Blog #170: The Key to More Retirement Cash Flow

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Bob Ritter's blog 170 The Key to More Retirement Cash Flow image

We often illustrate policy loans with Indexed Universal Life (“IUL”) and thought you might like to see a specific mathematical comparison between fixed and participating loans.  The key to the latter is the significant increase in values provided by loans secured by cash values that continue to earn the indexed interest that is credited to the policy.  Fixed loans don’t include this feature.

To do this, we used the new InsMark Compare module that is available on the Personal Insurance tab in the InsMark Illustration System.

Case Study

Consider the following two alternatives:

  1. $1,054,069 IUL with an increasing death benefit to age 65; level thereafter, issued at age 45 max-funded with 20 annual premiums of $50,000 (just short of a MEC) with level fixed policy loans of $150,000 starting at age 65.
  2. The same as #1 but with level participating policy loans of $150,000 starting at age 65.

As you can see below, the difference is dramatic.  Although each has the same face amount, premium pattern, and level of policy loans, the participating loans create 8.4 times as much long-range cash value: $9,203,690 versus $1,094,383.

Image 1
Fixed Loans vs. Participating Loans
Analysis of Cash Values

Bob Ritter's blog 170 Fixed Loans vs Participating Loans Analysis of Cash Values image

Click here to review the entire InsMark Compare illustration.

The difference in cash values can be even more dramatic for an in-force IUL policy.  NAIC AG 49 requires IUL illustrations featuring participating loans to utilize a 200 basis point spread between the loan interest rate charged and the interest rate that is credited to cash values.  Many carriers utilize a 100 basis point spread for in-force IUL policies producing a built-in 100 basis point hedge for even better IUL performance than illustrated.

An Alternative Comparison

The additional cash value in the IUL illustrated at 7.00% could support annual, participating, retirement loans of $205,000 yet still retain ending cash values in excess of $2,000,000.  Click here to test that against an equity account assuming growth at 7.00% plus a 2.00% dividend1.  As you will see, the equity account doesn’t stand a chance of competing; it is depleted by age 79.

1Mgt. fee: 0.5%; income tax bracket: 35%; capital gains and dividend tax rate: 25%; portion of capital gains long-term: 65%; portfolio turnover rate: 35%.  The equity account would have to have a growth rate of 9.73 plus the 2.00% dividend in order to match the after tax loans and residual cash value of the IUL.


blog-170-image-2-potential-tax-bomb-in-life-insurance-that-can-accidentally-be-triggered imageMany of you are rightly concerned about the potential tax bomb in life insurance that can accidentally be triggered by a careless policyowner when policy loans are present and net cash values are so low that the income tax on the gain on surrender (calculated using gross cash values less basis) is more – often significantly more – than the net cash surrender value.

This lurking tax bomb can be present in all forms of whole life and universal life where policy loans of any type are utilized.  It can be avoided, and you, the producer, are key to making sure your clients are aware of how to sidestep it.

A tax bomb can be avoided if the policy is neither surrendered nor allowed to lapse, since the policy death benefit wipes away the income tax liability.  The foundation of this special treatment is IRC Section 101.  This statute provides that the proceeds of life insurance maturing as a death claim are exempt from federal income tax.  This applies to the full death benefit, including any cash value component whether loans exist or not.

Note: It is best if you design the policy with no premiums scheduled after retirement if loans are anticipated in retirement years.  This may require higher premiums during pre-retirement years, but a policy with no premiums scheduled is much more tolerable at advanced ages than one with continuous premiums.

Can your clients remember these facts years into the future?  If they are incapacitated, will family members understand the issues?  It is probably best to file a short note with the policy – something like this (although your compliance officer will likely have preferred language):

If/when you take policy loans on this policy, be sure to talk to your financial adviser before surrendering or lapsing the policy in order to anticipate unexpected tax consequences that may otherwise be avoided.

Does this note make it harder or easier to deliver the policy?  It’s harder if you haven’t discussed it with your client; easier if you have.  And that’s the point – you should discuss it.

Some life insurance companies have concierge units that monitor loan status at the point of lapse or surrender.  To be effective regarding the tax bomb, they need to be proactive in their client relationships, not merely reactive to client inquiries.  I hope that ultimately the policyholder service division of all life insurance companies will bring this potential liability to the attention of those surrendering or lapsing policies, particularly those policies with 50% or more of the gross cash value subject to outstanding loans.  I also hope that any such policies issued with lapse supported pricing do not produce “let ‘em lapse” directions from senior management.


Participating loans are a very significant development in the life insurance industry.  Their long-range consequences are difficult to appreciate fully without the mathematical comparisons illustrated in this Blog.  Whether you are presenting a large or small amount of insurance, the impact of such loans is considerable.

If you would like some help creating customized versions of the presentations in this Blog for your clients, watch the video below on how to download and use InsMark’s Digital Workbook Files.

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If you obtain the digital workbook for Blog #170, click here for a guide to the content.  It will be invaluable to you.

For those not licensed for the InsMark Illustration System who would like to review the case-specific, digital workbook file used for this Blog #170, we will be pleased to provide you with a complimentary 30-day installation for the software along with the applicable, digital workbook file.  Contact Julie Nayeri at or 888-InsMark (467-6275) for details.  (This offer applies to any digital workbook file discussed in any of my Blogs.)

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Important Note #1:  The hypothetical values associated with this Blog assume the nonguaranteed values shown continue in all years.  This is not likely, and actual results may be more or less favorable.  Life insurance illustrations are not valid unless accompanied by a basic illustration from the issuing life insurance company.

Important Note #2:  The information in this Blog is for educational purposes only.  In all cases, the approval of a client’s legal and tax advisers must be secured regarding the implementation or modification of any planning technique as well as the applicability and consequences of new cases, rulings, or legislation upon existing or impending plans.

“InsMark” is a registered trademark of InsMark, Inc.


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