The Spectrum of Permanent Life Insurance Products
Explaining the variety of key permanent life insurance products
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What is the point of Life Insurance?
Permanent life insurance policies differ slightly in their design and function, but all have the same main attributes: they are intended to last the lifetime of the insured and contain a cash value and a death benefit.
A policy’s cash value is where premiums are invested after insurance and other policy costs are withdrawn. At the death of the insured, a policy’s listed beneficiary is entitled to receive the death benefit tax-free.
The U.S. Treasury provides a definition of life insurance in Internal Revenue Code §7702. Within this section, there are tests a policy must meet so that both the policy’s cash value and its death benefit are compliant and can receive tax advantages. One test requires a minimum amount of death benefit for every dollar invested in a policy. This difference between the policy’s cash value and its death benefit is known as the policy corridor and differs based on several criteria including the insured’s age, gender and health.
If the §7702 tests are satisfied, the cash value can 1) grow tax-deferred, 2) be accessed tax-preferred, and 3) the death benefit can be received income tax-free.
Learn more about the point of life insurance in our previous blog post.
How do different life insurance products work?
Whole Life (WL)
WL is the life insurance industry’s core product and is traditionally sold by the big mutual life insurance companies, including MassMutual, Northwestern Mutual, Guardian, New York Life and Penn Mutual.
A mutual is an insurance company that is owned by the policyholders and not stockholders. As the owner of a WL product, the cash a policyholder invests in the policy is eligible to receive dividends from the insurer. Those dividends are a function of how the insurer invests premiums paid and shares the returns. Traditionally these dividends highly correlate to the Moody’s BBB bond index, which makes sense as the big mutual insurance companies are a core player in the US bond market.
The life insurance dividends can be received in the form of cash, utilized for the purposes of lowering premium payments, or left in the policy’s cash value to earn interest tax deferred.
The cash value build-up in WL has two components:
A guaranteed fixed rate of return which is usually around 2-3%; and,
An annually declared variable dividend on the excess money the mutual has after paying its expenses.
It is very rare to receive just the guaranteed rate, and this has only happened once in the last few decades. However, the predicted dividend will vary based on markets, inclusive of the interest rate environment.
WL has some other key attributes:
The Cost of Insurance (COI) the insurer charges to provide the death benefit are set and guaranteed from the beginning of the policy.
The premiums are fixed. The policyholder agrees to a premium schedule and, as long as those premiums are paid according to that schedule, the guarantees remain in place.
Most insurers offering WL allow the policyholder to borrow against a policy’s cash value while still letting the principal grow, potentially an advantage over borrowing elsewhere.
Flexible Premium Universal Life (UL)
UL was introduced to allow for more flexibility in payment schedules. As long as there is cash value available to meet insurance and other policy costs, the policy will continue. Delaying or skipping premiums is an attractive benefit; though, it is important to understand that since insurance costs increase as the insured gets older, it may be a good idea to fund a UL policy as designed in early years. This flexibility is typically offset by a lack of guaranteed premiums in the event that the crediting rate or cost of insurance charges vary. A policy’s cash value grows via a crediting rate that is typically guaranteed for one year once declared.
Flexible Premium Guaranteed Universal Life (GUL)
GUL combines the ability to have a guaranteed death benefit with premium payment flexibility. While the costs are slightly more to create a guaranteed death benefit for the policy, the security of this guarantee may mitigate a decrease in the insurer’s cash value crediting rate. Policy premiums are calculated so that the death benefit guarantee lasts until a target age, often to a determined maximum age (e.g. guaranteed to age 100 or age 121.) As with UL, GUL policies also have a guaranteed minimum crediting rate.
Indexed Universal Life (IUL)
IUL offers the possibility for greater policy performance by achieving a higher rate of return than UL. Instead of the insurer determining a crediting rate, cash value growth is linked to one or more indices, such as the S&P 500. To mitigate the potential for significant negative returns, IUL policies have guaranteed performance floors and maximum performance caps that can be adjusted by the insurer to meet market conditions. Currently cash value performance floors are set between 0% and 2% with caps in the neighborhood of 9% to 12%.
Guaranteed Indexed Universal Life (GIUL)
GIUL is a version of IUL where the insurer offers a guaranteed death benefit. The costs associated are higher in order to ensure the guarantee. As with GUL, policy premiums are calculated so that the death benefit guarantee lasts until a target age, often to a determined maximum age.
Variable Universal Life (VUL)
VUL is considered a security and regulated not only at the state level along with whole life, UL, GUL, and IUL but is also regulated by the Securities & Exchange Commission. In addition, those selling VUL are regulated by FINRA and must pass a series of examinations and be supervised by a broker-dealer. A primary reason for this oversight is that the cash value of a VUL policy is determined by performance from the underlying investment choices in which the cash value is invested.
Essentially, VUL functions as a ‘tax wrapper’ around a choice of investments offered on an insurer’s platform. Many VUL policies permit the policyholder to purchase performance guarantees to help mitigate potential investment losses.
Guaranteed Variable Universal Life (GVUL)
GVUL is similar to GIUL in that costs are charged to ensure a guaranteed death benefit. Because the carriers may have less reserve requirements since the cash is held in a separate account, there are times when the guarantee can be higher than both GUL and GIUL. It is always imperative to compare guarantees across all product choices.
Survivorship
All of the products listed can insure one or two lives. In the instance of insuring two lives, the death benefit is paid at the death of the second insured. Known as survivorship policies, insurance costs can significantly reduce insurance charges because costs are based on the mortality statistics of two insured dying.
Survivorship policies, which often have versions with a death benefit guarantee, are commonly purchased for estate planning. Since a married couple can pass assets tax-free to one another at death, liquidity to pay estate taxes is not due until the death of the second spouse. A survivorship policy is designed to provide that liquidity.
How do you choose from the many options?
While one of the life insurance products outlined might stick out to you, it’s imperative that you align your life insurance policy with your financial goals. Moreover, the nuances of each of these life insurance products differ across carriers, so one carrier might have more favorable terms for your goals than an other. No human alone can integrate your financial goals and compare across hundreds of thousands of policy outcomes across top carriers, and consistently give the best, most personalized recommendation.
This is why we built Optifino. We built a proprietary optimization engine to input your financial goals and identify the best policy portfolio for your life stage. We will help you quickly identify the best options for your goals, and educate you along the way to ensure you feel confidence and peace of mind in the decision you make. We also continue to provide an industry-first aftercare to annually review if the policy performance stays in alignment with your goals. Nobody else will help you accomplish your financial goals with the power of life insurance like we will. Get in touch and let us help you maximize tax protection, accomplish your financial goals, and build your family legacy!