Here’s two other videos explaining IUL scenarios:
What Happens to IUL When it’s Late-Funded
Indexed Universal Life’s Full Range of Flexibility
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What Happens to IUL When it’s Light-Funded?
Let’s look at what happens when your clients can’t fully fund an IUL policy, as you had originally intended for them to do. Even though it says Ex. Client on the top left that actually stands for example client – if you don’t want your clients to become ex-clients.
It’s good that they fully understand the range of flexibility inherent in IUL and this is actually part two of a series – before we looked at what happens when they pay their premiums late and how that affects policy performance long term.
What we’re showing here is if they can’t get anywhere near the projected funding amount and how that affects ongoing performance.
So let’s jump in here and look at the non guaranteed cumulative premiums. That’s what these colorful lines are representing – the blue is optimal and you can see they’re all overlapping down here so in the first two years this particular client pays 60,000 dollars a year for two years (cumulative funding of 120). This is the maximum allowable non-MEC premium for optimal growth and income in the future.
Now the blue line is the optimal funding scenario that you can see they get in five premiums of 60,000 dollars in five years. However, they fall far short of that with the green scenario and the orange scenario, and you could see that the orange scenario is funding substantially lighter premiums. Its actually five thousand a year for a number of years and they pay much longer than the green scenario who pays ten thousand dollars a year for a number of years.
Let’s just look at exactly what’s happening here in the simplified spreadsheet view. Again, we’re looking at the exact same policy across the board starting with 1.295 of death benefit and planned premium of 60. And you can see here that the 60 thousands are going in for five years, totally optimal. In the green scenario we see 60,000 dollars for two years and then tens for five more years filling it up after or filling up as much as they can after seven years.
What happens after that, is we drop the death benefit substantially, as well as with the orange scenario where we pay 60,000 dollars a year for two years, and then five thousand dollars a year until year 15 at which we drop the death benefit in the two light funded scenarios after the seventh year because, well let’s face it, the clients start this not as much for protection but for long term performance.
If we want the performance of this light-funded scenario to look good, we need to drop the death benefit to the lowest amount that the IRS will let us. There is a seven pay test in the way but after seven years we get a new seven pay test and we can go ahead and squash the death benefit.
Let’s jump back into the visual part of our software to see the effects on first surrender value. Actually, let’s look at the death benefit first, so you guys can see and visualize what happens with the death benefit.
For these first seven years, the blue is growing more because we’re using an Option 2 death benefit where the death benefit increases by the growth of the cash value. Obviously, when more premiums are going in, the death benefit and the cash value are growing in tandem.
But when we light-fund these, it’s hard to see the green behind the orange here but the two are in tandem. The death benefit stays relatively flat after that 60 and then you can see after the seventh year we just squashed the death benefit to the lowest level possible. Since more money went into the green scenario because they were paying ten thousand dollars in the death benefit, it’s going to be higher.
You can see the death benefits starts to go down again here between 64 and 65, and that’s because we start taking income and we’re going to visit that in just a moment. But if we now look at the effect of surrender value, you know obviously it’d be better to get more money in sooner to this policy and let it flourish.
You’d have a lot more cash value just for paying five premiums of 60,000 dollars a year. Even at the AG 49 rate, we’re looking at seven hundred and sixteen thousand cash value.
Now substantially less for the green scenario and the orange scenario. But remember in this scenario we only got in 170 of premium and it took us longer to get it in there. In the orange scenario, we got 185 thousand of premium and it took us even longer to get that money in there but still not a bad pile of cash for something that had the risk profile of something more like CDs, savings accounts, or the like.
If we stretched this out to see the effect on income here – let’s go out to life expectancy. We can see that what happens to the surrender value is the blue is going to be higher along the way – there’s more money in there. But the orange and green are holding strong in tandem.
If we look at cumulative income and let’s just back it up to the first year so we can see how much the level income is. You know, it’s obviously a lot less than the max funded scenario. But remember, we put in substantially less premium and it took longer to get it in there but still putting in 170, 185 thousand dollars to take 30 to 31, almost 32 thousand of tax-exempt income for 20 years, and a total six hundred and twelve thousand, six hundred and thirty-eight thousand of tax-exempt income over the course of 20 years is not too shabby especially considering that’s not all that happens here.
Clients often forget that this is a life insurance policy since they’re using it for income. And if we go back to the death benefit amount, even though the death benefit shrunk quite a bit, there’s still over six figures of tax-free death benefit left behind for heirs and most of our clients are not going to leave the undertaker with the bill. Sometimes they’re even going on these infomercials and buying burial policies anyway.
This essentially acts as their burial policy, cleans up any lingering affairs from any illnesses that they may have had – hospital bills and whatnot.
So close to two-thirds of the premium (or somewhere thereabouts) is actually left behind as a death benefit. And they’ve got to enjoy all this tax-exempt income plus some amount of death benefit the whole way.
What I want you to take away from this is: even though clients look at the bill of their insurance policy as this rigid thing that has to be met, although that may be optimal for them, it’s not as rigid as they think.
And so showing them that there are these escape hatches, there are ways to bow out of what was originally planned for them and how they can still produce a favorable result (not only during their lifetime but also at death) can often help them wrap their head around why they want to use Indexed Universal Life as an asset class.
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John “Hutch” Hutchinson
ChFC®, CLU®, EA, AEP®, CExPs®