This video takes a deep dive into Indexed Universal Life (IUL) and its internal fees. It examines year by year what these fees work out to be and refutes the common claim that IUL is expensive.
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IUL’s Fees Examined and Explained
Hi, this is Hutch with BankingTruths.com. And again we’re going to talk about the dreaded fees inside of an Indexed Universal Life policy and if you start reading about IUL online you’ll probably find these pieces that talk about the cost structure of IUL almost like a ticking time bomb – almost like it’s a trap that the insurance companies are waiting to spring on you. They can’t wait for you to get your money in there so they can just exponentially increase CCs.
So it cannibalizes your cash value and lapses your policy and all of something like that might happen in the most extreme situations. It’s hard to imagine a scenario where that can happen when the client’s goal is to max fund a policy, meaning put the most amount of premiums into the least amount of death benefit there.
Their performance would have to be so vastly different from what was projected or they’d have to have some kind of extreme scenario where the premium schedule they were hoping to put in was completely different from reality, in which case there are still measures to ratchet down the death benefit.
But I digress.
Let’s talk about what you’re seeing on the screen here and it is an example of a male age 45 preferred health, my age right now. Probably about my health.
And you can see that we’re using death benefit option two and what that means is we’re starting with an increasing death benefit that will increase in the early years, and then once we’re done paying premiums it’ll flatten as the cash value converges upon this.
So the cash value’s going to track along with the policy and then it will start to converge upon the death benefit, at some point, it will hit what’s called the corridor or the corridor test and the insurance company will automatically start pushing up your death benefit.
Now a lot of people don’t realize the fees and charges inside IUL is based on not the total death benefit but what’s called the net amount at risk. So if you use this policy structure then it would be about the same through this period because your death benefit is increasing by the size of your cash value. But then you can see it all starts to get smaller.
As the cash flow gets towards the death benefit and that’s really when the fees and charges (or the cost per unit of insurance) starts increasing near retirement age and really post-retirement.
After you retire, when it starts to get really bad so we can see here in this insured costs of insurance column that the charges indeed do go up as the client gets older. But then they hit a point right here where you can see it approaches 7300 and then it starts to go down.
So the cost per unit is still going up. So during this time, he’s paying for higher costs of insurance as he goes from a 61-year-old to 62 to 63 to 64.
But what’s happening is the cash value here is converging upon the death benefit so he is paying for less units of this insurance and I think that’s a very very huge point that most people don’t understand when they read these hit pieces.
So let’s just talk about the other fees and charges you’ll see if you have a supplemental report like this run on your illustration.
One is called the premium expense and tax surcharge and a lot of clients don’t realize but the insurance companies do need to pay something called a premium tax for every premium they receive, and they pay it to the state where the policy was issued.
Now it’s possible that maybe because the tax that varies depending on the state that the entire premium expense and tax charge won’t go to the state tax. But I liken this and this is an analogy this is not exactly 100 percent true.
I liken it to almost like old school money management. So it used to be when you bought mutual funds it was hard to find any no-load funds and you could either pay an upfront load so you could pay an upfront commission and have a lower load inside your mutual funds or you could pay no load and have higher loads inside your mutual funds.
And like I said, this is not apples to apples but when you think about it the insurance company is agreeing to manage your money at very favorable terms and later on you can see once you’re done paying a premium they’re not really collecting anything for that and all they’re collecting here is the cost of insurance. There’s this expense charge that is is more expensive during the first 10 years and this is what we call the acquisition charges for a policy and after that you’re merely paying for this low policy fee, it’s almost similar to paying more of an upfront load to have the insurance company manage your money in this way.
Now just continuing on the expense charge.
What’s nice is when you compare this to whole life, oftentimes the expense charges will be comparable. And it’s hard to unbundle, there is no charges report inside whole life but we find that you’ll pay something comparable in this expense charge but it’ll usually come out in the first one to three years of the policy, depending on how it’s structured.
And with Indexed Universal Life, at least it is spread out or amortized over 10 years. So you have the opportunity to have more money working for you, more money earning interest for you, even though your net cash surrender value might be lower.
That’s just because of an arbitrary surrender charge that the insurance company is going to put on to make sure they have enough time to recoup their cost for issuing this policy.
And on this particular policy, we did not use an enhanced cash value rider where you could waive the surrender or make the surrender a lot closer to the account value and that’s why you’re seeing zero. Also, it’s worth noting that this particular policy has very favorable chronic illness, critical injury benefits built into it – not as a rider just built into their underlying policy chassis so you don’t need to pay any charges.
Now what I’m going to do now is, I’ve taken the same fees and charges and loaded onto a spreadsheet because I’m sure some of you are thinking “Hey yeah these are the good charges but then it’s just going to get horrible like I was reading about”. Well, let’s take a look.
I’ve loaded all of this into a spreadsheet and I’ve added some key columns here so the main column that I’ve added is while the to our total account charges where we can aggregate all of these, if you’d see we just use the formula here and then also the charges as a percentage of the account value.
This would be similar using the mutual fund analogy again, this would be similar to expense charges as expressed as a percentage of what the asset value is.
When we look at this, the first five years are the worse years because you can see not only are you paying a premium load which eventually vanishes. These higher other expense charges, which eventually vanishes, but also you don’t have a lot of account value in there to offset the charges.
So it seems egregious and in a vacuum when you here you’re going to pay 16 percent maybe more because this is assuming you get some performance the first year. Nobody would sign up for that. However what I want you to see is from year 6 to 10, it becomes a lot more in line with say money management.
If you hire a financial planner to manage your money, oftentimes they’re going to charge one to one and a half percent plus whatever the underlying funds are. And so depending on how much that building blocks costs, you might be paying right around the same amount. Notice from year 10 to 15 it does go down substantially. And keep in mind you’re still paying this premium load even though the bulk of these expense charges vanished.
There’s still a hefty premium load coming out of your new premium dollars coming in, but since you have more of an account value to grow and offset some of those charges it doesn’t seem quite as bad. Notice what happens from year 16 on.
Now we’re talking about what today’s no-load index funds might cost anyway. Not to mention, I don’t know any index fund that’s going to give you a death benefit.
They’re not going to say, “Hey, you have $513,000 in our mutual fund. I’ll tell you what, if you die we’ll give you a million or eight hundred thousand or whatever it is.”
That’s pretty sweet.
So if we scroll all the way down you can see the charges go down and we’re all the way out to age 76, I think 75 and then it does start to go back up and you can see as a dollar amount the charges are pretty nominal and manageable because again the cash value is just right up against that death benefit. It’s only until these later years where death is set to occur that you start paying very large dollar amounts.
However and this is the total fees. If we look at it as a percentage of how much money you have in their earning interest it’s pretty nominal.
And although you may not need that much death benefit way out here because I did look at it age 90, we can just look together so we have four point three, four point four of cash value. If I go back to the illustration I think we’re page 22.
So 4.3, 4.4 of cash value there is only 4.5, 4.6 of death benefit. So you’re really paying for like two hundred seventeen thousand dollars a death benefit.
So again when you look at it in a vacuum and you say, “Gosh you know. Eighteen thousand dollars almost 19000 dollars is a pretty steep price to pay for a death benefit“. Well, guess what? There’s a really good chance you’re going to die at age 90 which is why they’re charging you that.
Not to mention, remember if you keep a policy in force even if you bleed it way down for income. All of the lifetime loans withdrawals up to basis are all deemed tax free once any amount of death benefit is paid here. Again as a percentage of how much money is in there working for you, it’s quite nominal.
If we just look at the average, we’re looking at one point five four percent. So not very much over the life of the policy. Now I know some of you are thinking, “You know Hutch, this interest rate you’re showing is probably a good one“.
You’re right. It is 7.25 but that is the IJI 49 rate which means they look back 65 years and looked at every 25 year rolling period in that 65 years, average that out with this particular carrier’s caps and floors.
And at the time of this video, that’s not a pen that’s a square, it’s zero to 13 percent. I just ran it just for the last 45 years since I was born in 1973. And they’re telling me I should use 7.28 instead of 7.35.
But we can’t, we’re using 7.25. And then I also ran how low of a cap does it need to be to do a percent below, to have a 6.35 and it’s actually the cap would need to be 10.2 percent if the cap was as low as went from 13 down to 10.2%.
Then in the last 45 years, it would only earn 6.25%. And let’s look at those fees and charges so if I move over to this tab if we scroll all the way to the bottom you can see that the average only went up to one point five nine percent not very much.
The other thing I want you to notice is the remember we paid 18000 of death benefit at age 90. Well, you’re actually paying for less death benefit.
Now it is a higher percentage because we have less cash value but you’re actually propping up less death benefit which is nice. So again this is manageable. We’ve squashed the cap in this scenario and it’s still very very far from blowing up.
I like to show one more thing that I think is interesting. I often tell clients that the first five years of paying premiums, you should almost liken that to just putting in a savings account or just putting it in a mattress.
And so if you do that and we just clear the contents, and we take this out of the average the rest of the years the average for the life of the policy is point 6 2 percent.
So all this talk about how expensive indexed universal life is or how expensive life insurance is in general. You know it’s really not based on facts.
Probably, if you heard even if you heard a former financial planner or account they probably just read the same garbage you are. So I would encourage you to test and measure your own numbers and take a look at your own policy and stress test it and see if that is an acceptable cost-benefit relationship. Check out our video to see how we stress test policies.
And one last thing, going back to the first five years being the worst years and having not a lot of benefit little or no we can see here even the six point twenty five you put in 100 at least you have 102 working for you even after the fourth year almost all your 80s working for you plus you had a death benefit.
But I talked to clients about how especially real estate investors are business owners. You know when you started your business were you profitable early on?.
Were you profitable in your first years? And even if they were, what if you factor all your time and blood sweat and tears into that were you really profitable?
Same thing with real estate – in real estate you might have to do improvements, paint curtains, whatever you’re doing and still these real estate investors are doing quite well because they realize what a great long term asset it is to own.
So I’ll often ask them, “Would you do it all over again?” And they say yes.
So I’d encourage you to not believe all the hype and do your own analysis on this.
John “Hutch” Hutchinson
ChFC®, CLU®, EA, AEP®, CExPs®