The founder of the Infinite Banking Concept (IBC) was pretty adamant about NOT using IUL in exercising this financial concept. This is because he understood IUL could end up costing the consumer big time as IUL is NOT guaranteed to be sustainable overtime. Many IUL agents are quick to make light of this accurate analysis, but I know that Nelson Nash was spot on when he insisted IBC was designed to be used with participating whole life insurance (PWLI) not IUL.
In the first place, insurance companies make more selling IUL products than when selling PWLI. This is because the insurance companies shift the investment risk associated with IUL policy performance to the policyholder instead of retaining and managing that risk themselves as they do when selling a PWLI policy. This risk assumed by the IUL policyholder ends up costing the policyholder more in the long run.
Secondly, instead of coverage being gradually converted to paid-up insurance overtime, as in a PWLI policy, an IUL policy has an ever-increasing cost to the life insurance coverage. This increasing liability, which the policyholder assumes in an IUL policy, frequently becomes unsustainable. When this occurs, coverage is lost, as well as 100% of the money which the policyholder has paid for the policy since the IUL was first purchased.
Recently, I designed several illustrations for a 30-year-old male in good health, trying to illustrate the risks a policyholder assumes when purchasing an IUL policy. Starting with the basic assumption of maintaining at least $396,891 of death benefit, illustrations were run showing the costs associated with owning an IUL policy, vs. owing a PWLI policy. Then, using a renewable term policy illustration, which provides a $396,891 of coverage as the control group, the cost of having $396,891 life insurance coverage is clearly observable.
The scheduled premium, which provided this $396,891 of coverage using an IUL policy, came to $9,309 per year. But this premium is flexible. And so, a common mistake made by many IUL policyholders is that they choose not to pay this entire $9,309 but rather only part of it.
This creates financial problems later on for the policyholder as those “extra” dollars included in the scheduled premium are supposed to earn interest and the interest earned is supposed to help offset the increasing costs associated with an IUL policy in the future.
However, by failing to pay the entire scheduled premium, the policyholder ends up losing any interest which could have been earned on that money. On top of this, if they do pay the “extra” amount included in scheduled premium, they will pay fees to the insurance company on those “extra” dollars. Either way, the IUL policyholder loses money. They lose money by having to pay fees or they lose money by not earning interest.
Knowing this, the premium necessary to have $396,891 of life insurance coverage isn’t $9,309 per year in the beginning years of any life insurance policy, including IUL policies. This can be seen by observing the premiums required for the purchase of renewable term insurance which, in this case, only costs $191 for $396,891 of coverage in the first year. But as can be seen on examining the attached, the renewable term insurance chart, the cost for renewable term insurance coverage becomes astronomically high in later years.
Therefore, without the interest earned on the “extra” money included in an IUL scheduled premium, 100% of these increased costs of coverage will come directly out of the policyholder’s pocket in an IUL policy, instead of being offset with the interest earned on the “extra” premiums paid in those scheduled premiums.
The theory behind IUL insurance is that this “extra” premium added to the scheduled premium is supposed to earn enough interest to reduce or even eliminate the out-of-pocket expense to the policyholder in future years. It’s kind of a pay now instead of later theory. But does this really happen?
As can be observed in the IUL chart above, the cost of scheduled premiums, through year 20, comes to a total of $186,180. Also take note, the surrender value of this IUL policy is only $142,579 in year 20.
If one adds the cost of the renewable term insurance for all 20 years, which in this case is $44,964, to the surrender value of the IUL policy after 20 years, the total is really close to what the total premiums would have been if this IUL policyholder had paid all the scheduled premiums, ($187,543 vs. $186,180) through year 20.
This means the cost for $396,891 of renewable term insurance policy was slowly being drained from the IUL policyholder’s surrender values instead of compounding for the policyholder. As can be seen, time increases the cost of renewable term insurance. This means more and more money will be drained from the surrender values of the IUL policy to cover those increasing costs in the IUL policy. Before too long, there won’t be enough money in the surrender value of the IUL to cover these increasing costs, and the policy will lapse if the policyholder can’t come up with the money to pay for the added expense. Note by the 5th decade of this renewable term illustration, the costs have exceeded the death benefit by $313,599 ($710,490 – $396,891).
Consequently, the surrender value of this IUL policy simply reflects overpaid premiums, with some possible interest earned on those “extra” premiums paid. This is because the surrender value is only $142,579 while total premiums are $186,180 by year 20. This makes the surrender value of this IUL policy $43,601 less than what has been paid. This $43,601 is only $1,363 less than if the policyholder had purchased the renewable term insurance at $44,964. Put another way, $1,163 of interest earned on $142,579 of overpayments over a 20-year time period isn’t exactly a rate of return to be proud of.
On the other hand, this individual could have chosen to purchase a whole life insurance policy. By year ten the guaranteed cash values, which represent real equity, not merely an over payment of premiums, will have exceeded the cost basis of this policy by over $5,000. In other words, there is more guaranteed cash value in this policy than what the policy owner paid for the policy.
In year 20, the cost basis of this whole life policy is guaranteed not to exceed $139,085. Remember the IUL policy had $186,180 of scheduled premiums due by year 20.
When adding the cost of 20 years of renewable term insurance coverage to the cost basis of this whole life policy one comes up with $184,034 ($44,949 + $139,085) which is really close to the guaranteed cash value in this whole life policy ($182,526). This represents $43,441 more in cash value than what has been paid in premiums for this policy over the first 20 years. To reach this level of cash values the base coverage in this whole life policy was slowly converted to equity (aka, paid-up insurance) over the past 20 years. This is in stark contrast to the IUL policy where cash values were systematically drained in order to maintain the $396.891 of coverage.
Having $43,441 more than what you paid for something is awesome, especially when the value of what you have been purchasing has increased. This is exactly what is guaranteed to occur in a participating whole life policy.
By year 21 the death benefit in this whole life policy has swelled to become a guaranteed $587,997! This is like purchasing a home and having the market value of the home increase by 48.15% over 20 years. With this whole life policy, the 48.15% increase in death benefit value is guaranteed!
Nelson Nash was right in insisting IBC be used with participating whole life insurance instead of IUL insurance. As Nelson used to say, “IBC is NOT about interest rates”. In fact, IBC is not about investing but instead focuses on recovering the cost of capital, using the guarantees which are only available when owning participating whole life insurance.
Dr. Tomas P. McFie
Most Americans depend on Social Security for retirement income. Even when people think they’re saving money, taxes, fees, investment losses and market volatility take most of their money away. Tom McFie is the founder of Life Benefits which helps people keep more of the money they make, so they can have financial peace of mind. His latest book, How to Build Sustainable Wealth, can be purchased here.