Author Topic: Indexed Universal Life Insurance  (Read 5100 times)

hs

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Indexed Universal Life Insurance
« on: May 10, 2014, 09:26:52 AM »
Hi! I am a newbie MMM reader, and one thing this website has done is to encourage me to take a deeper look at all aspects of my finances. I think that I have a big screwup on my hands, and is would appreciate other thoughts/analysis. My own head is sounding like an echo chamber.
To give you some background, I am 33, recently married with no dependents or house. My monthly expenses are around 5k, but my husband and I are working on getting that to 2.5 - 3k each. I make about 200k pretax, and my husband has a smaller, but still quite good, income.  Right now my assets are tied up in my business, as I bought out a partner 6 months ago. The value is about 750k, then subtract a loan with a 70k balance at high interest but at least pretax for the buyout.  However, in case anyone is interested, business ownership interests are very illiquid! Selling out would take at least a year.  My E fund is about 30k, and I have around $50k in IRA assets that I am in the middle of transferring to Vanguard. All debts other than the 70k have been paid.
My question concerns an investment/life insurance product that I bought into about a year ago, that I strongly suspect of being a turkey. It is called Indexed Universal Life Insurance, and has an investment component where contributions have a return indexed to the stock market, as well as a life insurance component. The hook for me was that even if the market goes down, the investment component will just return zero %. However, I did not factor in the costs associated with this product. I have been contributing 5k/mo after tax, and having total deductions of 1,928/month for expenses. Granted, this expense is fixed and would decrease as a percent as the account balance increases, but it's still a whole heck of a lot of money. My current balance is 66k, and I think that cashing out would be a good idea.  The poison pill here is that the surrender charge that I would incur is 28.5k.  This would decrease with holding time of the product, to be phased out at 10years. If I were to surrender today, I would get 37k. Please let me know what you think. I have a sinking feeling that this is a hair on fire situation, but I would like to get some feedback before pulling the trigger. Thank you.

Frankies Girl

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Re: Indexed Universal Life Insurance
« Reply #1 on: May 10, 2014, 10:00:41 AM »
Ohhh. Yucky. I had to go look up the general idea of what an Indexed Universal Life Insurance policy is, and it's basically two things - whole life insurance (not good) with an investment option inside an expensive wrapper (really not good).

If you have no dependents, there's not a huge need for life insurance of any kind, but you could technically say that being the sole owner of a business and making the lion's share of income could put your husband at a great disadvantage if something happened to you, so it wouldn't be out of line to have some sort of term life insurance in place for 10 years or so until you had significant liquid investments that could handle any disasters. Not sure, but you may even be able to look at term life on yourself as a business expense (definitely would need to check with a business accountant on that tho)

I'm definitely not an expert, but yeah, on the face of it this policy is crappy (nearly 38% paid out in fees and expenses per month? That's insane), and you may want to do as much reading/research on it as needed to get out of it as soon as you can. The surrender charge alone is a big red flag that it was a bad move - charging that much to cancel the policy means that they know some folks will wise up within a few years and get out of it, so they'll hit you again on the way out for getting suckered into it in the first place. Talk about adding insult to injury!

My back of the envelope math indicates you will have paid in over $200,000 in expenses alone if you stayed the full 10 years to avoid the surrender charge... that's crazy.

The money you'd lose on the surrender is part of the sunk cost - it's gone, and staying in this policy isn't going to make it any less of a bad investment and just compound your losses. Get out as soon as you can, and just chalk it up to a very expensive life lesson.

If you do decide on life insurance, term life all the way. You pay a lower fee for high coverage for a specific period of time and then you're done.

And you can definitely do investments much better/cheaper using someplace like Vanguard. If you're a business owner, I believe you can also do a solo 401k  and put your money in a tax sheltered vehicle that won't charge you hardly anything to invest. Using complicated wrapper products that combine investing and life insurance are just designed to profit the companies that make them; simple is always going to be better for the people actually using them.

And you can then devote some of that investment money that was eaten up in expenses to paying down that high interest loan...

I would definitely suggest you read Jim Collins' stock series to get up to speed on how investing works, and how easy it could be to just set up a basic portfolio:

http://jlcollinsnh.com/stock-series/
and he's in the process of switching hosting sites, so that link may not work as well, but it seems to be working right now... give it a chance if you get an error as his series is the absolute best in laying out everything you really need to know on investing.

Good luck, and don't be too hard on yourself -  it can be really hard to wade through all of the crap and sales polish they pitch out there!

« Last Edit: May 10, 2014, 10:08:28 AM by Frankies Girl »

MDM

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Re: Indexed Universal Life Insurance
« Reply #2 on: May 10, 2014, 10:58:18 AM »
+1

The only thing I might modify is "The money you'd lose on the surrender is part of the sunk cost - it's gone, and staying in this policy isn't going to make it any less of a bad investment and just compound your losses. Get out as soon as you can, and just chalk it up to a very expensive life lesson."

Before you make the withdrawal, compare "withdraw now" vs. "don't contribute any more, and withdraw later".  Under the heading of "making the best of a bad situation", a decrease in surrender fees might make it better to wait and withdraw later.  It depends how fast the surrender fee drops, how much you will pay in fees (38%? really???), etc.

Agreed, it doesn't look good.  You can however make sure you make the best choices going forward.

hs

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Re: Indexed Universal Life Insurance
« Reply #3 on: May 10, 2014, 11:24:20 AM »
Thank you. I do have key man insurance on myself and one other partner in the business, and it it a business expense. Basically, in the case of my death, the insurance is about the cash value of my equity share in the business, to cash out my husband.  He does make a good wage on his own as well, so I think I will look at a small term life policy.
As I was writing it out, I think that the surrender charge equals about a year and a half of expenses in this product. Barring anything I'm missing, I think I'm better off taking the hit.

hs

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Re: Indexed Universal Life Insurance
« Reply #4 on: May 10, 2014, 02:59:22 PM »
Unfortunately, businesses with a large discrepancy between the savings rates of management and lower level employees finish not being able to utilize many pretax savings options. I have looked into the solo401k, and I think it's fantastic. My husband may start his own consulting business this year, and would likely be able to utilize it, though. Right now I can only contribute to an individual IRA, and I am starting a Simple IRA later this year, which will let me put away about 12k pretax.

foobar

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Re: Indexed Universal Life Insurance
« Reply #5 on: May 10, 2014, 08:36:02 PM »
I don't know your particular product but in general they also cap the returns in good years to something like 12%. Now that sounds high  but there are a lot more years where the market goes up 20% than ones where it goes down 20%. Long term it totally kills the return. There are no free lunches in the market. When you limit your downside risk, you will limit your upside gains. Through in the fees and these are very niche products and the odds are really against them being good for you.

My question concerns an investment/life insurance product that I bought into about a year ago, that I strongly suspect of being a turkey. It is called Indexed Universal Life Insurance, and has an investment component where contributions have a return indexed to the stock market, as well as a life insurance component. The hook for me was that even if the market goes down, the investment component will just return zero %. However, I did not factor in the costs associated with this product.

brewer12345

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Re: Indexed Universal Life Insurance
« Reply #6 on: May 11, 2014, 03:13:46 PM »
I would echo the sentiment that you should surrender, take your lumps, and use your 5k/month in a more productive manner.

grandcanyon

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Re: Indexed Universal Life Insurance
« Reply #7 on: May 11, 2014, 09:03:24 PM »
Yeah, these products are real stinkers. They usually have some fancy sounding metric that determines the payout but in the fine print they usually say they can do whatever they want. I had something similar to this without the surrender and whole life and after I got out of it with a 1% gain. I looked back each year and saw that they were paying out 3% max and this was during the dot com boom era.

I'm surprised that your surrender is this high. Usually they charge you 10% the first year of all the moneys you put into it. What is the Cost of the Insurance per month? Usually it's very expensive but you could stop putting money into it and they will take the COI from the policy. The problem with these it's either take the hit now or over time and usually overtime it is worse even though it sounds high up front.

I had an annuity and I ate the surrender along with the high fees and poor performance and I moved it to Vanguard. It took awhile but it finally is on the plus side.

Sleestaks4U

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Re: Indexed Universal Life Insurance
« Reply #8 on: May 12, 2014, 08:19:25 AM »
I have one (actually 2, wife got one) of these as well.  We have had ours 8 years and I just need to find the motivation to get out.  Factors to consider (I call them reasons to do nothing) are the tax implications and your ability to get term insurance on the market.  I haven't found (haven't looked really hard) for anyone who can lay out the tax implications (certainly not the guy who sold these to us) and the wife and I have a somewhat checkered health history.

We had our policies evaluated by a third party a few years back and he said they weren't terrible, high praise indeed.

Ugh, just need to get out of this.  As always thoughts are appreciated.

hs

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Re: Indexed Universal Life Insurance
« Reply #9 on: May 12, 2014, 09:50:09 AM »
The returns are capped, with the justification that the losses in a down year are also capped, at zero. That wouldn't be bad, except for the costs. My idea is (and I could certainly be wrong) that the expenses are the equivalent of putting my money in the stock market and having a 40% crash in value. Why would I take a guaranteed 40% loss? I don't know about any tax implications, but I am in very good health, so I got quotes for 10 year term life for 500k at $150-200/year. I don't need millions of dollars in life insurance. In this case, my husband doesn't need much, and by 10 years we should have achieved FIRE. The really valuable part of posting this disaster situation is learning from my mistakes and gaining a better analytical rigor when evaluating future investments - although I am definitely sticking with Vanguard for a while!

foobar

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Re: Indexed Universal Life Insurance
« Reply #10 on: May 12, 2014, 01:03:29 PM »
That is the justification.  If you run the math over the past 20 years, I think you will find it pretty bad. You should also check and see who gets the dividends. I looked into one of these plans with my dad 10 years ago. There was a 10% cap, 85% participation rate and the company kept the dividends.  When you ran the math, they returned about half of what the S&P 500 index did.

The fees are just the insult on top of the injury.


The returns are capped, with the justification that the losses in a down year are also capped, at zero. That wouldn't be bad, except for the costs. My idea is (and I could certainly be wrong) that the expenses are the equivalent of putting my money in the stock market and having a 40% crash in value. Why would I take a guaranteed 40% loss? I don't know about any tax implications, but I am in very good health, so I got quotes for 10 year term life for 500k at $150-200/year. I don't need millions of dollars in life insurance. In this case, my husband doesn't need much, and by 10 years we should have achieved FIRE. The really valuable part of posting this disaster situation is learning from my mistakes and gaining a better analytical rigor when evaluating future investments - although I am definitely sticking with Vanguard for a while!

brewer12345

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Re: Indexed Universal Life Insurance
« Reply #11 on: May 12, 2014, 07:58:17 PM »
I have one (actually 2, wife got one) of these as well.  We have had ours 8 years and I just need to find the motivation to get out.  Factors to consider (I call them reasons to do nothing) are the tax implications and your ability to get term insurance on the market.  I haven't found (haven't looked really hard) for anyone who can lay out the tax implications (certainly not the guy who sold these to us) and the wife and I have a somewhat checkered health history.

We had our policies evaluated by a third party a few years back and he said they weren't terrible, high praise indeed.

Ugh, just need to get out of this.  As always thoughts are appreciated.

If you actually need mortality coverage, apply for term and see what response you get.  Set up the new policies before you cancel the old ones.

The tax implications are simple.  If the total cash value you get out of the policy upon surrender is less than the cumulative premiums you paid in, there is no tax.  Whatever amount you get out in excess of cumulative premiums is taxable income.  I bet you can cash out tax free.

Dollarbill49

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Re: Indexed Universal Life Insurance
« Reply #12 on: May 13, 2014, 02:20:30 PM »
I don't mean to rub salt in your wounds but two questions come to mind:

1.  Why did you buy this policy?

2.  Who did you buy the policy from?

hs

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Re: Indexed Universal Life Insurance
« Reply #13 on: May 15, 2014, 11:53:35 AM »
I bought it from an independent insurance broker. I was sold on a lack of downside, and definitely did not do enough homework. My area was having a lot of financial hardship, and my business was not in imminent danger of failing, but had definitely taken a hit. I think I let my fears overrun my common sense, as I just wanted something that would be stable, defined as not going down. T bills or money market funds would have been better. Sometimes you just need to sleep.

hs

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Re: Indexed Universal Life Insurance
« Reply #14 on: May 15, 2014, 05:07:01 PM »
When MMM recommends a 3-6 month emergency cushion, part of that calculation includes unemployment insurance. When you are self employed, you must pay unemployment insurance, but you can never collect unemployment. Because of that, you generally need more of an emergency savings cushion.  Even more than that, loss of "employment" as a self-employed person implies business failure, and loss of more than a job. Even very robust, anti-cyclical businesses can have periods in which the owners receive little or no income in a recession (happened to my Dad in the early 90s- he weathered it, but barely made payroll for a few months). Most smart small business owners set aside some funds for exactly this purpose.

hs

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Re: Indexed Universal Life Insurance
« Reply #15 on: May 16, 2014, 04:22:43 PM »
One other point that attracted me to this option was that it was supposed to be used as a retirement investment vehicle where as I got older, I would borrow from myself (no repayment required) the funds that I would need for living expenses, and that these would have no tax on them, capital gains or income. Hmm.

foobar

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Re: Indexed Universal Life Insurance
« Reply #16 on: May 16, 2014, 08:59:33 PM »
Would you rather pay 15% tax on an asset that has been generating 7% returns for 30 years or 0% tax on an asset that has been returning 5% for the past 30 years?:)

I actually like whole life a heck of a lot more than most people on this board but you have to ignore the marketing speak that it is sold with and run all the numbers yourself.


One other point that attracted me to this option was that it was supposed to be used as a retirement investment vehicle where as I got older, I would borrow from myself (no repayment required) the funds that I would need for living expenses, and that these would have no tax on them, capital gains or income. Hmm.

MDM

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Re: Indexed Universal Life Insurance
« Reply #17 on: May 16, 2014, 09:19:56 PM »
Would you rather pay 15% tax on an asset that has been generating 7% returns for 30 years or 0% tax on an asset that has been returning 5% for the past 30 years?:)
Value of $1 invested in
a) 15% tax on [annual earnings from] an asset that has been generating 7% [reinvested] returns for 30 years = (1 + .07*0.85)^30 = $5.66
b) 0% tax on an asset that has been returning 5% [reinvested] for the past 30 years = (1 + .05)^30 = $4.32

Bracketed terms show how I interpreted the question.

Appears option "a" is the winner.