The more IUL sales grow, the more its critics seem to froth at the mouth. Having surveyed a few of the more egregious IUL hit pieces over the years, I’ve noticed that the majority of the venom comes from a few distinct quarters: financial “gurus”, Bank-on-Your-Selfers, and buy-term-and-invest-the-difference advocates. While each of these groups have different guiding philosophies, they all have one principal thing in common: they have absolutely nothing to gain by the IUL’s explosion in popularity. It simply doesn’t play into their marketing approach and doesn’t further their narrative. As a result, they’ve perpetuated a number of myths about the viability of the IUL as a financial tool. In this article I take an in depth look at the 10 most insidious myths and attempt to debunk them in a balanced, open and fair-minded way. (As a side note, in an attempt to counter some of their most baffling criticisms, it was necessary to use real numbers and real track records from real companies which, in this article, shall go unnamed.)
Myth #1: Be wary of overly optimistic IUL illustrations.
Are the rates of return that agents are allowed to project in IUL illustrations not based in reality? IULs have been around since about the year 2000, so we have a full 15 years to test the track record of its unique crediting feature: participating in rising markets while protecting against downside loss. During that time period the market has been nothing short of a roller coaster ride. That notwithstanding, some well-regarded IUL companies have actual, verifiable rates of return of well over 8 percent during that time period.
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For those who are not satisfied with the actual 15-year track record, insurance companies provide historical back testing. In other words, given current variables, had this product been around for the last 20, 25, 30 or 40 years, how might it have fared? While historical back-testing is never a predictor of future results, it does give us some sense for how we might expect an IUL policy to perform in the future. Leading IUL companies have consistently shown through back-testing results that over each of these time periods IULs, given today’s variables, would still have averaged well over 8 percent per year.
The critics, however, will not be placated, insisting that 40 years of historical back-testing does not a track record make. The last 40 years, they maintain, have been an unprecedented bull market not likely to be repeated in the future. Keep in mind, however, that the last 40 years also includes the last 15 years, a period that included flat markets, bull markets, bear markets and one of the worst financial crises since the great depression. Yet, actual returns during that 15-year time period for some IULs were still over 9 percent! In short, whether we’re using historical back testing or actual, verifiable track records, many IULs perform in anything but an “over-promise-under-deliver” sort of a way.
Myth #2: Flexible caps should have you thinking twice about IULs.
Many companies these days provide caps of anywhere from 12 to 15 percent, but reserve the right to lower those caps at any point. While it’s true that caps can be lowered, we have to understand the circumstances that might lead an insurance company to do so. Index caps are determined by the price of the underlying options that insurance companies use to help the client “participate in the upside of the market.” The cost of these options ebbs and flows based on the VIX index, which measures the volatility or unpredictability in the stock market. The more volatile the stock market, the less predictable it becomes, the higher the cost of these options. And, as the cost of these options rises, the cap invariably begins to fall. In short, for insurance companies to lower these caps, the stock market would have to be even more volatile and unpredictable than it has been over the last 15 years. Further, even in the wake of the 2008-2009 financial crisis, some well-regarded IUL companies only lowered their cap by 1 percent!
Additionally, as I tell my own clients, whatever road you take in your financial lives, it is fraught with uncertainty. Your 401(k) could lose 50 percent in one year, your real estate values could collapse, your whole life product could dramatically underperform dividend expectations and, in theory, your IUL company could lower its caps. So, our clients have to recognize the risk inherent in nearly every financial alternative (however small in the case of the IUL) and follow the course that gives them the greatest opportunity for safe and productive returns.
Myth #3: Avoid IULs because of non-guaranteed insurance expenses.
After having given your IUL illustration a look, potential clients may come back to the table with misgivings about the “guaranteed” column of the illustration. This column reflects the “worst case scenario,” the limit beyond which the insurance company cannot legally raise the cost of insurance. While these expenses are staggeringly high and make any illustration look dire and apocalyptic, we once again have to revert to the “fraught with peril” argument from Myth #2. While every company does reserve the right to revert to a worst-case scenario, and is legally bound to disclose it in the illustration, we have to weigh this likelihood vs the risk of not utilizing the IUL’s benefits at all.
Many well-regarded IUL companies haven’t had to revert to these expenses in any of their products at any time in the last 100 years. So, while insurance companies do reserve the right to charge these expenses, should people start dying at a much more accelerated rate (i.e., pandemic, WWIII, etc.), it is not a likely scenario. The likelihood of having a repeat performance of 2008 is probably much greater by comparison (in turn, creating a greater need for the down-side protection of the IUL). Further, should insurance companies revert to guaranteed expenses, policyholders reserve the right to 1035 their surrender value into an annuity, effectively terminating the policy and eliminating those expenses.
Myth #4: Beware of the IUL’s non-guaranteed death benefit.
Critics claim that, while many IULs do have death benefits that stretch as long as 15 years, these guarantees expire at a time in the client’s life when they need the death benefit the most: when they are older and more likely to die. First of all, many IUL companies do offer IULs with death benefit guarantees to age 120, not just the first 15 years. Second of all, the vast majority of clients who utilize an IUL do so because they are planning on taking money out in retirement. Guess what? Even if your IUL did have a death benefit guarantee, you run the risk of voiding it the minute you take money out of the policy. So, if the vast majority of IUL policyholders are planning on taking money out of their policies in retirement, then the death benefit guarantee can often be a moot point.
Here’s the bottom line: if your client is interested in a death benefit guarantee and the ability to take tax-free policy loans in retirement, then they need two policies: one that provides a death benefit guarantee and whose cash value will not be touched, and another that is designed to build tax-free wealth that can be distributed as a tax-free income supplement in retirement.
Myth #5: The IUL has high fees.
Do IULs really have high fees? If so, compared to what? To establish a baseline, I decided to look at the average fees for America’s most popular retirement account: the 401(k). According to USA Today, the total expenses for a typical 401(k) plan are about 1.5 percent of the entire account balance per year. These fees go to pay record keepers, financial advisors and mutual fund managers. In practical terms, this means that if your account’s growth were 8.0 percent in a given year, your statement would show a net growth of only 6.5 percent.
Now that we have a baseline, we can see how the average fees in an IUL stack up by comparison. Generally speaking, the fees in an IUL are higher in the early years and lower in the later years. Considered over the life of the program, however, these fees can average as little as 1.5 percent.
The key to attaining this low level of expense lies in the proper structuring of the IUL contract from the outset. To maximize cash accumulation and minimize expense, the contract must contain as little life insurance as possible while being funded at the highest level allowed under IRS guidelines. This “maximum-funding” scenario ensures that the level of expenses, as a percentage of the overall contributions, remains as low as possible. (See my previous article, “The Roth 401(k) vs the IUL” for a more comprehensive discussion of IUL fees.)