Understanding the POWER of the Interest Credit Inside an EIUL

by | BiggerPockets.com

This time of year I get many phone calls from clients to wish me happy holidays and report on their EIULs.

Most are reporting that they are receiving a credit in the 12-14% range this year, right at the cap rate or just below. And some are reporting that they are starting to get a feel for why this strategy works so well.  The one idea about EIULs that is really hard to get people to understand is the overall effect of the interest credit strategy over long period of times.  After a few years, you start to really get it.  So I thought I would go over it here to give the readers an opportunity to see why my clients are so satisfied with how it works for them. Too much energy is spent on worrying about how much the return will be each year and not enough understanding of the long term effects.  I have had potential clients have me build illustrations with a wide variety of interest returns, one person a different one for every .5% difference, to satisfy their need for some certainty!!!

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How the EIUL Works

The first idea that must be understood is that your money is not in the market.  This is a fixed rate product not a variable product.  What that means is that your money is added into the general fund of the life insurance company.  The interest credit they pay on the life insurance policies, all fixed rate policies, is backed by the investments of the company with the investing guidelines and reserve requirements required by the government.

In EIULs they tie the interest credit to an index or group of indexes with a 0% floor and a floating cap rate.  The cap rate floats within a small range dependent upon overall interest rates environment that determine how much money needs to be used to make the guarantees on the insurance products.  Each year you get an interest credit that can’t go negative.  The insurance company is subsuming that annual risk for you.  And it is that risk which is so damaging for retirement accounts. Each year your account starts at the point it ended the year before locking in positive movements.  So you latch up each year like a staircase [except the years with a negative index movement].

The Last Decade Returns of the S&P 500

2002    ?22.10%

2003     28.69%

2004     10.88%

2005      4.91%

2006     15.79%

2007     5.49%

2008    ?37.00%

2009     26.46%

2010     15.06%

2011     2.05%

2012 will give around a 13% return.

Forgetting expenses for a second, Had you invested $1000 into the index at the start of 2002 by the end of 2011 you would have had $1,326.

The Last Decade Returns of an EIUL

If you had put that money into the Minnesota Life EIUL using actual cap rates for each of those years you would have $2,264.  Dramatic difference, right!  Now this last decade is not really that different from what the average 10 year span looks like. A couple of dramatic downdrafts, a couple of great years, and the balance with solid positive returns. It doesn’t always work out that the negative years are separated nicely, like the last decade, but that is the general way the market works.  There are some very dramatic and quick drops, and a wide range of positive returns that go on for several years.  But, what should be noted is the amount of time needed to overcome those drops.  If you are going to need those funds for retirement you better hope you don’t have a large drop close to your retirement date! Despite some really good years those in the market haven’t recovered from 2008 yet.  And that is what the difference between $2,264 and $1,326 is telling you.  Not enough recovery time yet.  Sometimes it takes decades to recover!

If you add an EIUL into your mix of retirement funding mechanisms, then you can use that very quality to better take advantage of your real estate or even an 401K/IRA.  Because each year you know you can take money out of your EIUL without devastating future earnings.  You might have a difficult year with your real estate and have to use that cash flow for maintenance or lost rent or a myriad of items real estate investors deal with. You might want to sell some real estate or might want to not sell because of the market and taxation situation, but with the security of being able to fund your personal needs with tax free money from your EIUL that decision can be made based on what is best in the long run, not on current need for cash.  If the equities market goes negative taking a hiatus from selling funds for income can make your money last decades longer.  Having this flexibility can be a life saver as you react to current conditions.

Of course, everything can go exactly as planned :-), and then you just have tax-free cash coming at you year after year after year to provide you with those things you want in retirement.

Average Rates are Misleading

Wall Street has done us all a disservice by concentrating our focus on one number, average return.  That number hides all sorts of risk and at best is a sin of ommission. In a recent post Jeff Brown notes the fallacy of looking for appreciation to make your real estate investments work.  Yet, I hear people talk about average rate of appreciation from real estate all the time.  Now here is a surprising truth, the EIUL interest credit strategy only depends upon variation, not on overall appreciation.  Imagine a market, like today’s perhaps, that makes dramatic drops and then slowly goes back to where it came from, then another dramatic drop and a slow climb back.  At the end of the day those in the market have gotten nowhere [actually lost $$], while those in an EIUL have made excellent returns.  And that is the power of EIULs interest crediting strategy!

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  1. Excellent article David.One of the biggest fallacies of today’s number crunching generation is that they have too many tools available without the expertise on usage of those tools.I have seen more people making bad investment decisions using charts than without using them,

  2. David,

    This is one of the better explanations of EIUL’s you have given. I’m still trying to wrap my head around it through. You state “Because each year you know you can take money out of your EIUL without devastating future earnings. ” Why and how? Are there penalties?

    2nd Jeff has talked about obtaining income for an EIUL that is tax free in retirement? Again, how is this so and how would you determine how much you can take in income? Does it deplete what you built up, or are you using the interest gained for that amount?

    You have mentioned your fees being heavy up front and diminishing later. Is there somewhere I could see a chart that breaks down an average EIUL annual influent money and effluent money flow?

    I recognize that EIUL can be a good supplement to retirement with tax free income, I just don’t quite understand how yet.


    • Jason, you take money out of a life insurance policy via a “policy loan” against the death benefit. These loans come in two types; a standard loan which typically costs .1% or a variable loan which works differently but allows you too get a positive or negative arbitrage between the interest paid for the loan and the interest credit gained [deserves a separate post for full explanation]. You can take these loans out for any amount up to the cash accumulation value at any time after year 1 of the policy without penalty or taxes.

      The expenses are dependent upon the structure of the policy, age and gender of the insured. Hence, they can be different for each illustration. What I tell all my folks is you have to see it to understand how it works. So making an illustration tailored to your needs and premium paying ability is the first step. The illustrations I send to my clients have a separate chart for expenses as well as overall internal rate of return inclusive of expenses.
      Usually, after seeing this, the expenses worry goes away, and the overall concept becomes the key to making a decision on if this is right for you.
      Hope this helps!

  3. Jeff Brown

    Seriously David, this post is why gettin’ you on my ‘team’, years ago, was so crucial. I remember, and I bet you do too, when, on another real estate/tech blog, I doggedly wrote about EIULs. It never failed to result in a tsunami of negative comments, some of them verging on malicious.

    I remember with a satisfied grin, as a year or so later (2009 or so) I remarked about Americans in love with their employer 401Ks who’d lost 30-45% of the value in their plan. Clients and readers who’d opted for EIULs before the 2008 crash? They ‘only’ made 2% that year. 🙂

    BiggerPockets readers: EIULs aren’t for everybody. But most folks can benefit significantly with them as part of their Plan. Talk to Dave if you’re even remotely curious. I endorse him, and EIULs completely.

  4. For fun, I crunched that series of performance numbers to see what I would have had with index accounts vs. an EIUL. Those numbers, when averaged geometrically (the right way) would produce an annualized growth of 3.79%. Pretty bleak if inflation right now is hovering around 3-4%.

    But if you filter each return through an EIUL, with caps at 0% and 15% respectively, the annualized growth becomes 8.59%.

    It’s not enough to build big wealth, but once you accrue some wealth through either real estate or you re-route what used to be 401K contributions, it becomes a nice place to store wealth that doesn’t suffer big tax hits as politicians change their minds on what is fair.

  5. jeffrey gordon on

    Hi David, I have a good feeling about EIUL’s be a key component of an investor’s portfolio, I just finished reading an article of yours this last week on stock market promises vs realities in my generation of investors–lots of food for thought. As an analytical type I would like to have a more detailed understanding of EIUL’s. Do you have any detailed text or video explanation of them?



    • Jeffrey, sorry no video or power point presentation. I have done presentations before but found it really needs to be a general presentation leaving the details for those interested in pursuing them.
      I have found that the best way for an individual to understand how they work is to look at an actual illustration created for their exact situation. There are so many subtle and not so subtle differences from person to person and from a properly structured EIULs and not properly structured EIULs that having an actual illustration to guide understanding is key.
      By the way, there is also the issue of intellectual property. I have had people call me up, get an illustration from me and then have a local agent try to mimic it and purchase from their “friend.” I haven’t found anyway to prevent this except to actually work with each person demonstrating why I do what I do with the structure so there is no doubt from the client as to there understanding and my expertise. Funny when one of those people give me a ring a year later to ask questions 🙂

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