Tax Free Retirement

Comparison of IUL Scenario Versus Mutual Fund Scenario

 

Assumptions: The S&P 500 Index returns one third what it has historically returned or 4% going forward. Now lets compare putting $100,000 into a indexed universal life insurance contract as opposed to $100,000 into a low expense, indexed mutual fund. Assume a 45 year old man in good health. Further lets assume the mutual fund was in a 401K wrapper for tax deferral. And finally lets assume a 15% marginal tax rate, the lowest possible which means they live in one of the five states that doesn't have a state income tax. 

 

First the life insurance contract. 

 

In order for it to abide by IRS rules and avoid being a modified endowment contract it must be funded over 5 annual payments. So we start with $100,000 make our first $20,000 payment and then put the balance of $80,000 in a money market getting 3%. 

 

That buys us $400,000 worth of insurance which we index to the S&P 500 Index. So if we die after 10 years we get $400,000. Our rate of return is 14.4% If we die after 20 years we get $400,000. Our rate of return is 7.2% We live to our life expectancy of 80 and we get $400,000. Our rate of return is 4.1%. 

 

But wait you say, you can't get to that money in a life insurance contract. 

 

Wrong, you can access the surrender value anytime you want taking out policy loans. At age 67 there would be $170,000 to access. 

 

But there is more to this strategy. You could use the interest earned in that money market fund you created to fund the life insurance to buy more insurance or you could just let it be. After your five payments are made there would be $6400 in the account. Let's assume you took the interest and purchased an additional 20 year term policy with it. You could purchase a $150,000 policy. Remember, you will accumulate no cash value with this so it is just added protection which will add to your wealth before retirement if you don't make it. 

 

Now you have $550,000 if you die after 10 years. Rate of return is 18.6% At the 20 year mark you die and you have $550,000. Rate of return is 8.9%. At 80 it would be the same (4.1%) since the term policy is no longer in force. 

 

Now let's compare that to the mutual fund. 

 

Once again it is an index mutual fund tied to the S&P 500 Index with a very low overall expense ratio of .5% (average is 2.5%). The rate of return for the fund is 3.5% (4% Index rate minus .5% expense ratio). 

 

If you die after 10 years you would receive $141,060. But there are income taxes due (your heir has to pay it). We assumed the lowest marginal tax rate of 15% so you pay $21,159 in taxes and end up with $119,901 for an after tax return of 1.8%. Not good! 

 

OK, you live to retirement age of 65. You have $198,979, but you gotta pay taxes on that so it reduces the amount to $169,132. Your return is 2.7%. 

 

You live to 80. Congratulations! If you have not used the account. You have $333,359 in the account. After taxes it is worth $283,355 for a return of 3.1%. 

 

Let's review: 

 

 

 

 

 

 

 

 

 

 

 

 

Bottom line is that you have significant better rate of returns from the life insurance at a cost of $21,000 in cash flow at age 65. A toss up in my book. 

 

Let's do this if the S&P 500 Index returns in the future what it has in the past because it dramatically changes the calculations. Your marginal tax rate goes up to 25% because you have to withdraw an amount that puts you in a higher tax rate. You also have a estate tax problem that cost you if you leave it in the mutual fund until age 80. All other assumptions stay the same, but the historical return of the index is 12%. 

 

 

 

 

 

 

 

 

 

 

 

 

 

So what I have done is to put the real numbers from insurance software against the best case of a mutual fund. So, if you have a mutual fund with an expense ratio of .5% which is 2% below average and you never access it. If you live to your age expectancy. If the market returns the same as it has historically done. 

 

If you are in the lowest tax rate possible and live in a state with no state income tax. And finally, if when you need the money the market is not in a down period then you come out ahead putting your money in a mutual fund. If any of these things are different then you don't. So there it is, I believe I have made a case for the mutual fund over cash value life insurance! Had to work hard to do it! 

 

I think this demonstration answers the question, is cash value life insurance an investment easily. It doesn't answer the question which is best for you. Only you can look at your situation and answer that. The is just an example and should not be construed in any way or form as investment advice!