Written by David Shafer
It always amazes me that folks can hold on to foolish ideas in their heads despite ample logical evidence of the foolishness of those ideas. For example, I constantly see referenced a couple of articles written by some Wall Street Lackeys about the superiority of stock investing over real estate investing. When you actually go to look at these articles, they are so poorly argued that it is amazing that the magazines that printed them would consider them fit to print in a financial oriented magazine. But, they get continually recycled.
For the record, historic research into internal rate of returns for investment real estate versus stocks demonstrate a huge advantage for real estate. This is not to say that fortunes can’t be made investing in stocks [Buffett, Lynch, etc.], only that arguing it is always better to invest in stocks over real estate is just dumb. I mean when you look at the wealth of super-wealthy people, on average, there is 3 times as much in investment real estate as stocks and bonds.
I bring this obvious point up to this crowd because the same Wall Street Lackeys continue to argue against life insurance as they do against real estate. Yet, when you actually look at who is buying large amounts of life insurance it is the Who’s Who of corporations, wealthy corporate executives [some of which sit atop corporations that hire people to tell others not to buy life insurance], and investors. Yep, even though they use the advantages of life insurance to reduce their own taxes, they still have the hired help tell people it is best to invest in mutual funds.
Like lemmings they chant the anti-life insurance mantra of too much expense, poorer returns, and it’s not an investment. So I thought we would explore the reality of those expenses and returns and let you decide where to put your money.
Let’s take a 45 year old man and that same $150,000 that was used in my last post. He is in good health. Let’s assume for this illustration that he will retire at social security retirement age [67] and will continue to pull out income until death [his cohorts life expectancy is 78 but we will add 6 years for our healthy specimen]. Further, let’s assume that the performance from the stock index that is producing the interest returns is 11% less, on average, than how it has performed over the last 30 years. [Thirty year look back is 9.26%, so I used 8.26%] We do this to stay away from being accused of overly aggressive assumptions.
The initial face value of the life insurance is $643,368. It rises to $802,237 during the 5 years of premium payments, where it stays until year 13. At year 13 it is lowered to $400,000 and starts to gradually rise until age 67 where it hits $608,012. This strategy is outlined in the earlier post. He is able to gain $52,257 of tax free annual income for 18 years. He still gets a death payout on top of that.
Let’s look at the internal rate of return [return minus all expenses] at various death ages. I will add in the cumulative odds of dying at each age as well as the total payout.
At age 50 he dies in a fiery car crash. 8% of men in his cohort will die by age 50: Internal Rate Of Return [after expenses] = 46.75% [It is a life insurance policy!] Total tax free payout $802,237.
At age 60 he dies of a massive heart attack. 15.1% of men in his cohort will die by age 60: IRR = 7.8% The total expenses has cost him .46% [8.26%- 7.8%]. Total payout = $431,272
He dies at age 70 from cancer. 28.9% of men in his cohort will die by age 70: IRR= 7.19% The total expenses has cost him 1.07%. Total payout is $209,028 in income and a death benefit of $546,940 or $755,968
He dies at age 80 from a stroke: 54.1% of men in his cohort will die by age 80: IRR= 7.16% The total expenses has cost him 1.1%. Total payout is $731,598 in income + $303,855 death benefit or a total of $1,035,453
He dies a happy and satisfied man at age 90: 96.3% of men in his cohort will die by age 90: IRR = 7.35%. The total expenses has cost him .91% Total payout is $940,626 in income + $390,924 in death benefit for a total tax free payout of $1,331,550.
OK, now let’s look at the expenses. As I have mentioned the majority of the expenses occur in the first 10 years of ownership. However as seen above, because it is life insurance, you aren’t effected by this front loading of fees.
The first year the expenses are like this:
Premium charge = $1,650 Cost of Insurance Charge = $668 Policy Issuance Charge = $2,625 Administration Charge = $60
These are not inconsequential charges. During the premium paying years the charges are essentially the same but for a small, incremental increase in insurance cost.
Year 6 charges:
Cost of Insurance = $959 Policy Issuance Charge = $2,625 Administrative Charge $60
The charges remain the same until year 11, where they decrease significantly:
Cost of Insurance = $1,497 Administrative Charge $60
From here on out there is the cost of insurance charge + administrative charge only.
Let’s look at age 60 for an example. Remember we lowered the face value to decrease cost of insurance expenses.
Cost of Insurance $389 Administrative Charge $60
With an accumulation value of $331,748 the total cost as expressed in percentage this year is .14%!
You tell me, are the expenses a big deal? Is the internal rate of return acceptable to get tax free income? Remember, my numbers are conservative both in rate of return and how long our friend will be around to collect that income! You put in $150,000 and get over $52K of tax free income for 18 years, plus a little kicker for your family at death. Now you see why I and BawldGuy are such big cheerleaders for this product!
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