IUL Retirement Income Projections May Mislead Clients
I’ve reviewed many attractive retirement income projections built on indexed universal life. Recently, one showed an indefinite retirement stream of better than 9% of the cash value at the beginning of retirement. That’s pretty attractive … considering the policy credits less than 7%, and the rule of thumb for income distributions is often meaningfully less.
Two Reasons for Discrepancy
There are two main reasons for this. They’re both based on underlying assumptions most policy owners likely don’t understand when they’re looking at the modeling presented to them.
The first is based on a difference between the real world and the hypothetical insurance projection. In the real world, things are dynamic. Markets go up and down, interest rates go up and down, and little can be expected to stay the same over time. However, life insurance projections assume precisely the opposite; everything is static.
Projections assume a crediting that’s exactly the same, year in and year out, indefinitely. Is that the world you live in? If you assume your retirement portfolio is going to return 8% every year on a level basis, you can pull more out annually than if you assumed it would rise and fall with market forces, couldn’t you? That 4% or 5% recommended by the advisor reflects the chances of the market being down in the early years of distributions. If that wasn’t assumed, you could take out much more.
The real world is apples and oranges relative to a life insurance projection.
The second reason is so simple that I have a hard time believing I don’t hear more about it in the market. The IUL illustration run at maximum allowable rates, as most are, is using the S&P 500 price return as the benchmark, a 100% securities-based basket. How many retirees are staying 100% in equities during retirement?
Let’s say a given retiree is comfortable with a 60/40 equities/bonds portfolio. This is closer to 8% than the 10%+ number that the Actuarial Guideline 49 (AG49)regs result in, and it’s incorporated into the insurance ledgers. If we’re going to be apples-to-apples, the IUL crediting has to be reduced as well. A reasonable number might be 5.25%. That’s certainly going to affect the projected income capacity of the IUL policy, isn’t it? If the retiree were more conservative than that with a traditional portfolio, then the IUL crediting needs to be reduced more.
I have no doubt there will be pushback from some regarding the “non-realistic” nature of the AG49 regs, but the math backs everything up.
Bonus Issue
Beyond these two reasons, there’s also the unfortunate realization that too many IUL-based income projections bleed the net cash value down to a razor’s edge to eke out every dollar on income, and this results in a rather risk-prone plan that doesn’t take policy and market variables into account, increasing the chances of policy failure. If policy owners truly understood the consequences of policy lapse if projections don’t pan out and everything isn’t managed meticulously, they’d likely not get on board in the first place.
As opposed to a traditional investment portfolio that might run out of money, which is bad enough, a failing life insurance policy where retirement income has been by way of loans for decades, they may face devastating ordinary income tax consequences on hundreds of thousands, or millions, of dollars of phantom gain generated by the failing policy.
The Point
What’s the axiom we’ve all heard throughout our lives? If it’s too good to be true. … Whether it’s in your best interest or not isn’t my point today. It’s that a prospective policy owner looking at life insurance as a retirement income vehicle understands the underlying assumptions of the model, insists on apples-to-apples comparisons and internalizes the pros and cons of each strategy.
