by Guest » Wed Feb 16, 2011 10:10 pm
I would like to get the opinions of some the insurance experts on this forum regarding a life insurance proposal. An insurance agent (who is a family friend) has proposed an Indexed Universal Life policy from Pen Mutual. The agent is selling it as a retirement investment. Some of its features are:
• Indexed to the S&P500
• Lower cap of 2% and an upper cap of 13%
• Loan rate of 6% with loan participating in returns
• Loan rate of 0% with loan not participating in returns
• Life insurance benefit of $2.8 million in the proposal
The agent is proposing investing heavily up front (the model he illustrated has $50k, $50k, and $35k the first three years and then $15k each year after that until age 65). Note, I would not put that much money into it, but I would front load it if I were to do it. He is then proposing to begin loaning from the policy in year three and reinvesting the money back into the policy; in the model it is $60k of loans each year. The idea is to leverage the money since you can loan at 6% and get an historic average return of about 8%. In good years you could make up to 7% on the loan value (13% cap - 6% interest); in bad years you would lose 4% (2% floor - 6% interest); and on average make 2% (8% historic average – 6% interest). The model shows a huge growth with the 8% average return that would allow tax free income (loans) at age 65 to 100 of around $690k per year.
He claims this is a low risk proposal. On paper it seems like a great way to save for retirement; my company recently cancelled the 401(k). I have done a lot of research on life insurance; particularly on if life insurance is a good investment for retirement. There are reputable sources/people with good arguments both for and against using life insurance as an investment. I cannot decide if it is or is not a smart choice. This particular proposal seems to be a more aggressive plan to use life insurance as an investment.
Is this proposal a good way to save for retirement? Is it very risky?
Thank you.
• Indexed to the S&P500
• Lower cap of 2% and an upper cap of 13%
• Loan rate of 6% with loan participating in returns
• Loan rate of 0% with loan not participating in returns
• Life insurance benefit of $2.8 million in the proposal
The agent is proposing investing heavily up front (the model he illustrated has $50k, $50k, and $35k the first three years and then $15k each year after that until age 65). Note, I would not put that much money into it, but I would front load it if I were to do it. He is then proposing to begin loaning from the policy in year three and reinvesting the money back into the policy; in the model it is $60k of loans each year. The idea is to leverage the money since you can loan at 6% and get an historic average return of about 8%. In good years you could make up to 7% on the loan value (13% cap - 6% interest); in bad years you would lose 4% (2% floor - 6% interest); and on average make 2% (8% historic average – 6% interest). The model shows a huge growth with the 8% average return that would allow tax free income (loans) at age 65 to 100 of around $690k per year.
He claims this is a low risk proposal. On paper it seems like a great way to save for retirement; my company recently cancelled the 401(k). I have done a lot of research on life insurance; particularly on if life insurance is a good investment for retirement. There are reputable sources/people with good arguments both for and against using life insurance as an investment. I cannot decide if it is or is not a smart choice. This particular proposal seems to be a more aggressive plan to use life insurance as an investment.
Is this proposal a good way to save for retirement? Is it very risky?
Thank you.
Posted: Fri Feb 18, 2011 07:02 pm Post Subject:
One other question, has anyone seen or have experience with a policy where large loans are taken from the policy so early (in year three) and put back into the policy? Leveraging like that could definitely increase the returns, but it also could result in large losses and the policy to lapse (causing a huge tax bill from the loans).
Posted: Fri Feb 18, 2011 07:10 pm Post Subject:
Dgoldenz what type of insurance are you referring to? Excuse my ignorance, but what do you mean by “GUARANTEED”?
By "GUARANTEED" I mean that as long as you pay the premiums and do not take any loans or withdrawals, the death benefit is guaranteed for life.
I have a few quibbles with this comparison.
1. This money would have to be a taxable account, so there would be annual taxes that the investments would generate. These could be minimized by investing in tax-managed funds or index funds, but the effective interest rate would be lower in taxable account versus a tax-deferred account (like a Universal Life policy).
2. The gains on the investments will be taxed when they are sold, so the money will be reduced by whatever the long-term capital gain tax rate is at that time. Who knows what that rate will be (15, 20, 30 40 percent)?
3. While $2.5 is a lot money in today’s dollars (at least it is to me), that would only produce yearly income in the low $100 thousands (it could be a lot lower if the capital gains tax goes higher) versus about $690,000 in the life insurance model that is being proposed (again, I am not saying that model would actually happen, but that is what is being shown).
Why would it have to be in a taxable account? You can put the money into an annuity that is tax-deferred, or put it into an IRA, Roth, 401k, etc. That keeps it separate from the life insurance and cost of insurance charges. The odds of you receiving $690k per year for life in tax free income as projected are somewhere between slim and none. That money is also not guaranteed because the cost of insurance charges can increase and interest rates can decrease.
Here's a question - what happens when the 13% cap is lowered to the guaranteed minimum, which is probably more like 5%? What happens when the "minimum guarantee" that is declared currently of 2% is reduce to 1% or less? There goes your projections, oops. Ask the agent to explain that one to you.
IMO, you are playing with fire here and there are so many things that could possibly go wrong in this scenario that would leave you with $0 and unhappy with the product you bought.
I like guarantees, not "trust me" scenarios where the insurance company holds all the power. Buy life insurance for the life insurance and keep your investments separate.
Posted: Fri Feb 18, 2011 07:17 pm Post Subject:
On a side note, if you are really intent on dumping that much into a life insurance policy to build cash value and death benefit, a good participating whole life policy would have much, much better guarantees than the policy you are being presented and the cost of insurance charges are declared at the beginning of the contract, not subject to change. Dividends are not guaranteed on whole life just as 8% crediting interest isn't guaranteed on the UL policy, but you'd be in a much better position with the WL policy if things don't go as planned since it won't "crash" like the UL policy can.
Posted: Sat Feb 19, 2011 04:38 am Post Subject:
your reading comprehension is in the toilet.
Sorry. I merely quoted what you wrote. It's not my reading comprehension, it's your inability to articulate a clear thought. I read your comment as if you were saying "A Roth IRA doesn't make as much (interest) as a traditional IRA" as the rest of my comment clearly articulated -- when you conveniently fail to quote that, to take my remarks out of context. On the other hand, you leave too much to interpretation when you don't make clear references to the comment to which you reply.
And, perhaps you also failed to notice that I stated that the Roth IRA makes a better savings vehicle for most persons because of the income tax-free withdrawal of gains after age 59-1/2 under current tax laws.
One other question, has anyone seen or have experience with a policy where large loans are taken from the policy so early (in year three) and put back into the policy? Leveraging like that could definitely increase the returns
Most people don't put enough money into a UL policy to be able to take a large loan in year 3 of the contract. Even if there was, I fail to understand how taking money out of the policy as a loan and putting it back into the same policy as principal creates any significant leverage. The typical UL policy loan interest rate is stated as 1% MORE than the interest crediting rate, so interest on the loan negates interest paid on loaned amounts. Putting the loaned amount back into the policy without repaying the loan results in a 1% reduction in net earnings compared to not taking the loan at all, but the accumulating unpaid loan interest will, itself, bear interest (aka COMPOUND interest), and future returns will be diminished even more, accelerating the potential for premature policy lapse.
Then again, the duplicate funding could also result in the policy becoming a MEC (violating the 7-pay corridor test) and then the whole scheme falls apart because the contract loses its definition of life insurance. This, in part, was almost the same scenario as in the early years of UL, when people were using 1035 exchanges from their WL policies into new UL policies, then taking large loans and deducting the [unpaid] policy loan interest on their income tax returns. The IRS smelled a rat and Congress created the MEC in response.
dgoldenz is right on target. The UL scheme being proposed is highly unlikely to perform as indicated, and a WL policy, with slightly higher annual premiums would, dividend accumulations aside. I have never seen a UL policy perform as originally illustrated when cash value is removed at any point after policy issue . . . and most don't perform as originally illustrated even when the cash value is not removed.
But with the future holding the prospects for double-digit inflation as the result of runaway government spending and printing money out of thin air, higher interest rates are likely to result, and UL policies may respond with in kind with higher internal rates of return not seen since the early 1990s, and come closer to their illustrations than not.
A UL policy issued in 2011 with a 2% minimum interest crediting guarantee is awful. Most companies are offering 4% or more as the guarantee. Not spectacular, but a far sight from 2%. Even EIULs are crediting 3% minimums instead of the 0% of just 4 or 5 years ago.
Posted: Sat Feb 19, 2011 10:29 pm Post Subject:
Max, you can’t be serious. I made a very clear statement that the OP could contribute to a traditional IRA and the convert it to a Roth. Your reading comprehension turned that into, “A Roth IRA doesn’t make as much (interest) as a traditional IRA.” The OP understood it perfectly fine. Personally, I think that the only way that it would be possible to not understand what I wrote is that if you didn’t know that one could get around the income contribution limits for a Roth by contributing to a traditional IRA and then converting it to a Roth.
Posted: Sat Feb 19, 2011 10:38 pm Post Subject:
Here's another area of an issue with reading comprehension, Max. You answered the question completely as a UL question and not an EIUL question.
Posted: Sat Feb 19, 2011 10:45 pm Post Subject:
Even EIULs are crediting 3% minimums instead of the 0% of just 4 or 5 years ago.
There is something to keep in mind. There is no reason to think that long term a 3% minimum crediting rate is any better than a 2% or worse than a 4%. There is no free lunch. The better that the guaranteed minimum is, in most cases, the worse the potential of the contract.
Ex. Contract A has a 2% minimum. Contract B has a 4% minimum. If the index drops by 10%, contract B's cash will perform better. However, if the index increases 15%, the contracts are probably written in such a way that Contract A's cash will perform better.
The point is that it's wrong to ASSUME that a higher guarantee is better. It might be, but it isn't an assumption that should be made.
Posted: Sun Feb 20, 2011 03:49 pm Post Subject:
Ex. Contract A has a 2% minimum. Contract B has a 4% minimum. If the index drops by 10%, contract B's cash will perform better. However, if the index increases 15%, the contracts are probably written in such a way that Contract A's cash will perform better.
Care to give some specifics rather than conjecture? If both contracts are written with a typical 75% of Index perticipation rate, and a 12% rate cap, the upside crediting rate will be identical . . . only if participation rates/rate caps are more favorable in your contract A will you assumption be correct. But whenever the crediting rate would fall below 4%, your contract B will outperform (but not by much) contract A, as indicated.
Then again, like all UL, if the premiums paid + current interest - expenses = <COI, the policy is headed for a lapse.
Posted: Mon Feb 21, 2011 01:15 am Post Subject:
MAX, the point is that if one contract has a better guarantee, it is a strong chance that something else is inferior.
Posted: Mon Feb 21, 2011 05:10 am Post Subject:
Why would it have to be in a taxable account? You can put the money into an annuity that is tax-deferred, or put it into an IRA, Roth, 401k, etc.
Ggoldenz, thank you for your responses. Most of that money could not be put into an IRA since there is a $10k limit per year or into a 401(k) since my company no longer has one (and we are already maxing my wife’s). I am not very familiar with annuities. I will look into them more, but a while back when I looked into them I had a negative impression (maybe they are a better option now).
Here's a question - what happens when the 13% cap is lowered to the guaranteed minimum, which is probably more like 5%? What happens when the "minimum guarantee" that is declared currently of 2% is reduce to 1% or less? There goes your projections, oops. Ask the agent to explain that one to you.
I did asked a similar question. The agent stated that if the caps (or the terms of the contract in general) were negatively changed that the product would not be competitive in the market place, so the company would not do that. Also, he said I could always transfer my policy to a new policy with another company that had better terms. Could anyone explain to me how this transfer would work? Is this something easy to do?
I fail to understand how taking money out of the policy as a loan and putting it back into the same policy as principal creates any significant leverage.
Max, my first post in the thread tries to explain how the money would be leveraged. The success of this scenario depends on having more years with the S&P500 (that is what the policy is indexed to) having returns greater than 7%.
Then again, the duplicate funding could also result in the policy becoming a MEC (violating the 7-pay corridor test) and then the whole scheme falls apart because the contract loses its definition of life insurance.
What is the “7-pay corridor test”? The agent did discuss MECs and the policy was carefully designed not to violate the rules. The amount of insurance changes with time to avoid becoming a MEC; the model has it increasing until age 65, then it goes down for a few years (when $690k is being taken out in loans each year), then grows exponentially until age 100.
Again, thank you all for your comments.
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