While term products may appeal to many clients who need a death benefit without cash value buildup, some clients overlook the dual benefits provided by permanent, cash value life products. One such feature is an income tax-free death benefit -- generally provided by all types of life insurance -- that will be available at the time of family survivor or estate or business planning needs, provided that the policyholder pays premiums in full, and in a timely manner. Another critical benefit is market investment, which is generally tax-favored and may be easily accessible after the surrender period.
Both variable and indexed life insurance allow the client to enjoy invested cash value. These types of policies have certain similarities, but there are also differences between the two. While clients who want a death benefit and investment results could be well-suited for a permanent variable or indexed life policy, they will incur mortality charges and a possible sales load on some insurance products. Because of this, clients who don't need a death benefit often prefer other products.
Variable life products are considered more "traditional" than indexed policies, as these products have been available for close to 20 years. While similar to the older whole life products in that they allow cash value buildup, variable product cash value is invested in client-directed separate accounts and a separate general investment fund. Clients often have myriad investment choices for the separate accounts -- such as stock, bond, and money market funds -- but as the investment risk is borne by the policy owner, the minimum cash value is not guaranteed.
Variable life insurance is issued with a fixed minimum guaranteed death benefit. The face amount of the life insurance contract at issue is a minimum benefit payable. However, depending on the performance of the separate account, the death benefit payable may increase above the minimum.
Unlike with fixed insurance products, the SEC regulates variable products. Therefore, while death protection is the primary goal of a variable policy, it can be similar to investing in the market, with four major differences:
- The availability of a death benefit
- Required premium contributions to keep the policy in force
- Possible charges associated with the death benefit
- Tax-favored distributions from the policy; while sales of mutual funds in a brokerage account would be subject to tax in the year of sale, the policy owner may withdraw policy cash value up to basis with no income taxes.
Indexed policies are a newer form of permanent cash value life insurance with available downside protection. In exchange, there is often a cap on return placed by the carrier. Generally, indexed policies are regulated in the same manner as universal life policies. Rather than a return based on the stock market, rates of return are typically tied to an indexed fund, such as the Standard and Poor's 500.
Because of the downside protection and upside cap, many consider indexed universal life to be a more conservative investment than variable life. Indexed policies feature the same four differences from investing in the market as variable products do, as well as offering the floor and ceiling to investment potential. Like variable policies, the client may consider purchasing a no-lapse rider to achieve guaranteed death benefit.
Choosing between variable and indexed
Both variable and indexed policies may be appropriate for clients who have maxed out their qualified plans and are looking for a death benefit along with a way to invest on a tax-deferred basis.
In order to determine whether indexed or variable products are appropriate, clients should seriously review their risk tolerance and time horizon. Both products require time for the cash value to build up to a meaningful amount, so the client should be willing to wait for distributions -- generally at least 10 years.
Consider this example: Mr. and Mrs. Peacock are each 53 years old. They are both working, and have sufficient income for an annual investment. They would like to retire at age 65. The Peacocks make maximum contributions to their 401(k)s, but do not feel they will have enough income for retirement. While they don't expect their estate to be subject to taxes, they feel their children will need liquidity at the second death. They would like to invest in the stock market, but feel they are already heavily taxed on income. They are also cautious about losing their investment. While they like the fact that variable has a longer history, the Peacocks ultimately choose a personally owned survivorship indexed policy to achieve cash value growth with downside protection.
When advising clients on their death benefit possibilities, it is critical to determine their future cash flow needs, as well. Both variable and indexed life policies may be an excellent complement to their current planning strategies.
Gail Brannock is the advanced market director at Time Financial, a Crump company. She can be reached at email@example.com.
More articles on variable and indexed life from ASJonline
Indexed Vs. Variable Life: Choosing the Right Product for Your Client
Indexed Life: Choosing the Right Product