Variable Universal Life - How to Flex and When?

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Mike83
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Variable Universal Life - How to Flex and When?

Post by Mike83 »

Variable Flexible Universal Life. Optimizing the Investment.

I know that this type of policy is typically advised against here, and I understand those arguments, so I respectfully ask holding judgement and instead contributing any knowledge you might have on the specific issue of flexing the investment parameters of an existing VUL policy.

I have this policy because of a past need to insure a buy-sell (on death) agreement for a business. The buy-sell rationale is no longer relevant, and I now own the policy on my own life.

current values in round numbers...
500k Face Value
600k Surrender Cash Value
1M Death Benefit

Never had a surrender penalty, 10 years into the policy, and the insurer is a well respected fair-cost provider.

I am at the threshold of passing the maximum joint exemption for the application of the estate tax under current IRS rules, and likely have a 10-15 yr runway before leaving this mortal coil. Investment is 100% SP500 at 0.04% ER, and yes I've had a good run. Future personal tax rates are max, and medicare penalties are almost max.

I am and have always been maxed out in all the usual tax advantaged accounts. Given the estate tax benefit and the tax free growth of the investment, at this point I consider it a decent investment vehicle. I realize I may need an ILIT to get the estate tax bypass.

On to my questions...

I understand I can manipulate three parameters of this investment (although I have never done so):
Death Benefit
Premium
Cash Value

...and I also understand they affect each other in mysterious ways and that there are guardrails on over-funding to avoid a thing called MEC, which if triggered would mess up the tax benefits of the investment.

My uninformed first impulse is to start a conversation with the provider about maximizing my premium contribution while minimizing the death benefit face value, without violating the MEC guideline. This would maximize the tax-sheltered growth, I think.

How does one actually go about optimizing these parameters? I do have some confidence that the provider will offer credible advice but I would like to know what *I* should be aware of going into the conversation.

And a follow up question for folks here...

Aside from the above consideration of optimizing the ongoing investment, what is an optimal target as I approach final destination? Minimal face value - since I don't need it? Maximum cash value? Are premiums irrelevant - since I can afford them? Put another way, if I become sickly ten years hence, can I and should I radically change the face value, cash value or premium?

Thanks for all the fish!
bsteiner
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Re: Variable Universal Life - How to Flex and When?

Post by bsteiner »

You could instead give other assets to the trust that you’re considering creating.
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Stinky
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Re: Variable Universal Life - How to Flex and When?

Post by Stinky »

The first thing I’d want to do is to see how my VUL contract, without modification, compare to a similar investment outside the VUL. That is, how does growing my investment inside the VUL compare to growing them outside the VUL. If the VUL looks more favorable, I’d want to keep it; if not, I’d want to surrender it and invest the proceeds in a regular taxable account.

To do this, I’d take the following steps:

—- Obtain an “in force illustration” from the carrier at a certain assumed earned rate. Say 6% gross earned rate.

—- Ask the carrier what the tax basis is in your policy. Use this information to calculate the “tax gain” if you were to surrender the policy now, and the taxes you would pay at your marginal tax rate.

—- Construct a spreadsheet comparing keeping versus lapsing the policy. Presuming that you’d want to keep the policy until death, the proper comparison is death benefit on the policy versus accumulated amount of investment in a taxable account. The spreadsheet will show you the year by year comparison.

In the “keep the policy” column of the spreadsheet, show the death benefit amount for every future year.

In the “surrender the policy” column of the spreadsheet, show the accumulation of the surrender value, net after taxes paid at the time of surrender. For example, if the surrender value is $600k and you will owe $50k in income taxes at time of surrender, start the column with $550k. Increase the column year by year at the same earned rate (say 6%), with a reduction of some amount for taxes you’ll pay on dividends. Assuming a dividend rate of 2% and a tax rate on qualified dividends of 20%, that would be a reduction of 0.40% in the earned rate.

—- Compare the two columns. In the early years, it’s certain that the benefit at the time of death would be larger in the “keep the policy” column, because of the explicit death benefit on the VUL policy. However, the real test will be in spreadsheet years 10, 20, and later, as the internal charges on the policy increase as you age. It’s possible that the taxable account will pull ahead of the VUL policy in the later years. You simply won’t know how the alternatives compare until you run the numbers.

—- Now that you’ve constructed a spreadsheet template, you can do some “what if’s”. For example, what if the gross earned rate is 3%, or 0%, or lower? (You’ll need to ask the insurance company for more inforce illustrations). Another thing - what is the necessary earned rate to keep the policy from lapsing?

—- As to changing your VUL policy, ask the insurer what the MEC limit is, and use your spreadsheet to see what would happen if you funded to the MEC level or beyond.

You also ask about changing the insurance amount. Please realize that increases in the insurance amount require evidence of insurability. So you can’t have a major health downturn and expect to be able to increase your insurance.

Post back with questions.
Retired life insurance company financial executive who sincerely believes that ”It’s a GREAT day to be alive!”
Rex66
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Re: Variable Universal Life - How to Flex and When?

Post by Rex66 »

There are estate tax benefits
Those are all with the ILIT. Any irrevocable trust wound provide similar.
It grows tax deferred. Yes the death benefit is tax free but that’s like saying my Berkshire stock grows tax free. It does not. Both get a step up basis at death.
You don’t seem to understand why someone wants to avoid MEC. If you actually are planning to use for estate then maybe you want to MEC it if they will let you. Also you seem to indicate you have lower expected life span. If so especially compared to original ratings then you want to do the exact opposite bc you typically don’t keep both the csv and death benefit. You sort of want it under funded if you really know you will die soon.
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Mike83
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Re: Variable Universal Life - How to Flex and When?

Post by Mike83 »

Thank you @Stinkey for the detailed explanation of valuation. I had something like this done for me when I did a 1031 exchange of the prior buy-sell policy for this one. I'll get some in-force illustrations and try the modeling out, or find someone to do it. Again many thanks.
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Mike83
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Re: Variable Universal Life - How to Flex and When?

Post by Mike83 »

Thank you @Rex66.I'll be having a conversation next month on the ILIT pros/cons with an estate attorney. Thoughts that you and folks here have contributed are my prep for those conversations. Sorry for sounding morbid but those estimates were just average life expectancy at this point with a bit of family history tossed in. Yes MEC is a black box to me. When researching VUL there is tremendous opinion (and pitches) on cons and pros, as well as discussions on purported flexibility. But there is really no readily available guidance of how and why to put that flexibility into practice for a particular goal.
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Stinky
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Re: Variable Universal Life - How to Flex and When?

Post by Stinky »

Mike83 wrote: Mon Nov 22, 2021 9:18 pm Thank you @Stinkey for the detailed explanation of valuation. I had something like this done for me when I did a 1031 exchange of the prior buy-sell policy for this one. I'll get some in-force illustrations and try the modeling out, or find someone to do it. Again many thanks.
It sounds like you had a good, business related reason to purchase a VUL policy initially.

Now, it makes sense to see whether it’s better to keep the policy with the intention of beneficiaries eventually collecting a death benefit, or surrendering the policy and reinvesting the proceeds. There’s no way to know that without running the numbers.

Let us know if you need any help as you walk through the process.

Best to you.
Retired life insurance company financial executive who sincerely believes that ”It’s a GREAT day to be alive!”
Topic Author
Mike83
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Re: Variable Universal Life - How to Flex and When?

Post by Mike83 »

Update: After a few conversations with carrier, we determined my premiums are currently running at the limit imposed by MEC, so no additional premiums can be made....

unless

I acknowledge intentionally crossing the MEC guardrails. Then a conversation about what the carrier may accept in terms of a face value change and medical underwriting, vs premium.

I did locate a Kitces article that explains the general tradeoff, within MEC guardrails, of maximizing or minimizing premium benefits:

https://www.kitces.com/blog/universal-l ... d-csv-irr/

It looks like the time to strategize this is when the policy is being formed (duh), not later. My option now is to have an informed conversation, thanks to the advice offered here, with my trust attorney and CPA.
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Stinky
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Re: Variable Universal Life - How to Flex and When?

Post by Stinky »

Mike83 wrote: Mon Dec 06, 2021 9:48 pm Update: After a few conversations with carrier, we determined my premiums are currently running at the limit imposed by MEC, so no additional premiums can be made....

unless

I acknowledge intentionally crossing the MEC guardrails. Then a conversation about what the carrier may accept in terms of a face value change and medical underwriting, vs premium.

I did locate a Kitces article that explains the general tradeoff, within MEC guardrails, of maximizing or minimizing premium benefits:

https://www.kitces.com/blog/universal-l ... d-csv-irr/

It looks like the time to strategize this is when the policy is being formed (duh), not later. My option now is to have an informed conversation, thanks to the advice offered here, with my trust attorney and CPA.
Thanks for the update.

It sounds like you’ll be getting some solid professional advice.

Let us know if we can be of any help.
Retired life insurance company financial executive who sincerely believes that ”It’s a GREAT day to be alive!”
Rex66
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Re: Variable Universal Life - How to Flex and When?

Post by Rex66 »

you should be prepared that its highly likely that neither of those individuals will know what to do. I find that they quickly tell you to ask the agent and insurance company which isnt going to get very far.

Agents never go into the end game when you buy these because if they did and fully explained all the details (which they frequently dont know or understand) then you likely wouldnt buy the policy. You likely would have eventually realized that you could have done better from the get go with term and investing and it would have worked with your business interests too.

It is always interesting that one has to rely on what the company says is within MEC limits or how far over they will or wont go. No two companies use the exact same criteria for what they will allow. For sure there are the criteria listed in that article for MEC but each company decides on its own how close they allow you. They actually dont want to allow you too close bc then there are less insurance charges which means less money for them. They have to compete with other companies in this space so they cant just ignore it.

One additional thing for you to consider. VULs become much more risky as you get older if you sort of compare them in the way stinky mentioned earlier. This is because the cost of insurance is directly related to the amount at risk (difference between death benefit and current CSV). So for instance you are doing great and now have a 2 million dollar death benefit with 1.5 million CSV. Only thing is the investment part goes to the hell for a few years. So the CSV drops to 500k or whatever. Now it would probably just bounce back in a few years but during those years the cost of insurance sky rockets which puts even more pressure on the csv. This is because you are now older AND bc of the difference of amount at risk. It can take a lot of management or you end up lapsing. When you invest outside of a VUL, you have the small ongoing yearly tax drag, but you dont take on this risk.
Makefile
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Re: Variable Universal Life - How to Flex and When?

Post by Makefile »

Rex66 wrote: Tue Dec 07, 2021 4:59 pm One additional thing for you to consider. VULs become much more risky as you get older if you sort of compare them in the way stinky mentioned earlier. This is because the cost of insurance is directly related to the amount at risk (difference between death benefit and current CSV). So for instance you are doing great and now have a 2 million dollar death benefit with 1.5 million CSV. Only thing is the investment part goes to the hell for a few years. So the CSV drops to 500k or whatever. Now it would probably just bounce back in a few years but during those years the cost of insurance sky rockets which puts even more pressure on the csv. This is because you are now older AND bc of the difference of amount at risk. It can take a lot of management or you end up lapsing. When you invest outside of a VUL, you have the small ongoing yearly tax drag, but you dont take on this risk.
I've always understood these to be designed for investment yet enough of a life insurance policy to pass as one and gain the income tax exemption for life insurance (which might go all the way back to 1913?)

Seems like they made a lot of sense for the high marginal tax rates of the 1930s-1970s and lack of tax-deferred or Roth space. In theory, if an investor today had (for some reason...) little or no Roth space available, they might regain some appeal?
123
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Re: Variable Universal Life - How to Flex and When?

Post by 123 »

VUL uses annual renewable term (ART) to fund the insurance component. As a consequence the cost of the insurance goes up every year. If the premium you pay (or don't pay) is insufficient to cover the ART insurance cost the cost is taken from the cash value.
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Rex66
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Re: Variable Universal Life - How to Flex and When?

Post by Rex66 »

123 wrote: Tue Dec 07, 2021 5:12 pm VUL uses annual renewable term (ART) to fund the insurance component. As a consequence the cost of the insurance goes up every year. If the premium you pay (or don't pay) is insufficient to cover the ART insurance cost the cost is taken from the cash value.
Its not just that....one also has to consider the difference between the CSV and the death benefit as one ages.

With fixed products WL, current assumption UL, and IUL, one doesnt have to worry about the CSV going down because of the investment performance and thus creating greater amount at risk for the insurance company.
Rex66
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Re: Variable Universal Life - How to Flex and When?

Post by Rex66 »

Makefile wrote: Tue Dec 07, 2021 5:09 pm
Rex66 wrote: Tue Dec 07, 2021 4:59 pm One additional thing for you to consider. VULs become much more risky as you get older if you sort of compare them in the way stinky mentioned earlier. This is because the cost of insurance is directly related to the amount at risk (difference between death benefit and current CSV). So for instance you are doing great and now have a 2 million dollar death benefit with 1.5 million CSV. Only thing is the investment part goes to the hell for a few years. So the CSV drops to 500k or whatever. Now it would probably just bounce back in a few years but during those years the cost of insurance sky rockets which puts even more pressure on the csv. This is because you are now older AND bc of the difference of amount at risk. It can take a lot of management or you end up lapsing. When you invest outside of a VUL, you have the small ongoing yearly tax drag, but you dont take on this risk.
I've always understood these to be designed for investment yet enough of a life insurance policy to pass as one and gain the income tax exemption for life insurance (which might go all the way back to 1913?)

Seems like they made a lot of sense for the high marginal tax rates of the 1930s-1970s and lack of tax-deferred or Roth space. In theory, if an investor today had (for some reason...) little or no Roth space available, they might regain some appeal?
Nope. This is because both permanent insurance and a taxable account both get a step up in basis at death.

A VUL only gets tax deferral compared to a taxable account which only has to pay a small amount on dividends at capital gains rates. Its a very small drag. You could i guess invest very tax inefficiently but there is no good reason to do that.

Loan costs on VULs are such that you very likely will pay more on that then you would with capital gains taxes if you sold some investments in order to access money while alive. You of course could also just loan against taxable if desirable.
Makefile
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Re: Variable Universal Life - How to Flex and When?

Post by Makefile »

Rex66 wrote: Tue Dec 07, 2021 5:36 pm A VUL only gets tax deferral compared to a taxable account which only has to pay a small amount on dividends at capital gains rates. Its a very small drag. You could i guess invest very tax inefficiently but there is no good reason to do that.
That makes sense. I also read WhiteCoatInvestor's analysis of these which was similar--only under specialized conditions did he feel the VUL was worth it.

But I suppose it could be different in a past environment of 70% or 50% tax rate (+ state), 15% bond yields, 8% dividend yields (and no qualified dividends), etc...
Rex66
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Re: Variable Universal Life - How to Flex and When?

Post by Rex66 »

Makefile wrote: Tue Dec 07, 2021 5:39 pm
Rex66 wrote: Tue Dec 07, 2021 5:36 pm A VUL only gets tax deferral compared to a taxable account which only has to pay a small amount on dividends at capital gains rates. Its a very small drag. You could i guess invest very tax inefficiently but there is no good reason to do that.
That makes sense. I also read WhiteCoatInvestor's analysis of these which was similar--only under specialized conditions did he feel the VUL was worth it.

But I suppose it could be different in a past environment of 70% or 50% tax rate (+ state), 15% bond yields, 8% dividend yields (and no qualified dividends), etc...
back then these products had enormous fees built into them.

I dont speak for Jim but years ago he seemed to have a lose association with one of the doctor financial firms that pushed this a lot (even though they denied it). I think he also has seen so many terrible ideas that a not so great idea he has become more acceptable. Its still pretty vague how it might work out better unless you make assumptions favoring insurance. Years and years ago i used to spend a decent amount of time on that site.

Going forward if you actually look at proposals (which never are going to happen), there is occasional consideration of removing tax benefits from life insurance so there isnt a good reason to think that all taxes will go to a direction that makes this appealing. Reason being is that if you look at actual dollars paid out, its all rich people. At that level they arent trying to grow their money.
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Re: Variable Universal Life - How to Flex and When?

Post by afan »

It is going to be difficult to get a meaningful illustration as long as the assets remain in the stock fund. The way VUL is often structured, the growth in the cash value depends not only on the average return of stocks but the actual temporal pattern of returns. If your policy caps your gains and losses, then the same average return over years for the market could give you different returns on the policy.
If you want to make it predictable, you could model putting the money into their general account fund, if that is an option. Or into bonds with expected return equal to the current yields.
It is possible that you have the option to reduce the death benefit, along with reducing your premiums. Although reducing premiums sounds counter to what you would want, it might let you get the amount at risk down to such a low level that you do not run a risk of high costs later in life. You may also be able to change the policy so that it remains life insurance but the amount at risk is not fixed but can actually go down as the cash value increases. These are options to discuss with your agent.

As you seem to know, getting the policy into the ILIT will require a gift and a gift tax return. You should check with your lawyer about whether the gift of the cash value to the trust will require gift taxes the year you make it. Also check about the GST tax.

If you can get the money into an ILIT and make the appropriate adjustments to the policy then it may be a good way to transfer assets to your heirs.
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