The entire life insurance works well as a pension income tool because it provides a very stable return compared to the year before. This feature minimizes the effects of return risk that causes other assets to (sometimes) make fewer saved dollars as income because they need a larger cushion to protect against potential asset reductions.
But how strong is the whole life insurance in this regard? We sat down to evaluate this view and put a figure on the relative strength that the entire life insurance has compared with a general equity portfolio. We hired the enemy's tools with Vanguard's pension calculator. I like this tool for this purpose, because it allows us to calculate the compound annual rate of return we need to achieve to give identical results to the whole life policy. I think you will find the results of this analysis eye-opening.
Evaluation of comprehensive insurance and the equity portfolio's pension income forecasts
We started with a standard (for us at least) entire life policy that maximizes the cash value through policy mix and maximum supplement. We compared these results with Vanguard's pension calculator. The calculator on Vanguard allows us to enter an annual savings amount, enter the number of years we plan to save and identify an assumed return. With that information, the calculator will produce the estimated pension income that we can expect from such an investment. <! – ->
The calculator reports other things, but they are not applicable to this analysis, so I skip discussing them in today's blog post.
With the help of the calculator, we can find out what type of return we need in the equity portfolio to match the entire life policy. But I have to make some important notes about this calculator.
First, it does not require any adjustments for fees. Secondly, it makes no adjustments to the taxes assumed to be paid in the liquidation of funds to generate income. So the numerator's reported figures throughout this analysis are gross figures, which may be net figures under certain unique circumstances, but probably not. <! – ->
I carry out this analysis on the assumption that a male age 40, who plans to retire at 66 years. He saves $ 25,000 a year in this scenario.
Current full-year dividend compared to market investment
By running the entire proposal for life, we get the following results:
There are many numbers here, but they Important to note is that we correctly assumed 25 annual payments of $ 25,000. The entire life forecast tells us that we can then use the cash value accumulated in the policy from the age of 66 to produce $ 62,265 in pension income per year. We can do it through the insurance owner's age 100 (not shown in the general ledger, but that's how I set up the design).
Using the Vanguard Calculator, focusing on the same $ 62,265 per retirement income, our hypothetical savers reportedly need to achieve an annual return of 9.1%. Here is the result from the calculator:
Vanguard's calculator reports the pension income as a monthly amount, so we simply need to multiply that figure with 12. This gives an income figure slightly over the entire life expectancy, but sliding the assumed return to 9.2% per year gives an income figure further away from the entire life expectancy, so I round off and call it 9.1%.
All Life with Reduced Dividend Scale
The smarter financial bloggers who detest all life insurance will quickly rush in and note that these forecasts are only projections based on a currently assumed dividend rate that may not become a reality. over the next 25+ years. I agree with the feeling, so I looked at the same scenario with a reduction of the dividend by 100 points. Here's what makes the dividend reduction pay off:
Our income figures drop to $ 47,274 per year. Certainly significant, and now we need to adjust the return assumptions using Vanguard Calculator to determine how this compares to stock market investments. Here are the results of it:
Our hypothetical saver needs 7.3% annual compound return to match the entire life policy with 100 points reduction of the dividend from the current level.
Zero dividend All life compared
There are some who suggest that the only way to really make a meaningful evaluation of the whole life insurance is to look at it without dividend. This is because it is the only way to find out what the policy guarantees. Even though it's an odd statement against a recommendation to buy shares (I'll let you find out the irony without explicitly pointing it out), I thought, why not?
So to leave no stone unturned, no matter how unlikely, reverse here is the zero payout scenario: <! – ->
The amount of income drops (no surprise) again, but how does it compare to the stock alternative according to the calculator? Here is the result:
Our hypothetical saver needs an annual return of 4.2% on their investments to match lifetime guaranteed results . <! – ->
Observation of these results
I am quite stunned by the return needed to match the current overall forecasts. We noted something similar to this result several years ago when we showed that the functionality throughout life made it very strong as a pension income tool. Simply put, full life insurance provides a great deal of pension for your investment money. While some people choose to argue over the nominal return and who has the largest balance in cash at the end of seemingly arbitrary years, I have always thought it wise to look at the absolute value one can derive from a given endeavor. That is why I have a favorable image of whole life insurance policies.
Keep in mind that the odds of actually achieving an annual return of 9.1% on a systematic investment over a period of ten years or more are extremely low.
I am equally stunned by the required rate of return required to match the 100-point reduction forecasts. While we agents often look at dividend reductions as terrible things, we often overlook the fact that there are many comprehensive policies out there that still … despite year after year announcements of dividend reductions … still compare extremely favorably to competing savings. option. All of life does not live in a vacuum, and the economic conditions that cause it to fall or increase in value also have a certain impact on other asset classes.
I think the guaranteed results are perhaps most interesting. In truth, I did not even care about the part of the analysis. It seemed pointless given the extremely low probability that such an event would develop. But when I look at the required rate of return required to match the results, I am shocked at what my whole life takes in this case. Remember, this is what the whole life insurance guarantees.
Certainly most people reasonably expect a return on the stock market higher than 4.2%. I think I can achieve something higher than that long term with my equity investments. But we must not forget that DALBAR continuously shows us the year before that most people fall very close to this result with equity-focused funds. And again … let's not forget that the entire lifetime of this scenario is guaranteed . It is not possible to guess, hope or overcome anxiety to open your latest statement.
The entire life insurance provides incredible value for its insurance owners. Return is an often quoted and often misunderstood vanity statistic that investment sellers and some (probably well-meaning) bloggers use to try to argue against life insurance. But if not or until the same people come to you with a solid plan that shows exactly what they intend for you to do with that return in stock, you have reason to be wary of their claim. After all, you can not buy food with returns alone.