In our last blog post, we did a comparison between Buy Term and Invest the Difference and IUL. The results showed us that IUL tends to yield less cash value at the end of the comparison period.
However, that analysis has two major flaws, if we correct them, the results could point to the other direction.
Flaw 1. Age 65 is NOT the end
In fact, for most people, age 65 (or whatever your retirement age) is just the beginning of another life stage - the retirement stage - and it could last another 20-30 years!
Implications:
Buy Term and Invest the Difference
If you are like most people, in your retirement stage, the biggest risk is the market crash (remember 2008?)! How to prevent it? By allocating money into more conservative assets such as bonds, which means your portfolio will have lower average return in this life stage than in your assets accumulation stage.
IUL
Because of the downside protection, the IUL portfolio could afford to remain fully tied to equity indexes, therefore keeping the 6% (or even higher) annual return assumption (see our online tool that compares IUL's back date testing against equity index results)
Conclusion
Given that people typically have at least twenty or more years of retirement life, the above rate change means IUL would catch up in cash value in the retirement stage.
Flaw 2. Ignored IUL's Tax Free Advantage
The cash value comparison focuses on the assets accumulation phase, however, IUL shines in the assets distribution phase, due to its tax-free advantage. There are two factors in play here:
Factor a. Tax-free Loan
Buy Term and Invest the Rest
When you invest on your own (or even in a 401k account), at retirement time, if you need to take money out to support retirement life, you need to pay tax. For example, assume you need $100,000 each year to support your life expenses, and the tax rate is 20%, the actual amount taken out of the account will be $125,000.
IUL
For IUL owners, the smart way to use IUL's cash value is to borrow from it, which means you are taking a loan, of course you don't pay tax on a loan! This means $100,000 taken out of the cash value is $100,000 arriving at your hand to use.
Factor b. Collateral Loan
The "collateral" feature is special to only some of the cash value life insurance policies - it means any amount you are borrowing against your cash value will remain fully invested in the equity index account and enjoy any return the market delivers. For example, your cash value is $500,000 and you are borrowing $100,000 out of it, you will pay interest on the $100,000 loan, but your cash value amount remains to be $500,000 (the $100,000 is treated as a collateral) and grows with whatever the market rate.
Buy Term and Invest the Difference
No collateral feature, any amount (for example, $125,000) taken out means your account value drops by that same amount and a lower base to grow in the future.
IUL
With the collateral feature, plus the fact that over long term, the average loan rate (typically less than 6%) is less than the average market growth rate (assumed to be 6% but could be better), your cash value will increase, instead of decreasing, over time. Over a twenty or thirty years time frame, that could be a substantial amount.
Conclusion
At the distribution phase, the IUL cash value could keep growing, while the other investment accounts will inevitably see account values decline because more money taken out each year, many 401k account even faces the risk of depletion by the age 70's or 80's (you can run our free 401K Evaluation Tool by yourself and see how long your 401k money will last - many people are surprised by the results!).
In Summary
After correcting the above two mistakes in our earlier analysis, our early conclusion will be reversed!
In our next blog post, we will discuss one of the major complains towards IUL - its costs are too high, again, the results could be very surprising!
However, that analysis has two major flaws, if we correct them, the results could point to the other direction.
Flaw 1. Age 65 is NOT the end
In fact, for most people, age 65 (or whatever your retirement age) is just the beginning of another life stage - the retirement stage - and it could last another 20-30 years!
Implications:
Buy Term and Invest the Difference
If you are like most people, in your retirement stage, the biggest risk is the market crash (remember 2008?)! How to prevent it? By allocating money into more conservative assets such as bonds, which means your portfolio will have lower average return in this life stage than in your assets accumulation stage.
IUL
Because of the downside protection, the IUL portfolio could afford to remain fully tied to equity indexes, therefore keeping the 6% (or even higher) annual return assumption (see our online tool that compares IUL's back date testing against equity index results)
Conclusion
Given that people typically have at least twenty or more years of retirement life, the above rate change means IUL would catch up in cash value in the retirement stage.
Flaw 2. Ignored IUL's Tax Free Advantage
The cash value comparison focuses on the assets accumulation phase, however, IUL shines in the assets distribution phase, due to its tax-free advantage. There are two factors in play here:
Factor a. Tax-free Loan
Buy Term and Invest the Rest
When you invest on your own (or even in a 401k account), at retirement time, if you need to take money out to support retirement life, you need to pay tax. For example, assume you need $100,000 each year to support your life expenses, and the tax rate is 20%, the actual amount taken out of the account will be $125,000.
IUL
For IUL owners, the smart way to use IUL's cash value is to borrow from it, which means you are taking a loan, of course you don't pay tax on a loan! This means $100,000 taken out of the cash value is $100,000 arriving at your hand to use.
Factor b. Collateral Loan
The "collateral" feature is special to only some of the cash value life insurance policies - it means any amount you are borrowing against your cash value will remain fully invested in the equity index account and enjoy any return the market delivers. For example, your cash value is $500,000 and you are borrowing $100,000 out of it, you will pay interest on the $100,000 loan, but your cash value amount remains to be $500,000 (the $100,000 is treated as a collateral) and grows with whatever the market rate.
Buy Term and Invest the Difference
No collateral feature, any amount (for example, $125,000) taken out means your account value drops by that same amount and a lower base to grow in the future.
IUL
With the collateral feature, plus the fact that over long term, the average loan rate (typically less than 6%) is less than the average market growth rate (assumed to be 6% but could be better), your cash value will increase, instead of decreasing, over time. Over a twenty or thirty years time frame, that could be a substantial amount.
Conclusion
At the distribution phase, the IUL cash value could keep growing, while the other investment accounts will inevitably see account values decline because more money taken out each year, many 401k account even faces the risk of depletion by the age 70's or 80's (you can run our free 401K Evaluation Tool by yourself and see how long your 401k money will last - many people are surprised by the results!).
In Summary
After correcting the above two mistakes in our earlier analysis, our early conclusion will be reversed!
In our next blog post, we will discuss one of the major complains towards IUL - its costs are too high, again, the results could be very surprising!
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