Don’t gamble with your retirement savings!
Would you take a home equity loan and use it to invest on Wall Street? That would be financial suicide, right? You shouldn’t be risking your life savings there either. The consequences can be just as dire.
If you retired in August of 2000, do you know what would have happened to your money if you kept it in the mutual funds of your 401(k) plans or IRAs? The S&P 500 index lost nearly 35% of its value over the next three years. It would have taken until 2006 before that portfolio returned to its August 2000 value. And then what happened in 2006? The markets crashed again and this time lost nearly 40% of its value.
People who retired in 2000 were wiped out if their money was invested in the stock market. Their portfolios lost a tremendous amount of value and they depleted their savings much, much sooner than they anticipated. It took until 2013 before the market returned to its pre-2000 level.
If you are within 15 years of retirement, you cannot afford to put your retirement nest egg at risk.
You need to protect your principal at all cost.
Watch this video to see why the typical retiree would have been wiped out if their retirement savings was exposed to Wall Street when they retired:
Focus on Income, not Accumulation
Life insurance, whether Whole Life or Indexed Universal Life, offers a better way to plan for retirement income.
First, the income from a life insurance policy is tax-free,
Second, the the cash value can provide more Retirement Income from the same amount of savings (2-3 times as much),
Third, the Cash Value of a life insurance policy is not exposed to the wild volatility of the stock markets,
Fourth, gains are locked in.
How Do IUL and Whole Life Differ?
Life Insurance policies like Indexed Universal Life, offer Interest Crediting that is linked to the performance of Equity Market Indices. These policies credit their interest each year and the best part is that when the market goes down, the policy holder does not lose any of their savings. The gains are locked-in.
It is important to understand that while the interest crediting of an IUL is linked to market performance, the underlying assets of the insurance company are still invested in the same conservative debt investments as any type of insurance policy (like Whole Life). The cash value is not invested in the stock market.
With an IUL your cash value gains from market movement to the upside but doesn’t lose value on the downside. Imagine that you can lock in your principal every time that the market goes up. This kind of protection comes with one important limitation. There is a cap on the amount of upside that you can capture. The cap for most companies issuing IUL policies based on the S&P 500 is currently at 11%. Some companies offer other indices and even higher caps.
Historical Performance vs Market Indices
IUL performance varies with the market but not with the same volatility of the market. Because the gains cannot be taken away, the growth over time is more step-wise. You can see In the chart below, that IUL performance is flat in years where market-based investments lost considerable value.
The performance of the cash value of a Whole Life policy is tied to the performance of the Debt markets. The performance of an IUL policy is linked to the performance of the Equity markets. Insurance companies invest primarily in bonds and mortgages: nice safe debt instruments. Again, this is true for both Whole Life and IUL. The interest that Insurance Companies earn is the source of cash to make Dividend payments in a Whole Life policy. However, in an IUL, the Insurance Company uses the interest income to go out to the index options markets and buy as much movement in the index as they can get with the money they have to spend. Its a very simple, mechanical process with one goal: to capture a premium over the “Debt” market return without increasing the risk.
For two identically-designed and over-funded policies, we can expect the performance of the IUL to be greater than the performance of a Whole Life because the cash value is earning a premium over the Debt Market rate of return.
This is why you see that IULs have caps and floors. Read the Life Insurance 101 article for much more detail on this.
Historical growth rates on IULs vary by period. If we take today’s cap rates and look at the last 30 years of market index values, this look back analysis shows returns in the 6% to 8% range. This is significantly higher than the dividend rates of Whole Life policies.
The performance of an IUL over the period from August of 2000 through 2012 dramatically outperformed the market index. As the chart below shows, the investor in an IUL did not realize the large double digit returns that the stock market indices achieved in the last few years, BUT the client who held an IUL didn’t lose 35 and 40 percent of their portfolio value each time the market collapsed. The lower returns where credited to an account with a much higher value to start with.
Keep in mind that if the market drops 25%, then you need to make 33% just to return to the starting point.
Also keep in mind that an 8% return in a tax-free investment is equal to a much higher rate in a taxable environment. A 12% return sounds great until you realize that after a 33% tax, you are left with only 8%.
There is no wrong time to get started.
Age does make as much of a difference in an over-funded life insurance policy as it does in a traditional (minimally-funded) policy. As a result, the cash value of an older policy holder will look very similar to the cash value of a younger client. The difference is that the death benefit will be much lower for the older client.
From a market timing perspective, the best time to get into an IUL is when the markets are at the top of the cycle. This preserves the cash value against future market declines. If the market were to crash 30% right after you started an IUL, the IUL cash value would remain even (zero is your hero). As the markets begin to recover, the IUL would have a significant accumulation advantage because of this head start. If you get into an IUL at the bottom of a market cycle, the market performance would likely exceed the IUL performance because of the capped returns.
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