Why building wealth with EIULs depends on specifics

I have read yet another article where someone is asking about using EIULs to build a nest egg, and gets dismissed with general platitudes instead of specifics, and directed back to index funds.

The person seeking advice is 29 and making $260,000. His financial advisor has told to him to go all in on an EIUL. This advise is to the point of taking out an interest only loan when buying a house so he can sink the difference into the EIUL and also taking out a HELOC out against the property to get yet more cash.

On the surface, I agree with the author of the article that this sounds a bit fishy and I wouldn’t recommend it myself. By the author quickly goes on to dismiss EIULs using generalities and no specifics. He ends up pushing the person back towards index funds and 401(k) funds which have shown a horrendous history of less than 4% annualized performance while also sucking out lots of fees by the time you reach retirement. Let’s look at some of the ideas posed by the author and compare them to real statistics.

For starters, I have some fundamental reservations about using equity-indexed universal life (EIUL) and similar life insurance policies (variable life, or VL, and variable universal life, or VUL) as vehicles to accumulate retirement savings.

Here is where I get my first tip off of the author’s biases. He is immediately conflating EIULs with VULs. VULs allow you to invest in variable products, i.e. mutual funds. That defeats the whole point of investing in life insurance contracts. I would never, ever, EVER invest in a VUL.

The idea with EIULs is to put away money in a vehicle that only grows and never shrinks in value. They might be “similar” based on the fact that they both involve a life insurance product. But you can also assert that all mutual funds are “similar”, when growth rates and fees can define the difference between success and failure. VULs fail in the sense that they don’t mitigate sequence of return risk.

Typically, you are also assured a modest minimum rate of return, say, 2% or so….while that arrangement may give the impression of an all-upside-no-downside proposition, the fact is that policies usually impose a ceiling on your potential gain, whether by crediting your policy with less than the index’s actual total return or by setting an outright cap.

It is quite true that EIULs have upper and lower limits. Mine has a lower limit of 0% and an upper limit of 15%. And yes, it’s true that if the market went up 26%, I would only get a 15% gain that year inside my policy.

This is a common tactic people deploy when they attempt to discredit EIULs. Who wants to lose that 26% gain? What’s missing is a complete analysis. It turns out that trading in that 26% for 15% will actually boost your total growth thanks to ALSO getting the 0% floor.

I actually wrote an application to compare historical market performance directly compared to being wrapped with a 0%/15% minimum/maximum return. Click that link and scroll to the bottom to see more detailed results. The results are staggering and conclusive.  If you look at every 25-year period from 1951-2010, and average their annualized rates of return, the S&P 500 averaged 7.15% while an EIUL averaged 8.18%.

Essentially, the negatives returns are very costly. Eliminating them in exchange for not getting peak returns is actually to your benefit. The author doesn’t seem to both investigating this. (BTW, invest in VULs, and you lose this advantage).

But once you go down that path of borrowing from the policy for tax-free income in retirement, you’re likely locking yourself in to keeping the policy going for the rest of your life.

Uh, that’s why it’s called permanent life insurance. EIULs only work if your ready to wait at least twenty years for them to build up their value and in turn you keep them for life. My policy actually has a built in rider that prevents me from withdrawing too much money and causing it to lapse.

It’s not really addressed in the article, but its important to set up the policy right. You want to maximize cash value growth. This means buying the minimum amount of life insurance for a given premium. You need the right agent to do that. Most don’t or won’t. As a tradeoff, you might not have enough actual life insurance for you or your family’s needs. That’s why I also have a much bigger twenty year term life insurance policy. After that time frame, I presume I will have built up enough net worth that I can drop the term life policy.

For these reasons alone, I’m skeptical of using EIUL or any other type of life insurance as a way to build one’s nest egg. I think you’re better off sticking to regular tax-advantaged plans like 401(k)s, IRAs and, if you’re self employed, SEP-IRAs and even solo 401(k)s.

We’re sort of on the same page here. I don’t invest in EIULs as my sole wealth building tool. In fact, based on the EIUL’s average growth rate of 8.18%, it’s actually not very good at building wealth. An EIUL is more like a wealth preserving tool. But the answer certainly isn’t mutual funds and index funds which average even less with higher fees.

That’s why I have leveraged rental property as well as dividend yielding stocks powered by my interest only HELOC.

An interest-only loan so you can plow more money into the policy? Borrowing against the equity in your home and then investing the loan proceeds into the policy?

I wouldn’t use all these avenues to pipe money into a single EIUL. But I’ve already received good dividend payments after buying my position in VNR using a HELOC. Harvesting the equity from your home can be powerful, but it requires that you understand all the risks and have a couple exit plans. This is the kind of tool that can grow your net worth, or take you to the cleaners.

For example, using the HELOC cash to buy a highly liquid stock position with a strong history of paying dividends is safer than putting the cash into a relatively inefficient real estate property. I certainly wouldn’t put it into an EIUL.

These sound like the kinds of schemes people hatched during in the heyday of the real estate bubble. The fact that someone would be out there pushing this kind of strategy now boggles the mind. Did this guy learn nothing from the financial crisis about the dangers of leverage and investing borrowed funds backed by real estate?

We need a proper perspective here. During the 2008 housing crisis, 99% of all mortgages were current and didn’t fall behind. Only a fraction of 1% of all mortgages involved variable rate loans that went under. Of course it was salivating material for the headlines, but I would never take the headline of a newspaper as an accurate read on the entire market.

Equity harvesting wasn’t “cooked up” this recently. It’s been in use for decades. That’s the reason the IRS has some pretty tough regulations in place should you choose to take out a loan on a rental and then attempt to sell it a year later using a 1031 tax deferred exchange. The IRS has known about people pulling out equity through clever tactics like this, and hence will go after you, treating that entire loan as “boot” and slamming you with stiff taxes.

And leverage has always had dangers. It’s why you need to do things like hold sufficient cash reserves so you don’t go under if you rental properties remain vacant for a year.

I can’t divine this person’s motivation or competence based on what you’ve told me. But phrases like “do what the banks do” and “make money off of borrowed money” sound more like the patter of a flim-flam man to me than dispassionate advice from a financial adviser.

Well, I can divine the advisor’s motivation. He wants to sell life insurance policies any way he can. Did I mention it’s hard to find the right insurance agent to set you up right? It’s also important to realize that setting up a plan with an EIUL, rental property, and stocks requires more than one advisor. A real estate broker isn’t going to have the knowledge on EIULs and vice versa. And what licensed financial advisor will ever suggest buying rental property? I haven’t seen one yet. They are all about mutual funds because that’s where they make commissions and fees.

By the way, banks make lots of money. As someone pointed out to me, checkout some of the biggest buildings in cities and the names on them. Notice how they are owned by banks? It’s because they know how to make money. I can either do what banks do, do what the rich do, or do what my 401K company officer does. The first two have much more historical basis to work than the third one.

And if after doing that you’re still considering investing in an EIUL or similar policy, I suggest you gather all the policy illustrations, brochures and other info the insurance sales person has given you, take it to a fee-only financial planner — i.e., one whose livelihood doesn’t depend on commissions — and ask that person to analyze how it stacks up vs. other alternatives.

This is the part that always annoys me. There is this running assumption that fee-only advisors are holier than thou and can do no wrong. My insurance agent is paid by commission, but he knows how to minimize the costs of the policy and maximize for cash value growth. It results in him getting probably 30% less than a typical agent. But he has built a solid business on word of mouth and has enough clients to support him nicely.

Insurance agents make most of their commission up front in the span of a few years. There is no guarantee that in the long run (20 years+) a fee-only advisor won’t end up taking more total money than a good insurance agent. That’s why it’s important to look at actual fees and not just general platitudes this author is offering.

So can we drop non-specific assumptions and actually look at actual numbers?

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