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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? 

Comments»

1. Joshua - March 7, 2009

Dave, I still haven’t heard back from you on my question. Its OK to say your stumped, this stuff can be hard sometimes. Thanks Daven.

2. shaferfinancial - March 8, 2009

Joshua, don’t know if I am stumped or not as I have not had a spare minute to do any research. These last couple of weeks have been very busy for various reasons. I will look into in soon. Just gotta give me some time.

3. Joshua - March 10, 2009

Thanks David for the reply. The best things in life are worth waiting for.

4. Mike - March 16, 2009

Dave, regarding the EIULs, is it best for the husband or wife to
enter into a life insurance contract, or both? Does it make sense for
both husband and wife to have their own EIUL policy? My wife and I are both the same age, late 40s, both healthy, and make about the same amount of money. The projected trend for us is that I will probably make more money during our 50s, as my wife has recently entered a new field and will be salaried, while I have 2 small businesses. Thanks

shaferfinancial - March 16, 2009

Mike,
It is really dependent upon your own situation. There are no advantages either way with the product. Now if one person can get a preferred rating and the other is standard then you are better off going with the perferred because of the lower insurance cost. On the other side you can use two different companies and spread your risk if both have their own policy. Beyond that it is really up to you how you want to do it and feel comfortable with it.

5. Arlene - March 19, 2009

EIUL is the way to go if you have time on your side – Enstein said that the person who does not understand compounding interest will pay for it. It is another vehicle to get to where you are going. It’s not how much one makes but how much one keeps! Just think about it – who knows what the taxes are going to be like in the next 20 yrs. Does anyone out there really believe that it will decrease? Pay taxes on the seed and not on the harvest.

shaferfinancial - March 19, 2009

Yes, and because it is insurance it is the way to go even if you don’t have time on your side. If you die earlier than you expect, then the rate of return goes up!

6. Damien Yoon - April 17, 2009

Dave, I am paying $300 a month for a AVIVA equity Index life insurance policy with a 2%-12% max return. Is this a good investment considering is started it 3 years ago when I was 22 years old?

shaferfinancial - April 17, 2009

Damien,

Generally speaking, yes it is a great start to your financial life. Setting a financial base with life insurance is a traditional [ie: oldie but goodie] way of starting your financial strategies. Over 10 years you should be able to build up cash value in the policy which can serve as a reserve account or a base for good financial strategies!

rocketman - July 27, 2009

I got a IUL with conseco life insurance. So IUL’s aren’t bad for peolple with lots of time on their hands.

7. David Thomas - October 19, 2009

Hello David,

Decent article; but I did not see you go into detail of the EIUL yearly fees — you discussed the 401k and mutual fund fees. Do more EIUL have no yearly fees? My nephew wants to see me a EIUL plan, which had some high upfront yearly fees, so I wanted to know if this is the norm, or should the scam aleart flash.

Thanks for your time,
David R Thomas sends…

shaferfinancial - October 19, 2009

Thanks for your comment. The fees are something I discuss pretty consistently, at least in general. Each company has their expenses and fees structured a little differently. Some companies disclose and create ways for me to illustrate the fees and expenses, while others do not. That is one of my reasons for liking Minnesota Life, because I can send a fee and expense illustration that outlines exactly what they are. I think I will take an actual policy [stripped of names of course] and demonstrate the fees and expenses for a blog post soon. That seems to be a way to help folks with this decision.

8. gq - January 14, 2010

the best investment is in global index universal life!!!…tax free $$ that can retire you,men where else can you get that????

9. Bilgefisher - July 29, 2010

David,
I realize the article is 2 years old, but I do have some questions.

Is this after tax income that is invested? If yes, wouldn’t a roth be better? Also what exactly do you mean the cost of borrowing is no more then the interest credited. Do you have an example I could see?

Jason

shaferfinancial - August 3, 2010

Jason, yes I can provide an illustration for you if you want to e-mail me. Roth’s are certainly better than standard IRAs but still have limitations. One type of loan these policies have is called a wash-loan that charges in interest the same amount your receive in an interest credit. That is what I mean. These policies are fairly complex to understand until someone that has much experience with them explains them to you. That is where my value comes in, as I have an intimate understanding of how these policies work which I insist upon sharing with my clients. Hint, it isn’t just the IRA/401K wrapper that makes these plans a loser, it is what you fund them with. The strategies inside an EIUL are very different than investing in the stock market, therefore abstaining from the most troublesome problems with IRA/401K funding.

10. Paul - August 7, 2010

My agent is showing me an EIUL policy from North American Company (Builder IUL) and one from Minnesota Life (Eclipsed Indexed Life).

Since you indicated in one of the above ciomments your liking Minnesota Life because it presents the fee and expense illustration of the policy….could you tell me if this translate into a preference of Minnesota Life over North American.

Thanks,

Paul

shaferfinancial - August 20, 2010

I believe the ML EIUL is still the best in the market. The NA product under the current low interest rate environment, seems to be a decent performer. I am studying the NA product lately to see if I like it better than the Midland EIUL as an alternative to ML. If I had a choice I would still go with the ML product, but as long as you stay in the top 5 products you will do fine!

11. Pavel - August 14, 2010

Fantastic post. Thank you so much. This clarifies a lot of myths that surround investing and money protection.

12. Stephanie - September 1, 2010

I like how you break down the truth behind the EIUL.
By the way, for those who are looking to have more cash value down the line, think about putting more than just the regular premium required. The growth is tremendous as compare to a targeted fund policy.
As to companies that exist with these policies, I personally think Pacific Life or Western Reserve Life are two leaders in these policies. They have good rating and solid companies.

13. Adam - October 13, 2010

My wife and I were just provided with Minn.Life Index Universal Life Ins. I have my own business and we have 2 kids…I am 37 and she is 35. We have a 0%-15% return. Our planner feels instead of me starting a retirement fund in my office I could use this vehicle for funding for my wife and I. WE will be paying $10,000 or more over the premium to keep it funded yearly. Do you agree with this plan, and can it really grow to use for loans for retirement. We also have some term life ins. to complement. We are just a little concernec with the big plan and investment of the EIUL.
Thanks, Adam.

shaferfinancial - October 15, 2010

Yes, it is what I have been talking about for a while now.

14. Bella - October 15, 2010

I have An Equity Index lif insurance and after looking at the fees (primum load of 5%) & other Charges fo 917 dollars totaling to 1159.00 dollars against my prmium payment every year.
Is this a normal fee?
I feel I have been cheated.

shaferfinancial - October 17, 2010

I have no way of knowing if the total fees are high and if it was structured correctly to reduce fees. But, as I tell everyone and demonstrate to my clients the fees are front loaded. What matters is what happens at the end as you take out income tax free. Most of the policies I structure have a total fees and expenses between .5% and 1.5% at the end of the day. These are competitive with mutual funds. Then when you think about not having to pay taxes on your retirement income it makes it seem like a real bargain. But remember, the fees are front loaded so the first 10 years or so they will seem to be high, but you make up for it during your retirement when there are few fees and only the expense of insurance. I also tell folks that EIULs are a long-term strategy, so don’t enter into them unless you are fully prepared to keep them for the duration. Hope this helps alleviate some of your concerns.

15. Sanjay Gupta - November 2, 2010

Good Article! However, I see comparison to 401 and ROTH. Would you care to have comparison among various life insurance products espacially whole Life insurance to EUIL with respect to Fees and benefits.

I still think that whole life has all the benefits that you have described in an EUIL and may just be a different name to sell it. I came across something Term Life with Cash..

I think other readears would benefit if you could draw some comparison among Life Insuance products too.

Thanks

shaferfinancial - November 2, 2010

Great idea. I will write a post soon talking about different life insurance products!


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