Using Indexed Universal Life Insurance for Funding College and Retirement
by Robert B. Ritter, Jr., Chairman and CEO, InsMark
Does a life insurance policy make sense for college funding? For retirement? Some say yes; some say no. Let's examine the mathematics to make certain who is right.
Sam and Jessica Callahan, ages 35 and 33, want to begin putting money away for the education of their two children, ages 3 and 1. They want to provide each child with $20,000 a year for four years starting at age 18. Their adviser has recommended they include a factor for educational inflation, and we used our Educational Needs Analysis module to help with the calculations.
| Year | (1) Robbie Callahan Age 3 Funds Needed No Inflation | (2) Katie Callahan Age 1 Funds Needed No Inflation | (3) Total Funds Needed No Inflation (1) + (2) | (4) Total Funds Needed 5.00% Inflation1 |
|---|---|---|---|---|
| 15 | 20,000 | 0 | 20,000 | 41,579 |
| 16 | 20,000 | 0 | 20,000 | 43,657 |
| 17 | 20,000 | 20,000 | 40,000 | 91,681 |
| 18 | 20,000 | 20,000 | 40,000 | 96,265 |
| 19 | 0 | 20,000 | 20,000 | 50,539 |
| 20 | 0 | 20,000 | 20,000 | 53,066 |
| Total | 80,000 | 80,000 | 160,000 | 376,787 |
Let's compare two different ways of accumulating the necessary funds:
Strategy 1a
- Type of policy: Indexed Universal Life (level death benefit)
- Face amount: $1,800,000
- Death benefit: Level
- Premiums: $25,000 for 14 years
- Interest assumption: 8.00%
- Cash flow from policy: Withdrawals to basis; loans thereafter equal to Column 4 in the Table above (starting in year 15).
See Pages 7-10 for details of Strategy 1a using the Illustration of Values module from the InsMark Illustration System (available under the Personal Insurance tab).
Strategy 1b
- Investment: Hypothetical Equity Account
- Payment to the account: $25,000 for 14 years
- Sales charge: 4.00% ("A" shares assumed)
- Dividend rate: 1.00%
- Growth rate: 7.00%
- Management fee: .70%
- Portfolio turnover rate: 35.00%
- Nature of capital gains: long-term: 75.00%; short-term 25.00%
- Composite capital gains tax rate: 22.50% in years 1-3; 26.25% thereafter2
- Income tax bracket: 30%
- Dividend tax rate: 20.00% in years 1-33 (ordinary income tax thereafter)
- Cash flow from equity account: After tax withdrawals starting in year 15 equal to Column 4 in the Table on Page 1
See Pages 11-14 for details of Strategy 1b using the illustration named "Details of Hypothetical Equity Assets" from Wealthy and Wise® (previously named InsGift®).
Both Strategy 1a and Strategy 1b produce the desired cash flow for college.
The life insurance policy in Strategy 1a is illustrated to contain residual cash values in year 20 of $329,015. In addition, the life policy has provided valuable death benefit throughout the years illustrated. At this point, the equity account in Strategy 1b is illustrated to contain residual values in year 20 of $263,655. The life policy has 25% more living value--plus the life insurance coverage.
Assuming no further payments to the life policy or the equity account after year 20, by Sam's age 100, the life policy is illustrated to have $11,246,252 in net cash values, and the equity account develops $2,869,697. This is an astonishing difference, and it is caused by the multiple items that are typically present that retard the growth of an equity account compared to the power of the particular indexed universal life we are illustrating. (See the P.S. at the end of this report for details.)
Below are the residual values for both Strategy 1a and Strategy 1b in various years:
| Strategy 1a | Strategy 1b | ||
|---|---|---|---|
| Year | Life Policy Cash Value4 | Life Policy Death Benefit4 | Hypothetical Equity Account4 |
| 20 | 329,015 | 1,422,380 | 263,655 |
| 30 | 668,086 | 1,416,395 | 448,090 |
| 40 | 1,448,332 | 1,522,779 | 761,703 |
| 50 | 3,286,515 | 3,453,316 | 1,294,809 |
| 60 | 7,447,251 | 7,597,403 | 2,201,029 |
| 65 | 11,246,252 | 11,472,509 | 2,869,697 |
An Enhancement for Retirement Cash Flow
Once 20 years pass and the children have finished with their four years of college, Sam and Jessica can begin thinking more creatively about retirement.
Let's assume for the subsequent 10 years they reinstitute their $25,000 premium/savings commitment in order to produce additional retirement income.
Using the same assumptions as presented for Strategy 1a and Strategy 2a, let's see what we can do for the Callahans in retirement and discover which approach--continuance of the life policy (Strategy 2a) or the equity account (Strategy 2b)--has the best results.
With Strategy 2a, there is sufficient value illustrated in the life policy to produce $75,000 a year in tax free cash flow (using loans) through year 65 (Sam's age 100). At that point, the policy is illustrated to contain residual net cash values of $1,886,615.
In addition, the life policy has provided valuable death benefit throughout all the years illustrated.
See Pages 15-18 for details of Strategy 2a using the Illustration of Values module from the InsMark Illustration System (available under the Personal Insurance tab).
See Pages 19-22 for details of Strategy 2b using the illustration named "Details of Hypothetical Equity Assets" from Wealthy and Wise.
With Strategy 2b, when the equity account is subjected to the same $75,000 after tax retirement withdrawal as the life policy, the account provides the $75,000 only through Year 44 (Sam's age 78); then $10,590 in Year 45, at which point the account is depleted.
Below are the residual values for both Strategy 2a and Strategy 2b in various years:
| Strategy 2a | Strategy 2b | ||
|---|---|---|---|
| Year | Life Policy Cash Value5 | Life Policy Death Benefit5 | Hypothetical Equity Account5 |
| 20 | 329,015 | 1,422,380 | 263,655 |
| 30 | 1,047,959 | 1,416,395 | 781,912 |
| 40 | 1,133,953 | 1,219,681 | 293,295 |
| 50 | 1,307,201 | 1,449,832 | 0 |
| 60 | 1,615,734 | 1,702,479 | 0 |
| 65 | 1,886,615 | 1,992,405 | 0 |
The only way the equity account can closely match the illustrated net cash values of the life policy of $1,886,615 at Sam's age 100 is to reduce its retirement withdrawals to $29,620, which is only 39.5% of the retirement cash flow from the life policy. You can see this result with Strategy 2c on Pages 23-26.
Below are the residual values for both Strategy 2a and Strategy 2c in various years:
| Strategy 2a | Strategy 2c | ||
|---|---|---|---|
| Year | Life Policy Cash Value5 | Life Policy Death Benefit5 | Hypothetical Equity Account5 |
| 20 | 329,015 | 1,422,380 | 263,655 |
| 30 | 1,047,959 | 1,416,395 | 781,912 |
| 40 | 1,133,953 | 1,219,681 | 925,362 |
| 50 | 1,307,201 | 1,449,832 | 1,167,294 |
| 60 | 1,615,734 | 1,702,479 | 1,580,310 |
| 65 | 1,886,615 | 1,992,405 | 1,886,009 |
Which vehicle would you pick--the life insurance or the equity account? It isn't even close--the life insurance is far superior. This will come as quite a surprise to your stockbroker friends willing to take the time to study this overall evaluation.
The preferred value of the life policy becomes evident only when you account for the multiple items that retard the growth of an equity account. InsMark is your only source that can include all the items listed at the top of Page 2 in your evaluation of an equity account.
You may wonder why we used indexed universal life. We chose this policy form because of its powerful economics assuming it to be reasonably reflective of Sam and Jessica's risk tolerance; however, an impressive "win" for life insurance can be made with any policy form provided the interest rate used for the policy and the combination of the growth and dividend assumptions used for the equity account are reasonably equal (and all the various items that retard the growth of an equity account are accounted for). So--if indexed universal life is not part of your portfolio, you can usually outearn an alternative equity account using any policy form using the logic presented in this report.
Workbook Downloads
The educational funds needed and the two life policy illustrations (Strategy 1a and Strategy 2a) were prepared using the InsMark Illustration System. If you are (or become) licensed for this System, you can review all the reports and menu entries associated with them by selecting the InsMark Illustration System Workbook named MA 171.!II from InsMark's website at www.insmark.com. From the home page, click on Producer's Center, then Workbook Download.
The three equity accounts (Strategy 1b, Strategy 2b and Strategy 2c) were illustrated using the Equity Account report (only) from Wealthy and Wise (previously named "InsGift"). If you are (or become) licensed for this System, you can review all the reports and menu entries associated with the three equity solutions by selecting the Wealthy and Wise Workbook named MA 171.!WW from InsMark's website at www.insmark.com. From the home page, click on Producer's Center, then Workbook Download.
Within the respective System, you can then import each Workbook by clicking on Client Workbook, then Import Workbook.
Note: Assuming you have upgraded to Version 13.0 of the InsMark Illustration System and Version 7.0 of Wealthy and Wise, you can also double click on each of the downloaded Workbook names to open the respective Workbook.
So--we ask you: Does an indexed universal life policy make sense for college funding? For retirement? We say a resounding yes; how about you?
Note: The policy values reflected in this report are from Indianapolis Life's indexed universal life product. Special thanks are due to Mark Farr of Indianapolis Life for helping me understand the intricacies of this vibrant new policy form.
Additional thanks to Dan Stusynski at Jonathan Hind Financial Group ("JHFG") for helping with the life policy's illustration numbers. JHFG can also help you with your InsMark illustrations using a wide selection of life insurance companies (including several that are not yet linked to InsMark). For more information, contact Jennie Boland at JHFG at (651) 429-3868 Central Time.
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- See Page 6 for the Educational Detail Page from the Educational Needs Analysis module available under the Personal Needs Analysis tab in the InsMark Illustration System.
- Composite capital gains tax rate is calculated as follows: 25.00% short-term gains subject to ordinary income tax and 75.00% long-term gains subject to capital gains tax of 20.00% in years 1-3; 25.00% thereafter (includes a provision of 5% for state taxes in all years).
- Dividend tax rate includes a provision of 5% for state taxes in years 1-3. (Bush tax rates reflected in both capital gains and dividend tax.)
- After accounting for the identical policy cash flow used for college.
- After accounting for the policy cash flow used for college in both cases. Thereafter:
- For the Life Policy (Strategy 2a): After tax retirement cash flow of $75,000 in all retirement years from Years 31 through 65 (Sam's age 100).
- For the Equity Account (Strategy 2b): After tax retirement cash flow of $75,000 from Years 31 through 44 (Sam's age 78); then $10,590 for one more year.
- For the Equity Account (Strategy 2c): After tax retirement cash flow of $29,620 in all retirement years from Years 31 through 65 (Sam's age 100).