IUL know-how: What is arbitrage, exactly?

As financial professionals, we know that one of the biggest problems in retirement is the fact that every time you spend a dollar, you lose a dollar. If you have $10 in your retirement savings account, and you withdraw $5, you now only earn interest on the remaining $5 account balance—and nothing on the $5 withdrawal.

So what if there was a way to earn interest on every single dollar you take for income? Indexed universal life (IUL) policies can give your clients the opportunity to do just that. IUL offers a unique feature called arbitrage, which enables them to leverage income to enhance the growth potential of their cash value. This special feature is one of IUL's greatest tools to help clients maximize the power of their income to potentially increase their retirement savings.

Here's another way to think about how arbitrage works inside an IUL. Consider your income distribution (or withdrawal) as a loan from your retirement savings (or your IUL cash value). With arbitrage, if your cash value interest rate is greater than the loan interest rate, you can earn interest on the withdrawal amount (your income distribution or loan).

Now let's put this concept into action. Let's say your client, Mary has a money market account balance of $10 and she withdraws $5. In this scenario, Mary earns interest on her remaining $5 account balance and nothing on the $5 she withdrew.

Let's compare that example to an IUL approach with arbitrage. Mary has a cash value of $10 in her IUL and takes a $5 loan from the policy. If her cash value interest rate is greater than the loan interest rate, Mary earns interest on the $5 loan she took from the policy. And of course, she continues to earn interest on her remaining cash value.

Many financial professionals ask us what happens when the loan interest rate is greater than the cash value interest rate. This is a "negative arbitrage" scenario, and typically clients would not be able to earn interest on their policy loan. There are, however, index safeguards that put a cap on the loan interest rate. This helps reduce the impact of negative arbitrage.

Strengthen your IUL know-how

We've created a special white paper that provides a deeper look into IUL, illustrative rates, policy loans and arbitrage. It also highlights key myths and misconceptions you don't want to fall for as you help clients navigate retirement challenges and address income goals. To get the paper, click here or call us at 866.866.7050.