Indexed UL-funded retirement income: 9 questions answered

Hersch: How have IUL products evolved since they were first introduced a decade ago?

Konopik: When they rolled out the first wave products, carriers simply attached an index chassis to a conventional universal life policy and declared it an IUL product. The only change was in how interest was credited. That was enough to generate incremental sales, but not enough to take full advantage of what an index chassis can do for clients.

Carriers' lack of understanding about the IUL's full potential represented an opportunity for us: to educate their product development people about modifications that could be made to the chassis — in particular, the index crediting mechanism — so as to maximize long-term cash accumulation and income payments to the policyholder.

The trade-off resulting from these changes is a reduced death benefit paid to policy beneficiaries. So this type of IUL product is for individuals who are more focused on funding retirement income needs than on providing a legacy for heirs.

Hersch: How else have indexed UL products evolved?

Konopik: A second wave of IUL products introduced additional living benefits, such as riders offering financial protection for those suffering from a critical or chronic illness. Some of the new features hold long-term value for a policyholder; others are more window-dressing — features that let producers more easily sell policy benefits.

Hersch: Given clients' desire for cash accumulation and thereafter an income stream, would it not be equally advantageous to go with a traditional UL product offering a greater death benefit, and supplementing the policy with a fixed indexed annuity?

Konopik: That's certainly one approach, but most IUL buyers have two primary concerns: (1) insulating themselves against market volatility; and (2) immunizing themselves from future tax law changes. An IUL policy is better able to accomplish these twin goals than alternative solutions, first because the policy locks in a percentage of stock market gains; and second because policy withdrawals and loans are distributed income tax-free.

Add to this the fact that IUL is self-completing: should the policyholder die premature, the retirement bucket — the death benefit — goes to the surviving beneficiaries. There's really nothing else out there that can provide all three benefits.

Hersch: What further developments can we expect in the IUL space? How will the products evolve going forward?

Konopik: IUL manufacturers have always focused on generating tax-free income. But IUL's analog, the fixed indexed annuity, provides guaranteed income. I believe this will be a major focus in the IUL space in the next several years: developing products that not only provide tax-free income, but also a guarantee on distributions — and thereby peace of mind for policyholder entering their golden years.

Hersch: What will it take to get to this next generation of products? What obstacles might have to be surmounted?

Konopik: The biggest hurdle to providing guaranteed income relates to reserve methodologies that insurers to insure future benefits. On the taxation side, the challenge is to structure the policy so as to provide a guaranteed, tax-free income stream compliant with Internal Revenue Code Section 7702.