Draining a VUL Insurance Policy
John Kristian
from a VUL (Variable Universal Life) insurance policy, and
also reducing its death benefit sharply? Assume the policy
doesn't lapse; that is, premiums are paid as needed to cover
expenses and loan interest.
Does California taxation of a VUL policy parallel Federal
taxation? What about other states? In particular, does the
state tax money borrowed from the policy (secured by its
accumulation value)? Such loans are free of Federal tax, I
think. How about withdrawal of paid premiums? The IRS
considers this a tax-free return of cost basis to the policy
holder, I think.
I'm thinking about buying a VUL policy as a retirement fund.
I don't need insurance. I plan to pay maximum premiums
(short of making it a Modified Endowment Contract) for ten
years or so. Then I'll stop paying premiums, and reduce the
death benefit as much as possible (thereby reducing
insurance expenses, since the insurer has less at risk).
Then, during retirement, I'll withdraw the premiums I paid
and borrow most of the remaining accumulation value. Most
of the death benefit will go to repay the loan.
The money will come out of the policy tax-free, I think. Am
I mistaken? There's an ominous statement in the prospectus
of one policy:
"A policyowner may decrease the minimum death benefit ...
This may affect the cost of insurance rate and the Net
Amount at Risk (that is the amount by which the death
benefit exceeds the accumulation value), both of which may
have Federal Tax consequences."
What consequences?
If the policy gets close to maturity, I plan to add the
rider to extend maturity indefinitely, which also stops
insurance expenses (by reducing the death benefit so the
amount at risk is zero). But there are ominous statements in
the prospectus about this:
"This rider is not available in all states. The Internal
Revenue Service has not issued a ruling regarding the tax
consequences of this rider."
What's the issue? Any idea what IRS might do? Would it
also apply to my plan to reduce the death benefit after I
stop paying premiums?
Finally, is IRS likely to pull the rug out from under this
house of cards in my lifetime (say 40 years)? Pure
guesswork, I know, but your guesses are more educated than
mine. If I worked for IRS, I would try to plug this
loophole. <grin>
I know that a 401(k) or Roth IRA is better (I'm funding them
to the limit, already), and that the expenses are a steady
drag on investment performance. It still beats long-term
capital gain.
The best policy I've seen is Ameritas Flexible Premium
Universal Life. Its expenses are (in summary):
taxes: 3.5% to 5% of premiums paid
administration: $27 to $54 per year
insurance: amount at risk (death benefit - accumulation
value) multiplied by an actuarial number
(under 1%)
mortality: 0.75% to 0.9% of subaccounts (accumulation
-loans)
management: 0.2% to 0.48% of subaccounts
loan interest: 0% to 0.5% of loans (after adding return on
fixed-interest collateral account)
Can you recommend a better one? A guaranteed 0% net
interest rate on loans would be an improvement, for me.
Bill Brown
> . Its expenses are (in summary):
>
> taxes: 3.5% to 5% of premiums paid
> administration: $27 to $54 per year
> insurance: amount at risk (death benefit - accumulation
> value) multiplied by an actuarial number
> (under 1%)
> mortality: 0.75% to 0.9% of subaccounts (accumulation
> -loans)
> management: 0.2% to 0.48% of subaccounts
> loan interest: 0% to 0.5% of loans (after adding return on
> fixed-interest collateral account)
Unless I don't understand something, there is no way the
"insurance" can cost any where close to "under 1%" when
you get older. That may be a real number when you are
40-50, but at 70, it would be magic.
John Kristian
> ... there is no way the "insurance" can cost any where
> close to "under 1%" when you get older. That may be a
> real number when you are 40-50, but at 70, it would be
> magic.
You're quite right; the actuarial factor of the insurance
cost rises with age. Sorry I didn't say so.