Post of the Day
June 29, 1998

From our
Insurance Board


Subject: Re: Variable Life Insurance
Author: mrichmrich

"My friend mrichmrich and I have recently been doing a bunch of calculations on one variable universal life (VUL) policy that both of our families happen to hold."

What Dave said!

There's a nice article on life insurance in the latest Consumer Reports (July 1988). It mostly deals with term insurance (why you should get it and where you can get the best deals), but also has a page or so on other variants of life insurance, such as whole life and VUL.

One memorable quote from the article:

"Case in point: An IDS Life Insurance variable-universal policy with a "12 percent gross" return will end up yielding just 9.1 percent over 20 years once all fees have been siphoned off."

This quote is especially memorable to my wife and I, who are currently plotting our best strategy on getting out of an IDS turkey that she bought into 6 years ago. It would seem that we are actually getting an average annual yield of 7.6 %, despite IDS assurances that we are actually making 14.5%. Our opinion of IDS financial managers has plunged to new lows. The good news is that even with the egregious surrender charge, we'll recover this surrender charge in only 2 - 3 years in some other (almost any Foolish) investment.

The VUL sales entities will make a big pitch about this being a "tax-free investment". Well, yes and no. For legal purposes (as written on the policy) it is not an "investment", but "life insurance" that you just happen to be "overfunding" (paying more in than you need to pay for the cost of insurance). Somewhere in your policy, it will say something like along the lines of "under current IRS interpretations, overfunding one's life insurance policy is not considered an investment, and interest income from this overfunding is hence not taxable". So, what if you go through life "overfunding" this policy and then retire -- How do you get your money back? Well, you don't, because it's "life insurance", and you're still living. However, for a few percent interest (on your own money), the company will "loan" you this money, which you then live on for the rest of your life. With IDS, they will "loan" you up to 85% of your policy value. The other 15% they keep and invest (at some better rate of return than they gave you, no doubt) until you die, when it goes to your beneficiaries. Personally, I'd like to have the option of spending it myself.

"The main thing to remember about VUL sales entities is that they are trying to SELL you something. They make money by charging you all manner of service charges and fees,..."  

If you invest the money yourself, you will have to pay taxes on the profits your make. However, if you can find an alternative investment that nets a sufficiently higher interest rate, you can still come out ahead. How much greater is this interest rate? There's very nice coverage of this point in the Fool School on retirement that deals with this very point at http://www.fool.com/Retirement
/RetirementStep4.htm
. For example, with my wife's IDS policy, we were netting a miserable 7.6 %, although tax free. Using the formula from the retirement page, it's easy to figure that a taxable investment (at the 28 % rate) at 10.6 % will give the same return.

The main thing to remember about VUL sales entities is that they are trying to SELL you something. They make money by charging you all manner of service charges and fees, not by giving you great advice or by making you wealthy. I must admit that I've been impressed by how sincere all of the VUL sales entities have seemed to be. They can be pretty persuasive about what a good investment they feel that VUL's are. One such entity said that she and her husband were putting as much of their own money as possible into a VUL. After analyzing the inferior returns of VUL's, I can only conclude one of the following:

a) she is ethically challenged
b) VUL sales entities get a "sweetheart" deal from their companies that is a lot better deal than that given to the great unwashed masses.
c) she is ethically intact, but has been brainwashed by her own propaganda.

Mind you, Dave and I consider this IDS policy that we have to be one of the better ones out there, and it stinks!

So, my advice, DON'T DO IT!!

If you do, however, it's possible to get out of it later, if the prospect of a surrender charge ($6000 - 8000) doesn't bother you and you don't mind the thought of the lost income from such an inferior investment.

Cheers,

Mike Richardson


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