"Busting the Biggest Lie of Modern Finance" By Tom DysonSubmitted by barracuda_trader on Sun, 02/09/2014 - 05:29
By Tom Dyson
Income for Life involves putting your cash into a dividend-paying whole life insurance policy with a mutual insurance company.
It’s a way to grow and compound your cash at rates of up to 5% per year. Your money only grows each year. It doesn’t go down in value... even if there’s a big stock market crash. It also grows tax-free.
Best of all, you can use your account to finance expenses such as buying cars, paying for vacations, or funding your children’s college education. Or you can use it to supercharge the returns of your investments.
Today, I want to bust one of the biggest lies in modern finance. That is, that permanent life insurance (the type we use with Income for Life) is the biggest rip-off because of its higher fees and commissions.
Some years ago, my wife and I were shopping for life insurance. (This was before I knew about the Income for Life strategy.) A friend had referred us to an agent for Northwestern Mutual in Jacksonville, Fla.
He was trying to sell us a permanent life insurance policy. My wife and I were getting frustrated with how much he pried into our finances. And he was taking up too much of our time.
I knew the perfect question to end the meeting...
“So how much commission do you make from this policy?” I asked.
“I take a 100% commission,” he replied.
I was expecting a high number, but this seemed impossible.
“That’s right,” he said. “The insurance company pays us 100% of your first year’s premium payment as a commission.”
No wonder everyone thinks permanent life insurance is a rip-off, I thought. And with that, we excused ourselves and left.
Life insurance companies have a reputation for charging the highest commissions in finance. This reputation is so bad there are pages and pages on Google with titles such as “Why you should never buy whole life insurance” or “10 reasons permanent life insurance is a scam.”
There are even two popular finance gurus—Dave Ramsey and Suze Orman—who actively campaign against permanent life insurance because the fees are so high.
To see this for yourself, try this experiment. Tell a financially savvy friend or family member you’re thinking of taking out a permanent life insurance policy. See what he says.
Well, it turns out, this is one of the biggest misunderstandings in finance. The reality is...
Permanent life insurance has LOW fees. When it’s set up the Income for Life way, over the long term you can end up paying less than 0.15% in annual fees.
That’s as low as it gets... lower even than the famously cheap Vanguard Index mutual funds.
Was the life insurance agent trying to rip me off? Of course not. The government regulates life insurance fees and commissions. You’d lose your license—and maybe even go to jail—if they caught you overcharging your customers.
The reality is that the 100% first-year commission is actually a great deal for us. I’m going to demonstrate this to you with some simple charts we’ve made. Once you’ve seen them, you won’t be able to look at permanent life insurance the same way again.
How We Evaluated the Fees
To compare fees on investments, you can’t look at just one year.
Life insurance companies charge a 100% commission upfront. Then the fees taper off. Mutual funds charge almost nothing in year one. Then the fees get bigger every year. To compare the two, you have to add up how much you’d pay over the entire life of the investment, under identical circumstances.
So that’s what we did. And what we discovered shocked us.
First, we got a copy of the fee schedule from one of the top mutual insurance companies in America. One that our Income for Life experts recommend you do business with.
We produced a 40-year simulation in an Excel spreadsheet. We used actual data from a real-life insurance policy set up the Income for Life way. Then we put in the premium payments a person would have paid. Finally, we added up the total amount of fees the policyholder would have paid to hold this policy.
Then we produced a 40-year simulation of a mutual fund investment. Why a mutual fund? Mutual funds are the most successful investment products of the last 50 years. Everyone uses them.
At their core, they do the same thing. A mutual fund company has a manager who allocates investors’ money with the idea to grow it. A mutual insurance company does the same thing. It invests, manages, and allocates money that customers pay in premiums with the idea to grow it over time.
And besides, the fee mechanism mutual funds use is very common throughout the financial industry. It’s Income for Life’s biggest competition, in other words.
We put the exact same amounts of money into the mutual fund each year, on the same dates, as we did for the life insurance policy we examined. Over the 40-year period, the exact same amount of money went into each account every year.
And we grew the money in both accounts at the exact same rate (a low 3.9%) each year. Then we introduced a 1.5% annual management fee to the mutual fund.
[In the mutual fund business, they call this annual fee the “expense ratio.” Consumers use this number to compare management fees across different mutual funds. The mutual fund industry claims its average expense ratio is 1.31%.
But according to research by Forbes and the WSJ, mutual funds are actually charging, on average, 2.75% per year. Trading costs are the reason. They generate an expense of 1.44% per year on average, but mutual funds don’t have to report them.]
The same amount of money went into each account over 40 years. But we kept the fees structure for a policy the same. And we kept the fee structure for a mutual the same.
Here’s what we found:
The insurance agent doesn’t actually take 100% of your first year’s total payment. He takes 100% of the first year’s BASE PREMIUM. With Income for Life, the base premium is usually around only 35% of the actual money you’ll put into the policy in its first four years. That’s because you’ll use a PUA rider to turbocharge the cash build-up in the initial stages of the policy. Our Income for Life experts will be more than happy to explain this to you.
After 10 years...
Life insurance fees paid = $33,825
Mutual fund fees paid = $34,160
Life insurance account value = $340,552
Mutual fund account value = $345,297
So far, it’s pretty close. The fees paid and the account values are similar.
What about after 20 years?
Life insurance fees paid = $39,075
Mutual fund fees paid = $108,111
Life insurance account value = $734,269
Mutual fund account value = $607,534
Now the gap has widened.
After 30 years?
Life insurance fees paid = $44,325
Mutual fund fees paid = $226,242
Life insurance account value = $1,280,336
Mutual fund account value = $921,889
At this point, the person in a mutual fund in a mutual find has paid out five times more infees the person in the Income for Life policy has.
After 40 years?
Life insurance fees paid = $49,575
Mutual fund fees paid = $397,336
Life insurance account value = $2,017,154
Mutual fund account value = $1,298,721
Are you getting the picture?
The bottom line is that “little” annual 1.5% mutual fund fee generated eight times more fees as the life insurance policy after 40 years. More importantly... that 1.5% mutual fund fee caused a difference of more than $700,000 in final account value. The mutual fund investor has an account with $1.3 million. The policy holder has an account value of $2 million.
They’ve both contributed the exact same amount of money over that 40-year period.
Next, we calculated the fee a mutual fund would have to charge to compete with a properly structured dividend-paying whole life insurance policy. We found...
After 20 years, the fees in the life insurance policy equate to what would be a mutual fund with an annual 0.50% fee.
After 30 years, the fees in the life insurance policy equate to what would be a mutual fund with an annual 0.25% fee.
After 40 years, the fees in the life insurance policy equate to what would be a mutual fund with an annual 0.15% fee.
This was astonishing, even to us. But there’s no mistake. Let me explain...
Why That Little Fee Does Such Big Damage
There are two ways you can extract fees from an investment...
First, there’s the standard mutual fund way, which is now the standard Wall Street way. They assess your fee on the total money under management, once per year. It could be 1% per year. Or 2% per year.
The great thing about this method for Wall Street is the fees get bigger and bigger as your money grows. They compound. This is Wall Street’s little secret.
I never realized how devastating these “little” annual fees could be until I started investigating this issue. They look small and insignificant, but they’re not.
Look at this chart. The green dots represent your account growth over time in a mutual fund-based fee structure. And the red dots represent the fees your account generates. Look how the fees grow in size as your account value grows in size.
How Fees Accumulate in a Traditional
Investment Account (401(k), mutual fund, etc.)
In a traditional investment account, the account manager takes a percentage
of the account balance in fees. As the account balance grows, the account
manager’s fee grows.
Then there’s the life insurance method of charging fees. First, the insurance company bases its fees on the money you put into the policy each year, NOT the account’s total value.
Then the insurance company front-loads the fees. So you pay a big fee upfront, then usually a small fee for the next 8-10 years, and then a maintenance fee for the remainder of the policy.
This way, over time the fees shrink, instead of growing. Look how the fees get smaller with each passing year with the life insurance method of charging fees.
How Fees Accumulate in an Income for Life Policy
In an Income for Life policy, the fee the life insurance company charges you has
nothing to to do with your account balance. It’s based on the money you pay in,
using a fee schedule that tapers off. This way, the fee you pay diminishes,
and your account balance grows free of any fees or commissions.
It’s a vital distinction. And it makes an enormous difference. How big?
Look at the charts above again. At the bottom of each chart, there’s a red dot that represents the total lifetime fee each method generates. After 40 years of collecting fees, the mutual fund’s green dot is eight times larger than Income for Life’s red dot.
Or consider the numbers from our simulation. Investing the same dollars at the same time and growing them at the same rate, the mutual fund generated $347,761 more in fees. And because the fees obstructed the compounding power, it ended up with $718,433 less in the account after 40 years.
The bottom line is that you don’t need to worry about fees and commissions when it comes to buying permanent life insurance. As long as you hold your policy for more than a few years, the fees are tiny.
Instead, you should be concerned with the fees you’re paying on your mutual funds and in your 401(k). Because whenever you pay a fee based on your total account value—even if it seems like a small percentage—you’re getting ripped off.
That’s because the fee compounds as your money compounds and eventually becomes enormous.
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