Bogleheads

[daryll40]

I KNOW this was discussed ad nauseum before. But a good friend of mine, a physician, has been pitched some sort of Variable Life Insurance scheme instead of traditional investing. I can't quite sniff out what's wrong with it, because the insurance folks do such a great job making look like the best investment available. But it doesn't pass my smell test and I hope you guys can help me better state what is wrong. My friend is not a DIEHARD but I will give him this site to help monitor the discussion.

The deal is that he can "invest" $30,000 for every $1M of life insurance he purchases at some very low "term" insurance premium. You invest in sub-accounts similar to variable annuities that can have equities, fixed income, etc. He says that at retirement age (not sure exactly what age), you start taking $8000 per month per $1M of insurance tax free. It's not clear to me how a 3% interest charge is deducted. He said you can take out 90% of the accumulated value. It's also not clear to me if you do that at age 82 and live to be 100 what happens.

I know all of this is rather sketchy but I suspect some of you will recognize the overall basics of this and can easily point out the flaws and benefits. I'll post more details from my friend as the conversation develops.

[tfb]

See http://www.diehards.org/forum/viewtopic.php?t=3058.
_________________
The Finance Buff

[EmergDoc]

The usual problem with these investments (aside from the initial fees/loads/commissions) is the ongoing expenses. I have a policy that I can convert to a variable life policy, but once I realized the average ER of the funds available to me was 2% I realized how stupid that would be. Unlike an IRA, which can be invested in any fund/stock etc, these policies usually limit you to 5-20 funds, which all generally suck.

Your friend would probably benefit more from investing in Index funds, municipal bond funds, and tax-managed funds than getting into one of these.

Insurance should always be separate from investing.
_________________
1) Invest you must 2) Time is your friend 3) Impulse is your enemy
4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

[daryll40]

[stratton]

[EmergDoc]

[tfb]

[hound buff]

I ALMOST bought one of those policies -- I went to two Financial "Advisors" and both tried to sell me these policies (physicians are HUGE targets).

Actually, both explained to me that one of the benefits is that the money grows tax free AND it is withdrawn tax free because it is considered a "loan" against the accumulated value of the life insurance policy. As the money is withdrawn the potential death benefit decreases.

Of course, in making these illustrations, both of the "advisors" failed to illustrate the true nuances of our current tax system so these variable annuity life insurance policies seemed like great investments....for the advisors.

I still have the illustration from one of the sales attempts. They suggest an annual premium of 24,000 for 10 years with retirement at year 25 would provide a 140,000 annual after tax retirement benefit. This illustration assumes a return of 12% on all investments. If I made no money on my investment, then the policy would lapse at year 24 (right before retirement). I think that was a slightly ambitious illustration, but they assume that people will continue to pay in after the first 10 years. Also, in the fine print it states "You also should understand that generally your insurance risk charge rate increase annually as the age of the insured increases, and that your risk charge increases as the amount of policy risk increases. You can reduce the likelihood that you either will incur a significant income tax liability should your policy terminate before the death of the inured, or that you will need to make substantial payments to keep your policy from terminating, by monitoring and reviewing all aspects of your policy on a regular basis with your tax advisor, you financial representative, and/ or any other financial advisor you might have."

Since I could never get the advisors to explain how rates might change, and they failed to explain the legaleze in another product that I (unfortunately) bought, I decided no thanks. What would the cost of this product be when I was 50??? No clue. Can't pull an answer out of them, either. However, I think what happens is people keep contributing to these vehicles, failing to recognize that costs are increasing.

[hans37]

[mephistophles]

Have your friend ask the agent to write a statement, and sign it, guaranteeing the benefits you mentioned above before proceeding with an application. The agent will refuse to do this. End of problem.

Regards,

ole meph

[LH2004]

[EmergDoc]

[alexander]

Putting money in a taxable account into Vanguard's Total Stock Market index would have expenses of around 0.1% per year (in ETF or with Admiral). The tax drag of 2% dividends would increase that by 0.3%, which would be far less than any expenses charged by the annuity

[LH2004]

[larryswedroe]

few thoughts

First you should buy insurance ONLY if you need insurance. Insurance is not an investment product. Why pay for insurance if you don't need it. Remember equities in taxable accounts are very tax efficient (assuming you use tax efficient vehicles).

Second, borrowing reduces the value of the policy for which you paid the insurance premium.

Third, you have the MEC issue. So you buy the insurance, presumably for a reason (like death benefit) and due to PERFORMANCE inside the VUL the policy BUSTS--you no longer have insurance, perhaps just when you need it.

Fourth, equities inside of life insurance lose the tax loss harvest option--a valuable option. Also any FTC would be lost. And of course you cannot donate appreciated shares to charity.

Fifth, you have the issue of who owns the policy. Is it in your estate? That creates other issues. Generally want to hold policy outside of your estate (at least if subject to estate taxes). If hold outside of estate you gave away the assets.

[dm200]

such plans that are pitched by high commissioned folks is that they make several critical assumptions, that may not be true in the future.

1. Since taxes are involved, future changes in the particular tax aspects related to these plans can wipe out the benefits.

2. There are future, sometimes complicated and long, commnitments to continue with the plan over many decades. For many/most of us, things change.

dan

[daryll40]

OK, over the weekend my friend forwarded to me an illustration from his AXA/Equitable Variable Life Insurance agent. We then spent an hour on the phone and I had a VERY hard time trying to refute the agent.

It appears that this policy has an $800,000 advantage over 30 years versus index investing. The agent claims this was designed when marginal tax rates were 90% as a way to compensate executives around the high taxes and that it's the tax savings that well overcomes the increased costs.

It still does not pass the smell test to me, but I just can't sniff out the flaws. I'd love to have someone else look this proposal over.

[EmergDoc]

[alec]

Daryll,

Some of the articles by Peter Katt here directly address the VUL vs. taxable account. Peter also has an audio presentation of the The significant problems inherent to variable life insurance.

If all else fails, ask your friend to "get a second opinion." He should get a kick out of that. Preferably one from an independent fee-only planner that can run the numbers correctly.

btw - anyone that wants a good easy to read paper on VA's vs. taxable index fund, see William Reichenstein's research page.

- Alec

[dm200]

it is hard to "refute" many of these arguments. Chances are that this agent is much more charming and persuasive than any of us. That is a job qualification for a Life Insurance salesman. He/she is being well compensated to sell "illogical" investments.

A key here is "30 years". Even assuming ALL of the justification for such an investment (and that is itself a big assumption), you have to do everything right for 30 years!

On the other hand, with investing in a well diversified portfolio of low expense mutual funds (whether index or managed), you could do very well even if you put money in for only 15 of the 30 years.

dan

[mephistophles]

Hi again Darryl,

Please reread my post, above, from June 14th. If the VUL is so good the agent should not have any problem writing and signing a statement guaranteeing these benefits. The fact that the agent will refuse to do this should be proof enough that the agent cannot and will not support his claims.

That being said, the reason you cannot sniff out what is wrong with the "illustration" is that it is not designed for the layman to understand. The illustration is too complex and has too many moving parts. In fact, the total illustration probably totals 10 to 40 pages, and you must read and understand all of it in order to make sense of it.

Put simply, the wonderful results promised by VUL salesmen are based on fictictious "assumptions" that do not exist, and can not exist in the real world. You probably are looking at compounded annual gross returns consistently at 12%. You are probably looking at illustrated current expense charges that are much, much lower than the maximum charges allowed by the contract. You are probably looking at mortality rates that are lower than can be charged. You probably are looking at an overfunded contract where premiums are always paid and money is never withdrawn and loans never taken. You are probably looking at a retirement annual payouts based solely on (non-taxable) loans based on illustrated loan interest/crediting rates which can change in the future and which also assume there will never be a change in the laws governiong life insurance taxation. If you are also looking at a comparison to other types of investment performance you probably are looking at an apple/oranges comparison.

Darryl, I am a 4 decade life insurance expert who has sold and trained salesmen in how to sell VUL type products years ago. Through self education (not insurance company training) I became aware of the many flaws and lies and half truths embedded in the product.

If your friend insists on buying this type of product then your friend will find out first-hand the huge financial mistake he is making.

Darryl, if you really want to help your friend, you need to refer him to someone who is an expert in this field to help him.

Regards,

ole meph

[hans37]

[MossySF]

[daryll40]

[EmergDoc]

Daryll, I'll put the problems I see in this post as I find them.

1) (The catch you noticed) The illustration put together by the insurance salesman indicates a 20% capital gains tax every year on the entire return of the taxable account (it assumes it works like a bank account or something). If your buddy really plans to sell every holding he has in his taxable account every year, perhaps he would be better off in a life insurance product. Notice also that the current highest capital gains rate is 15%, so he is assuming taxes will be raised. This might be a valid assumption, but why not assume that the tax loopholes which variable life policies use to provide "tax-free" loans will be closed too while we're at it! If your friend can manage to buy and hold tax-managed funds, he may actually only pay something less than 1% per year (1/20 of what this illustration assumes), perhaps less with good tax-loss harvesting, with 15% at the time of withdrawal only.

2) He assumes 8% returns for the life insurance product and only 7.5% returns for the taxable account. Hardly a fair comparison, especially when the reverse situation is more likely given the high expense ratios inherent on most variable life insurance funds. The funds included in this plan have ERs ranging from 0.72% (the MM fund) to 1.64% (an international fund.) Compared to a Vanguard admiral index fund of something like 0.1%, you've got to assume the taxable account will have higher returns by something like 1%, not -0.5%. Unless your friend believes the equitable mutual fund managers can best the return of an appropriate index by >1% per year for 50 years, I think the illustration is a pipe dream.

3) The life insurance is less liquid than the taxable account. For the first ten years, the insurance return is significantly diminished by penalties should your friend want to withdraw the money. In fact, this illustration shows he would be over 50% in the hole if he decided he wanted his money back after the first year. What is this illiquidity worth? I don't know, but it is worth SOMETHING.

4) When you get further into the illustration, you see they show another chart in very small print. This shows you what happens if your life insurance "investments" only make 4%. Rather than lasting you until age 90 like when the policy assumed 8%, you can only make withdrawals until age 58. That isn't a problem, is it?

5) I would add the usual disclaimers about the risk of this contract turning into a MEC at which time most of its benefits disappear and your friend would owe an immense amount of back taxes on the money he thought he had withdrawn tax-free.

I'll edit this a bit more later; I gotta go eat for now.

All right, I'm back. I decided to thumb through some of the funds available in this lousy variable life policy. Let's start with the first one I picked, which is called Multimanager Mid-Cap Value. It has an ER of 1.58% currently and is apparently a load fund. I am not certain what load if any your friend would have to pay. By the way, morningstar lists the ER of the A shares at 1.9%, with a waiver good for 10 more months at 1.75%. If your friend is lucky, he might get the Y shares at a somewhat better 1.44% ER and no load. It would be nice if the prospectus mentioned which fund is actually available to him. At any rate, the 3 year return on the B shares (hope your friend doesn't get these at 2.44% ER) was 14.85%. Compare this to the index the Vanguard Mid-Cap Value Index Fund tracks at 18.49%. Doesn't look like that high ER is getting you much. Even the best of these (the Y shares, whatever they are) only managed 15.89%. Not much of a track record.

The policy also has an S&P 500 index fund. It has an ER of 0.58, about 1/2% higher than Vanguard.

They also have a health care fund, just like Vanguard. I'm sure your physician friend would be very interested. Of course, the Multimanager health care fund (not sure, but I believe the ticker is AHLAX) has an ER of 1.63% (compared to Vanguard's 0.25%) with a 5 year return of 7.8% (compared to Vanguard's 11.36%.) Of course, Vanguard's fund is closed, because it actually makes money and stuff, but anyway.

Let's try one more (and remember, there is no selection bias here, these are the only funds I've actually looked at off their list.) Let's try their Value fund. ER is 0.94% and 5 year return is 10.55-11.68, depending on which of the various load options this policy takes (which it doesn't mention, BTW.) A good comparison is the Vanguard Value Index, with an ER of 0.21% and a 5 year return of 12.21%.

So I think it is pretty clear that it is pretty unlikely that he will get the same return with the crappy investments in this policy as with good, solid taxable Vanguard funds. So what would happen to the illustration if we assumed that the taxable investor made a full 1% better/year than the life insurance user. We'll subtract a little for taxes, say 0.25%. I think that is fair given the usual distributions of Vanguard's index and tax-managed funds. So we'll assume the taxable investor makes 8.75% while the life insurance investor makes 8%. After 20 years of paying in $31,705 per year, the taxable investor has a balance of $1,577,225 and the life insurance investor has a balance of $1,216,324. Hmmm, over $300,000 behind already, this doesn't look good. All right, for the next ten years, we'll assume the investor wants to get $84,620 per year from the portfolio, leaving the SWR discussions for another day. Since the taxable investor has a basis of something like $600K, we'll assume the 15% capital gains rate is applied to about 2/3 of the withdrawal, so we'll call it a 10% tax rate. So this investor will need to withdraw $84,620 + $8,462 from his portfolio to pay the taxes, for a total of $93082 per year. So after 30 years total, with equal after-tax withdrawals from each portfolio, the taxable investor has a portfolio worth $2.25 Million. Meanwhile, our life insurance investor has a cash surrender value of $1.16 Million. Let's give it ten more years and see what happens. Still withdrawing an after tax 84,620 per year. (Inflation apparently doesn't exist in this life insurance salesman's little world.) The taxable investor now has a portfolio of $3.8 Million and the life insurance investor has $1.03 Million. Let's go ahead and run it out to the end of the illustration, 75 years after the insurance policy was bought. The taxable investor now has a portfolio of $52 Million. (Why he only withdraw $93K a year is beyond me.) The life insurance investor has a cash surrender value of $1446. That's right, less than 2 grand. But at least he still has $50K worth of permanent life insurance. Hopefully in 75 years that'll still buy a coffin.

There may be an error in my calculations, but I couldn't find it. All the life insurance numbers come directly from the illustration. Even if my numbers are off by a little bit....I think the point has been made.
_________________
1) Invest you must 2) Time is your friend 3) Impulse is your enemy
4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

[hans37]

Great work Doc.

So your analysis result is :

It's a great retirement plan







for the salesman

[tfb]

James H. Hunt, a life insurance actuary with 45 years experience and a former insurance commissioner of Vermont, evaluates life insurance policies for $60 flat fee. If your friend is seriously considering this policy, spend $60 and have it reviewed by an expert. It will put all arguments to bed.

http://www.consumerfed.org/eva....policy.cfm
_________________
The Finance Buff

[hans37]

[tfb]

[Taylor Larimore]

Hi Doc:
I cannot read your insightful analysis without telling you how much I admire it.

I know Daryl will give it, and the other Boglehead posts, to his physician friend--who owes you a big debt of gratitude.

Your analysis will help all of us the next time someone tries to sell us insurance as an investment.

Best wishes.
Taylor (who once sold insurance)

[daryll40]

[daryll40]

By the way, thank you EmergDoc for reviewing this and to everyone else for your input. I appreciate it!

[EmergDoc]

[mephistophles]

Life Insurance was created to protect beneficiaries from the financial loss of the death of an insured. It was, and is, a highly cost efficient way to protect human life values from unknown risk.

Life Insurance was not created to be an investment, and to promote the product as such, is at best unethical and at worst, unadulterated fraud.

In four decades in the life insurance business, as an agent and as a manager, I have never witnessed a single instance where I would rate life insurance as a good investment.

That being said, when life insurance is purchased for it's intended purpose, death protection, I have never seen any other financial product that can provide so much benefit for so many people at so reasonable a cost. Except in some business, estate and other special situations, term life insurance is, by far, the product of choice which provides the greatest value to the consumer. In all cases, Variable Insurance rates among the worst products ever created by the insurance industry, and when all is said and done, will provide the least value to the consumer at an incredibly high cost.

Just my humble opinion,

Regards,

ole meph

[EmergDoc]

Daryll--Keep us advised about what your friend eventually ends up doing. Did he actually read this thread?
_________________
1) Invest you must 2) Time is your friend 3) Impulse is your enemy
4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

[Zander]

There was a book written that describes this scam, er I mean, 'strategy' called "Missed Fortune". http://www.missedfortune.com
The author runs seminars for insurance agents promising them he'll teach them how to become "millionaires" too! Just by selling these 'overfunded' policies. Run, do not walk away. Here is a Scott Burns article where he does a very thorough job debunking the book and its concepts. http://www.dallasnews.com/shar....53d87.html

Here is my personal review of the book (and the concept) that I posted on Amazon a few years ago:

[daryll40]

[daryll40]

OK, one comment that I've gotten back from my brother who invests like me (DIEHARDish) and is as skeptical and cynical as I am about life insurance as an investment:

"The Diehards failed to address the fact that if you can really get the money out of the life insurance scheme tax free, it's such an enormous benefit that it does seem to override all of the costs and other friction".

[MossySF]

[EmergDoc]

[daryll40]

It's also not clear to me...are there a double set of fees. In other words, the insurance company readily fesses upto and admits that there is 1.2% or so of fees. Are the sub-account management fees IN ADDITION to that? Meaning an 8% market return would be 6.8%...or much LOWER if there are hidden management fees in the sub-accounts?

Finally another issue here. If you invest according to the proposal, you are 100% equity. So there is an asset allocation problem.

[MossySF]

[mephistophles]

[mephistophles]

Policyholders who take a series of tax free loans in retirement face the serious risk known in the industry as "The Surrender Squeeze." The surrender squeeze happens when the policy becomes too expensive to keep and too expensive to discontinue, at the same time.

This happens when the cumulative loans plus cumulative, compounded loan interest charged on the tax free loans become larger than the remaining cash value, unless more money is deposited into the policy. This scenario is likely to occur as mortality charges dramatically increase as the insured gets older, if the stock market has any kind of significant decline, thus depleting cash values virtually overnight, or for other reasons. When the squeeze occurs the insured quits taking loans and has to resume premium payments plus enough to cover the interest charges on a now "huge" loan. This is so expensive that the insured just wants to quit.........but..........if the policy lapses or is surrendered, ordinary income taxes are due for the entire gain, including the loans. These taxes can be huge and are due in that taxable year. So, the insured is caught between a rock and a hard place, i.e. The Surrender Squeeze."

And now for the best part of this scam: The insurance company compliance departments put out annual statements for agents to sign stating that they understand that it is inappropriate to use "tax free" language in presentations, that the client should consult their own tax advisers and that the policy should not be called a retirement or pension program and that the main reason for buying the policy is for the death benefit and that policy loans can result in a surrender squeeze. Interestingly, THIS COMPLIANCE INFORMATION IS "NOT" TO BE SHARED WITH THE PUBLIC.

Just a view from the inside.

Regards,

ole meph

[daryll40]

Now we're getting somewhere. It seems that the AXA agent is saying your "squeeze" scenario can't/won't happen. But it's not clear to me that he is guaranteeing it and it's not clear that he's minimizing a risk that is greater than minimal. I will press this issue with my friend to get clarified.

I suspect this is where the agent will finally back off of all the sales hype when pressed for a guarantee. I heard his pitch and it's amazing how he has answers for every objection. I like new cars (unfortunately, a whole 'nuther story) and it really seemed like a "what's it going to take to have you buy this car TODAY" pitch. At least with a car, you're done! This goes on and on and on!

[daryll40]

[subrosa]

Hello daryll40

Apologies for intrusion, and I am far from expert here, neither own, sell, or buy VUL as of this posting, but I've looked at some and I'd note if your friend is at high risk for litigation the use of insurance might (emphasis might) entail some asset protection characteristics that these comparisons with low cost after tax index funds completely ignore.

If used in a favorable state this might well be worth the extra costs.

So maybe this is an issue for him?

If so, and if you want to take a totally different tack, go to tiaa-cref, download the prospectus for their intelligent-life VUL policy, give to your friend, and make the agent explain why your friend should go with AXA over tiaa-cref.

That would be a true apples to apples comparison; and iirc tiaa does not use commissioned salespeople, charges zero exit fees, charges zero load, uses state minimum tax on premiums, has an M&E that starts at 0.95 and drops to 0.65 and ahgain to 0.35 with time or asset growth, and has standard s&p 500, small cap, and bond fund subaccounts with expense ratios between 0.06-0.10. No other hidden fees or riders iirc (but check on this).

That way if your friend does think insurance is the only way to invest he can compare two VUL vehicles.

Make the agent defend the AXA policy pricing apples on apples- as all the borrowing/loans/tax treatments will be the same with either VUL (except exit fees which will be lower with tiaa).
_________________
@-->-->--

Please note: this and all posts by me are for entertainment value only & not as medical / legal / tax / financial or other investment advice. Consult your professional in all matters.

[subrosa]

[EmergDoc]

[RiskAverse]