This is the second half of an article setting out what the author says are the tax and value-building qualities of life insurance in the various forms in which it operates in the US.
As FWR readers know, lawmakers in Washington DC are pushing for tax hikes on capital gains, estate and income taxes, among others. Whatever the rights and wrongs of these measures, tax mitigation is at the top of the wealth management agenda. In this detailed article, the author examines the life insurance toolbox.
The writer is Andreas Stuermann, president of Stuermann Consulting, a firm which specializes in designing, implementing and administering life insurance solutions for individual and institutional clients.
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Choosing the policy
Two types of cash value life insurance policies provide wealthy individuals with the structure and flexibility to integrate into a tax diversification strategy: (1) General Account Life Insurance, including traditional whole life (“WL”), universal life (“UL”) and indexed (“IUL”); and, (2) Separate Account Life Insurance in the form of variable universal life (“VUL”).
General account cash value life insurance policies place most of the investment risk underlying a policy’s performance with the insurance company. The insurance company makes either all or most of the investment decisions, choosing mainly to invest into high quality intermediate fixed income securities, leaving a policyholder to accept a share of the relatively conservative and stable returns. Clients seeking separate account life insurance policies are typically seeking to adopt more of the performance risk by making investment selections from a life insurance company’s platform of professionally managed sub accounts by major fund companies. While VUL contracts historically had little in the way of downside protection, new iterations allow the policyholder to purchase guarantees to either or both the performance of the cash value and death benefit.
How much risk an individual will assume is a key component to evaluating a financial strategy that includes cash value life insurance. A bearish client is likely best suited for either a WL or UL policy that provides the greatest safety, but the least opportunity for growth. Someone who is bullish may find a VUL policy that offers the greatest opportunity for growth with the opportunity to participate in the market best option.
Clients who identify as in between bearish and bullish might find IUL meets their tolerance. UL offers a balance between VUL on one end of the spectrum and UL and WL on the other, offering greater growth potential with an indexed account than with a fixed account. It also offers downside protection from negative market returns with a guaranteed floor.
“It is important clients have a deep understanding of how a policy works and should perform,” says Rice. “For instance, when considering a variable insurance contract, the client should know that much of the investment risk supporting the policy is being shifted from the insurance company to the client. This differs from general account policies like traditional whole life and universal life where the insurer retains most or all of the investment risk.”
When evaluating cash value life insurance policies, stress
testing is recommended to see how the policy is projected to
perform in various return and insurance cost scenarios; it never
hurts to look at best- and worst-case scenarios. A review of the
carrier’s financial ratings and its treatment of existing
policyholders along with understanding the contractual rights of
the policy-owner should also be conducted to ensure informed