Newer Insurance Products May Outperform Mutual Funds

MDalert.com staff.

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  • Bank saving accounts return close to 0% interest.
  • Mutual funds can be associated with high taxes and fees.
  • Universal cash-value life insurance can offer a 54.6% increased return over mutual funds at 40 years.

The Mutual Fund Dilemma

It has been shown by academic economists that it is difficult if not impossible for investment advisors to outperform the market over time. This is one reason why lower fee index funds have become popular, and the competition among investment advisors has become so fierce.

To justify management fees, investment advisors and fund managers have to work very hard to try to beat the S&P index (or other benchmark). A simple “buy and hold” strategy may not suffice, so fund managers may make more trades in an attempt to get that extra bit of return. This leads to the second major investor concern: taxes!

Investors have no control over the fund manager’s buying or selling of securities inside the fund. Every time a security is sold, there is a potential taxable event for every investor in the fund. As recently as 2013, long-term capital gains tax rates were as low as 15%. If you earn more $400,000 annually, you now pay 20% plus the 3.8% Medicare tax on long-term gains, and 43.4% (39.6% federal tax + 3.8% Medicare) on short-term gains.

If you live in New York, California, or another state with high state income tax, you could pay more than 30% on long-term gains and significantly more than 50% on short-term gains. If you earn short-term profits through your mutual fund, more than half of those gains could be wiped out by taxes.

The third dilemma of mutual funds, and index funds, is market risk. As recently as 2008, the S&P 500 dropped 38.5% in value. Of course, it has done very well lately. The only lessons we can take are a) the way to earn money in the markets is to buy and hold; and b) the markets are dynamic and volatile.

Both a diversified fund of various stocks and an S&P index fund would have lost more than 30% of its value in the ’08 crash. Investors in index funds won’t likely have the same tax concerns as investors in mutual funds, but they will have the same risk to their principal in a down market. If you think the economy is looking up, you are not concerned with our significant debt to China, and believe that national healthcare will improve our economy, then you may not see this risk as substantial and can ignore it for now.

Understanding what was Wrong with Insurance

The age-old adage, “Buy term insurance and invest the difference” makes sense for 90% of Americans. This makes it acceptable conventional wisdom. However, for high-income taxpayers, the costs of the insurance policy are often outweighed by the tax savings that the cash-value insurance product offers.

This is why high-income Americans use cash-value insurance as a place to warehouse money tax-efficiently. When you consider that many states also give insurance cash values statutory asset protection (even from bankruptcy), you can see why insurance policies are considered safe money.

In the past, the biggest challenge to maximizing the tax and asset protection benefits of life insurance policies was the up-front cost, or load. Typically, life insurance policies offer very large up front commissions to the agent. This is reflected in a large surrender charge for any policy owner who wanted to get his or her money out of the policy. This nuance made cash-value life insurance a long-term investment, suited mainly for investors who were very comfortable with the idea of parking money for at least 7 to 10 years. This recently changed for the better!

Disruptive Technology: The New Insurance Product

For decades, corporations and banks bought life insurance products as investments. These corporate owned life insurance (COLI) and bank owned life insurance (BOLI) products were designed to be performing assets on the balance sheet. As such, they had to have immediate liquidity, downside principal protection, and offer tax-efficient returns (see Table). They were designed with lower commissions and they invested in index-based options accounts with principal protection.

In a recent trend, more and more companies have been offering these types of products on the retail side. Now, individual investors can buy equity-indexed universal life insurance policies that follow the S&P index (or a variety of other indices) and have a minimum annual return of 1% or 2% (even if the market drops 38%). You can buy a product that offers at least 90% of the premium in liquidity in year one. The agent then has to service your product for 5-10 years in order to earn a full commission. For investors who are tired of agents selling products and disappearing, this is a very attractive option.

Reconsider Insurance with Consumer-Focused Products

If you like the asset protection and tax-efficient growth of life insurance, but don’t like the variability of mutual funds or the high commissions of traditional policies, you now have new options to consider. Ask your agent about the potential risks and benefits of cash value and indexed cash value life insurance as retirement choices. As you would with a physician, get more than one opinion.

For more information, contact Michael S. Berry, ChFC. He is a financial advisor to MDAlert.com and was recently named one of the “150 Best Financial Advisers for Physicians in 2014” by Medical Economics. You can reach him at mberry@msf-advisors.com or 855 449 7100.

Table. No-fee mutual funds with no state tax paying investors vs. cash value life insurance.*

Investment in No-Fee, Low Tax Mutual Funds

Investment in Life Insurance

Year

Age

Annual Mutual Fund Investment

6.8% After Tax Growth

Retirement Withdrawal

Year End Balance

Annual Insurance Premium

Withdrawals
and Loans

Value
at Death

Amount Earned at Death vs. Mutual Funds

1

35

$48,000

$1,632

 

$49,632

$48,000

$0

$1,160,994

$1,111,312

10

49

$48,000

$41,723

 

$679,294

$48,000

$0

$1,832,780

$1,153,486

15

49

$48,000

$76,669

 

$1,228,158

$48,000

$0

$2,947,312

$1,719,154

20

54

$48,000

$125,227

 

$1,990,800

$48,000

$0

$4,241,600

$2,250,800

25

59

$48,000

$192,698

 

$3,050,487

$48,000

$0

$5,815,060

$2,764,573

30

64

$48,000

$286,290

 

$4,522,913

$48,000

$0

$7,802,940

$3,280,027

31

65

 

$283,290

$356,879

$4,449,324

 

$440,000

$7,401,372

$2,952,048

35

69

 

$261,138

$356,879

$4,101,409

 

$440,000

$6,828,168

$2,726,759

40

74

 

$223,848

$356,879

$3,515,733

 

$440,000

$6,343,556

$2,827,823

45

79

 

$172,034

$356,879

$2,701,940

 

$440,000

$5,888,176

$3,186,236

50

84

 

$100,038

$356,879

$1,571,181

 

$440,000

$5,597,232

$4,026,051

55

89

$0

$0

$356,879

$0

 

$440,000

$5,660,016

$5,660,016

Total

 

$1,440,000

 

$8,921,974

 

$,1,444,000

$11,000,000

 

 

*The figures illustrated in this table represent potential returns on the two products represented over the time periods show.

†This represents a $2,078,027 increase in retirement Income (a 23.3% higher return” over investing in mutual funds in the conditions illustrated above.

 


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