A place for VUL? Advice appreciated..

[BryanMD]

I think these are fairly important nuances to the VUL debate. The answer to every VUL question I’ve come across on the forum has been “ditch it, cut your losses, move on.” But maybe a discussion is due on the very rare instance where VUL might be an ok choice.

Is it reasonable for an $800k earner? If the premiums you were going to pay in were instead only going in to a taxable account? If the top income tax and LTCG rates raise? If, God forbid, LTCG gets taxed at income rates or worse unrealized gains get taxed?

[zlandar]

I think these are fairly important nuances to the VUL debate. The answer to every VUL question I’ve come across on the forum has been “ditch it, cut your losses, move on.” But maybe a discussion is due on the very rare instance where VUL might be an ok choice.

Is it reasonable for an $800k earner? If the premiums you were going to pay in were instead only going in to a taxable account? If the top income tax and LTCG rates raise? If, God forbid, LTCG gets taxed at income rates or worse unrealized gains get taxed?

That tax tail is wagging the dog overtime.

If a high commission product requires a “very rare instance” to be an “ok” choice you already have the answer.

[Lithium]

I think these are fairly important nuances to the VUL debate. The answer to every VUL question I’ve come across on the forum has been “ditch it, cut your losses, move on.” But maybe a discussion is due on the very rare instance where VUL might be an ok choice.

Is it reasonable for an $800k earner? If the premiums you were going to pay in were instead only going in to a taxable account? If the top income tax and LTCG rates raise? If, God forbid, LTCG gets taxed at income rates or worse unrealized gains get taxed?

I guess we could all come up with crazy proposals by Congress that ruin taxable accounts or make cash value life insurance awesome, but it seems just as crazy to buy a policy based on legislative conjectures.

Let’s start with where we are. The highest federal LTCG rate is 23.8%. What is yours? Feel free to include your state tax as well.

[BryanMD]

Isn’t this the real “sunk cost fallacy” of VUL? If you’ve already got the VUL then the commission you paid is irrelevant going forward. Paying a big commission is the mistake to start with. But once that mistake is made it shouldn’t really factor into the decision to keep the policy active vs getting rid of the policy. It’s not like the agent you paid commission to is going to split the surrender charge loss with you.

I think once the plan is in place then the financial decision is whether the high fees and premiums offset the distant future retirement benefits. Maybe that inflection point never comes, but that inflection point is probably different depending on individual earnings and future tax consequences.

[GasFIRE]

Isn’t this the real “sunk cost fallacy” of VUL? If you’ve already got the VUL then the commission you paid is irrelevant going forward. Paying a big commission is the mistake to start with. But once that mistake is made it shouldn’t really factor into the decision to keep the policy active vs getting rid of the policy. It’s not like the agent you paid commission to is going to split the surrender charge loss with you.

I think once the plan is in place then the financial decision is whether the high fees and premiums offset the distant future retirement benefits. Maybe that inflection point never comes, but that inflection point is probably different depending on individual earnings and future tax consequences.

I would review flow chart in the (much) earlier post by DMFA. Do your heirs need to receive a guaranteed minimum inheritance (e.g. a special needs child)? Do you highly value the asset protection feature? Are you confident that the tax savings will outweigh the insurance cost for you?

This conversation centers around the 3rd question and the general consensus is NO. IMO unless I am confident that I will be subject to significant estate tax after I (and my wife) die, I find it difficult to imagine a scenario where it is cheaper to access the cash value from the VUL vs a taxable account.

[afan]

The upfront commission is only part of the problem with VUL. The second problem is the ongoing fees. Many will charge several percent of the cash value, on top of the cost of insurance. The deferral of taxes on growth in the underlying portfolio is worth something but not much at all.

If you put your VUL money into VTI in a taxable account instead, then the nominal expenses are 0.04%. Include revenue for securities lending and the net cost is about zero.

With an investment in a total stock or S&P 500 fund inside the VUL, you will be paying far more in fees every year.

The taxes on your taxable VTI will be at the LTCG rate on the dividends. If you were to sell, then the taxes on your capital gains would be at that same rate. But you are not going to sell. You will hold onto this for decades. During that time, you will pay up to 23.8% federal on the dividends. The current dividend rate is about 1.4%. On $100,000, that would be dividends of $1,400. At the top tax rate, you would pay about $333 on your $100,000 investment. That is 0.333%. To avoid this, you would be paying, perhaps, 4% on your VUL policy +the cost of insurance.

If you could get the total cost of the VUL below 0.333%, including the cost of insurance, then you could break even on VUL.

They will tell you that you can borrow against your VUL cash value to tap the funds when you retire. Did they tell you that you can borrow against your taxable account as well? Your broker will be happy to set up the loan. Compare the current interest rates on such a loan to the interest rate on a policy loan. The life insurance loan will be far more expensive.

As with a life insurance loan, the funds you receive when you borrow against your taxable account will be tax free.

If you live in a high tax state, then you need to add in the state taxes. But something like VTI throws off little income in dividends and none in CG. So your state income taxes, whatever the rate, will be on a small amount.

I have seen claims that in a high enough state bracket the VUL can be worth the very high costs. I have not seen someone show the figures to demonstrate this.

A while ago there was a poster on WCI who said that they had run the numbers for their policy, that the policy beat a taxable account and promised to post the figures. They never did. I don't know whether it was a life insurance sock puppet but the strong declarations of the value of the policy, followed by silence when asked to prove it, makes me assume that they were.

I looked at a VUL policy years ago out of curiosity. It took some wrangling to get the agent to send me the prospectus. They wanted to sell just based on some illustrations. When I pointed out that they were required to provide the prospectus they finally sent it. It was over 100 pages. Slogging through and noting each fee, I came up with at least 4% on the investment portion, plus the cost of insurance.

The policy was so bad it was funny. The agent hardly seemed surprised when I told them I was not buying. I got the impression people who read the prospectus never bought the policy.

If someone has seen a policy that has fees, including cost of insurance, low enough to compete with taxable, please post the details

[afan]

Note that having life insurance only saves estate taxes because you end up with less money, having paid the cost of the insurance. If you own the policy, then it is part of your estate.

You could set up a trust, put money into it over the years and get these payments and the growth on them out of your estate. But there is no need for the trust to hold life insurance. In the case of a single doc, who would be the beneficiary of the trust? If the trust owned the policy, then the doc who set it up could not draw on those funds in retirement.

[BryanMD]

Thank you. This was very helpful. I did not even consider that you could take loans against your taxable account. I assumed you needed collateral with a guaranteed fixed amount.

[The White Coat Investor]

Would life insurance make sense for a later career physician entrepreneur with a very large tax deferred account, a very large taxable account, a very large real estate portfolio, ownership of a highly valued, privately held business, and a likely huge estate tax bill coming due in a few more decades?

The downsides of the policy (low returns) would matter a lot less so the upsides (maybe asset protection, some estate planning or business uses) might outweigh them.

[afan]

A great reason to do some estate planning and fund irrevocable trusts while the exclusion is high. No need for life insurance to do that.

The main advantage of life insurance would be avoiding annual income taxes and some asset protection, depending on your state. Take your simple asset protection steps and make sure you isolate the real estate and business liability from personal liability to the extent you can.

On income taxes, run the numbers for the taxes you would pay and the amounts you would have after tax with or without the cash value policy. If you are in a high tax state then maybe the tax advantage of VUL or some other cash value policy would be worth it. Be sure to calculate the taxes on a taxable account correctly. Insurance salespeople like to pretend that a 7% return means the entire 7% would be taxed at ordinary income rates every year. The actual effective tax would be much lower, making it more difficult for the insurance policy to be better.