It's time to answer the whole life vs IUL debate once and for all. Because really there is no debate. There is no right and wrong. There are simply choices. But I want to keep you informed about the newest technology and by far the IUL is the better engine for growth.
Whole life insurance is a life insurance policy that remains in force for the entire lifetime of the insured, as long as the premiums are paid through to the maturity date. Whole life is best understood as the opposite of a term life insurance policy, in which the policy is only in force at its original premium for a specified period of time (the “term”), say twenty or thirty years, during which the policy holder is statistically very unlikely to die. At the end of the term, if the policy is not cancelled, premiums typically escalate dramatically, which means that the closer the policy holder gets to the likelihood of really needing the policy, the more unaffordable it gets.
The uncapped Index Universal Life (IUL ) is also a form of life insurance. Both have a health qualification, and both offer a death benefit for the spouses of veterans. However, the death benefit is not the primary or most attractive feature of the IUL. The real benefit of the IUL is its capacity to be a cash accumulation vehicle. It also offers significantly greater equity growth and significantly fewer restrictions for accessing your money than Whole Life.
What is Whole Life?
In the 1990s, some financial firms catering to military and veterans began selling whole life insurance as a way to privatize the protection of a military pension, offering a permanent solution to estate planning, something that a 30-year term policy could not do. Whole Life policies were typically offered in conjunction with retirement plans. At a high level, these plans are very attractive. They provide a death benefit for the insured’s loved ones and allow them to leave a permanent legacy. At some point in retirement, the policy is paid up, and the insured no longer has to make payments. They also have the option of continuing to increase their coverage every few years with something called paid-up additions. As long as the insured pays a little more, they are guaranteed to get some more insurance.
The Problems with Whole Life
While Whole Life insurance can offer both equity and permanent coverage, which term policies cannot do, Whole Life policies have some major flaws.
Whole life insurance hasn't changed in many, many years. Using these old Whole Life policies for estate planning today is like choosing to work on an old IBM PC from the 1990s. Sure, it performs the same underlying functions, but it is lacking in DECADES of innovation and is simply not the best tool for the job.
These policies can be very confusing, not only to those who buy them, but to those who sell them as well. Most agents don’t really understand what they are selling, so they are not necessarily recommending them because they are the best tool available for an individual client’s situation; rather, these agents are just doing what they’re told to do by their agency. Neither do many agents understand the unique situation of military/veterans.
To compound the problem, many the of veterans who purchase whole life insurance don’t really understand what they are purchasing. It is not uncommon for someone to find out five or ten years into paying for a whole life insurance plan that they can get the same or similar death benefit for a fraction of the cost with a term policy. But comparing a term policy to any type of permanent policy, especially a Whole Life insurance policy, is comparing apples to oranges.
Veterans who decide that it makes better out-of-pocket-right-now sense to switch to a term policy end up losing what equity they had built into their Whole Life policy, even if it was only a few thousand dollars.
Almost all the costs of a Whole Life policy is paid for up front, which means that much like a mortgage, it can be a decade or more before you have built any real equity. Although that equity can be accessed tax-free later in life, there is often a loan provision stipulating that you have to pay the company in order to access your money, just like you would get a home equity loan from a bank to access “your” equity in a home.
Finally, a traditional Whole Life insurance policy doesn’t offer a great deal in terms of equity. The return on investment (ROI) is severely limited by market interest rates. These policies see growth comparable to a bank Certificate of Deposit (CD). That’s not a smart way to leverage compound interest over 30+ years. In fact, the way the interest is credited to the equity is in the form of “declared dividends.”
This is really just the board of executives of the company sitting around at the end of each year and determining how much of the company’s profits they want to give back to policy holders, when in reality, those profits came FROM the policy holders, so it’s more like a rebate than a dividend. And historically, as more investors move away from whole life, those profits and rebates have been decreasing.
All things considered, while you may end up realizing some benefits from your a Whole Life insurance policy decades after initiating one, there are far better things that you can do with your money that will benefit you more and sooner than Whole Life.
What is the IUL?
The IUL is an investment grade, private placement, free market life insurance policy. It is a completely new approach to privatizing a pension that represents a major technology shift from the Whole Life policies being sold to veterans and military personnel in the 1990s. The modern IUL can provide the death benefit protection of a Whole Life or term policy while also producing an annuity stream much like a military pension, because you can use it while the veteran is still alive!
After 30 years, the ROI on the IUL is significantly higher than on a Whole Life policy. In the best case scenario, Whole Life plans usually grow between two and four percent compounded annually. The death benefits are also typically significantly higher than they need to be because they are sold as an alternative to term instead of as a compliment.
This benefits the agent (not the client), who gets paid much more for selling Whole Life. As a result, the cost to insure is also very high, and it takes about 10 to 15 years of regular contributions for an insured person to fully cover the cost of Whole Life before they break even and can access any equity.
Whole Life vs IUL: How is the IUL Different from Whole Life?
The IUL differs from Whole Life in some very important ways.
While you can fund an IUL with a single lump payment spread out over a few years, you don’t have to. You have total flexibility in funding. You can contribute as much or as little as you want, over as short or as long a period as you want. You can also set up monthly contributions that you can increase, decrease or stop at any time. Unlike with Whole Life, you are contractually obligated to make the same monthly payment, month after month, year after year.
Mechanism for Market Growth
Like Whole Life, the IUL is a permanent life insurance policy that accumulates equity. However, equity growth in a Whole Life policy is based on the federal bond rate, while equity growth in the IUL is based on the S&P 500 performance. With the IUL, you get guaranteed principal growth when the stock market is up and protection from losses when the stock market is down. This kind of risk-free investing is possible because these insurance companies are using an options indexed investing strategy.
They take a little cut of the gains on your principal in exchange for guaranteeing that you will never lose money in the stock market. It’s almost like you’re going into partnership as investors: your money plus their expertise and the purchasing power they are able to wield by combining your money with that of other IUL account holders. his safeguard against negative market returns allows you to both comfortably fund your retirement and still be able to leave a legacy behind you when you die.
90% of the Money in an IUL is Liquid
While you will have to wait a decade or more to access any significant equity in a Whole Life policy, the IUL offers liquidity at any time, for any reason, without penalty. The IUL has something called the cash surrender value, which is the amount of fully liquid cash that's available to be taken in distributions without penalties or taxes.
As long as a person keeps 10% of the cash surrender value inside the plan, they can do whatever they want with the other 90%, which is comprised of a combination of contributions and the returns on invested dollars. Furthermore, you can use your money for what you need when you need it while it continues to grow in value when the market is on the rise. For more information about how this works, see this article.
Most of the policies that were sold to veterans in the 1990s and since then don't offer any advantages for being in good health beyond smoker and non-smoker rates. When you qualify for an IUL, your good health will be rewarded with lower premium rates. That said, if you are not in excellent health, don’t let that deter you from qualifying.
The health qualification determines the amount of the death benefit the insurance company will offer you. The better your health, the more death benefit you can qualify for. However, as I explain below, with an IUL we are not looking to maximize the death benefit, and while there are many health issues and disabilities that affect veterans, very few of them have any significant impact on a veteran’s ability to qualify for the IUL.
The IUL Is About More Than Just a Death Benefit
The costs of an IUL vary depending on the amount of the death benefit, which is a lump sum payment to the named beneficiary on the policy should the policy holder die while the policy is in force. By setting up your policy with the lowest possible death benefit, we can keep your costs lower and reduce the amount of time it takes to fully fund your policy and thus the amount of time before you can begin to access your money.
Doing this also maximizes the growth of your money. Again, the IUL is not about the death benefit. It is about getting tax-free growth on your money.
The IUL Offers Additional Benefits
An IUL also offers additional benefits like the ability to pay for long term care for yourself. A Whole Life policy does not offer these benefits.
What If You Already Have Whole Life?
Service members and veterans who have already sunk money into older whole life insurance plans can redirect that investment into an IUL, along with whatever other contributions they want to provide, using an IRS mechanism called a 1035 exchange.
Moving these funds into an IUL using the 1035 provision allows returns on your investment to take effect much earlier than the 10 to 15 years it can take for a Whole Life policy to mature. This basically amounts to taking money that you've already put to work for you and giving it a raise.
The primary differences between Whole Life vs IUL are lower costs, greater principal growth, and more liquidity. With an IUL, 90% of your money is liquid and available to you whenever and for whatever you need it. If you are not in a position to fund an IUL aggressively or to commit to it for the long term, then it probably isn’t the right financial vehicle for you.
But what we have found is that for individuals who do not want to follow the traditional path from military service to 9-to-5 job to retirement, for those who want to devote their post-military lives to a new means of service that involve starting a business or any other kind of lifestyle that will require the availability of funds much sooner than the normal retirement age, an IUL offers a huge advantage over a Whole Life policy because it includes both sensible financial protection for the family (tax-free retirement income, long term care protection, legacy for heirs, etc.) and the flexibility, control, and liquidity that will allow these individuals to forge their own path.
If you think that the IUL might be right for you, or if you are interested in getting more information about how to convert your existing Whole Life policy into an IUL using a 1035 exchange.
I hope you’ve found this information helpful as you make your decision about life insurance. Whole life and IUL are both great options, but based on the current market and technology available, I believe that an IUL is the better engine for growth. If you have any questions or would like to schedule a consultation. We are here to help you make the best decision for your family.