Life Insurance

Making Variable Universal Life Work In This Economy – The New Combo Products
by Shawn Britt, CLU

Modern times call for modern solutions and life insurance is no exception. To address today’s concerns, life insurance has become a very multi-functional product. In these uncertain market times, guaranteed death benefits have become a major subject of discussion for clients. Clients are worried about the effects of inflation during retirement or outliving their income. The need for long-term care (LTC) is on the increase as our population ages and medical technology improves. This article will take a look at the new variable life insurance contracts that can offer your client financial protection for their family, cash accumulation for potential supplemental retirement income, features that offer terminal illness funds, and riders that help fund LTC costs - all with one product.

As your clients’ lives change through marriage, birth of a child, or job promotion etc., so will their life insurance needs. Choose strategies and products that are suitable for long-term life insurance needs and weigh your clients’ objectives, time horizon, and risk tolerance as well as any associated costs before investing. Also, market volatility can lead to the need for additional premium in the policy.  Variable life insurance has costs of insurance vary with the insured’s gender, health, and age; underlying fund charges and expenses; and additional charges for riders that customize a policy to fit your clients’ needs.

Keep in mind that both loans and withdrawals obviously reduce the immediate cash value of the policy and the death benefit. They can also cause the need for additional premiums, later on, to keep the policy in force. Make sure that your clients’ life insurance needs continue to be met after taking money from their policies. Finally, since the LTC rider payout is an acceleration of the death benefit, it will reduce the death benefit dollar for dollar. Depending on the product, policy cash values may be reduced. In other cases, only cash surrender values are reduced. Make sure that your clients’ life insurance needs continue to be met even if the rider pays out in full. There is no guarantee that the rider will cover the entire cost of the insured’s long-term care since they vary for each insured.

Times Have Changed For Considering VUL

Until recently, variable universal life insurance was for clients with a relatively high risk tolerance. Due to the lack of guarantees, owning VUL required a strong stomach to withstand the roller coaster-like ride of the market. But times have changed. VUL products are now available for clients who want to enjoy the potential gains of the market, but don’t want to risk their death benefit lapsing due to poor cash value performance. The client can purchase an optional extended death benefit guarantee (EDBG) rider that provides a guarantee period from 20 years to a lifetime and allows the client to protect from 50% up to 100% of the total death benefit.

These riders are also easy to explain. Your death benefit is guaranteed if you pay the required premium. Most EDBG riders offer unlimited catch-up provisions that just require you to pay the exact amount of past premiums missed; no penalties or lost interest need to be figured in. There is a charge for the EDBG rider and a higher premium is required to fund the policy. But, with positive market performance, that higher premium may result in cash accumulation that can provide supplemental income in retirement years.
 
Will Your Clients Outlive Their Income In Retirement?

According to the Social Security Administration, 50% of all Americans sign up for Social Security benefits at age 62. A study by Senior Capital Services.net shows that, if both spouses are still alive at age 65, one of them has a 50% chance of living to age 92. That means that a retiring couple may have to face the prospect of having enough income to last at least one of them through 30 years of retirement. Between inflation and the potential to outlive income, deciding how these obstacles can be overcome should be part of the retirement planning discussion.

One potential solution is the use of VUL. In addition to the life insurance coverage provided, VUL allows clients to invest additional dollars in the contract and the cash value will enjoy tax-deferred treatment. Additional dollars invested, which are not needed to support the death benefit, are not subject to cost of insurance charges. They are subject to loads associated with premiums. These dollars have the potential for tax-deferred growth and the client has the potential to take tax-free income as long as the policy stays in force and is not a modified endowment contract (MEC).

Under the current Internal Revenue Code, cash value within a life insurance contract accrues tax-deferred. However, in most situations, a client can get income from a cash value life insurance contract income tax-free. This assumes the contract qualifies as life insurance under Internal Revenue Code (IRC) Section 7702.  Most distributions are taxed on a first in/first out basis as long as the contract meets the non-MEC definitions of IRC Section 7702A. Surrender charges may apply to partial surrenders. Loans and partial surrenders from an MEC are generally taxable. Also, if taken prior to age 59½, they may be subject to a 10% tax penalty. Loans and partial surrenders will reduce any death benefits payable. Suppose your contract lapsed with an outstanding loan. The loan amount, in excess of basis, would be treated as a distribution. All of it or a portion would be subject to income tax. Some contracts offer riders to help prevent lapse when policy is over-loaned.

Better yet, there are no pre-59 ½ penalties for taking income early as long as the policy is not an MEC. So this may be a good source of supplemental income for a person who wants to retire early. Clients can still plan to use traditional retirement income sources, such as Social Security, 401(k) assets, pension plan income, IRAs and annuities. However, the potential to take tax-free income from the VUL can be an added source of retirement income or a tax-efficient source that will allow for deferring the use of taxable sources of income. In addition, if living too long becomes an issue, the client can take income from the life insurance contract long after retirement begins. In this case, the income stream would replace other income sources that have ended or no longer supply the income needed to retain a desired style of living.
 
Funding Terminal Illness Costs With VUL

Terminal illness is not a pleasant topic, but, as part of a financial planning discussion, it would be wise to explain how a terminal illness could be funded. Many variable life insurance policies allow part of the death benefit to be paid in an accelerated manner when the insured is diagnosed with a terminal illness. How this feature works varies among companies, but a common scenario is for a company to require certification that the insured has 12 months or less to live. Part of the death benefit then becomes available. Some companies cap the maximum dollar amount (tax free) to help with medical or other expenses associated with the terminal illness. Even if the insured is able to pay the bills, they may want to take advantage of this feature to help fund any last wishes they may have.
 
VUL Riders Can Help Fund LTC

An LTC rider is another living benefit that can be added to the VUL contract, usually at an additional charge. Discussions about long-term care are not just for your pre-retirement clients. Forty percent of those who need long-term care are 18 to 64, according to a report by the Dept. of Health and Human Services (HHS). That statistic may be a reason to bring up long-term care with younger clients. Some clients are resistant to purchasing a stand alone long-term care policy, but they may be open to adding a LTC rider to their life insurance policy. Many older clients resist purchasing long-term care policies as well, often due to the use it or lose it argument. But keep in mind that HHS also stated that at least 60% of people over 65 will need long-term care services at some point in their lives. For couples over 65, there is a 70% chance that one partner will need long-term care, according to PrepSmart.com.

Adding an LTC rider to life insurance may be a more agreeable solution. With most companies, there is a 90-day elimination period and the benefit is paid tax-free via an accelerated death benefit. Some companies pay the LTC benefit -indemnity-style directly to the owner of the contract, requiring no bills or receipts to be submitted. Other companies pay via a reimbursement plan, requiring bills and receipts to be submitted each month, then reimbursing the contract owner for bills already paid or the facility for the bills the insured has incurred.

The insured qualifies by having the inability to perform two activities of daily living (ADL) or having severe cognitive impairment. If long-term care is never needed or not all the funds are used, most companies will pay the remaining death benefit to the beneficiaries federal income-tax-free, although estate taxes may apply. Provisions with these riders vary greatly among life insurance companies, so please review company contracts for specific details. Our life insurance needs and our circumstances change as we age. A  life insurance policy with an LTC rider can continue to provide protection against long-term care costs during the retirement years even after the mortgage is paid off and college educations are paid for.

Conclusion

You can get all the features we’ve discussed in this article in one insurance product. Some companies are now offering life insurance products that provide wide-ranging protection that can be customized to your client’s needs. Using a variable universal life insurance contract as part of your clients’ diversification strategy may provide the death benefit protection they need and the guarantees they are looking for. In addition, VUL may provide tax- efficient investing, tax-preferred income, and lifetime benefits that may be delivered in a tax- efficient manner.
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Shawn Britt, CLU, is a Senior Advanced Sales Consultant with Nationwide Financial Services (NYSE:NFS) in Columbus, Ohio. She may be reached at britts@nationwide.com.