Rebalancing my portfolio – CDs vs. EIULs
I recently wrote my first installment about rebalancing my portfolio. In it, I discussed some of the cons involved with investing in financial instruments that suffer losses. Essentially, if your account loses 20%, you must gain 25% to overcome that. The bigger the loss, the bigger gain you need just to get back to where you started. I wrapped it up by introducing the concept of overfunded life insurance in the form of an EIUL.
Every now and then, I like to tip toe out and read various responses people have about life insurance. It gives me a feel for how much people really research things on their own vs. repeat what others are saying without doing their own research. I usually don’t comment on these threads, but I often see a slew of comments that end in usually one of two categories. More on that in a second.
I was spurred to tip toe into the raucous debates when I heard that TV ad I see all the time is about the Gerber Grow Up Plan. The first time I heard about this was probably a few years ago, way before I had done any research. The promise of growth sounded hard to believe, and when I realized it was a life insurance policy, I thought to myself, “Huh? Who would buy life insurance for their kid?” This is because the founding principle of life insurance is to replace one source of money with another. Children don’t provide sources of money. Rather, they are more like a drain on it! (I know, I have two.) So why buy life insurance for them? Coupling that with other TV and radio shows I had seen that eschew the concept of cash value life insurance, I knew my opinion of this crazy plan was correct.
Then something happened: I shared this opinion with my wife. That is, I said to her, “You know, there is this baby food company that sells life insurance, and it’s a crazy idea.” Her response was “Why?” I wasn’t expecting a question, just acknowledgement of my valid opinion, duh! Of course I proceeded to answer: “It’s life insurance being sold by a baby food company. That’s crazy.” Not being combative, my wife again asked: “Why? I’m not arguing with you. It just seems you haven’t told me why it’s a bad idea. Can this company not sell baby food AND life insurance?” That really put me off my guard. Not because my wife was arguing with me, but instead because I hadn’t really answered her question. The fact is, I didn’t really understand WHY it was crazy. I was regurgitating someone else’s opinion, and in fact did NOT understand the whole thing.
Let’s circle back to the TV ads I mentioned along with internet thread discussion about it. Like I said, there are basically two camps of answers. 1) Some people say this plan is good because it guarantees growth. Coincidentally, many of these people seem to be insurance agents or have one in the family. 2) The other people say it’s bad, and you would do better by putting your money in either CDs, a money market fund, or a 529 plan
I have slowly learned to not fall for this 2-corner dichotomy. Often times, the answer is somewhere in the middle.
Responding to both of these groups:
1) This plan, if you look it up, really is whole life insurance. It means that with 100% honesty, they can tell you that the amount of money accrued will NEVER fall in value. You add money, and it’s value grows. But it also grows on its own as well. Insurance companies have survived dozens of market corrections, depressions, wars, and are still in operation. Part of it is because they are required to much bigger cash reserves than banks (who sell CDs?!?), and are geared to operate for much longer stretches of time. But this isn’t good enough, because the growth rate of whole life insurance tends to be around 4%. Whole life insurance carries all the aspects of durable money such as tax free, not being forced to ONLY being used on education, and protecting you from downside losses. But it just doesn’t grow fast enough. Considering inflation hovers around 3-4%, most if not all of your gains are eaten up by inflation. Scratch that plan.
2) Many of the comments answering one mother’s questions about the value of this program advised her to cash it out and put the money in a CD, money market, or 529 plan, indicating that any of these would be better. Can you guess when these comments were written on the thread I just read? May, 2008. That’s five months before the October crash of 2008. The S&P 500 recorded a 38.5% loss for that year, which would require a 62.6% gain to get back to where you started.
I was just accessing my online banking and noticed that the savings account I have opened to fund some real estate granted me hardly anything at all. Looking it up, I noticed this money market account was yielding 1% annually. That means if you put $20,000 in there, you won’t get more than $200 a year. That is pretty bad, and definitely way below what a whole life policy would have yielded. Money market accounts don’t suffer losses, but that is because they buy fixed rate vehicles that also doesn’t yield much at all in down years. To cap it off, the government is going to want their cut of that measly $200.
529 plans have their own issues. For one thing, the money can only be used for school. What happens if your child decides to go to a school not covered by the plan? What if they don’t even go to college but pick a different career path? I’ve even read that some schools offering the pre-paid tuition options are having to revise (i.e. cut back) what is provided because they are suffering unforeseen financial losses and unable to meet their pre-paid commitments. These commitments are really “we’ll do our best” situations. So, scratch this plan too.
Since both of these solutions aren’t good enough, what’s left? There is a solution, and it doesn’t seem to appear on discussion threads except on rare occasion: an EIUL. Let’s imagine you have been a bit lazy and waited until your kid was 5 to start saving money for college. Assuming he or she will start at the age of 18, that gives you just 13 years to grow something. If you want to risk it on an 500 index fund, then you should know the average annual growth of every 13-year window since 1954: 7.19%, but (and this is a big but) there has been everywhere from a -0.32% 13-year average growth to a 14.88% average growth. Your performance is most likely between 3.04% and 11.34%. Since you wouldn’t want to use your 401k or an IRA of any type, you’ll have to invest the money naked, subjecting you to taxes when you withdraw it. If you are in the 28% tax bracket and make the middle of the road, you are looking at a 5.1% growth, which isn’t much better than the TAX FREE whole life I was talking about earlier.
But if you went and setup an EIUL that limited downside to 0% and upside to 15%, the average of all 13-year periods would be 8.17%, with a minimum of 5.92% and maximum of 10.01%. Your performance would most likely land between 7.15% and 9.19%. Considering the likely minimum virtually hits the index funds average should tell you something off the bat. The money you would be able to withdraw would also be 100% TAX FREE. This would leave whole life’s 4% return in the dust, and it certainly would get things going in this day and age, where CDs and bonds aren’t doing much.
Basically an EIUL won’t make you rich but it is a GREAT place to store money and get it back tax free. It’s sort of like a Roth IRA on steroids without the restrictions on when you can access the money. There is one limit: overfunded life insurance typically takes at least 10 years to really get going. 15 years is even better. In our scenario we were at the edges of accessing some tax free money. If you can start sooner and push it to 17-18 years, then you are better off. That’s because EIUL’s front load the costs. After 10-15 years, you have paid all the big costs and built up enough cash value to really start earning better returns. You can borrow from it to put your child through college, their wedding, or whatever.
And don’t stop there. Keep investing that money into your EIUL until you reach retirement. Then you can start withdrawing it in a nice, comfy tax free way. This means no need to shout at the TV when politicians talk about raising your taxes. Just one tip: dipping into your EIUL to pay for college can impact how much will be waiting for you at retirement. That is why I recommend continuing to chip into regardless, and seeking other flows of cash to build it back up. Basically, if you can generate extra cash, your EIUL is a good place for long term storage. Definitely better than a CD or a 529 fund. What’s that coming on? Another instance of Gerber Life TV ad? Go figure.
I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.