(Presentations were created using the InsMark Illustration System.)
Next time you are confronted by a “termite” who tells you cash value life insurance is a lousy investment, try asking one of these questions:
1. “If something you believe to be true turns out to be wrong, when would you want to know about it?”
Or this:
2. “If I agreed with you, then we’d both be wrong. Do you want to know why?”
Or this:
3. “Do you dislike cash value life insurance so much that you’ll give up yield just to avoid it?”
If a CPA or attorney is the termite, either #1 or #2 can be effective, but #3 needs to be reworded a little.
4. “Do you dislike cash value life insurance so much that you recommend clients give up yield just to avoid it?”
If you’re bold enough to use these questions, you must be able to prove the point, so follow-up with this question:
“Would you like to see how you would have to earn over 12% in order to match the yield of cash value life insurance?”
Most reasonable observers will generally answer that they would like to see the proof of your claim.
Proof? As an example, click here to review the indexed universal life (IUL) illustration we prepared for Elizabeth Rand, MD, from Case Study #2 in last week’s Blog #36. Her policy is intended to be a source of after tax retirement cash flow coupled with substantial death protection.
After reviewing Dr. Rand’s comparison to term insurance and a side fund on Pages 1 – 3 (note on Page 2 of the illustration that the term and side fund evaporate in year 28), pay particular attention to Page 4. It shows that Dr. Rand would have to earn a pre-tax, equivalent, compounded rate of return of 16.12% on the side fund each and every year to match the results of the IUL cash value.
Might you be asked to prove it? You might, but it’s simple. Run the illustration with the side fund at 16.12%, and you’ll have the documented proof as the side fund and cash value come together in the last year of her illustration.
Note: Dr. Rand’s IUL illustrates participating loans which makes her comparative yield pretty substantial.
Does Dr. Rand’s illustration apply to all prospects? Of course not, and we suggest you develop several masters at different ages and different amounts and carry them with you. This way, an appropriate one will always be available when you need it — and you will need it.
Click here for a similar comparison using a less substantial policy. Page 4 in this case illustrates a pre-tax equivalent rate of return of 13.29% for the side fund to match the results of the IUL. (The difference is mainly caused by the fact that this particular IUL carrier does not illustrate participating loans.)
The Suze Ormans of the world are relentless in discrediting cash value life insurance. I don’t care how big or small your case is — they are simply wrong! If you have the cash flow to buy permanent life insurance, you’re nuts to buy term.
We prepared Dr. Rand’s comparison to “Term and Invest the Difference” in the InsMark Illustration System. For licensing information, contact Julie Nayeri at julien@insmark.com or 888-InsMark (467-6275). Institutional inquiries should be directed to David Grant, Senior Vice President – Sales, at dag@insmark.com or 925-543-0513.
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Note: Last week, we promised to compare how Dr. Rand intends to use her IUL as the funding instrument for a deferred compensation arrangement. We will do that in one of the next few Blogs.
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More Recent Articles:
Blog #36: The Magic of Indexed Universal Life
Blog #35: Revisiting the Pothole in Wealth Planning (Good Logic vs. Bad Logic™)
Blog #33: Referred Leads – How to Use Them Effectively
Blog #32: Documents On A Disk™ is Now in the Cloud
Blog #31: IRA Rescue Made Easy
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Robert B. Ritter, Jr. Blog Archive
“Hi Bob,
We have never connected on any business but I am a frequent reader of yours. I have been a good producer for 30 years making a nice living with consistent TOT production from selling life insurance for strictly death benefit oriented purposes (almost never for accumulation and distribution).
I want to comment on you blog. Your spreadsheets have such clarity, and are clean and tidy, but your “invest the difference” math in my view is not reality.
( https://www.robert-b-ritter-jr.com/downloads/Blog-37-Dr-Rand-Term-vs-Permanent.pdf ).
On the “invest the difference”, your spreadsheet must assume the hiring of a hypothetical portfolio manager who is earning 75 bps (so-far-so-good) and also turning over the portfolio at a rate of 100% every year, and always incurring a 45% max tax rate. I say this because your net return on the “invest the difference” is in the mid 3% range; I am thinking that you took 6.75% (7.5% minus .75%) less a 45% tax hit = 3.7%. That is not realistic. What about different/lower tax rates for cap gains? What about stocks that don’t turn over every year? What about harvesting tax losses to offset gains? What about when the “invest the difference” is being ultimately depleted to zero and there should be tax-free return of basis? A real world portfolio would never be managed like your “invest the difference” fund.
Anyway, I would appreciate your reply, and perhaps you can set me straight on what I am missing. I am not an investment guy per say, but all my investing (outside of what I have in cash values) is done by a manager who does not incur this type of annual tax hit on my portfolio.
Best to you, Glen”
—
Hi Glen,
Thanks for taking the time to write your thoughts on my Blog discussing Indexed Universal Life compared to “Buy Term and Invest the Difference”. You apparently misunderstood that I was reflecting a purely taxable account as the side fund (unusually generous at 7.5%) in the term combination, not an equity account. Based on that, my math is accurate.
In response to your comments, if an equity account is used for the side fund, the results aren’t all that much different. I think you will agree they are favorable toward the equity account.
Case Study #1
Conservative Equity Account Assumptions
Growth: 7.50%
Sales Charge: 0%
Mgt. Fee: 0.75% (unusually low — most advisers charge 1.00% to 1.50%)
Income tax: 45% (including a conservative amount for state capital gains tax)
Capital Gains Tax: 25% (including a conservative amount for state capital gains tax)
Portion of realized gains that is long-term: 70% (generous)
Portion of realized gains that is short-term: 30% (equally generous)
Portfolio turnover: 10% (unusually low — assumes an index-type fund )
30-year level term insurance: $3,000 a year premium for $3,600,000 million (which expires by Dr. Rand’s age 70)
See the first attached illustration named “IUL vs. Term & Equity Account #1.pdf” for full details of Case Study #1. The term insurance expires at age 70 and the equity account runs out of gas in year 32 at Dr. Rand’s age 72. The term and equity combination are distinctly in second place. Please be sure to review Pages 8 – 13 due to the backup detail required for the various equity account charges.
Case Study #2
Reducing the Term Insurance to $1,800,000
The term alternative does have an advantage in Case Study #1: In some years, the overall death benefit of the combination package is greater than the death benefit of the IUL; however, since one of the primary purposes of the transaction is to maximize long-range, after tax, retirement cash flow, I believe this is tolerable difference. But perhaps a fairer comparison would be reduce the amount of term insurance, say, in half to $1,800,000. In this case, the equity account runs out of gas one year later — in year 33, at Dr. Rand’s age 73 again leaving the term and equity combination still distinctly in second place.
See the second attached illustration named “IUL vs. Term & Equity Account #2.pdf” for full details of Case Study #2. The term insurance expires at age 70 and the equity account runs out of gas one year later — year 33 at Dr. Rand’s age 73. The term and equity combination remain distinctly in second place. Again, please be sure to review Pages 8 – 13 due to the backup detail required for the various equity account charges.
Note: Responsible producers should remain in a long-range advisory position with owners of cash value policies where substantial policy loans are expected since, if a surrender or inadvertent lapse of the IUL occurs in later years, the tax consequence could be onerous,. This is one reason I retained substantial long-range residual cash value in the both attached IUL illustrations. Some life insurance companies have developed concierge units to help monitor such plans.
Thanks again for commenting.
Bob
—
“Hi Bob,
Thanks for clarity about your illustration and explanation that side fund is simply a side fund and not an equity account. I will study newly provided examples which are geared towards an equity fund comparison.
I have never sold life insurance as a core wealth accumulation tool, but I am warming up to the idea of near-MEC funding of policies for some of our clients, or my own investing. In the meantime, to conduct my own due diligence, I have been searching for some long term data to get my brain around the true ongoing tax drag of a low-cost (nearly passive) long term equity portfolio.
My equity manager, http://www.portfoliosolutions.com , has a CFA there who passed along some data about all of this. Basically, the data says that very long term historic equity returns are tied to mostly dividends, then inflation growth, then, and then the true earnings growth of the actual corporate entity (see page 27 of the PDF – Robert Schiller – Yale Prof ). So, one would think that just the tax on the dividend component alone is going to cause the equity fund to lose more to annual income taxes than what a life policy loses to policy expenses and COIs. So, that makes me feel that life insurance’s tax deferral will make it a winner in the long haul vs. the well run equity fund – BUT, what about dividends in the IUL’s S&P 500 indexed accounts? There are no dividends factored into in IUL returns – is that correct? Also, when I looked at your “IUL vs. Term & Equity Account #1.pdf” there are a bunch of zeros for the dividend column in the equity fund assumptions (your pdf PAGE 9 OF 13).
So, how do you account for the dividends that would be part of “buy term and invest the difference in an equity fund”?
Thanks in advance for the thoughtful exchange.
Appreciatively, Glen”
—
Hi Glen,
It was good to hear from you.
Re your dividend comment, you are correct, most (all?) IUL carriers provide no credit for S&P dividends. I personally believe that the fact that an S&P credited yield (or a portion of the S&P due to a lower cap rate) to an IUL policy can never go below zero in negative yield years is a very valuable trade off to the absence of a dividend yield.
You are correct. Although InsMark Systems can include a factor for dividends, I did not include a dividend assumption in my illustrations. If I had, I would have likely reduced the growth to 6.50% and added a 1.00% dividend (or 5.50% growth and a 2.00% dividend). I checked both of those assumptions with both illustrations I sent you (taxing the dividend at 25%), and the equity account crashed in the same year in both cases.
Could you justify comparing IUL at 7.50% with the equity account growth at, say, 7.50% plus a dividend? I tried 7.50% plus a 2.00% dividend, and the equity account still crashed at Dr. Rand’s age 83 in both illustrations.
I draw the following conclusion from all this: Assuming reasonably similar yields, if you measure all the factors that can retard the growth of an equity account compared to what retards the growth of an IUL policy (mortality charges and expenses), I believe the IUL can come out the winner every time — except over short term durations where the commission loads of the IUL have not had time to be absorbed. With no-load or light-load IUL, this would not be as severe in early durations. (I know of no such products, do you?)
Your thoughts?
Best regards,
Bob
Thanks for all the great informative blogs Bob,
I really appreciate all the tips and tricks you provide.
Tom