Equity Indexed UL vs. Whole Life November 23, 2010Posted by shaferfinancial in Finance.
Tags: equity index universal life, Whole Life vs. Equity Index, Why EIUL over Whole Life?
Tip of the hat to a reader who suggested this exploration!
There is a parallel group of insurance thinkers that suggests using participating [whole] life policies for what they call the “infinite banking” concept. The concepts are basically the same, build up cash value in your policy and then use the cash value as your own bank, borrowing and paying it back as you need to. The concept is sound, but the product has limitations in my mind.
First of all whole life has much less flexibility built into it. Once the premium is set, then you must make that premium payment or put your policy at risk. Instead of getting interest tied to a stock index, you get dividends, which are basically the excess interest earned by the life insurance company over their expenses. These participating policies has a long and successful history. If you choose a solid company [Northwestern Mutual, Guardian, Penn Mutual, etc.] you should be assured of getting a consistent dividend.
There are three areas of performance that we should be looking closely too. The first is the cash value build up. The second is the actual historic internal rate of return over a long enough period to even out the good and bad years. The final is the amount of income that can extracted from the policy. In all three areas the performance of Whole Life is wanting. The cash value build up is around 15-25% less for the best whole life policies compared to the top EIULs. Now, I will say that whole life has a much longer history than EIULs and so we are comparing actual performance [going back 30 years] of WL with theoretical performance since EIULs only go back 15 years. But if we look at the actual life [10-15 years] of EIULs compared to Whole Life we see the same real performance differences as our longer analysis, so I believe the analysis is sound.
The comparison goes downhill for WL from there. The actual historic rate of return is between 2-3% [except Northwestern at 4.65%]. Northwestern is a great company, but the expenses are much higher inside the policy so the final results are similar to other companies despite the higher rate of return. Remember, our 30 year look back for Minnesota Life is 8.86%. Finally the amount of income that can be extracted from whole life is about 50% of that from the top EIULs because the the poorer performance and the lack of a variable loan option.
One note, you can’t lower the insurance amount down, like you do in EIULs, so you have to do what is called “paid-up additions.” The end result is about the same, but EIULs allow you to be more precise.
Bottom line is that the strategy of “infinite banking” is solid. The idea’s of using life insurance for a tax efficient savings vehicle is the same. But the lack of flexibility and the poorer performance should be a deal killer compared to the EIUL.
Oh, and one more observation. Whole life policy illustrations include a projected return for 20 years down the road. The projections always seem to be much higher than the actual returns. With the long history of WL, you would think they would project it a little closer to actual returns. For example the Guardian projected return in late 1989 was 5.25%, but the actual 20 year return was 2.97%.
I hope this discussion is helpful for folks looking into using life insurance as a savings vehicle.
As always let me know what you think and give me a call if you want to further discuss EIUL!