Equity indexed universal life insurance policies were developed in response to issues in the variable universal life policies. Despite this, to this day, some critics lump the two together. For retirement purposes the EIUL uses a far superior strategy. Let’s take a look.
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EIUL Interest Credit Strategy
Variable products simply use sub-accounts that are usually mutual funds inside a life insurance wrapper for tax favored treatment. As a result, you have the usual issues with mutual funds [ex. sequence of return risk], plus have to deal with front loaded fees of life insurance that can cause a policy to need more cash inputs early in its life. Equity Indexed products were designed to avoid these issues for a more stable product. It is important to note that money inside EIULs are not invested in the market. An EIUL is considered a fixed rate product, hence gets an interest credit tied to a stock index or group of indexes with a ceiling [cap rate]and a floor [usually 0%]. Because you are depending upon the overall investment portfolio of the insurance company it is important to purchase an EIUL from a stable and top rated life insurer.
Because you are not a victim of the full variance of the market, its losses as well as its big upward movements, you end up with a higher average rate of return in almost all 20-30 year historic time periods as well as mitigate sequence of return risk. Let’s look at a 20 year historic comparison of strategies.
Compare investing in the index versus EIUL strategy with a 15% cap
S&P 500 Index EIUL Interest Credit
Here are some notes: 8 out of the 20 years there were identical returns from the two strategies. Six out of the remaining 12 years [or half]the straight index beat the EIUL strategy. Now let’s see what the results are.
If you invested $1000 in both strategies, at the end of 20 years [without consideration of expenses]you would have:
EIUL $4,809 [47% more]
Compound Annual Growth Rate
More Notes: Negative numbers hurt much more than big positive numbers helped. After 1999 the stock index was worth $3,327 while the EIUL strategy was $2,153. Money invested in the stock index hadn’t reached that 1999 peak by the end of 2012 [13 years later].
It’s the Strategy, Stupid
When I get calls from people who try to compare an index’s returns to the interest credit inside an EIUL, the first thing I need to get them to understand is that they are comparing apples to oranges. The strategy employed inside an EIUL gives you more consistent growth, eliminates those really scary year returns [2002,2008], and in almost all historic time periods provides higher compound growth rates.
On top of the math, there is the psychological aspect. Study after study provides evidence of what happens when people see a really bad market. They panic and sell low. It also provides evidence of what happens in a good market, they get all giddy and buy high. This is what drives the overall underperformance of individuals compared to the actual mutual funds they are purchasing.
So from both a market perspective and a behavioral perspective the EIUL strategy works better for most people.