To generate a tax-free income stream from cash value life insurance a few major caveats need to be in place. First any cash value policy needs to be designed to comply with the TAMRA regulations that address guideline or cash value accumulation tests. Secondly, the policy must remain in force for the life of the policy insured. If the policy were to lapse or terminate for any reason, the policy loans of gain and the unpaid interest on those loans would be characterized as phantom income and taxed as ordinary income in the policy owners tax bracket.
IUL uses the earnings from the indices credited to the policy. Those indices can be domestic, as well as foreign to generate interest rate returns. Policy owners don’t participate in dividends, but they also don’t participate in the negative returns of the policy indices, i.e. zero is the lowest crediting rate in the crediting account. That being said, the policy expense loads in a zero year could generate a negative return. These types of polices are for conservative to moderate investors with long time horizons.
Compliant IUL withdrawals to basis and policy loans of gain have the potential of generating tax free distributions that are not includable in the provisional income test for Social Security benefit taxation. The design of an IUL for income purposes like a retirement supplement or college funding must construct the policy with the minimum death benefit to allow maximum accumulation. Keep in mind that client suitability is paramount for using IUL or any other cash value life insurance policy.
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