My Story:
So I was contacted by a couple of guys who work at an insurance company, one of them claiming to be a CFP who wanted to see if they could offer their services to me. Sure, why not? It's free. I have nothing to lose.
I went there and they started asking me about my financial situation. Then they started talking about permanent life insurance. That's when I knew I had been bamboozled. But, really, how bad could it be to learn about IUL (Indexed Universal Life) insurance? Since they clearly thought it was a good idea to invest, I thought it would be interesting to review IUL and other UL policies thoroughly. So, I did my research on permanent life insurance and their claims about it. Here I present my conclusions.
Please note I'm not a licensed insurance agent. I'm just some dude on the internet. Please correct me if I've written anything wrong.
For the uninitiated: What is indexed universal life insurance?
This insurance, like most permanent life insurance products, has many different moving components.
CASH VALUE - This is the value which grows inside the account. Every so often, depending on which asset your cash value is invested, your cash value will be credited a percentage based upon an index with a cap and floor. The floor is guaranteed to be higher than 0%. The max is usually somewhere around 11%. If the S&P gains 5%, you get 5%. If it gains 20%, you get 11%. If it goes -50%, you get 0%. These are tax free gains.
BASIS - This is the amount of your own cash you have contributed to the policy after all fees are accounted for. Withdrawals from this do not have a taxable impact.
GAINS - This is the amount of cash value that has been credited to your account. Withdrawals from this is a taxable event at your marginal tax rate.
LIFE INSURANCE POLICY - This is the policy inside of the account which must be paid for with your premiums. It uses ART (annual renewable term). This means every year your insurance rates inside the policy will increase because you are getting older.
SURRENDER FEE - For the first ten years of the policy, there is typically a surrender fee of 10% in the first year, decreasing by 100 basis points per year (so in year 10, there is no surrender fee).
LOANS - You can take out loans against your total cash value in your account. The loan you take out has an interest rate which is equal to the amount of credit your account receives that year. Your loan, therefore, is practically free because you're borrowing from yourself at almost 0% interest rate.
NO LAPSE GUARANTEE - This is a policy rider. The rider says that if you do not pay your premium or interest on the loans you took out for the month, your cash value will cover the difference.
VARIABLE PREMIUM - You can pay a variable premium throughout the life of your policy. There is a floor (no lapse guarantee floor) which you cannot pay less than. This is the minimum amount to keep the policy in force (at least until the policy can pay for itself). There is also a maximum premium you can pay into the policy. I won't cover it here, but just google for "Modified Endowment Contract" (or MEC) if you want to learn more.
Phew! That was a lot of stuff to understand. So, what does all of this mean?
IN THEIR IDEAL, PERFECT WORLD:
Here's how things would work:
- You max out your premiums to build a huge cash value within the policy.
- You gain 10% per year in cash value within the policy
- When you want to retire, you begin withdrawing your basis.
- After your basis runs out, you begin taking loans against your policy gains, which will have a No Lapse Guarantee.
- Eventually, the policy will collapse because you'll have taken out too many loans against the policy and your remaining cash value can't cover the premiums. The cash value within your contract (which are now 100% gains) will pay off your loans. This evades the taxable event of withdrawing your gains.
- Voila, you get sweet tax free gains!
But all is not so rosy. Let's look at this claim and many other claims that these insurance agents made about this policy.
Their claims:
- "Permanent Life Insurance is good because it allows you to stay far more aggressive in investments in your later years with no downside risk. With IUL, you can stay invested at S&P returns after retirement when, usually, you'd only be risk tolerant enough for bonds."
So, let's talk about fees within the IUL. According to the disclosure I received on costs they are:
- 5% of all premiums paid until age 100
- M&E (mortality and expense) which lasts for the first 10 years of the contract. This is typically ~20% of premiums paid, vanishing at 200 basis points per year for 10 years (meaning at year 10 you pay nothing)
- Administration fees ($50/year)
- Cost of insurance
- Cost of any riders
Because of all of these expenses, this is why your cash value will not accumulate much during your first 10 years. In effect, you are paying 25-30% in fees your first year!
Plus, there is an additional fee you may not have noticed. Let's look at how stock market gains are applied to your account. When the stock market increases, you only get your gains - you do not receive a dividend. Usually, for the S&P 500, you receive an annual 2% dividend which you do not get on this permanent life insurance contracts. That's an additional expense for you because you won't receive a dividend.
Therefore, I place the fees on your premiums to be about 30% in your first year. This slowly vanishes to about 5.5% after year 10.
The vast majority of people are not maxing out their retirement accounts. Would you rather pay 30% fees or 0.07% fees on the S&P fund in an IRA/401k? I'd wager you'd rather take #2 than #1.
The final point here is that a dollar today is worth more than a dollar tomorrow. Losing 30% to fees your first year is an absolute stock market gains killer.
So, to refute their point, yes, you can stay in a more aggressive market, but at what cost?
- "Eventually, Permanent Life Insurance is good enough that, once funded, it will pay for itself and serve as an investment vehicle which is completely tax free gains."
This is absolutely true. However, look at the previous answer. Do you want to pay 30% fees upfront and lose out on stock market dividends? I don't.
- "The life insurance in the policy gets cheaper with age, not more expensive. You can see in the cost summary that the cost is less than if you had taken out term life insurance. We do that because we prefer people to have permanent life insurance policies. One of the benefits, man!"
This brings up something interesting. Let's talk about how they do insurance premiums.
Your cost of insurance within the policy is determined to be your death benefit MINUS your cash value. So, if you have a $700k death benefit and $200k cash value within the policy, you only need to insure $500k worth. So your cost of insurance is for $500k for whatever age you are at that point. This is why the insurance gets cheaper even though you're getting older. You are essentially self-funding your death benefit through the permanent life insurance policy. In later years, your cash value will be barely behind the death benefit, so your cost of insurance will be extremely low.
- "Buying term and investing the difference is only good for those that actually do it. However, according to our research, most spend the difference, not invest. Think of it like a house and forced savings. Doing this is like building equity in a house."
If you want forced savings, do an automated withdrawal from your bank account to your retirement account. You'd have to do that anyway with the life insurance premium. If you can do that with a premium, certainly you can do it to an IRA.
- This eliminates the risk of a bad market and offers asset protection. You can never lose money in the account.
OH YES YOU CAN.
Remember all of the fees from before? Those have to be paid. In a bear market, you will receive a 0% credit rate on your cash value minus the fees (cost of insurance, administrative, and such). This means in bear markets you may have to increase the amount of premiums you pay to keep the policy from collapsing. So the worst case scenario is that you purchase this policy and an immediate bear market happens. This means you'll have to shoulder all of the fees in cash for the first few years which are the most expensive.
Don't forget that the premiums are expensive. I was quoted $500/mo for a $375k policy! Such policies can be had for not even $60/mo for term life for a healthy person age 30.
- Permanent life insurance is better than a taxable account because the taxable account gets bogged down by, well, taxes.
How about the 5% fee on all premiums, no 2% dividend, and administrative fees?
Try going to this site and put in a 2% expense ratio. You will see that after 25 years you will lose out on almost half of your gains. In a taxable account, assuming you are a buy and hold investor, you will pay 15-20% as long term capital gains. Now, which costs more - 50% or 20%? You tell me.
CONCLUSION:
For the vast majority of people visiting this subreddit, permanent life insurance (and specifically, indexed universal life) is not a good option to buy. It's simply too expensive. Based on my experience and research, term life is far cheaper and I'd always go for that.
Anyway, thought I'd share my research and experience.
Submitted August 06, 2017 at 05:28AM by mechpaul http://ift.tt/2ufyJSd
