Retirement Planning With VUL - Tax Free Retirement

When used properly, VUL can be an effective supplemental investment tool.

The national savings rate for American consumers is at an all-time low and household debt is at an all-time high. Compounding these problems is the fact that the financial services industry has not designed appropriate products for long-term, systematic investing. Also, many advisors seek clients with investable assets, typically in the range of $100,000 to $1 million. And due to administration costs, most product manufacturers target customers with a significant amount of assets ready to invest. Many advisors are reluctant to pursue new customers interested in investing only $10,000 a year. However, this group may present a niche opportunity in an industry desperately seeking new customers.

VUL to the rescue
Most people need some life insurance protection at almost every stage of their lives, are interested in tax-free accumulation of cash and need additional retirement savings. As long as there is a bona fide need for insurance protection, and the client has disposable funds to “over fund” a variable universal life policy, it may be possible to kill two birds with one stone.

In addition to providing valuable death benefits, a VUL policy can serve as an alternative investing vehicle. A VUL policy, when funded to the maximum limit allowed before becoming a modified endowment contract (MEC), can function as a systematic investing plan with tax-deferred growth potential and provide necessary death benefits. And because it is life insurance, the policy owner can access his accumulation account income-tax-free through the withdrawal and loan provisions, as long as the policy does not lapse. Remember that loans and withdrawals reduce the cash surrender value and death benefit. Policies depending on the underwriter, may be built and structured with a No Lapse Guarantee Rider to ensure that this does not happen. Although you must make sure clients understand they are purchasing life insurance when suggesting it as a retirement vehicle, the tax advantages of a VUL policy make it a product clients may find extremely attractive. Unlike other investment vehicles, a life insurance policy can also provide retirement benefits for a spouse if the client dies. And it is rare to meet a client who would not benefit from owning additional life insurance.

In the ’90s, many agents sold VUL at the minimum premium to carry the policy to age 100, based upon a gross return on the sub-accounts of 10 percent to 12 percent. Under these assumptions, a VUL policy was a seemingly low-cost method of providing a significant amount of death benefit protection, but was risky if the market did not perform as illustrated.

AMERICANS ARE NOT LIKELY TO SAVE IN ANY MEANINGFUL WAY FOR RETIREMENT UNLESS THEY ARE MOTIVATED.

As a result of the bear market from 2000 to 2003 and 2007 to some time in the future, VUL policy owners who funded their death benefit at low premium levels were forced to substantially increase their premiums or face the risk that their policies might lapse. VUL policies should not be funded at minimum premium levels or illustrated as a low-cost method of obtaining life insurance protection. Instead, they should be funded at or near the MEC limits. This is the concept of over funding the policy, the minimum payment will only over the life insurance aspect of the policy not the retirement benefits.

VUL benefits
When funded at near-MEC levels, a VUL policy may outperform other commonly used investment vehicles as a source for supplemental retirement income on an after-tax basis. However, this is not the most cost-efficient way to purchase life insurance protection.

A VUL policy may provide the economic motivation for advisors to aggressively market and encourage Americans to start a systematic investment program.

Producers should always put the best interest of the client first before considering compensation issues, however. Fortunately, a VUL policy can be an alternative to other commonly used investment vehicles for clients in good health. And for those with medical impairments that could prevent them from qualifying for life insurance, a VUL policy may still be a sound alternative. Remember, the policy owner owns the accumulation account, and if your client does not need or cannot qualify for the life insurance protection, he can put the coverage on his spouse or children.

Incentives to save
Over the last two decades, many companies have shifted their emphasis to products aimed at advisors who help clients move money from one investment instrument to another. Many advisors and companies that offer investment products are ignoring clients who need help in establishing a plan to systematically save for retirement.

Americans are not likely to save in any meaningful way for retirement unless they are motivated. For example, consider 401(k) participation rates—the majority of investors do not maximize their 401(k) contributions, although they should. Recently, President Bush suggested the creation of lifetime savings accounts to increase consumer savings rates. His proposal has raised concerns because LSAs would allow an individual to save and spend, as opposed to saving for retirement. It is highly unlikely that newly created savings plans will increase the personal savings rates of Americans. The best way to motivate a client is through a face-to-face meeting with an advisor. It is the advisor who can calculate how much money the client will need for retirement and how much money he has to invest over time to reach his goal.

Remember the contractual mutual fund plans that were popular in the early ’80s? The compensation of contractual mutual fund plans motivated advisors to extol the benefits of systematic investing over time to as many clients and prospects as they could. Millions of Americans were encouraged and given the opportunity to start a plan. Contractual mutual funds have disappeared because of criticism from regulators, the media and the public over the high up-front sales charges.

Today there are financial products that can help advisors market a systematic investment plan concept to millions of Americans who need to supplement their 401(k) plans with nonqualified investment programs. When used properly, a VUL policy can be that supplemental investment product. It is a shame too many advisors and their clients are overlooking it.

Target Date Funds: Here Today...Regulated Tomorrow

For a while now, target date funds have seemed like a good option for retirement plan investors, many of whom don't want to sort through dozens of funds and don't know how to determine the right mix of investments to suit their retirement needs or their risk tolerance. Instead, plan participants could simply choose a fund based upon their retirement date, and the actively managed funds would shift over time to provide an appropriate asset mix. For investors who didn't want to spend a lot of time monitoring and researching their holdings, they were like a simple solution.

So it's no wonder 401(k) plan money has poured into the funds since their arrival in the market nearly two decades ago. And in 2006, when the Department of Labor deemed them a suitable automatic enrollment default option, participation accelerated.

Now, however, the plans are under scrutiny, with the Department of Labor and the Securities and Exchange Commission hosting a joint, all-day hearing featuring dozens of investment advisors, fund representatives, and industry analysts last week to determine whether target date funds require increased regulation or disclosure.

These target date funds are a combination of stocks, bonds, equities, money markets, cash reserves, indexes and other mutual funds. The fund managers will often put their worse performing funds into these target date funds to help bring money into the lower ranked and lower performing funds. These funds allocations are often not conservative enough and therefore are not suitable, which can cause issues for the fiduciary duties of the plan administrator. The underlying funds are often not known, and neither are the expenses for having stocks inside of a mutual fund, and mutual funds inside of a target date fund. 

Be on the look out for changes to these funds in the coming months, more regulation will be needed to ensure that the investor is aware of what these funds represent and the dangers that people face when investing their money into Target Date Funds.