What is Indexed Universal Life Insurance (IUL)?
By James Chittenden
Employee retirement plans for small business owners is a topic many entrepreneurs prefer to avoid as long as possible. Most of them are too busy wearing all the necessary hats to operate a business and retirement plans are something they prefer to keep o the back burner.
But if you are going to keep good employees, you’ve got to take care of them. Part of that is providing retirement plans. And since you too are an employee of the business, the business can contribute to yours as well. Take advantage of the tax benefits both you and your business receive and take care of yourself in retirement too.
One way to do that is to buy a indexed universal life (IUL) insurance policy. What is that?
An indexed universal life (IUL) insurance policy combines a death benefit with a cash value component. It can provide lifetime coverage while also allowing for potential cash value growth based on the performance of a selected stock market index.
The moving parts of an IUL
- Premiums: As with any life insurance policy, you pay regular premiums to keep the policy in force. Within certain limits, these premiums can be adjustable, allowing you to change the amount you contribute over time.
- Death Benefit: The policy provides a death benefit that pays your beneficiaries if you die while the policy is active. The death benefit can be set or it can be variable depending on the cash value accumulation.
- Cash Value: A percentage of your premium payments build build cash value in your policy. The insurance company credits the cash value with interest, which is usually guaranteed to never be negative. The value accumulates over time and is accessible while you are still alive, subject to specific policy regulations and limitations.
- Indexing: The opportunity to collect interest depending on the performance of a stock market index is a unique feature of an indexed universal life policy. The insurance company establishes the policy’s participation rate and cap rate. The participation rate determines how much of the index’s gains are credited to the cash value of your insurance. The cap rate limits the maximum interest that can be earned.
- Indexing Options: You normally have the option of linking your policy’s cash value growth to the stock market index of your choice. The S&P 500, NASDAQ 100, and Russell 2000 are popular selections. The interest credited to your cash value is determined by the index’s actual performance, subject to the participation rate and cap rate.
- Policy Flexibility: Indexed universal life policies frequently let you to change premium payments, death benefit levels, and even the indexing options. These modifications, however, may be subject to policy limitations, fines, and potential tax ramifications, so it’s critical to contact with your insurance provider or agent first.
- Risks: An IUL policy has the potential for cash value growth depending on stock market index performance, but it also has some hazards. If the index underperforms, you could earn little to no income and this will constrain the growth of your cash value. Fees and expenses linked with the policy can also lower your returns over time.
- Tax benefits: The cash value growth in an IUL policy accumulates tax-deferred. This means that as long as the owner keeps the policy, the growth is not subject to income taxes. Furthermore, policyholders can access the cash value tax-free through policy loans or withdrawals up to the amount contributed to the policy.
Can you use an IUL to provide retirement benefits and protection?
Yes you can! IULs are designed to do exactly that. Claudia Fehribach leads Fehribach Financial Group of Five Rings Financial is an expert in using IULs in employee retirement plans for small business owners.
How can small businesses use these policies for insurance?
CF: Insurance can protect partnerships. The policy can purchase the
partner’s portion of the business in the event of death or
incapacitation. Note that these investments are NOT bank products and are not FDIC-insured. However, they are backed by top-rated insurers who maintain adequate reserves. Currently, the reserve guideline is $1.09 in reserve for every $1 committed.
How can small businesses use these policies to incentivize your best people?
CF: It can be an incentive to keep key people. For example, you can use the policy to provide a bonus of $100k for each employee after 15 years.
What index is the policy tied to?
What tax benefits does an employer get?
CF: Of course the growth of the cash value is tax-deferred and any death benefit is tax-free. You can take loans against it and that is also tax-free. Premiums are paid with after-tax dollars. This means that withdrawals are tax-free. Your business can deduct the cost of premiums IF the business is not a direct or indirect beneficiary.
You have said that these plans invest funds from banks. Does this increase your gains?
CF: Yes. Under a Kai-Zen program, a bank matches your contributions. They get 1.5 percent. The bank takes their funds back after 15 years.
Pro Tip. A retirement account can fund a new startup or business purchase.
Yes. You can use a retirement fund to start a new business. Withdrawing the funds IS considered a rollover. This means that you have 60 days to invest those withdrawn funds into something else. Otherwise the withdrawn funds may be subject to taxes and penalties if done before age 59 1/2.
This is know as a ROBS (Rollover As Business Startups) transaction It allows an entrepreneur to buy a new or recapitalize an existing business, tax-deferred and penalty-free, using their existing 401(k)/IRA. They are commonly used for starting a business that has a high initial investment, such as buying a franchise. This sort of financing is highly niche, so use a company that specializes in ROBS transactions.
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