Benchmark Based Life Insurance and Annuities
The stock market crashes of 2000–2002 and 2008–2009 have made many people less tolerant of investment volatility. In response, some insurance companies and financial advisers are suggesting so called “index” products that reduce downside exposure. These products may or may not be suitable for you; as always, you should consider the details carefully before making any commitments.
Index universal life
These policies are a form of permanent life insurance. You pay a substantial premium, a portion of which goes into a savings component, sometimes called the cash value. In this respect, indexed universal life (IUL) insurance resembles whole life, universal life and variable life insurance.
The difference between IUL and the others lies in the way your cash value grows. That growth is tied to an index such as the S&P 500, or to a mix of various indexes. If the relevant benchmark goes up by, say, 7% in a 12-month period, your cash value might increase by 7%.
As straightforward as that might seem, IUL policies can be complex. Often, cash value growth is capped in some manner. In return, your cash value typically is shielded from market losses. Proponents argue that this product design (possible upside with scant downside) will result in substantial growth over the long term. Eventually, perhaps after you retire, you can take tax-free policy loans.
Once you sort out all the details, you might consider IUL if you have a long-term need for life insurance.
Fixed index annuities
People who do not need additional life insurance but who want supplemental retirement cash flow can evaluate fixed index annuities (FIAs). These are deferred annuities, so the basic tax rules apply. No income tax is due on buildup within the annuity contract. Withdrawals are on a LIFO basis (last in, first out), meaning that you’ll owe tax as long as you’re withdrawing untaxed earnings. Alternatively, you can annuitize the contract and receive a stream of income, perhaps over your entire life, and spread out the tax obligation.
Again, with an FIA, the contract growth is pegged to one or more market indexes. You sacrifice some potential accumulation in return for protection against loss if the index declines.
IUL policies and FIAs are offered by many insurers, and the fine print varies greatly, from company to company. Our office can help you determine whether a particular offering provides a desirable mix of risk reduction and growth potential.
- Most distributions from deferred annuities before you reach age 59½ are subject to an additional tax of 10%.
- This 10% tax applies to the part of the distribution that you must include in gross income.
- The additional tax does not apply to any part of a distribution that is taxfree, such as amounts that represent a return of your cost.