What was the last life insurance policy you sold? In this environment, probably a good number of financial professionals would say a universal life (UL) policy with a guaranteed death benefit. If that was your answer, the next question is was no-lapse UL the only product considered? If yes, you may want to consider additional product options for planning flexibility and to avoid limiting your clients' options.
When you are creating a financial plan and assume a static environment, you are risking a plan failure. On the surface, a no-lapse UL product may appear to be the perfect solution: A fixed guaranteed premium and death benefit for life -- no problem, right? But what happens when a premium needs to be skipped, a client needs a short-term loan, the premium frequency needs to be changed to monthly, or a client decides to pay additional premiums? The inflexible nature of no-lapse UL may not lend itself to the changing long-term financial requirements of your clients.
Have you received a call where your client asks a question such as:
"Can I skip a premium this year?"
"I need to pay my policy monthly rather than annually, can I do this?"
"I had some unexpected expenses, what is the most I could borrow from my policy?"
It is difficult to explain the impact of these actions on a guaranteed no-lapse UL policy to clients. With a no-lapse UL policy, if a premium is skipped, the length of the death benefit's guaranteed period will be shortened. To restore the guarantee period, future premiums will need to be increased. The more premiums skipped, the greater the future cost required to maintain your client's no-lapse guarantee. Furthermore, many no-lapse UL products were designed with guarantees shorter than lifetime, and many were designed to last to age 95. In these cases, it becomes even more critical because the reduction in the guarantee period may jeopardize your client's intended financial and estate planning strategy should death occur beyond the reduced period.
Moreover, taking policy loans has the same effect as skipping premiums, assuming that cash value is actually available. On top of this, there is the additional burden of loan interest, assuming that cash value is actually available. Typically, cash value is nonexistent because of guaranteed coverage charges for the no-lapse rider, leaving little or no loan value for emergencies.
Finally, adding more premiums than originally planned offers limited flexibility for a client. This is because the death benefit is usually level in nature. An increase in cash value would extend the year in which cash value would hit zero, but offers little hope for developing supplemental funds that can be accessed for emergencies.
Alternatives to no-lapse UL
When developing a life insurance plan for a client, many things should be considered besides the death benefit. These include cash flow, financial emergencies and changing financial needs. Even the wealthiest of your clients likes to save money. Because of this, consider the efficient use of premium dollars in your solution.
We need to shift our thought process to one of offering multiple product options -- even if the products considered may include higher initial costs. Clients today may appreciate a solution offering a cash value fund in addition to the protection guarantee. By offering options that include both cash accumulation and protection, a client can have an insurance plan with flexibility for unanticipated changes that may occur down the road.
So how is this shift in thinking accomplished? An answer may be to start offering multiple product options, rather than the single solution of no-lapse UL. Other products to consider would be universal life, non-participating whole life and participating whole life. Each of these products offers different characteristics to fill a client's financial need. These permanent products offer cash-value accumulation and protection guarantees. Although these products may require initial higher premiums, they provide for more long-term flexibility than a no-lapse UL product.
These products offer flexibility in different ways. For this discussion, assume there is enough money (typically at least three premiums are paid), and available cash surrender value, to meet premium payments when needed.
Current assumption universal life by its nature offers assistance to meet premium payments. You could skip a premium because they are not required to be paid. This works as long as there is sufficient value to cover all charges and the policy will remain in force. Next, if you need cash in hand, policy values could be borrowed against using loans. Some UL contracts offer preferred loan rates after a specified time. Finally, withdrawals may also be used to access cash values. As long as the withdrawals are less than the cost basis and the policy is properly structured and is not a MEC, (1) they are tax free.
Non-participating whole life products offer limited flexibility. The feature they offer is the ability to borrow policy values for premium payments or short-term cash needs. These products do not offer the additional potential for increasing the cash value accumulation through policy dividends.
Participating whole life products offer more flexibility. They also offer a guaranteed premium and death benefit similar to no-lapse UL. Premiums are required to be paid each year. To skip a premium, the client must either release (withdraw) the cash value of paid-up additions or make a premium loan as long as there is sufficient cash value. Moreover, loans can be accessed to meet short-term needs.
There are two types of loan methods available. Direct recognition, which typically uses a fixed loan interest rate, and non-direct recognition, which uses a variable loan interest rate. Lastly, policy values may also be available by using withdrawals from paid-up addition cash value. As long as the policy is properly structured and these withdrawals are less then the cost basis, they are tax free.
Flexibility matters
When developing insurance plans for your clients, you should always consider different ways to meet their objectives. The lesson we should have learned from the economic boom of the 1990s and the financial downturn nearly two years ago is clients should be prepared for multiple possibilities in life. We should realize now cash value build-up within a life insurance product is not a luxury but perhaps a necessity for responsible long-term insurance planning. Clients need the protection of the death benefit but may also want to be able to enjoy the living benefits of having the opportunity to access the cash value in the policy via policy loans and withdrawals in a tax-favored manner.
While the primary purpose of life insurance is the death benefit protection, it is important to understand the advantages cash value accumulation can provide to clients. So the next time you offer a client a no-lapse UL product, also consider discussing the flexibility, the cash value accumulation and attractive features other permanent life products offer your clients.
With these distinguishing characteristics, cash value life insurance can be a powerful solution to meet many of your clients' needs: by providing life insurance protection as well as potentially valuable asset within your clients' portfolios. By presenting multiple product solutions, you may get a whole new look on life.
Robert Passero, CLU, ChFC, is a senior advanced sales consultant for MetLife Investor's Wealth Advisory Group.
The information contained in this document is not intended to (and cannot) be used by anyone to avoid IRS penalties. This document supports the promotion and marketing of insurance products. You should seek advice based on your particular circumstances from an independent tax advisor.
MetLife, its agents, and representatives may not give legal or tax advice. Any discussion of taxes herein or related to this document is for general information purposes only and does not purport to be complete or cover every situation. Tax law is subject to interpretation and legislative change. Tax results and the appropriateness of any product for any specific taxpayer may vary depending on the facts and circumstances. You should consult with and rely on your own independent legal and tax advisors regarding your particular set of facts and circumstances.
FOOTNOTE:
1. Tax-free distribution assumes that the life insurance policy is properly structured and not classified as a Modified Endowment Contract (MEC). Withdrawals are made up to the cost basis and policy loans thereafter. If the policy is a MEC, cash value is taxable upon withdrawal and if withdrawn before age 59 1/2 , a 10% federal income tax penalty may apply. If a policy should lapse or be surrendered prior to the death of the insured, there may be significant tax consequences. Loans and withdrawals will decrease the cash value and death benefit.
