Help a Reader: Investment Opportunity

I recently received this email from a reader:

I just finished a meeting about fixed index universal life insurance.  I have not heard of it before.  It has been around for about 12 years. 
 
How it works in my example: 

• 41 years old invests $6,000 a year for 25 years ($150,000 invested).


• At that time I start taking out $40,000 a year for life tax free.


• The investment never loses money and will not have more than a 17% gain in any one year. 


• On years that the stock market goes down, the investment earns 0%.

It would seem like this a good investment if I live to 70.
 
There has to be more to it.  I was wondering if the readers have heard of this and what would the downfall be?

What's your advice for him?

Comments

[Jen M]

I have this product through Pac Life (provided by my employer), after 4 yrs it has no cash value. I'm so embarrassed to have this that I don't even include it in my net worth. I do however, pay taxes on the premiums....

[Jonathan]

Well, it's certainly not true that it would be a good investment if you only lived to 70...Consider that the money you're putting in each year could be growing in some other form of investment. If $6,000 per year grew for 25 years at a reasonable 6%, you'd have around $330k. If you then stopped contributing and started withdrawing $40k, continuing to earn 6%, the account wouldn't go to the red until you were 76 years old. The internal rate of return of this investment is at most about 8% no matter how long you live.

[Apex]

First your comment about it being a good investment if you live to 70 is misguided.

I presume you arrived at that by using 66 as the age to start taking $40,000 and then by age 70 you will have received $160,000 and only paid in $150,000. This assumes no return on your money during that time. If you like that deal then I will gladly take $6000 a year from you for 25 years and then give you $160,000 back on year 25. If you were to get a 5% return on that money over that 25 years it would be worth over $300,000 so you can't just compare to the original value of the money invested.

Secondly the $40,000 promise is not guaranteed. That is a model. I would argue the model is highly inflated and your policy will likely never be able to pay you the numbers they are showing you.

So here are the 4 points I will make about the policy:

1. Did they explain to you that when you start taking out the $40,000 that it is a loan against the accumulated death benefit of the policy? That loan needs to be paid back. The theory of course is that it is just carried by the policy in perpetuity and paid back by the death benefit at time of death, but there are costs to loans and those are born by the policy, namely interest on the money that you are not paying back and that can affect how the policy performs.

2. Did they show you what fees they are charging you annually to do this? Are they keeping the dividends from the index funds or are those invested back in your death benefit? This is not a savings or retirement vehicle. It is life insurance that is being used as an investment vehicle. There are costs to the life insurance. It can still work as an investment vehicle but you are paying inherent life insurance costs that you would not be paying with other vehicles. The tax free benefits may out weigh that but keep in mind my first point that it's never really truly your money. It's a loan against the policy which will be paid back at death.

3. It would take an 8% annual return to get you enough money to take $40,000 after 25 years and have the policy value not draw down assuming you continued to get a steady 8% every year after that. That also assumes no impact from the interest charges on the money you are borrowing out of the policy as well as no impact from the cost of the underlying life insurance and those are definitely not true assumptions. The underlying life insurance cost will definitely have a real impact, and I don't know how to compute the impact of either. So the real numbers will definitely be worse than the numbers I am using because I am just pretending this is operating like a savings account but it will be worse than that cause there are multiple fees being extracted. Also 8% would be a pretty darn high return given that you get capped on the big years at 17% and often times the market is stagnant for periods and then has huge up years in between. I would not feel comfortable assuming anything close to an 8% return on this type of policy.

At 7% the policy would draw to 0 in 19 years.
At 6% the policy would draw to 0 in 13 years.
At 5% the policy would draw to 0 in 10 years.

At 5% returns you could probably draw a little less than half what you are expecting.

4. If something happens along the way and you are not able to keep up the $6,000 per year contributions that is going to cause some serious issues. Have they discussed how that would be handled?

[Apex]

Wow, everything I typed is overshadowed by Jen M's comment. As I said the numbers you saw are a model. The model is not guaranteed. I would guess the model almost never comes true. I honestly don't know how they can sell these things the way they do.

Remember the first rule of money: If it sounds too good to be true .... don't be a sucker.

[Steve Mertz]

Jen's right on the money-this example is purely hypothetical and not guaranteed! It really looks good on paper but just remember Jen's story when considering this product.

[jim]

Don't do it.

Key reasons :
1) high fees associated with cash policy life insurance undercut your investment returns
2) betting on a 0-17% swing in the stock market sounds good but its not really that great. It just averages out to like 6-8% annual return due to all the years the market is negative or underperforms plus you don't cash in the high returns from years the market booms.
3) this policy will lock you in for several years with high 'surrender fees' which means if you need to stop the policy due to an emergency like a job loss then you will get little to none of your money back. See Jen's comment above, she's paid 4 years and has $0 cash value.
4) It would be easy to duplicate it yourself. Put $6k a year into an investment and hopefully grow it 8-9% and you'll end up with over $500k which will buy you an annuity for close to $40k.
5) If you're not maxing your 401k or Roth already then those are certainly better.
6) Did the salesman tell you about the big fat commission he/she is going to make off you? I'm sure its >$5k range for this sale. Keep that in mind when they ensure you how great it is.
7) Do you actually have a need for a large permanent insurance policy? Why not just buy a cheap term policy and invest your money wherever you want?

I would bet good money that the investment projection you were shown by the salesman were NOT guaranteed and are just 'forecasted' or 'estimated' returns. In other words that is as good as the paper its printed on and nothing more than a 'hope' that they will perform well. They are likely assuming something like 10-12% annual returns for the stock market. I'm sure if you ask what the GUARANTEED performance of the investment is that it would be much less impressive.

This is not to say that cash value insurance is all awful. Some of it is OK investment. But its only appropriate in certain circumstances such as a family with a disabled child or someone who's a multimillionaire planning for estate taxes.

[tcupaz]

I am the one who asked the question. Thank you for the responses. Very good info from you and that is why I asked FMF for answers. I have a second meeting with the salesman this Wednesday and this info will help me for when I turn him down and he wants to know why.

[tom]

tcupaz,

When you turn him down, you don't need a reason.

Furthermore... I think Jim hit it with the fees and the commission.

Also, with index funds, you still get a dividend payment, with this... you get nothing.

Universal Life promoters love to tell you how your returns will be huge or 0 and how they consistently beat the market. They fail add fees and leave out the dividend when comparing to a specific index.

[Lowdown]

Better yet, cancel the meeting. Don't expect the salesman to thank you for your time and walk away. He will have an explanation and counter argument for every objection you make. He has heard them before and will be prepared. The high pressure sales will then ensue.

[Joe]

tcupaz - Don't bother having a 2nd meeting with the salesman. Like you said, he is a sales man and will not accept what you are showing him. Basically, anything that has to do with your money just don't talk to a salesman about it.

[Mark]

You'll be doing both the salesman and yourself a favor by not having the second meeting. You won't risk being convinced to make a mistake and he won't be wasting time he could be using to sucker someone else.

[Kenny]

Bottom line on these investments:

1. Fees and Commissions are High.
2. Surrender Value is significantly diminished in the first x years if you cancel.
3. Charges for Indexing are part of a rider (option) and it will feel like buying an expensive option on a car (like collision detection system or something high end).
4. You can do the same by yourself with an Annuity account, or IRA or even a Taxable investment account with ETFs with a lot lower fees.
5. None of the terms on the proposal given are a guarantee. Read the contract that you get when you sign up, but ask for it, AND, go through it before you signup. It will be challenging for you to get your hands on it, and the language is written by some very high paid lawyers. I have read it, and declined ALL policies upto now.
6. Buy Insurance of the cheapest kind (called Term) to a certain age, and then you do NOT need insurance. Insurance is for 'insuring something that needs to be replaced'. When I am 70 or 80, I do NOT need to be replaced, except in the minds and hearts of my family. And, they will have 10x more assets than Insurance to look after and enjoy. So, why does anyone who is successful need insurance. That is why you see the $10K insurance commercials on TV by that actor. It is for people who are not financially sound at age 60-70-80-90. And, they charge a pretty penny for a meager $10K in insurance (for cemetery/burial expenses).

Good luck.

Kenny