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Equity Indexed Universal Life Insurance May 28, 2008

Posted by shaferfinancial in Uncategorized.
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When BawldGuy asked me to blog on equity indexed universal life insurance (EIUL), I thought no problem, since I had been blogging on it for a couple of years on both my site and others.  Then he asked me to look at the archives from Bloodhound to see his previous blogs and I knew I had to write something a little different.  In order to make sense of EIUL contracts you really need to understand the misinformation that underlie the arguments being put out by folks in books, the mass media and blogs on both sides of the issue.  You need to be clear on what your wealth creation plan is and what it isn’t.  So bear with me for a few paragraphs as I burn down the straw-men arguments before we get into the mechanics of EIUL’s.

 

 Usually these discussions surround a common theme, EIUL’s versus mutual funds inside a tax deferred wrapper (401K, IRA’s).   First let’s talk about mutual funds.  Mutual funds were designed to reduce risk or as financial experts describe it variance.  They were a boom to Wall Street as mutual funds induced many folks to invest in stocks, something they were not inclined to do in the past.  They have been around for 2 generations so we have plenty of data to tell us accurately how people do investing in mutual funds.

 

 

We have plenty of studies of wealthy folks too; many specifically designed to find out how they became wealthy and what wealthy folks invest in.  What they tell us is very clear.  The higher the net wealth, the smaller percentage of wealth is in mutual funds.  Or to be more exact, the super wealthy (net worth in excess of $10M), have less than 5% of their wealth in mutual funds (mostly bond mutual funds), the wealthy (net worth $1M to $10M) has only a slightly higher percentage of wealth in mutual funds, and the mass affluent ($100,000 to $1M) has close to 30% of their wealth in mutual funds (second in percentage only to home equity).  And if you look at this class closer you see a curve that continues the trend with the higher the net worth ($500,000-$1M) looking more like the wealthy and those under $500,000 in net worth having the highest percentage of their wealth in mutual funds.

 

So it is very clear that those that invest primarily in mutual funds are planning to be in the $100,000-$500,000 net worth category.  Now there are some real reasons for this and they can be summed up quickly:

  1. The rate of return people get from their mutual funds is meager.  Study after study has pointed out that individuals’ rate of return from mutual funds on average ranges from 7-10% BELOW market returns (Dalbar, Inc. Vanguard, etc.).  Average fees range from 2-4% of value for mutual funds.  Employer managed 401K’s have the highest fees sometimes as high as 6%;
  2. People don’t consistently put money into mutual funds as they are instructed to, because life intervenes and the money is used to cover expenses; and
  3. The experts advising folks on mutual fund investments actually cause folks to have a lower rate of return than if they did it themselves.

 

The bottom line is that when your advisor or the mass media you are listening to tells you to invest in mutual funds they are putting you on a plan to have low six figures in net worth in today’s dollars.  One can reasonable assert that investing in mutual funds will not make you wealthy, only keep you from being poor.

 

Tax deferral programs (401K, IRA’s) were designed by the government for two reasons.  One was to encourage folks to save money.  It should be noted that it was never thought to be the only retirement vehicle, but an adjunct to defined benefit pensions and social security.  The second reason is to increase tax revenues.  By giving a tax break as you put the money in and taxing it as you take it out, even getting a meager rate of return will assure greater tax revenue.  It is pretty simple to understand.  From these meager beginnings 401K/IRA’s have become the only retirement vehicle most people have outside of social security. 

 

Those that oppose the use of EIUL’s accurately state that most people upon retirement have a decrease in income, and tend to move down a tax bracket.  And they also accurately point out that the advantages of EIUL’s goes up as your retirement tax bracket goes up.  So for those who plan to have a drop in income and/or a drop in tax bracket EIUL’s might not be advantageous.

 

By now you are probably wondering why I am talking about mutual funds and 401Ks instead of the topic at hand EIULs.  I am trying to bring some clarity into the readers’ thinking in order to break down certain categories in your mind.  Categories created by folks surrounding investing, retirement, wealth.  Frankly, most people are on a snipe hunt when it comes to creating wealth through mutual funds.  They are looking at the amount of fees charged, or which mutual fund returns slightly better than others last year, or speculation on how much their 401K’s will be worth somewhere in the future.  Frankly, all that stuff doesn’t matter.  It only appears to be important because of the categories you have created and put mutual funds/401Ks into; retirement funds or wealth creation.  Truly, mutual funds don’t belong in those categories; they really belong in the asset protection category or more specifically the asset transfer category.  I know that is a hard pill to swallow, but if you really look at information I have given you, and really think about it, you will understand why.  You really are just moving some of today’s income into tomorrow’s income hoping to account for inflation.

  

Now let’s talk about the EIUL.  It is a life insurance contract.  Life insurance is designed to solve two problems.  The first is to protect against the loss of income in the case of death of an income producer.  The second is asset protection from the tax man.  Life insurance like mutual funds will not make you rich.

 

 

So let’s burn down those straw men right now.  Neither mutual funds nor life insurance have demonstrated the ability to make their owners wealthy.  Anytime a mutual fund salesman/financial planner/CPA tells you that the rate of return from mutual funds is 8, 10 or 12% they are not being entirely truthful.  (Don’t respond with your own fantastic returns from mutual funds, it simply doesn’t matter in this argument).  Planning to live on less money in retirement than in your working life is planning to fail, no question about it.  And not planning to have enough assets to have to protect them from the tax man is not what I call a real wealth plan.

 

Now it’s time to put the pedal to the metal.  Everyone who is planning to have a net worth less than $500,000, please raise your hand.  Everyone who is planning to have a big drop in income when you retire, please raise your hand.  Everyone who has no dependants or who plans to not have dependants and/or who plans to not have any assets to protect, please raise your hand.  O.K., all those with your hands raised, EIUL is not for you.

 

Now, for the rest of you, here is how it works.  Permanent life insurance has two sides, an insurance side and a cash value side.  The cash value side either earns a fixed amount of interest or in the case of a variable universal life can be invested in the stock market.  Equity indexed universal life insurance is of the fixed interest type, although your interest credited is connected to a stock index.  EIUL’s have a floor in which the interest credited can’t go below and a ceiling in which the upside is capped.  So you know each year the cash value of your life insurance will go up between those two figures, say 2% and 12%. So each year, you look at how much the benchmark index (usually the S & P 500) goes up or down and you know how much your cash value will appreciate.  Now here is the key provision.  You can access your cash value through policy loans.  The loans costs are generally no more than the interest credited (companies have different plans so make sure you understand how your company treats loans).  When you take out a loan against your policy there are no tax implications as long as it was set up correctly initially.  You are under no provision to ever pay back the loan.  Now previous to 1982 you could load these contracts with as much cash as you wanted.  Many of the wealthy loaded up their contracts with massive amounts of cash, enough to get the attention of the IRS.  The IRS subsequently put limits on how you fund the cash value and how much insurance you need to go along with the cash.  So the strategy is now codified into tax law.  Follow their guidelines and you have no tax problems.

  

Properly structuring these life insurance contracts now means minimizing the face value of life insurance, which maximizes the cash value.  The cash value increases in value depending upon the index, but never goes negative.  By maximizing the cash value the cost of insurance stays low.  The contracts I sell have a rider on them that precludes the owners from taking out so much cash that the insurance is not covered, keeping these contracts from lapsing and a taxable event occurring. Surrender fees generally stop at year 10 to 15, but the point is once you fund the contract to keep it for life, so surrender fees are really meaningless.  Expenses and commissions are front loaded, so it takes about 10 years for these contracts to really start performing.  That means if you are in your 60’s this strategy probably doesn’t make sense for you. 

 

Anytime during the contract you can access your cash value with a policy loan tax free.  Some people use them for retirement income, while others use it as a bank, purchasing automobiles and paying the policy back instead of occurring interest by getting a bank loan.  They can also be used as a reserve account for emergency funding.  This liquidity and flexibility is what makes them so attractive to folks like me and BawldGuy.  What rate of return can one expect?  Well, I run them with 6.5%, but the historical amount (using data back to 1950 and plugging in that historical figure is 7.5%).  I like to be a little on the conservative side.  Once again, the point is to transfer assets so as to protect them from the tax man, not create wealth.  Look, the bottom line is an unleveraged investment must get a rate of return well over 12% to really build wealth; neither mutual funds nor EIUL’s are likely to get that high of a return!

 

So what is the bottom line?  You use real estate investments to create the wealth.  Leverage, depreciation, 1031 exchanges, etc. all do the wealth creating.  Then you protect those assets against the tax man by using EIULs.  And if something bad happens to you, your family is protected.

  

When you take away all the “straw men” arguments it all gets clear.  Protect or not protect assets?  Protect or not protect dependants? Accept a moderate rate of return for these benefits?

 

You choose? 

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Comments»

1. Bella - November 4, 2010

Can I send you a copy of the plan to get your advice?

Thanks
Bella

2. David - November 27, 2010

I also like that when retiring, you can stop paying the premium (vanishing), and the cash value will cover that portion, keeping the policy enforce, allowing continued funding of the cash value portion. You can then start drawing up to 90% of the cash value out, I don’t recommend that excessive amount, but withdraw a lesser figue. Say maybe as much as 10-20% per yr, or say $40-60k per annum,depending on how long the policy has been enforce and the cash value that has accrued, and use that for living expenses.(i.e.:travel,grandkids educ.,whatever) If you are collecting social security, the loan from the policy does not get credited back against the SS proceeds, therefore it will not cause a drop in benefits,as I understand it.I believe the EIUL is a way for younger middle America to protect their family and provide for retirement with tax free proceeds from the cash portion,since it is not income,but a loan,and as you pointed out,no need to repay it ever.Besides after 2036 or 2037, will 30 somethings have a SS benefit coming to them,but it likely will not be there, as some have stated.So then what? I strongly believe, that this is the way for the time being,unless other steps are taken within the congress and the taxing bureau of our country to provide other relief, to have something to use for living when retirement comes for those mentioned above, or they can keep working, be a Walmart greeter,sit in a glass enclosure accepting payment for gas purchases,or some other menial type employment, and live on mac and cheese for rest of their lives.Perish the thought,but hey what do I know? I am just a guy trying to figure things out, and maybe help someone with their figuring things out as well.

3. Karl Christen - July 28, 2011

Bravo.. loved your post.

I was in the mortgage industry over 15 years, I’ve recently entered the insurance/financial planning industry as of recently. There has been a serious disconnect between the two industries for some time. I attended a number of “mortgage planning” training seminars from 2005-2007 and was enamored with the concept that Doug Andrews teaches in his book Missed Fortune. But he does make some aggressive claims on ROI that I have failed to see in most EIUL products. But the EIUL is one of the best products I’ve encountered that would allow tax free “income” after age 65.

I’ve looked at the numbers like you and I do not see how you can show anyone the light at the end of the tunnel through simply investing in Mutual Funds or Perm insurance contracts. If that’s the best you can offer your client then you are sadly missing the boat. I’m attempting to create a Wealth Advisory Team with Mortgage, Real Estate, and tax specialists.

Insurance should be used to preserve the wealth you amass. Real Estate, even in this market, is the tool to create real wealth.

If you are on Bloodhound, say hello to Brian Brady for me.

4. Rob - November 12, 2011

What are some of the best companies to talk with regarding IUL? I’ve heard that Midland National is good. Does anyone have an opinion?

shaferfinancial - November 12, 2011

Minnesota Life and North American are the top two on my list at this time.

5. murrydog - November 12, 2011

not sure who listed MN life and NOA as the top EIUL policies, but the comment is misplaced.

MN life is #5 on my list and NOA is #6.

Midland is a sister company to NOA and so it’s also #6 on my list.

Roccy DeFrancesco
Author: Retiring Without Risk

shaferfinancial - November 14, 2011

Honest people can disagree about which is the best EIUL out there. Brett Anderson has North America #1 for example.
It all depends upon what factors you think are most important. Some folks have intimate relationships with certain companies and therefore that factor weighs heaviest for their analysis.
My most important factors in order are:
Financial strength of company as illustrated by ratings [Comdex].
Actual historic performance [These products have a history and we can look at them to see which would have given you the best performance over their life span. This includes actual expenses, historic cap rates, etc.]
Structural components; for example does it have a variable rate loan, allow for moving entire loan amount from fixed to variable, over-loan protection, accelerated benefit, guaranteed bonus, etc.
There are some other factors I look at but these are the main ones.

Of course even the best product if it is not structured correctly for maximum performance is not what a consumer would want to purchase. So much depends upon dealing with someone that is experienced and honest and willing to lower their commissions in order to improve performance.

6. murrydog - November 14, 2011

No, it doesn’t have anything to do with honestly. It has to do with understanding policy designs and NOA is definitely not the best policy out there.

As i indicated, NOA is a good policy, but if the goal is maximum borrowing in retirement, it is behind several others in the marketplace.

There are other unique features to the NOA policy that might give reason to buy it over another policy that has a better chance to build more wealth, but there are few that will apply to.

7. Reuven Kishon - February 4, 2012

Roccy,

I see from your previous posts that are you are very familiar with the IUL product that the Life Insurance Company of the Southwest (LSW for short) offers. Well, I recent spoke to an agent and was pretty happy with the illustration I was shown (assumed an average 6% annual return).

My questions to you (of which i plan to ask my agent), or Mr. Shafer for that matter, are the following:

1) Are the available loans variable or fixed rate?
2) I’m not sure how you could guarantee that the wash loans will in fact be wash loans. The way I understand it is that the loan rate is equal to the rate of return on your policy. If that’s the case, then you can end up taking a loan out in year 2 who’s rate is based on the return you made on year 1, and the return on your policy in year 2 could be significantly lower than the loan rate you are locked into! I hope I wrote that in an understandable fashion 🙂
3) Does the cap on the rate of return, or participation rate, change over time? I was thinking it was locked in for the life of the policy.

Dave,

One question to you. Earlier posts mentioned something called a “5 pay period”. The way I read this is that you can make 5 lump sum payments per year instead of the regular 12 monthly payments. Am I reading this correctly? If not, please enlighten me on what exactly this means. Is this 5 pay period option something that most IUL providers allow?

Thanks in advance to both of you!

– Reuven

murrydog - February 5, 2012

Reuven,

can you e-mail me at roccy@thewpi.org so i can ask you a few follow up questions so i can provide you the information you need.

there is only one policy in the industry that look decent when you illustrate the crediting rate at 6%. An older LSW policy that’s been around for a while.

my guess is the agent showed you a variable loan rate with today’s historically low numbers and projected that rate out 20+ years which is totally unrealistic.

wash loans are what they are. they are guaranteed to be there, but you don’t know the rate.

yes, the cap will change over time.

no you read the five pay period incorrectly.

you should strongly consider getting my book http://www.retiringwithoutrisk.com.

it will give you a full education as to how EIUL policies work.

shaferfinancial - February 5, 2012

Reuven, I sent you an e-mail because it is apparent that you have some misunderstandings about EIULs.

8. dkretirerich - March 15, 2012

Hi, I am looking for an EIUL and cannot find one online that I can compare to Western Reserve Life (WRL). I was told that after 10 years, I can start withdrawing loans from the WRL EIUL tax free (so long that I keep10% in the EIUL). I was also told that I’d never have to pay it back. This one has a guarantee of 1% with a cap of 11%. I have no idea what the fees are. I see that Min Life and NOA have been recommended. What are your thoughts on WRL? and are there any others I should consider?

My goal: highest returns possible, financial strength of the company, lowest fees & tax free

murrydog - March 20, 2012

That product is not even in my top ten best EIUL products in the market.

MN life is a decent product. NOA is #6 on my top ten list.

I recommend you educate yourself on these products which you can do at http://www.retiringwithoutrisk.com

9. BobH - July 8, 2013

Doesn’t the mortality expense (cost of the underlying annual renewable term) do a fair share of cutting into the cash value? I’m thinking that 75 year old that has one of these in the $1Mil must be seeing quite a hit each year on the cost of the insurance portion of this product. I understand that this affects the cash value. Also, if this is meant to transfer wealth tax-free AND to provide the owner some income, the death benefit (transfer of wealth part) is reduced by the loan amount.

I’ve had a person tell me (I did raise my hand a number of times above) that EIUL made sense for the mainstream (transfer your home’s equity to one of these…yeow!). I told him he was on drugs! Your explanation does make sense, but, only if the person buying in really understands the expenses.

Thanks for pointing out that this is NOT for everyone.

shaferfinancial - July 9, 2013

The strategy of overfunding the policy keeps expenses down. The actual insurance you are carrying goes down as your cash value goes up. Depending on your age and gender when you initiate the policy, overall maximum expenses range from .4% to 1.8%. That is all expenses including mortality expenses. Really need to look at an illustration to understand how it all works.

10. Mike - August 3, 2013

Good artcle. So you are recommending to not use investing in stocks as a means to get wealthy??? Hahaha, I think Warren Buffet would laugh at you!

shaferfinancial - August 4, 2013

No, if you read the many other articles on this blog you would see I own much stock. In fact my major position is Buffett’s Berkshire Hathaway which I have been collecting since 1996. I also collect dividend producing stocks. Mutual funds on the other hand I do not like and there are many articles on here why.

11. education read more - June 27, 2014

education read more

Equity Indexed Universal Life Insurance | Uncommon Financial Wisdom

12. Woodworking Projects at CutTheWood - May 9, 2017

One thing I’d like to say is that often car insurance cancellation is a dreadful experience and if you are doing the appropriate things being a driver you simply will not get one. Many people do receive the notice that they have been officially dumped by the insurance company and several have to struggle to get additional insurance after a cancellation. Low-cost auto insurance rates are generally hard to get from cancellation. Having the main reasons for auto insurance cancellation can help drivers prevent getting rid of in one of the most crucial privileges readily available. Thanks for the tips shared through your blog.


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