I was asked by a client recently to compare the returns between two vehicles, a tax-free vehicle with reinvested dividends, and a cap-and-floor strategy adopted by a specific Indexed Universal Life policy.
Illustrations normally show a projected fixed return from the market, instead of actual historical returns. I have yet to see one anyway. Illustrations also do not compare returns with an indexed fund strategy using a tax-free vehicle such as a Roth-IRA. That is what I set out to do.
As an appointed agent, I had access to a particular product provider’s actual cost of insurance, and was able to obtain, year for year, the actual cost-of-insurance and other expenses, for a 6 year old, with a face value of $250,000.
The results are interesting, but not unexpected. Since the IUL does not include dividends, it is only fair to include them in the buy-and-hold indexed fund strategy.
I used historical dividend yields from multpl.com. A chart of dividend yields over time shows that yields are on a downward trend.
I compared the performance of the IUL with expenses over selected time-frames of the SP500 (1970-2016) and the Nikkei (1980-2016), and the results are shown below. Assume that $1,875 is invested annually for fifteen years, and thereafter no further investments are made. In the IUL case, the $1,875 is the premium paid annually for fifteen years, and no premiums paid thereafter. This was actually the guided premium for the policy.
Comparison using SP500 historical data
This graph above shows that in a bull-market, the IUL simply cannot capture the upside as well as a tax-free vehicle with reinvested dividends. The IUL performs roughly on par with a taxable account at the 28% tax rate, where all gains are taxed annually at that rate. Notable is that during the 40% market drop in 2008, the IUL catches up to the 15% vehicle.
Comparison using Nikkei historical data
For the Nikkei I used an average yield of 1.68%, which was simply the average of the dividend yields over the years 2010 through 2017, at the time of writing.
The graph above shows the performance of the IUL overtaking the indexed fund strategy in 2000 as the floor protection feature of the IUL protects it from plunging as the index suffers three years of consecutive loses of -27%, -23%, -18% in years 2001, 2002 and 2003 respectively. After the plunge the Nikkei recovers and meanders for awhile, and just arrives back at its 2000 high in 2016. In the meantime, the IUL is able to make progress and in fact, pull away from the index fund strategies.