One Monday morning in October 1987 I couldn’t have been more grateful. I awoke from a bad dream—one in which I thought a bear was shaking my cabin. I was on a hunting getaway at the family cabin in Sanpete County, UT. It took me a moment to realize it wasn’t a bear, but a mild earthquake rattling Utah. Later that same day I learned, along with the rest of the country, that something far worse was rattling the entire nation. With a 22 percent drop, America experienced the worst single-day stock market decline since the Great Depression (at the time). What had been 1987’s booming bull market turned into a bear market in a matter of hours.
During a recent interview, I recalled, “I was out deer hunting, riding my Jeep at the top of the knoll, when I turned on the radio. I heard everyone wailing over the stock market crash. Instead of having to say to myself, ‘I’ve got to rush back to the office to field those desperate phone calls,’ I could relax. So could my clients. They knew their principal was protected. And they knew they would still be getting an 11 percent return that year. I felt good because my clients weren’t losing.”
I found this new path thanks to a special type of insurance policy that emerged in 1980—universal life. Over the years I’ve focused on strategies for making the most of this vehicle—something that has been called a “miracle solution” because it provides liquidity, safety, rate of return and income tax-free advantages. Upon death, it also blossoms as it transfers to heirs income tax free. My clients were happy because I got them out of the market and made them immune from three dangers: 1) taxes going up, 2) inflation eroding their purchasing power, and, 3) market volatility. In 1997 indexing was introduced to the universal life marketplace and I immediately fell in love with the strategy.
Most of our clients maximum-fund their life insurance policies within the IRS TEFRA/DEFRA and TAMRA tax citation guidelines to enable themselves to access tax-free income during their retirement years. In fact, the majority have paid the maximum allowed guideline single premium into their indexed universal life policies in the initial five years, in full compliance with TAMRA, to avoid a MEC (Modified Endowment Contract) to not trigger unnecessary income tax when accessing cash out of their policy via tax-free loans. That is one of the benefits of universal life—you can usually comply with TAMRA within five annual premium installments rather than spreading it out using the “7-Pay Test” as required by whole life insurance.
The Power of Indexing
The advantage of max-funded insurance policies is the opportunity to “index” your policy. Indexing allows the money in your policy to gain interest when the stock market goes up, and to be completely protected from losses due to market volatility when the market goes down. How is this possible? Because your money isn’t directly in the stock market, it’s simply linked to the market.
To illustrate, let’s say you have $1 million in an IUL. You have several choices for which index you’ll choose—you can choose a single index or you can link your policy to a combination of them. In this case, let’s say you opt to link your policy entirely to the S&P 500. You also have options when it comes to crediting methods. Let’s say you choose annual point-to-point and your policy has an anniversary date of December 31.
Let’s assume the following: On December 31 of last year, the S&P was at 1,000. On December 31 of this year, the S&P increases to 1,100 (a 10 percent increase). The insurance company is contractually obligated to pay you the yield, which is 10 percent. On $1 million, that means they will put $100,000 into your policy. That $100,000 is locked in as new principal.
Now, the following year, there’s a financial disaster and the economy tanks. While most Americans invested directly in the S&P could lose a significant amount (which millions of Americans did, losing as much as 40 percent in 2008) … here’s the great part … you don’t.
With indexing, your principal is completely safeguarded from losses due to market volatility. What’s more, every year your index “resets” on your policy anniversary. Essentially, with your annual point-to-point crediting method, where the S&P 500 is on your anniversary date becomes the new set-point for the coming year.
So, let’s use historical numbers for a moment. On your anniversary date of December 31, 2007, the S&P 500 gained 2.43 percent. You would have received a 2.43 percent addition to your principal, which would be locked in and protected as new principal. The index would reset as it moved into your next policy year. On December 31, 2008, the S&P 500 index dropped 39.37 percent from the previous year—this would have been a devastating loss if you were in the market, but since your index floor is zero percent, you would have lost nothing due to market volatility. The index would have reset for the coming year, and by December 31, 2009, it gained 23.81 percent. That year, you would have gained up to your cap. The cap that year for the policy I own was 16 percent.
That’s a great overall return for that three-year period compared to what the rest of the country that was in the market was experiencing.
So in up years your policy gains, and in down years your policy’s value is protected from losses due to market volatility. With most indices the floors are zero percent, and the gains are capped (caps vary by index, and insurers can change them from year to year). To illustrate, let’s say currently the S&P 500 is capped at 12.5 percent. If the S&P saw a 15 percent increase this year, your earnings would be capped at 12.5 percent. But if the S&P 500 lost two percent this year you would see a zero percent gain, and your principal would be protected from losses due to market volatility.
In summary, the safety and rate of return advantages of a properly structured and max-funded IUL are:
The point is, in the worst decade since the great depression, 2000–2010, if a person had $1million in the S&P 500 in the year 2000, they would have lost about 40 percent from 2001 – 2003. It took four years (2004 – 2007) to make back what they lost. Many Americans felt like they had lost their future. Then in one single year, 2008, as Warren Buffet put it, “When the tide went out, it revealed who was swimming naked.” The $1 million nest egg would have suffered a second loss of 40 percent in one single year! By the end of 2010, many Americans were still down 38 percent from what they had a decade earlier. Most ten-year periods in history will have seven gain years to three loss years. The decade from 2000–2010 is referred to as the “lost decade” because most people weren’t even back to a break even until 2012.
Using indexing, the lowest cap that I experienced in that decade was 15 percent with my IUL policy. If I had just sat there from 2000 – 2010 with my policy linked to the S&P 500, I would have only “capped out” at 15 percent two of the 10 years, three other years I would have made money, but the other five years I would have earned zero—but I didn’t lose! My average return would have been 7.23 percent—meaning that $1 million in 2000 would have grown to more than $2 million, tax-free, all while people who were in the market were still in loss territory.
What did I really earn during that worst decade? 9.62 percent—by rebalancing. You see, I didn’t sit there and earn zero percent for five years (from 2001–2003 and 2007–2008). I only earned zero percent for two years. The other three years I simply changed the allocation and earned the general account portfolio rate (five percent at the time). Then, after the market turned around, I changed back to the 15 percent cap index option for one year and then changed to the 13 percent cap with a 140 percent participation when the market was sideways. (With 140 percent participation rate, I was credited at 1.4 times whatever the index that I was linked to achieved. If it went up five percent, I got credited seven percent. If it went up nine percent, I got credited the cap of 13 percent).
Many of our clients locked in gains on their IUL of 13.65 percent, 11 percent, 9.5 percent, 15 percent and even 24 percent in the year 2017. When the market eventually corrects (it’s not a matter of if, but when), they have peace of mind because they won’t lose the gains they locked in during the last few years. Whereas those investors in the market may end up suffering severe losses once again and it may take several years to make it back. I love locking in my gains each year and resetting. It’s like tightening a bolt when using a ratchet wrench—it only tightens (makes progress) and resets.
Douglas R. Andrew
is the founder of Live Abundant, a comprehensive personal and business financial planning firm with several divisions. He was a Top of the Table Producer for 12 years prior to becoming a best-selling author of 11 books and launching his weekly radio show that has aired for 10 years. He is a nationally recognized speaker and often keynotes with his presentation, "Ten Keys to Dramatically Transform Your Practice and Establish a Profitable Career." He has spoken for MDRT, the Genius Network, Anthony Robbins, and his messages have been distributed nationally and featured in Success Magazine, Forbes and Huffington Post. He is a regular contributor to Forbes, Thrive Global, the Medium, US News and World Report, and recently featured in Harvard Business Review. He has 12 financial professionals in his firm that collectively produce more than $6 million annually in IUL target premium. Andrew's firm, Live Abundant, is located at 6340 S. 3000 E. Suite 280, Salt Lake City, UT 83121. Telephone: 801-987- 5665. You can learn more by visiting LiveAbundant.com. To book Andrew as a keynote speaker, please inquire by emailing: [email protected]