jump to navigation

Five things you should understand about EIULs March 9, 2009

Posted by shaferfinancial in Finance.
Tags: , , ,
trackback

One of the most popular post on this blog is the post on equity indexed universal life insurance policies (EIUL).  I think that life insurance sales folks are really pushing these policies.  Unfortunately, there is much misinformation on these financial instruments because the great majority of insurance sales people don’t have the finance background to really understand how they work nor do are they worried about their clients wealth creation.  I will keep this post short.  Here are 5 things everyone should know before they purchase an EIUL.

1.  They are for long term planning only.  There are substantial fees included in them that need a minimum of 10 years to overcome;

2. They are extremely unlikely to give you anywhere near double digit returns.  Once again the fees and the insurance costs eat into the returns so you can always get better returns investing directly into the market (not necessarily with mutual funds which have their own return reducing issues).  So the real reason for having an EIUL is to legally avoid taxes and to have a place to put your wealth that will appreciate well beyond inflation rates. 

3. When structured right, you can minimize the fees and maximize the cash value.  But most insurance agents either don’t know how to structure them in this way or won’t because they are trying to maximize their commissions;

4. EIULs are great complements to wealth creating activities.  But, they shouldn’t be the only savings/investing tool you are involved in; and

5. There are many moving parts in these products that have the potential to effect your returns.  Find a company that have a history of not making changes to their products once launched.  Also make sure the policy is from a top rated company. 
 

Hope this helps.  Contact me if you are interested in an EIUL.  I sell them in most states.  And I will always give you honest answers to your questions!

Advertisements

Comments»

1. heilie - November 15, 2012

I am 28 year old and have no retirement plan yet. Should i go with western reserve life or stick with roth ira for my first investment?

shaferfinancial - December 1, 2012

Hellie, I would have to have more information to advice you on the Roth versus EIUL. However, I can suggest that if you did decide that and EIUL was best for you, that you might consider Minnesota Life or North American policies which perform better.

2. kevin - January 9, 2013

I had acquired one of these plicies through my employer. I was wondering if my premium was a bit on high side. Im 35 non smoker great health. I hae a 250,000 policy,and im paying 2135 a yeae. Is that right? Its throug Western Reserve

shaferfinancial - January 9, 2013

Kevin, seems about right, but can’t really tell until
I see details. How long are you scheduled to pay premiums for?

3. kevin - January 9, 2013

My policy is a freedom global IUL II.

4. Richard Powers - April 24, 2013

Hi David,
Please help my wife, who owns a small business in Los Angeles, Calif, set up a retirement plan with a reasonable rate of return and a minimum downside risk. She is 47 yrs, non smoker, good health. I am 69 yrs in good health and retired. She asked me to look into some plans because she works 12 hours a day 6 days a week running her small business for the past 20 years. This is new to me, so I am researching online. I found out that a 401K for small business allows business owner to set aside up to $50K per year tax deferred until the money is taken out after age 65 yrs. Her before tax net income is stable at $150K. She could easily invest $700 per month for retirement. I have not made up my mind on exactly what retirement strategy to use, and am open to suggestions.

We have no credit card or automobile debt. We only have a small mortgage debt. Do you think that since we only owe about $200K on our mortgage, that we should also try to pay it off as soon as possible to stop paying out interest?

I am trying to compare a investment in mutual fund and term life versus EIUL.

What do you think about the following investment strategies:
She buys term life of $500K with a guaranteed rate for the next ten years.
She would invest in mutual fund: Vanguard Wellesley Income (VWINX)
Wellesley is the mirror image of Vanguard Wellington. While Wellington has about 65% of its assets in stocks and the rest mostly in investment-grade corporate bonds, Wellesley reverses the allocations. That makes Wellesley an ideal fund for those who want to minimize risk. Wellesley’s record is impressive. Over the past decade, it returned 7.3% annualized. That outpaced the typical fund in Morningstar’s conservative-allocation category by an average of 1.8 percentage points per year. It also beat the S&P 500 by an average of 1.1 points per year. In 2008, the year in which the S&P plunged 37%, Wellesley lost 9.8%, and the average conservative-allocation fund slumped 19% (source Kiplinger). Pros: (1)She can defer income tax on the money she invests in 401k, while she is in a higher tax bracket until she is retired and then she is taxed at a lower income when she slowly spends the money during retirement. (2) After the mutual fund has been started with the minimum required funding, there are no fixed mandatory monthly payments into the mutual fund as in EUIL. If insured is short on funds and misses several mandatory monthly payments in EIUL she looses everything she has put in for up to 10 years. Now, that is what scares me about EUIL. Cons: (1) She could loose everything in the mutual fund (although the possibility is remote) in a stockmarket crash, especially if the market crashed right before or after she reached retirement age. Even if the fund only lost 1/3 of its value, she would get substantially less out of the fund for her retirement years. That did happen to people’s retirement income when the stock market tanked in 2008. But if they did not sell their stock, the market has recovered overall. (2) She cannot access the funds until after age 65 with the exception of paying bills for catastrophic illness.
For a higher risk more aggressive investment, Vanguard offers the
Versus:
Western Reserve Life: Freedom (NOT GLOBAL) UIL II
Their agent made the following statements (these are approximations)
Female, age 47, non smoker, good health. Payments must be made without fail for over 10 years before any benefits accrue. Therefore, she needs to keep substantial cash reserves in her savings account to pay her insurance premiums in case her small business income decreases for a few months or she will loose all she has invested in the IUL. She can buy an IUL policy of 500k for $660 per month, $7920/yr; $79,7200 for ten yrs with a cash value of $64,000 at age 57 yrs and cash value of $176,000 at age 65 yrs and a cash value of $500k if she invests an additional $8K per yr. The rate of return is based on S&P 500 index.
PROS: WRL claims to guarantee that insured will not lose money and guarantees a minimum return of 1% and a max return of 12%. All money she pays is taxable now and tax free upon retirement as long as she continues to pay the insurance premium after she is retired. Upon her death estate taxes would not be owed by her heirs on the IUL investment. (source salesperson for WRL).
CONS: I believe that the cost of the life insurance (which insured must pay to get the investment portion) is excessive when compared to the cost of term insurance. I believe there are hidden costs that the agent either didn’t know or didn’t want to talk about. For example, since the insured has to continue to pay life insurance premiums after retirement age, that is an additional cost. What if my wife’s business income started dropping off due to competitors taking her clients or if she had a long term illness or disability. If insured is short on funds and misses several mandatory monthly payments in EIUL during the first 10 years, she looses everything she has put in for up to 10 years, up to $79,200. Now, that is what scares me about EUIL. The WRL agent calculated the cash value of the insurance and additional investments based on the assumption that the insured would be getting an 8% return, but that is an assumption. The insured could earn more than 8% or less than 8%. Therefore, the amount the agent stated the insured would retire with, is just speculation. WRL states that they can change the percentage (based on S&P 500 index) they pay to the insured at any time (if I read their literature correctly- you can find it on their website). So actually, the insured’s rate of return can change to whatever the insurance company wants it to be and the insured is locked in to a 10 year contract. I don’t like that. We all heard about a big insurance company AIG that could not meet its obligations and the US Government had to bail them out. Well, although, unlikely, it could happen to another insurance company in my opinion. So, what makes people think investing in an insurance company is safer than investing in stocks and bonds of America’s largest most stable corporations? You can change the investments in a 401K, as far as I know, investors can take their money out of the market and hold in cash, if the market starts to crash, as long as the investor leaves that amount in the 401K. The investor is not locked into just one investment for 10 years as with the EUIL.

I feel that my wife would be better off with term insurance and investments in conservative mutual funds. I just used Vanguard as an example, you may be able to suggest some others and give your reasons.

Please tell me you thoughts on these retirement plans.

shaferfinancial - April 24, 2013

Rich, your wife should be happy that you are doing a good job on your due diligence. The information you have on EIULs is not quite correct, but you are asking the right questions. You also ask about alternative investing strategies and I have written about investing in real estate and dividend champions equities which are both prudent investment strategies. I will e-mail you privately to discuss EIULs as there is much you need to understand in order to properly evaluate whether it works for your situation or not.

Greg - May 9, 2013

Another factoid: the AIG bailout didn’t involve life insurance contracts. It had to do with bailing insurance used to protect certain financial instruments.

As Dave has pointed out on other posts, life insurance companies have been making payments on policies for well over a hundred years despite wars, recessions, and all that stuff. If one insurance company is in trouble, other insurance companies will jump to buy their book business.

5. Tommy Tibajia - May 31, 2013

Dave… would you mind shooting me over a similar email to better understand IUL’s? I have a WRL policy that I should have done this due diligence on BEFORE i bought it… but better late than never.

Mary - June 27, 2013

I actually am in the same situation as Tommy. I currently have the WRL Freedom Global IUL II. I have other agents telling me that I should purchase term and invest the rest. I would like more information to make the right decision for me.

6. joe - November 7, 2013

What is indexed universal life insurance?

IUL is also known as equity indexed universal life (EIUL)
IUL is a type of permanent life insurance policy (i.e. not term insurance) that provides both a death benefit to named beneficiaries and living benefits to the policy owner in the form of policy (or cash) values
What is unique to IUL is the growth of the policy values is linked to the positive performance of one or more securities or market indexes, like the S&P 500 Index, while NOT exposing the policy values to the downside risks of the markets
Whereas variable universal life (VUL), which also has policy values linked to securities, has both unlimited downside and upside exposure to the linked markets, IUL provides downside protection from market risks (in the form of a guaranteed minimum annual return) in exchange for a capped upside of any positive annual market returns
IUL policies combine the long-term growth potential of equity or other markets with the security of a traditional life insurance contract
Many people who “drink Wall Street Kool-Aid” are surprised that life-insurance-company-based products are a significant part of the net worth of some of the savviest and wealthiest institutions and individuals in the world:

According to a New York Times (Charles Duhigg) article published in 2006, “Hedge funds, financial institutions like Credit Suisse and Deutsche Bank, and investors like Warren E. Buffett are spending billions to buy life insurance policies” on the secondary market
According to government disclosures, Federal Reserve Chairman, Ben Bernanke, has the majority of his liquid net worth on deposit with life insurance companies (not deposited in banks or invested on Wall Street) – Medical Economics 6/19/2009
The nation’s large banks invest immense sums of their Tier 1 capital reserves (a bank’s most important asset and a key measure of its strength) into permanent life insurance underwritten by major life insurance companies – Medical Economics 6/19/2009
As of the date of the article, Bank of America, JP Morgan, Wells Fargo, US Bancorp and Bank of New York Mellon had more of their Tier 1 capital reserves in permanent life insurance than they did in bank premises fixed assets and real estate COMBINED
During the economic downturn of 2008-2009, Wells Fargo almost tripled its holdings in permanent life insurance
So a good question might be: Why do they do that?

Well, after a brief analysis of the five key elements of any prudent asset, the answer should be clear. These five elements are:

Liquidity
Safety
Expense
Return Potential
Tax Efficiency
Since no one asset is the best in each of these areas, it is important to know the pros and cons of each asset using these five elements as a guide.

The following bullet points are only meant to highlight some of the pros and cons and are not a comprehensive discussion. In addition, any reference to specific financial products is not a recommendation to buy or sell these products.

Liquidity

Though IUL is designed to be held long term (at least 10 years), it offers significant liquidity
Of all other long-term, tax-favored assets (i.e. IRAs, 401(k) plans, annuities) it provides the most liquidity without a tax penalty
IUL is the only long-term, tax-favored asset used as collateral for a bank loan
Using an annuity or retirement plan as loan collateral, even if allowed by the bank, will trigger a taxable event
Due to IUL liquidity, banks will even lend money for the purpose of purchasing IUL, using the policy values as primary collateral
It is not uncommon to have access to 100% of your principle within a few years
Some IUL policies have a provision for 100% liquidity from the beginning of the policy
IUL liquidity provisions include either withdrawals from the policy values or loans from the insurance company using the policy values as collateral
According to a Medical Economics article on 6/19/2009:
John McCain used the liquidity of his large life insurance policy to initially finance his campaign
Doris Christopher used the liquidity of her life insurance policy to launch Pampered Chef—that she eventually sold to Warren Buffet for $900 million
J.C. Penney used the liquidity of his large life insurance policy to begin resuscitating his retail stores after the crash of 1929
Safety

An IUL policy that is properly structured and funded with a highly-rated insurance company should be one of the safest assets to hold in a portfolio
IUL is sold by some of the largest and highest-rated insurance companies in the world
Unlike banks, life insurance companies do not use excessive leverage
If a bank has $1 million on deposit, it can lend out up to $10 million
This “excessive” leverage is a reason many banks are failing
If a life insurance company has $1 million on deposit, it can lend out no more than $920,000, meaning life insurance companies are 100% reserve-based lenders, making them stable institutions in down economies
According to the Medical Economics article, during the Great Depression, when more than 10,000 banks failed, 99.9% of consumers’ savings in life insurance remained safe with legal reserve life insurance companies
IUL, since it is a life insurance CONTRACT, contractually guarantees that though the policies values are linked to various markets, there is a guaranteed minimum return in case of negative markets
In addition, all positive interest that is credited to policy values is protected from future market losses
In many states, life insurance policy values are protected from creditors (lawsuit, bankruptcy) by state law
There are two main risks of losing money in an IUL:
Not properly funding the policy
This risk can be mitigated with proper structuring (i.e. minimum death benefit per $ of premium) and source funding (i.e. using assets, instead of cash flow, to fund the policy)
Cancelling the policy in the early years
This risk can be mitigated with proper planning and ongoing policy servicing
Expense

There are six (6) main expenses associated with IUL:
Cost of insurance (also known as mortality charges)
Monthly expense to pay for death benefit
Premium expense (also known as premium tax)
One-time percentage (usually 5%) of each paid premium which is paid by the insurance company to the government
Policy expense (also known as monthly expense)
Monthly expense to cover insurance company expenses
Cap-rate enhancement expense
Expense to purchase more market-index upside
Loan interest
Subtracted from policy values if not paid in cash
Surrender charge
Possible back-end expense charged if policy is cancelled before a certain year (usually 10-15 years)
Many IUL companies offer policy riders that waive the surrender charge
From an expense perspective, since IUL is “front-loaded” and typically has a surrender charge, it usually does not make sense to purchase IUL as part of your short-term portfolio (i.e. less than 10 years)
Purchasing IUL requires a long-term approach—much like the mindset you take when deciding to purchase a home versus rent a home (i.e. short-term pain for long-term gain)
Due to the number of possible expenses of IUL, it has the reputation with some people of being “expensive”, but in and of itself, IUL is neither expensive nor inexpensive—it depends on the policy structure, funding and utilization
A properly funded, structured and utilized IUL can have a relatively low expense ratio compared to many other assets; conversely, due to non-cash-value-correlated expenses of IUL, not funding IUL properly, or cancelling it in the early years, can lead to a high expense ratio
To minimize the expense ratio of IUL, you should purchase as little death benefit as possible (see Internal Revenue Code (IRC) §7702) for each premium dollar paid—that way, more money is retained in your policy values
The expense ratio of a policy can be projected/calculated using the difference between the illustrated (gross) rate and the internal (net) rate of return (IRR)
For example if the gross illustrated rate of the IUL contract is 8% and the net long-term IRR is 7.6% then only .4% is lost to policy costs (or about 5% of the total return)—which compares favorably to mutual funds and other managed portfolios
With most mutual funds, the annual expenses that have to be subtracted from the gross return include fund fees, management fees and taxes
For example, if you owned Fidelity Magellan Fund (FMAGX), according to Yahoo! Finance, the annual fee paid to the fund is 0.59%
The management fee paid to your advisor could be around 1% (less or more depending on how much you invest)
Since the fund has a turnover rate of 102%, that means that most of your gains in the fund would be taxed at short-term capital gain rates (i.e. your marginal tax bracket) and have to be paid each year
Therefore, if the fund grossed 8% (its current 10-year return is less than 1%), then the net after-tax return would only be 3.82%–which means you would lose 52% of “your” return to the fund, your advisor and the IRS:
0.59% to the fund
1% to your advisor
2.59% to the IRS, assuming a 35% marginal federal tax bracket (not including potential state income tax) and taxed at short-term capital gain tax rate (due to high turnover rate of the fund)
Therefore, with the expenses and taxes associated with the Fidelity Magellan Fund, using the assumptions above, the fund would have to average almost 16% per year to net what an IUL would net with an illustrated return of 8% and an IRR of 7.6%
So, in this example, would you rather pay 5% of your long-term return to have death benefit throughout the term of the policy (and downside protection from the markets) or would you rather pay over 50% of your return to have no death benefit (and no downside protection from the markets)?
Again, the expense of an asset is always relative to what you are comparing it to
Rate of Return Potential

IUL policy values are linked to various market indexes that allow your policy values to grow up to maximum annual cap rates
Using long-term historical performances of market indexes, most policies will illustrate future policy value growth based on historical averages of 7%-9%, depending on the index and cap rate
There are several ways to potentially increase the long-term IRR (net return) of IUL policy values:
Purchase IUL from companies that have higher participation caps
Some companies have annual cap rates as high as 20% on their index strategies
Purchase IUL using premium loans (also known as premium financing)
This strategy alone can significantly increase the long-term IRR of IUL
Use fixed participating loans when accessing the policy values
These are loans where you pay a fixed rate to the insurance company but you still have the upside of the market indexes for your policy values
One company offers a fixed participating loan that is contractually guaranteed to be 5.3% for the life of the policy
Use fixed participating loans during your “accumulating” years to purchase appreciating assets like real estate and other investments
This allows you to have the potential to experience a double positive arbitrage (the difference between what you pay in interest versus what you gain through rate of return)
You can earn the difference between the loan rate and the IUL index crediting rate, PLUS…
You can earn the difference between the loan rate and the return on the appreciating asset
Sell the policy on the secondary market
During your retirement, if you decide you no longer want or need your policy, you could sell the death benefit (i.e. contract) for more than the policy value
This would obviously be in your best interest but may not be in the best interest of your beneficiaries
The secondary life insurance market is what was referenced to earlier that hedge funds, banks and investors like Warren Buffet are involved in
When a policy on a senior citizen is sold/purchased on the secondary market, it is known as a “senior life settlement”
In the right situation, it can be a win/win for both the seller and buyer since the seller (you) is getting significantly more than the policy values, while the buyer is purchasing your death benefit at a deep discount
Tax Efficiency

IUL can be one of the most tax-favored assets under the Internal Revenue Code (see your tax advisor for specifics regarding your situation)
A properly structured, properly funded and properly utilized IUL (see IRC §101 and IRC §7702) has similar, but arguably better, tax benefits than Roth IRAs (see IRC §408A and IRC §7701)
Premiums are paid with after-tax dollars
Policy value growth is tax deferred
Policy value profit can be accessed tax free via withdrawals and/or policy loans (that can be paid back via the death benefit at policy maturity)
Policy death benefits (usually significantly more than policy values) can be received tax free by beneficiaries
The two main advantages of IUL over Roth IRAs are:
You can put significantly more money into IUL than a Roth IRA
IUL has significantly more early liquidity (i.e. penalty-free withdrawals/loans) than a Roth IRA
However, if a policy is “cashed in”, any profit in the policy would be taxable at your federal marginal tax bracket
This tax can be mitigated if the policy values are rolled directly to another qualifying permanent life insurance policy (see IRC §1035)
This is similar to doing a real estate tax-free exchange (see IRC §1031)
This tax-free exchange option is important since there is a high probability that future insurance policies will have more desirable features, and policy owners may want to “upgrade” their contracts without having to pay a “tax toll”
Therefore, since properly structured, properly funded and properly utilized IUL:

Is more liquid than most assets…
Is one of the safest assets…
Is relatively inexpensive…
Has historically-based, above-average return potential, and…
Is one of the most tax-efficient assets…
IUL is at the top of my list as a foundational part of a long-term portfolio.

7. Ap999 - August 11, 2014

I have a 700k WRL IUL policy, I am quite pleased with it. It’s coming a long great even after just 7 years of owning it. The key is to fund it as much as you can but of course just below the max to avoid it becoming a MEC. I would only recommend this for people who are already maxing IRA/401k. I have been maxing my IRA, maxing my IUL, and the rest goes into a taxable account invested in low cost index funds.

8. insurance verification - October 18, 2014

insurance verification

Five things you should understand about EIULs | Uncommon Financial Wisdom

9. Kenny - November 17, 2014

I am trying to educate myself on IUL’s before purchasing one. I am looking into getting one through Trans America which offers the writes IUL’s through Western Reserve Life. I was told to ask to see the Historical Experience Crediting Report. I have not seen it yet and have asked for it twice from 2 different reps. I’m getting a little nervous about signing up now. Are you familiar with this report? If so, what is it and why would they not show it to me? Are Index Universal Life and an EIUL the same? I have a Universal Life insurance policy now but I’m wanting to know if this IUL would be a better investment. Sorry I have lots of questions but not enough answers. Any feedback would be greatly appreciated!

Thanks!!!!

shaferfinancial - November 17, 2014

Kenny, if you would like to talk, give me a call or e-mail me. The contact points are both on this blog and my website.

Rob S - February 10, 2015

If you currently have Universal Life that is out of surrender period, I would highly suggest 1035 exchange it for IUL. In 10+ years, IUL should return 3 to 5% higher than UL. Most IUL product would have returned around 8% for last 20 years with no negative years had it been in existence 20 years ago. If wanting grow money is more important than the death benefit, then it must be structured such that you minimize death benefit to the point where it will allow you to put in your monthly premium at IRS guideline (Seven pay premium / annual guideline premium test)

10. melinda j. - August 25, 2017

Hello,
Can you please explain to me how they are structured to be a great investment?

Thanks,
Mj

shaferfinancial - August 25, 2017

Of course. You can send an e-mail through the system or give me a call 727-804-9271 to set up an appointment for a discussion.


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: