The most common objections we hear from the talking heads against permanent life insurance and indexed annuities is that the fees are too high, it’s expensive and only pays the broker a high commission. The uninformed say this far too often so I’d like to dispel this myth once and for all by comparing insurance products to traditional products and investments.
Expenses in Universal Life Insurance
To set the record straight I must first say that life insurance can be expensive. The fees are based on the amount of insurance you are purchasing, or more specifically, the net amount at risk. In other words, you have to pay for only the amount of insurance that would be paid by the insurance company at death, which is the amount of insurance over and above your policy cash value. Traditional life insurance planning has you purchasing the most amount of insurance possible, which results in lower cash values and higher costs, so this myth of high costs has merit because most agents structure insurance this way. The truth is that a properly structured indexed life insurance policy with the minimum amount of death benefit the IRS will allow you to purchase will be cheaper over the long run than other traditional investments.
For our example, we will use a 45 year old male, preferred non tobacco, with a $100,000 premium paid into the policy as fast as the IRS will allow in order to maintain the favorable taxation of life insurance. There are multiple fees inside the policy which include a premium load of six percent, $90 per year administration fee, policy issue charge of $2,070 for ten years and a mortality charge that is based on the net amount at risk. After totaling up the fees in the first year it comes out to 16 percent of the premiums paid in year one. If this is where the story ended, then we would conclude that insurance is expensive. Fortunately, that is not where the story ends.
Life insurance has some unique tax benefits such as tax deferred interest, tax free access via loans and tax free death benefit to your beneficiary. However, in exchange for these tax benefits, the IRS has put limits on how much money you can put into a life insurance policy and how fast you can pay that premium in. A better way to explain this is through a story. Let’s say you could buy a five-story apartment building that would produce tax free income. Sounds great right? There’s a catch to this building though—you are only allowed to fill it with tenants one floor per year. If there was no such rule everyone would buy these apartment buildings and the IRS wouldn’t collect any taxes. In the first year you fill up the first floor, but you are paying for the overhead on the entire building, so this investment would be expensive the first year just like this insurance policy. With each new year you fill up the building floor by floor with tenants, and by year five you have a full building and all the rent and profits are completely tax free. This is how a maximum funded life insurance policy works.
The first year of a maximum funded IUL is expensive, but each year the cost goes down and eventually it will become incredibly inexpensive just like the hypothetical apartment building. In the sixth year of the policy the cost is two percent of the account value and by year 11 it’s only .57 percent. By year 20 the cost is .5 percent and by year 30 it’s .1 percent. Over a 30 year period, the total fees for this policy are only $75,000. This might seem like it’s expensive, but compared to other types of investments and account types life insurance is not expensive.
Expenses for Traditional Investments
To prove my point that indexed universal life is not expensive we must look at other types of places you could put your money. First, we’ll start with a mutual fund account. If you put the same $100,000 into mutual funds or an advisory account, over a 30-year period at a 1.5 percent per year expense, the total fees in that account would be over $130,000. So relative to other types of investments, and over the long run, a maximum funded indexed universal life insurance policy is incredibly cheap versus the cost in our example which can be up to 30 percent for these investments. Life insurance is not expensive.
Okay, so mutual funds and advisory accounts might be more expensive than an IUL, but a cost-conscious investor is going to just put his money into another type of retirement account and choose cheaper investments and not pay a person to manage it for them. Let’s assume that the same person had $100,000 in an IRA or 401k that had no fees whatsoever (now this type of investment doesn’t exist because all investments will have some sort of fee or expense, but please play along with me). If that account grew at seven percent for 30 years it would be worth over $1 million. The problem with any sort of pre-tax account like an IRA or 401k is that when you take the money out you will have to pay taxes and taxes are an expense. An IRA is the most expensive of all types of investments because this $1 million account has a tax liability attached to it. Essentially, the IRS has a lien on that account and they are going to determine what tax rate you will pay on the IRA at some future point. If you pay 15 percent in taxes, the expense would be $150,000, at 25 percent it would be $250,000 and at 35 percent it would be $350,000. Even if you purchased a product within the IRA that had no expenses, the IRA itself has an incredibly high expense in the form of taxes, and ultimately will be much more expensive than the indexed universal life policy because life insurance is not expensive.
What You Are Paying For?
Life insurance provides a useful social service by paying a beneficiary a death benefit when the insured passes away, so the IRS allows this to be tax free. This tax favored payment is given to us as an incentive to buy life insurance so the government doesn’t have to take care of widows or young children. Regardless of whatever fees are charged inside a life insurance policy, we always must remember what those fees are paying for. These fees aren’t paying for a mutual fund manager that might or might not outperform an index or benchmark, and they aren’t going to an advisor who might or might not get your money out of the market before it crashes next time. You aren’t paying a person by the hour every time they meet with you about your money, and you’re not paying a bank. With indexed universal life insurance you are paying less than you would have for these other investments, and what are you getting out of it? You are getting tax deferred growth, tax free access to the money and most important a tax free death benefit to ensure that your family is taken care of in their greatest time of need. In my opinion this is the cheapest purchase you can ever make because indexed universal life products are not expensive.