed account.
The risk to the company is low because they know they can afford the $10,000 death benefit, and you get the advantage of keeping the policy in tact with all the benefits associated with an IUL.
As you can see this method of changing the structure of your Indexed Universal Life as you get older is a way for you to keep your Life Insurance policy intact, while keeping your premiums consistent and manageable. This may still be a bit too much to take in at once so let me finish with this little illustration:
Let's assume that a 30 year old husband and father chooses to take out an IUL for $500,000. He will pay into this policy for 20 years and gradually grow his cash value over time. His Cost Of Insurance is going up every year by a small amount because he is getting older and is therefore more at risk to die. But his COI is still very manageable and he is able to grow his cash value.
Let's assume that by the age of 50 he has a cash value of $200,000. If he were to die at age 50, his beneficiary would receive his death benefit of $500,000, plus the cash value* of the account, $200,000. The total amount to his beneficiary would be $700,000, tax free.
[*IULs offer different death benefit choices including a level death benefit, a death benefit plus cash value and a death benefit plus return of premiums, minus any withdrawals. OK, back to the article.]
Now in this scenario the insurance company would likely have lost money, because the insured died at a much younger age than normal. However, let's continue this scenario another 20 years assuming the man is still alive and doing well. At age 70 the man is still alive and is thinking about retirement. His cash value is now sitting comfortably at $600,000 because of the power of compounding interest. So if he dies at age 70, the beneficiary would receive a total of $500,000 death benefit, plus the additional cash value amount of $600,000. The total $1,100,000 would be given tax free.
Did the Insurance company make money here? Actually the Company probably lost money again, even though they really started to raise the Cost Of Insurance prior to the death of the insured. The additional COI was still unable to make up for the large death benefit at the age of 70. Even though many men die at age 70 or younger, the odds are still fairly low that he would have died at this age, so the insurance company is willing to write policies like this.
Let's continue on to age 90 for the man. He is still alive and feeling fairly good. His COI was going up and up during his late 60's and early 70's so he decided to lower his death benefit (he didn't want to see his story talked about online by some stock broker). Because of his age and the fact his children were on their own and doing well, the man decided that he no longer needed $500,000 in coverage. So at age 72 he lowered his death benefit to just $10,000. This drastically reduced his COI, and additionally, he was able to use his cash value to pay his monthly premium (another benefit of an IUL). From age 72 forward, the man paid his premium straight from his cash value, and his policy stayed in place and he reaped the rewards of the IUL.
At age 90 the man finally passed away. His cash value diminished while he was withdrawing from it over the past 20 years, but he was never worried for his income. At age 90 his cash value was $200,000 and his beneficiary was presented with a check for $210,000 tax free ($200,000 cash value + $10,000 death benefit). The combination of the death benefit and the cash value of the account.
The Insurance Company made money and the man and his family reaped the benefits of the IUL and had protection along the way.
Insurance companies will make money on these policies more often than not because they use the actuarial tables to tell them the odds of death and write the policies over a large group of people. The law of large numbers is in their favor here.
They will also make money if you choose to cash out your policy early on because you believed some crazy story about horrible policies being sold to unsuspecting and helpless people. But if you structure the policy to suit your needs as you age, you'll be able to reap the substantial benefits of an IUL.