Do you find that people are seeking the death benefit protection offered by life insurance while also looking for a little bit more? Often times, the “more” is about potential cash surrender value growth within permanent life insurance. Cash surrender value could provide clients with options down the road should they need to access it, but how do your clients go about accessing potential cash surrender value?
Should your clients use withdrawals, loans, or maybe a combination of the two? In order to make an informed decision as to what might be best for your clients needs we need to understand the difference between withdrawals and loans.
Defining Loans and Withdrawals
A loan (standard or variable interest rate loan) does not reduce the account value. A loan is a stand-alone transaction where the policy account value is held as collateral and is subject to available cash surrender value. There is a reduction in cash surrender value and death benefit until repaid, but since it does not reduce the account value, your clients earn interest credited to a larger amount making compound growth potentially much stronger.
A withdrawal is a partial surrender of the net cash surrender value resulting in a reduction in the face amount and the account value of the policy. Clients can withdraw money from the account value, subject to the available net cash surrender value, but withdrawals in excess of the basis (cumulative premium amount) can be taxed. It is important to note that any interest earned is credited to the account value of the policy. So by taking a partial withdrawal, clients are lowering the account value and lowering the amount to which interest is earned.
Take a look at these three hypothetical examples. The samples use the exact same variables except in how the cash value is accessed. A 45 year old male, Preferred Non Tobacco, Builder IUL® indexed universal life insurance, $250,000 face amount, interest rate projection of 7%, a premium of $4,700/yr (near the guideline level maximum) for 20 years and followed by 20 years of distributions.
In the first example below, we’re showing a withdrawal to basis and then variable interest rate loans of 6%. (For perspective, we included an example (Example 3) using standard loans only so you can see how this scenario compares.) In the first example, notice the reduction in account value when the withdrawal is taken.
In the second example, we a variable interest rate loan at a cap of 6%. Notice the significantly higher account value after the loan is taken.
With the variable interest rate loan-only option, a client is able to take out nearly $1,500/yr more in distributions! Also, note the large difference in all policy values after 20 years—the loan-only option has over double the account value, over double the surrender value, and over double the death benefit!
The third example shows the standard loan option.
It’s important to know the effects of withdrawals and loans on the policy and why the variable interest rate loan might perform better. The illustrations below illustrate how using withdrawal and various loan options differ when put on the same foundation.
In some situations loans and withdrawals may be subject to federal taxes. Clients should be instructed to consult with and rely on their own tax advisor or attorney for advice on their specific situation.
Income and growth on accumulated cash values is generally taxable only upon withdrawal. Adverse tax consequences may result if withdrawals exceed premiums paid into the policy. Withdrawals or surrenders made during a Surrender Charge period will be subject to surrender charges and may reduce the ultimate death benefit and cash value. Surrender charges vary by product, issue age, sex, underwriting class, and policy year.
The net cost of a variable interest rate loan could be negative if the credits earned are greater than the interest charged. The net cost of the loan could also be larger than under standard policy loans if the amount credited is less than the interest charged. In the extreme example, the amount credited could be zero and the net cost of the loan would equal the maximum interest rate charged on variable interest rate loans. In brief, variable interest rate loans have more uncertainty than standard policy loans in both the interest rate charged and the interest rate credited.
The information presented is hypothetical and not intended to project or predict investment results. Illustrations are not complete unless all pages are included.
Index Universal Life products are not an investment in the “market” or in the applicable index and are subject to all policy fees and charges normally associated with most universal life insurance.