Understanding the Expenses and Tax Implications in an EIUL
Expenses in an EIUL are a big deal because most agents won’t structure the EIUL properly to minimize them. When properly structured, they should be between .5% and 2%. They are also hard for the layman to understand because most are trained to look for expenses like they are in mutual funds. Because it is life insurance, the expenses are mostly front loaded. And vary depending upon year of death. This is why it is so difficult to compare to a mutual fund expense ratio.
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The following is an expense chart based on a 40 year old man, in good health, who is putting in $20,000 premium for 10 years.
Note that after 10 years their are only small charges, the cost of insurance and a small administration charge of $60 or $120. So the first 10 years you have a premium charge and a policy issue charge. These represent the profits and commissions paid out for the policy and are not insignificant. Here we see why this is not an appropriate short term vehicle, but a long term vehicle.
I have reduced the life insurance amount down as far as the IRS rules will allow me. This keep all the expenses down in the first 10 years significantly. This reduces commissions significantly too.
At age 62 with almost $700,000 of accumulated value the total expenses are less than $1000, an insignificant amount. The expenses started being insignificant after the premiums have been paid at year 10 and continue for the life of the policy. When the accumulated value is at its highest, in the years right before retirement, the expenses are minimal. This is exactly the opposite of the way mutual funds work, which take the most expenses when the value is at its highest.
Understanding what this means,
I have this pretend man taking out income from age 68 until age 95. The above chart gives you the bottom line internal return after charges and expenses have been taken out. Since these policies are designed to payout a death benefit a small portion of your return will be the death benefit. Look at the last column “death benefit IRR.” The estimated average interest credit I used was 8%. This is well below the 20 year look back [what you would have gotten if you started this policy 20 years ago]. At age 66 the internal rate of return goes below the 8% interest credit. Before that year the insurance is creating leverage and giving you a return greater than your interest credit. That is why, as long as you don’t surrender the policy, that the front loaded expenses really don’t matter. The internal rate of return decreases to age 75 where it is 7.51%. That means your overall cost at that point was .49%. Die any other year and the costs were less. You will note that the death benefit is lowering each year during the income phase. That is because I have this man taking out $104,500 each year from age 68 until age 95, which lowers the available cash value and allows the policy to lower death benefit under IRS rules. This happens automatically.
In my opinion, the total expenses inside the policy are really a non-issue because they are very moderate. You might disagree with me on this? One way to look a it is you are trading off a moderate cost [.5% in this case] for not paying income taxes on the income.
When properly structured from the outset, any funds taken out of the policy are considered either a return of premium or a loan against the death benefit. That is why they are not taxable. These funds never have to be paid back, but can be. There are few limitations on taking out cash. You can not take out more than your surrender value. So they aren't really loans in the classic sense. Taking out loans is a full post in itself, so I won't go over that here. All my policies have a rider on them that will freeze your policy once you have taken out the maximum amount and guarantee the death benefit at that time until death. So there is no chance you could accidentally take out so much in retirement as to cause a forced surrender.
Unlike an 401K or an IRA, which tax money taken out as income, there are no taxes due on cash taken out of the EIUL Policy. No more guesswork on the tax rates many years in the future.
Related: Why Purchase an EIUL?
So let’s review. First this is not an appropriate vehicle for short term thinking or money. Second, this is not appropriate for folks who can’t save. For those who do have an ability to save or who have an amount of money they want to take off of the tax roles, then there are 3 main advantages. 1. A solid rate of return, most likely higher than what one would get in a mutual fund. 2. Reduced sequence of return risk. 3. Significant tax savings in the future. For those advantages the cost is .5% to 2% per year.
Photo: JD Hancock