Here’s a graph I created to put some numbers into perspective for a client. Any comparison like this is dependent on numerous variables. I’ve listed what I consider to be the most pertinent.
The net 10% return accumulation value for the investment assumes no investment expenses of any kind. The 10% gross return in the variable universal life policy assumes sub-account expenses and reflects all other policy expense. Most S&P 500 sub-accounts in a variable universal life (VUL) policy are going to run 10 to 35 basis points. In an investment portfolio they will likely run from a little lower to much higher depending on the investment model of the individual.
The point of the graph is to compare tax drag on an investment to expense drag on a life insurance policy. Of course, this will change based on the investments and the tax efficiency of the portfolio. For this example, we’re keeping it simple by utilizing the S&P 500. Generally speaking, life insurance will benefit and investments will suffer the higher the assumed portfolio turnover rate and tax rates.
The S&P 500 itself, as a benchmark, doesn’t realize gains, but a fund, ETF or managed fund will. S&P 500 investments have effectively no short-term capital gains and turnover is roughly 5%, which I will ignore. However, I will assume that 200 basis points of the annual return is dividends that will be taxable. This equates to 7% of the return lost to income taxes annually, or a 9.3% net return after tax.
I’m further attempting to demonstrate the effect of both income and estate taxes on the investments and insurance in an irrevocable trust and not in an irrevocable trust. Note that in all circumstances insurance is assumed to be owned by a trust or other entity not taxable as part of the estate. I’m not trying to give insurance the edge here, but chances are an individual in an estate taxable situation will have insurance be trust owned at a significantly higher rate than their investments. Under these assumptions, life insurance will be income and estate tax free while the investments will be subject to either estate taxes, if owned in the estate, or income taxes in the form of capital gains tax on the investments gains in the trust.
Note that this is not an attempt to posture life insurance as an accumulation or retirement planning instrument, but simply to compare an efficiently built VUL policy cash value and death benefit to an investment.
What do you find fair and not fair? Any insights?
Bill Boersma is a CLU, AEP and LIC and the founder and owner of OC Consulting Group. More information can be found at www.OC-LIC.com, www.BillBoersmaOnLifeInsurance.info or email at bill@oc-lic.com or call at 616-456-1000.
Securities offered through Valmark Securities, Inc. Member FINRA, SIPC. Investment Advisory Services offered through Valmark Advisers, Inc. a SEC Registered InvestmentAdvisor.
OC Consulting Group and its affiliates are separate entities from Valmark Securities, Inc. and Valmark Advisers, Inc.
The examples given are hypothetical and are for illustrative purposes only. Actual results may vary from those illustrated. The returns shown do not represent actual market performance and are not intended to predict or reflect real-world investment results.
