Is Indexed UL or Whole Life better for infinite banking?
As I showed in a previous blog post, real estate investors can make more money by leveraging the cash value of permanent life insurance to make their investments. I am very careful to state "Permanent" versus specific types of life insurance like "Whole Life" or "Universal Life". All life insurance companies are required to make loans to their policy holders against the cash value of the policies. This is true for both Whole Life and for Universal life.
If you saw the numbers in the business case I offered, you know that these loans are a truly wonderful thing! You can literally put your money to work in TWO places at ONE time.
The interest crediting rate on an Indexed UL is tied to underlying stock market indices like, but not limited to, the S&P 500. In years when the index loses value (like the previous 12 months), the policies credit no interest. Strategies based on the S&P 500 index have averaged around 8% for the prior 5, 10, 15, 20, 25, and 30 years.
And with policy loan rates around 4.2%, an IUL offers a very compelling business case for real estate investors that are comfortable with the interest crediting mechanism.
One problem, however, is that if you search the internet for information on Indexed Universal Life (IUL), you will find a lot of misinformation. The following “Top 10” list, for example, comes from one of the market leaders in teaching people the concept of using the cash value of permanent insurance as your own personal bank. The problem is that they are trying to distance themselves from their competition by discrediting other insurance products. As insurance experts, they should know better. Both Whole Life and Indexed Universal Life make great platforms for what I’ll call a "Magic Checking Account” to avoid any trademark or copyright issues. Each have their advantages and disadvantages, but at the end of the day it comes down to what the client's comfort level with the mechanics underneath the hood of each policy.
The information below is intentionally misleading, if not outright wrong, and unless you talk to a well-rounded and unbiased expert you’ll never get the full story. When all you have is a hammer, everything looks like a nail. The only thing that is truly guaranteed in a Whole Life policy is that the policy will not lapse if the premiums are paid. The companies can and do change the dividend rates, which are held artificially high, annually. The reason dividends are not taxed is that it is considered a return of premium. Getting your own money back is not a return on investment. Anyone who has faith in the long term performance of the stock market will see the value of using an IUL to meet their Life Insurance, personal banking, and retirement planning needs. Those uncomfortable with the variable returns are better suited for Whole Life policies.
#10 Internal costs are not guaranteed
Internal costs are minuscule. They could triple and it would still be a rounding error. But notwithstanding that, can you think of any reason that insurance companies would go out of their way to raise costs in a highly regulated industry and make their products less competitive with other products in the market?
#9 Mortality charges are not guaranteed
Mortality charges are based on actuarial tables. They estimate deaths per thousand in groupings by age, and rating. Did you know that the cost of 1 year of ART is typically less than 0.25% of the cash value in a properly designed and overfunded IUL? This is all shown in the policy fees and expenses report on every illustration. This is less than the management fee of most mutual funds on Wall Street. The actuarial tables would have to change drastically for mortality charges to make any significant difference in cash value growth. If the actual mortality costs change for a Whole Life company, they jeopardize their own health because they have to absorb those costs. Do you think they might lower the dividend to make up for it? A shift of a few percentage points in the deaths per thousand might happen, but the impact will likely be at the thousandths place in percentage terms.
#8 Market drops cause double pain
If the market drops 40%, the cash value stays the same and the insurance company subtracts the cost of insurance (~0.25%). In this case the IUL would outperform the market by 39.75%! IUL cash values are not impacted by drops in the market at all. Perhaps the author is confusing a Variable UL with an Indexed UL. If this isn't a lie, then the author really doesn't know the business and the products.
#7 Late premiums kill any guarantees
There is no direct linkage between premiums and guarantees in an IUL. The insurance company simply subtracts its costs from the cash account. As long as there is cash in the account, the policy will remain in force. I hate to be blunt, but the Guaranteed rates in an IUL are meaningless. The circumstances that need to occur for the guarantee to be paid just will likely never happen. Its hard to find any 5 year period where an IUL doesn’t beat the best dividend rate on any whole life policy in the industry.
#6 Dividends from the index don’t get credited*
Its an index-based strategy. This is trying to create an issue where none exists. Dividends get factored into the prices of all the stocks that make up the index. A claim that the indexing strategy has returned 8.2% annually, for example, doesn’t have to be adjusted for dividends.
#5 Participation ratios are often less than 100%*
This is a lie wrong. I don’t know of a single company that doesn’t offer a strategy with 100% participation with a 12-14% cap. Each company usually offers 5-6 different options. Many companies offer options with participation rates much higher than 100%.
#4 Returns are usually capped at various interest rates*
That’s the whole point. That’s what makes an IUL so safe compared to investing directly in the market. The client gives up some of the upside potential in exchange for zero downside risk. Call Options are utilized to lock in gains and prevents losses. Its like an insurance policy against market drops. The long term IUL return is 8.2% for a 1 year point to point option. The long term return on the S&P 500 index is 9.6%. Given that the average mutual fund expenses are 2%, the IUL should outperform the S&P 500 index on a net basis with no risk of loss due to the market. That is powerful!
#3 Guarantees are not calculated annually*
As stated earlier, nobody seriously considers the guarantees because they are so unlikely to ever happen. If the market is down annually for 5-10 years, the economy is probably screwed beyond belief and we’ll all have bigger problems to worry about. A typical IUL strategy has a cap of 13% on the returns and a floor of zero. Meaning that if the market goes down, the policy cash value will not earn anything. The guarantees must obviously cover longer time spans otherwise the contract would simply offer a 2% floor instead of zero, for example.
#2 All of the above can be changed by the company
Considering that everything in a life insurance policy is known in advance, this is ridiculous. Companies have their reputations and competition at stake. If I need to save X amount in Y years to pay a death benefit, I know exactly what I need to get for a return. They are simply exploiting the word “can”. Dividend rates by whole life companies can be changed at the discretion of the company.
#1 The risk is shifted back to the insured
Not really. Everything is spelled out in the contract. I know my interest crediting is tied to the market. The costs could shift slightly, but that would be a rounding error in the big picture.
To call this list “biased” is a tremendous understatement. The author uses uses lies incorrect statements or misrepresentations in every single point. I don’t see the point in attacking the IUL in this manner. Both Whole Life and IUL are valid tools for “micro-banking”. Any true insurance professional should see the value and uses for both products and not go out of their way to attack one or the other. From a long-term, retirement planning perspective, the IUL will appeal to anyone who is comfortable with investing in the market and understands that they will outperform most mutual funds over time. The market may go up and it may go down, but over time back-tested results show about an 8.2% return.
From the "Magic Checking Account" perspective, the loan options are much more attractive on an IUL. Today’s low variable loan rates are much lower than corresponding fixed rates on Whole Life products. Interest rates may rise in the future, but when they do, the client has the option of switching to a fixed rate loan where the loan rate will match the crediting rate. This has much the same effect as a withdrawal, only you don’t have to pay taxes on a loan.
Whole Life, on the other hand, offers nice consistent dividend payouts and guarantees. This is attractive for any client that wants that degree of certainty.
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Note: The Infinite Banking Concept is a registered trademark of Infinite Banking Concepts, LLC.