Step-up Your Setup

by Zaahirah Souri, LifeTrends Product Analyst

A man walks into…a producer’s office with a bag of extra cash to put towards his future financial needs. The producer suggests putting the money into a life insurance policy so that he can provide financial security to his loved ones upon death, while also having the option to access any cash for retirement income or other needs that may arise as he ages. If the policy stays within the guidelines of life insurance, no taxes will be owed on any of the cash gains in the policy. If it fails, the policy becomes a Modified Endowment Contract (MEC) and will be taxed. Luckily, the trusted producer lays out a policy plan that can optimize the income that may be needed during retirement, referred to as maximum distributions (MaxDist), while keeping the tax benefits of life insurance. In this month’s blog, we step through the many components of a typical distribution-oriented illustration setup that may ensure a policy’s premiums, cash accumulation, and death benefit work together to stay within current tax guidelines.*


For this this plan, the client will pay large level premiums for a set amount of time before he retires. The goal is to “overfund” the policy so that it can accumulate the most cash before any withdrawals are needed. The most popular payment structure is regular payments up to retirement age, paying evenly for 7 or 10 years is also common. Shorter payments, especially single pays, are less desirable for this structure. They make the initial death benefit high, which causes the policy to be more expensive in the early years. To overcome this, some companies offer ‘Premium Deposit’ accounts that spread out the lump sum premium over multiple years.

Death Benefit

Choose the lowest possible death benefit that avoids taxes, which is known as the ‘Minimum Non-MEC Death Benefit’ solve option for most carriers. A smaller death benefit will be less expensive and reducing costs will create more room for potential accumulation.

Death Benefit Option (DBO)

Setting the DBO to increase (Option B) while premiums are being paid into the policy, then switching the death benefit to level (Option A) also lowers the overall costs associated with the death benefit. The amount for the minimum non-MEC death benefit is determined by how much premium is paid into the policy. A level DBO amount looks at premiums over the entirety of the policy, but an increasing DBO adjusts the death benefit and only looks at the premiums paid in each year. By choosing an increasing death benefit, the initial face amount will be significantly lower and the charges will be less at the outset.

Death Benefit – Other Options to Consider
  • The Spread Death Benefit Option: Instead of paying a death benefit in one lump sum, there is an option for the carrier to pay the benefit out over time. This structure lowers the carrier’s cost and they pass that cost reduction on to the policyholder.
  • The Death Benefit Reduction Option: When the death benefit is set to increasing (Option B), it grows by the policy’s accumulated cash which sometimes raises the face amount above what is needed to satisfy the MEC limit. This creates an opportunity to reduce the face amount to the recalculated minimum non-MEC death benefit at the time of leveling out.
  • Optimal Switch: Once premiums stop being paid, switch the death benefit from increasing to level. The “optimal switch” can be triggered earlier, which sometimes creates an advantage.

While few carriers offer such options, they can all potentially lower the death benefit costs which allows for more cash accumulation. As illustrated, the reduction and optimal switch illustrate in an ideal way. In reality, these death benefit changes can be difficult to implement. Depending on how the policy actually performs (and not by what is determined on an illustration) changes to the death benefit must be recalculated and applied to the policy in the future when the time is right. This requires attentive policy administration that falls in the hands of the selling producer’s due diligence. When considering these options, look for carriers who offer administrative support systems to help keep the policy on task with the clients goals for owning the policy.


The client can use the accumulated cash for retirement income and other financial obligations. Structure the policy to take out maximum distributions in the form of withdrawals and/or loans starting at retirement age and continuing over the next several years. Withdrawals are capped at total premiums that have been put into the policy, while loans taken out against the policy allows the client access any cash accumulation. Loan structures will depend on the client’s risk tolerance. For more on participating loans, see our “Participating Loans” article from October 2017 POINTS.

  • Annual vs Monthly: It is common for policies to allow distributions to be taken out monthly rather than annually. Annual distributions are taken at the beginning of the year, but monthly ones are spread out over the entire year. Cash value left in the policy after each monthly disbursement has time to grow throughout the rest of the year, causing monthly distributions to be more advantageous than annual ones.
  • Targeting: Once distributions are set to be taken out, the policy needs an additional cash value goal to ensure there is still enough cash in the policy to remain in force. There are multiple philosophies on targeting, such as choosing a $10,000 cushion at age 100, $1 of CSV at maturity, or endowment. Because of the number of accumulation years in an illustration with an all positive interest assumption, we have found the targeting is almost inconsequential when compared to the interest rate assumption,see our “Safety in Numbers” article from November 2019 POINTS.
Interest Rate

For Indexed Universal Life (IUL) and Variable Universal Life (VUL) policies, the cash grows based on an interest rate reflected by their respective accounts. The producer can illustrate an average rate of return throughout the life of the policy. In IUL, this rate can be difficult to determine. The maximum rate a policy can be illustrated, also known as the AG49 rate, is a set level based on a calculation using the company’s current assumptions and a specific averaging of returns over the last 65 years. It is advantageous to look at an upper (such as AG49) and lower range of values rather than a single illustration. With the variety of structures and account options available in IUL, this window of values will effectively illustrate the volatility across products. The end values are useful to show how the product mechanics function. For more information on considering range of values, please see our “LifeTrends 70% Window” article from March 2019 POINTS.

As you can see, there are many moving parts to an income replacement/distribution-oriented illustration. It is important to understand how the parts work together to keep a policy within the limits of MEC and the definition of life. Now, with a life insurance policy structured according to the setup above, the client is on his way to protecting his assets, managing his retirement needs and providing for his family.

* An illustration is designed to highlight how a product may function; actual policy performance (including returns, and premium payment and design structure) should always be monitored after the sale.