We get this question a lot: what types of life insurance policies are the best?
To answer that, we’ll look at the difference between types of insurance: term life, whole life, and universal life.
Then we’ll examine how you can essentially “buy term and invest the difference” on steroids with universal life policies, which is my favorite way to go.
We’ll also talk about how to use life insurance for more than the death benefit–actually leveraging it for living benefits, as well.
To get us started, here’s a quick overview:
- Term Life Insurance – Essentially, term life insurance guarantees payment of a predetermined death benefit if the insured (the person covered by the policy) passes away during a specified term (often 10, 15, or 20 years). If the term expires and the policyholder is still alive, the policy can be renewed for another term, converted into permanent coverage (such as whole or universal life insurance), or allowed to terminate.
- Whole Life Insurance – Whole life is similar to a level-premium term policy, in that you pay a level premium for the life of the policy, but there are key differences. Unlike term insurance, whole life provides permanent death benefit coverage for the life of the insured (not just for a specified term). Whole life also adds the advantage of a savings component, where cash can accumulate on a tax-advantaged basis. You can choose to reinvest dividends into the policy’s cash value and earn interest. (There are variations of whole life insurance, but this gives you the basic idea.)
- Universal Life Insurance – Universal life insurance is another type of permanent life insurance (with death benefit coverage for the entire life of the insured), that offers a cash value accumulation element. The beauty of universal life insurance (and whole life) is the money inside of the policy accumulates tax-free.
MY JOURNEY FROM TERM LIFE TO UNIVERSAL LIFE
As background, I started in the financial services industry back in 1974, and I was a big “buy term and invest the difference” proponent. From 1974 to 1980, I helped over 3,000 people in 13 western states learn how to set aside money in a term insurance policy and invest the difference in an environment where they could have liquidity (the ability to access your money) and see predictable rates of return (the less volatility the better).
The challenge with this approach, however, was that a lot of people weren’t investing the difference. To counter that, I would show people the math behind the strategy, illustrating how to out-perform traditional whole life insurance (remember at the time, there was only term or whole life insurance).
In 1980, EF Hutton changed all of that, essentially asking, “What if people could buy term and invest the difference–but this time under a tax-free umbrella?”
EF Hutton understood that in the Internal Revenue Code Section 101(a), life insurance is considered something of a sacred cow, with specific tax-free benefits that many other financial vehicles don’t offer. Why would the government allow for this? Because they want to incentivize Americans to take care of their own, to provide for family or other beneficiaries that would be financially impacted by their death (and in turn avoiding putting a strain on social services that might otherwise have to help those left behind).
With the introduction of universal life, however, EF Hutton decided to flip the typical approach. Rather than getting the most amount of insurance for the least premium possible, the goal now was to get the least amount of insurance required by the IRS, while putting in the maximum amount allowed, essentially turning life insurance into a cash cow.
EF Hutton called it universal life because the policies could be used for universal applications. In the decades since 1980, the tax laws and codes related to Universal Life have evolved, and so have the strategies we recommend to take advantage of maximum-funded, indexed universal life insurance policies (what we call The LASER Fund).
Since taxes have a profound impact on your wealth accumulation, it’s helpful for you to understand the laws (like TEFRA, DEFRA and TAMRA that impact how you can fund your policy) and key tax codes (like Section 7702 that impact how you can access your money tax-free). You can read more about these topics in my book, “The LASER Fund”, Section I, Chapter 7 (which you can read for free–find out how at the end of this article).
3 TYPES OF UNIVERSAL LIFE
Over time, universal life also evolved to offer three primary types:
- Fixed universal life – Here, policyholders can expect reliable cash value growth based on a fixed interest rate, which is often the same interest rate that the company’s fixed general account portfolio earns (general account portfolios are typically comprised of AAA and AA bonds, real estate investments, and more). These policies tend to be less risky than other universal life policies, but their growth potential is also the most limited.
- Variable universal life – Here, the majority of the policyholder’s premium is invested in a choice of investment accounts, which could include fixed-income, stocks, mutual funds, bonds, and money market funds. Because the money in the policy is tied to market-based investments, policy cash values can stand to gain–and lose, depending on market conditions. For this reason, variable policies are often considered the most risky.
- Indexed universal life – Here, policyholders can choose from a variety of index strategies, which means the money in their policy is linked to index strategies, without the money actually being in the market. These policies also offer a 0% guaranteed floor, which can provide a good degree of safety and help protect policyholders in market downturns.
WHY I PREFER INDEXED UNIVERSAL LIFE
I like indexed universal life policies for several reasons:
- Liquidity – You can access money in your policy at any time, tax-free, via loans. Need money for a home repair? Borrow it. Want money during retirement for annual tax-free income? Borrow it. As explained in “The LASER Fund” book, there are certain guidelines to avoid collapsing your policy and/or creating a taxable event, so be sure to talk to your IUL specialist to ensure you’re accessing your money the Smart Way.
- Safety – With indexed universal life policies, “zero’s the hero.” Because your money is not actually in the market (just linked to the market), you have the reassurance of a 0% ground floor. This means your policy will not lose cash value due to market volatility during a year that the market goes down. And when the market goes up, you can get the benefit of that increase based on your index choices, up to a cap (or no cap, depending on your index strategies). Personally, I’ve earned as high as 39.22% in an up-year, and since 2000, I’ve averaged 8.47%.
- Predictable rates of return – In any given period, especially at the end of the day, I’ve usually been able to earn at least 2% higher rates of return in universal life than whole life, because I’m able to structure it under IRS guidelines to perform better with an internal rate of return.
LEARN MORE – FREE BOOK
IMPORTANT NOTE – It’s critical that an indexed universal life policy is structured properly and funded correctly to get the benefits I’m describing. That’s what motivated my sons and I to write our latest book (my 11th book), “The LASER Fund.”
(Incidentally, we call a maximum-funded indexed universal life policy The LASER Fund because it passes the “Liquidity, Safety and Rate of Return Test” with flying colors–when it’s structured right.)
In this book, we talk about how to tell if your financial professional is structuring your policy correctly. In fact, people who read this book often know more about these insurance policies than the majority of insurance agents or financial planners out there.
I would love for you to have a free copy. It’s 300 pages of in-depth education that can transform your financial future. Go to laserfund.com, and we’ll send it to you absolutely free. You just pay a nominal shipping and handling fee, and it’s yours.
At laserfund.com, you can opt for the print, audio, or digital version, as well as register for online classes for a deeper understanding. I can’t wait for you to explore the impact a LASER Fund can have on achieving your financial goals.
You can also watch the related YouTube video to see me explain “What Types of Life Insurance Policies Are the Best?” (and while you’re there, be sure to subscribe to my YouTube channel so you don’t miss a thing!).
Want to find out if a LASER Fund (a maximum-funded, properly structured indexed universal life insurance policy) is right for you? Join us for an upcoming webinar where you can explore these strategies.