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Why purchase an Equity Indexed Universal Life Insurance Policy? January 21, 2014

Posted by shaferfinancial in Finance, Uncategorized.
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Its been several years since I have written a post outlining the basics of Equity Index Life Insurance Policies [EIUL]. EIULs are life insurance policies that credit the cash value with interest tied to a stock index or group of stock indexes with a floor of 0% and a moving cap [currently between 13-16%]. Here is a key point; when we structure it for future tax free cash flow, we minimize the amount of life insurance to its lowest level allowed under IRS rules. By lowering the face value of the insurance we drop the expenses within the life insurance policy significantly [including the commissions] increasing the internal rates of return received on the premiums paid into the insurance policy. When one needs money from the policy you access it via policy loans. These are loans against the face value of the policy. Most EIULs have loans that are at “no cost” or “minimal cost [.1%].”

One important factor is that most of the expenses are taken out in the first 10 years. There are also surrender fees that go on for 10-15 years. This combination makes this product unsuitable for those looking for short term or even medium term products that can be liquidated over 15 years. No one should enter into an EIUL unless the plan is long term in nature. Obviously in emergency situations the cash value can be accessed any time after year 1 so it does serve as an emergency reserve fund, but this should not be the plan for this product.

Here is how it works:
Premium must be paid in over no less than 4 years. It can be paid in for as long as someone needs to.
Each year expenses are subtracted from the premium each month. The balance is put into an index leg chosen by the policy holder. At the end of 1 calendar year each leg is given an interest credit that matches an index or group of indexes. That interest credit is locked in at this point. The following year the locked in amount plus the additional premium added is given the interest credit. Each year the worst thing that can happen is if the index has gone down you get no gain [and no loss]. So a big fat 0%. So if the stock market does one of its usual swoons [averages 3 times a decade] you lose nothing. If the stock index goes up you get the gain up to the cap. This strategy testing backdated data for almost any period of time gives you higher rates of returns than the actual index.

The math in this strategy is that losses hurt more than gains help. An easy way to look at this is a simple example: You put $1,000 into an stock index fund. The first year it goes down 33%. You now have $667 of value. The second year it goes back up that 33%. It is now worth $889. What happened to the other $111? It is lost in the “average” returns. Your average return was 0% [-33% + 33%/2] but you actually loss 11% of value! Now you know why Wall Street loves to talk about average returns! In your EIUL what happens. The first year your value stays at $1,000 even though the market dropped 33%. The second year you get the cap of 16% so have $1,160 in your account [compare that to the $889]. Now you know why in most markets the EIUL strategy will give you higher rates of returns.

Expenses are very different in the EIUL as opposed to your basic mutual fund. In your mutual fund there is usually an expense ratio applied to your premium dollar. This is subtracted annually no matter whether there were gains or losses in the account. And more importantly the bigger the account gets the higher the actual expenses are. In an EIUL the expenses are fixed up front and with the exception of the premium load and insurance costs are subtracted from the premium over the first 10 years [in the ML EIUL]. Once you stop paying premium and get beyond the first 10 years the expenses basically stop. So in the years that you have the most cash value your expenses are extremely low. This difference is hard for folks to get their head around, but when we look at total expenses over a lifetime we find that the cost of the life insurance policy is generally between .5% and 1.7% depending on what age you start the policy. Bottom line is that you can get lower expenses if you have absolute control over your money [not in an 401K for example], but the expense are generally in-line between what most people have in their 401Ks and these policies.

The one risk Wall Street hates to talk about is sequence of return risk. This is the risk that even though the “average” rate of return is sufficient, the actual sequence of returns could leave your retirement nest egg insufficient. Take someone that retires within 5 years before or after a major market downturn. They simply don’t have the time before they need the money to make up for a -30% year or heaven forbid another -40% year. And if you are unlucky to retire close to a series of market downturns [remember the 2000s] your anticipated retirement income could go down over 50% annually just because of bad luck. Do you really want to leave your retirement to pure luck??? Might as well walk into Vegas and put it all down on black!

Now under current IRS rules [revisited three times by the IRS], you can take loans against your face value and there are no tax consequences as long as you keep your life insurance policy intact. So tax free distributions from your EIUL.

Finally, these are insurance policies so they work to complete one’s financial planning. Most people never imagine an early death but it does happen to 24% of individuals who die before retirement age. 16% of men [12% of women] die between the ages of 45 and 67, which happens to correspond to the years most people are able to put the most money aside for their retirement. It also corresponds to the years most people are not insured because they have dropped their term life insurance. This is often a disregarded function of these life insurance policies, but for 16% of folks having a substantial death benefit can help complete their family financial planning.

To summarize:
1. These are for people with a long term savings strategy
2. History suggests a higher rate of return over the long term using the step up and lock in strategy inside EIULs
3. Sequence of return risk is eliminated
4. Expenses in line with most mutual funds inside 401Ks
5. Tax Free Distributions
6. Death protection against an early demise
7. You own these yourself so the company you work for can’t lock you away from your money
8. No penalties if you need to take money out in an emergency. You would get a 10% penalty in an 401K/IRA
9. Your money doesn’t go down in bad market years
10. You sleep better at night not having to worry about “the market,” something totally out of your control

At last a reasonable way to save money and get a decent rate of return is available to those who can think outside the box Wall Street has created with its propaganda. Now, I always suggest combining an EIUL with other investments that will diversify yourself and provide potentially higher rates of return [like real estate investing and dividend producing stock]. The beauty of starting an EIUL is that it only takes a monthly commitment and not large sums of capital to start like real estate. So, no matter what the age we can structure an EIUL that will create a bountiful retirement. Don’t you owe it to yourself to look into this savings vehicle? Contact me and we will create an illustration that fits your particular situation so you can make a comparison to what you are currently doing.

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