Episode #109: How IUL Index Loans Work

Episode #109: How IUL Index Loans Work


Given the ever-increasing national debt with the recent government bailouts and the funding issues surrounding Social Security and Medicare, the wealthy are anticipating that tax rates are likely to go up and are implementing strategies that reduce, or completely eliminate, taxes all together while in retirement. In this episode of Money Script Monday, Kyle explains how you can become your own bank by utilizing the indexed loan feature on your IUL policy.


 

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Video transcription

Welcome back to another episode of Money Script Monday.

My name is Kyle Tomko and today we're going to be talking about how indexed loans work, how they operate, why it's such a powerful feature and how we're able to become our own bank inside these contracts similar to how the wealthy leverage and utilize positive arbitrage.

Now, when we take a look at structuring a policy for max efficiency there are three different stages that we want to look at.

However, there is more emphasis on the first two which is your contribution and accumulation phase.

Overfunding up to the non MEC guidelines and earning a decent interest overtime during our working years.

That third phase, the distribution is something that is less concerning for most when it should be up on the forefront.

How are we able to access those dollars in a favorable manner is the question. I have five different ways that we're able to do that inside these contracts.

There are recommended options, there are preferred options and we'll talk more about why indexed loans make the most sense.

Accessing your IUL cash value

how to access money iul

The first one is a standard loan. Essentially, this is a loan that you're talking out in the first one to 10 years.

Not recommended where you're essentially paying a 1% net cost. A preferred loan where you're taking out a loan after year 11. It's a 0% net cost.

Now, both of these are very conservative in nature and how to access those dollars where you can miss some opportunity cost on the back end and I'll explain why.

Withdrawals. Now again, you're going to return your cost basis first. This is going to reduce your account values dollar for dollar.

So again, could be losing some opportunity utilizing indexed loan instead.

Full surrender. Now, of course, if you need to walk away from the policy there could be some tax implications.

You could be responsible for paying tax on any interest that you earn inside the contract above the basis.

But again, if you need the money, it's there. You can absolutely walk away.

And then lastly, indexed loans.

This is where it becomes most lucrative where you're able to take out a loan, have that loan be charged a certain percentage and then have that loan still participate inside the accumulation value earing that uninterrupted compound interest.

And I'll show you an example in a little bit after we talk about the three ways that we're able to do this legally utilizing and taking full advantage of the Internal Revenue Code and three different sections.

Section 101 is talking about how we're able to move, transfer our death benefit to our errors tax-free, free of any income tax.

Section 72E is how we're able to grow our assets on a tax-deferred basis and then section 7702 is how we're able to access those dollars tax-free.

Like I mentioned before, how are we able to be our own bank inside this contract.

We're able to do that through the view of an indexed loan. But before we do that, how do banks make money?

It's very simple. The amount that you deposit to them they're going to give you a small interest rate.

They're then going to loan that money out or leverage those dollars out and charge someone to utilize those dollars.

That difference between what they're giving you and what they're charging someone else is their revenue.

The question is how can we replicate that, how can we mirror that revenue stream inside our IUL contract.

I have an example here where we're able to show you.

Index Loan Scenario

Let's just take this example.

index loan scenario

We have $100,000 built up inside our cash value account and we want to take out a $10,000 loan.

Now again, cash value inside these contracts are tied to an external index just as the S&P, the PIMCO, the BUDBI, the NASDAQ where we're able to earn up to the cap at 16% in this scenario and zero during our down years.

Such as in '08, and up to the cap such as 2009 where we're able to do so.

In the long turn, in a 30, 40-year period, we're averaging about a 6.5-7% return assuming these rates.

To be conservative for this particular case, we'll assume a 6.5% average rate of return.

Here's how it works. We want to access those $10,000, we're going to be charged a loan percentage from the insurance carrier.

In this case, it's 5% that's contractually guaranteed, locked in for the life of the contract.

We know what it is going to be today, we know what it is going to be in the future.

They're going to charge us 5% on that $10,000.

As you can see here, we have a $10,500 loan balance that is now separate from our policy.

Let's take a look on our accumulation value account where we have that same $10,000 that we loaned out and are now being charged 5%, but we have that inside our accumulation value where that $10,000 is going to earn that 6.5%.

In result that $90,000 is also going to earn that 6.5%. The money that we loaned out is still participating inside our contracts.

Essentially, we're able to create that positive arbitrage that I spoke about earlier where if we're being charged 5% and we're earning 6.5%, we just created a spread in our favor of 1.5%.

Now, there are years where we won't earn 6.5% and there are years where we'll earn more than that.

So, the larger spread can obviously be more beneficial.

It is more of an aggressive way to access our cash value but a more lucrative way long term if we're able to average 6.5%.

As you can see here, we're earning 6.5% on both of these accounts. We're being charged 5%.

Now, that interest that we're being charged can accrue up and we do have the option of paying that off.

But again, one of the benefits these contracts is not having to worry about paying off that interest that we're being charged.

Essentially, again, that's our policy's collateral for that loan balance so when we do expire in the future your beneficiaries will collect the net amount after the loan balance is paid off.

An indexed loan, this is how we're able to create our own bank. We talked about the five ways to access cash value.

We talked about the three different sections of the Internal Revenue Code that we're taking full advantage of.

I want you to reach out to your financial advisor and ask them how you can become your own bank and start utilizing this indexed loan feature.

Thanks again for tuning in and hope to see you next week on Money Script Monday.

About Kyle Tomko

Kyle Tomko is a Field Support Representative at LifePro. He coaches hundreds of financial professionals on how to build effective financial strategies that achieve their clients' long term goals and helps them stay educated on the latest industry trends.

Disclaimer

This information is meant for educational purposes only.

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