Ever take an IUL application on Friday afternoon only to get a voice message from your prospect on Monday morning saying he’s had a change of heart? Over the weekend he researched what the online “gurus” had to say about IUL and, based on his findings, he’s not too eager to proceed.
If you’re in the IUL market and this has never happened to you, well, just give it a little time. The truth is 90 percent of your clients are doing online research on you and your recommendations between appointments. And when they research IUL online, they all walk away with the same conclusion: IULs have high fees. Because of those onerous fees, they contend, they’re much better off steering their retirement dollars towards a low-fee, tax-free alternative like the Roth 401(k).
The Roth 401(k) vs the IUL
This of course begs the question: Is the Roth 401(k) really less expensive than IUL? Comparing an IUL’s fees to traditional tax-free investment accounts can be a tricky proposition, especially if you fixate on first-year expenses alone.
Let me illustrate with an example. According to USA Today, the average expense ratio of a Roth 401(k) account is about 1.5 percent per year. So, if you make a contribution of $10,000 to your Roth 401(k), your first year expenses will be $150. Conversely, if you contribute $10,000 to a properly structured IUL, your first year expenses might be closer to $1,500.
Based on this comparison alone, the Roth 401(k) seems the obvious winner. But comparing first year account balances hardly tells the whole story. Here’s why: The fees inside the Roth 401(k) are low when taken as a percentage of the first year’s balance (in our example, 1.5 percent per year), but when measured in actual dollars, the story changes dramatically over time. For example, if that $10,000 Roth 401(k) grew to $100,000, the annual fees would jump from $150 to $1,500. If it then grew to $1,000,000, the annual fees would balloon to $15,000. In other words, the more money you accumulate in a Roth 401(k), the more fees you pay.
Contrast that with the ongoing fees of a properly structured IUL. Generally speaking, when an IUL is structured to maximize the cash accumulation within the growth account, the fees stay relatively level. This is accomplished by buying as little life insurance as the IRS requires while stuffing as much money into it as the IRS allows. Under death benefit option 1 or A, the amount of insurance you have to buy under IRS guidelines actually decreases as your cash value accumulates. Even though the internal cost of insurance is rising, you’re actually buying less of it as time wears on. This keeps the IUL’s fees relatively stable over the life of the program.
Even though the fees in the IUL are stable, they grow smaller over time when seen as a percentage of the overall cash value. For example, when an IUL account value grows from $10,000 to $100,000, that same $1,500 fee now represents only 1.5 percent of the total account value — the same as the Roth 401(k). When the cash value of the IUL reaches $1,000,000, however, that $1,500 now represents only 0.15 percent of the cash value. The following chart demonstrates the IUL’s cost-effectiveness over time when compared to the Roth 401(k):
And the winner is
So, given a full accounting of fees over the life of both programs, which alternative is the least expensive? By looking at the trajectory of fees in either scenario, it appears that, given enough time, the IUL eventually wins out.