Can You REDUCE Risk by ADDING Risk?

6a017c332c5ecb970b0192aa32ebb9970d-500wiJim Lorenzen, CFP®, AIF®

Does ‘adding’ a riskier position to a portfolio actually REDUCE the total portfolio risk?

The fact is many investors are often their own worst enemy.  The media gurus – usually selling their own DVD sets – have succeeded in focusing on fees and expenses (something they’re correct in doing) to the exclusion of any possible value (something they’ve been successful in doing to the point of dereliction).   The unfortunate result has been many portfolios that are scattered vs. diversified (as this Morningstar chart depicts) and too conservative to the point of being risky.

But, risk is a concern!  However, it is often possible to reduce risk by actually adding a riskier position.  The key lies in understanding investment correlation.

You might find this short report helpful;  just click on the button below.
Adding Risk Report


Danger in Future Inflation, Interest Rate, and Tax-Law Changes.

6a017c332c5ecb970b01a5116fb332970c-320wiJim Lorenzen, CFP®, AIF®

Back during the 1990s, many Americans, particularly baby-boomers, were focusing on accumulation.  Many of us can remember the focus on mutual funds and a rising stock market.  Today, these same boomers are thinking more about protecting what they’ve saved.

The problem, as is often the case, is Uncle Sam.

For years I’ve believed that our 401(k) and other tax-deferred account statements are misleading.   Someone who’s successful and in his/her 50’s might open their retirement account statement and see a balance of $600,000, for example, and believe they actually have $600,000!

Not likely.  For someone in a 28% federal bracket, for example (we’ll ignore state taxes for  now, but you shouldn’t), the statement should read:

Your money:  $432,000
iStock_UncleSamLiftingWallet_MediumThe Federal Government’s money:  $168,000, unless your tax bracket changes and unless the federal government decides to change how much will be required to fund government operations.  If more is required, the government can increase it’s share of your retirement account without your consent.

And, there lies the problem.

According to this chart, federal finances may experience a bleak future.

201603i_Federal Finances

I aplogize for the poor image quality, but the upper-left depicts the annual deficits both past and projected, while the lower left chart shows the effect of these accumulated deficits

There’s more you should know about this and how this issue, combined with a few others, has important implications for baby boomers who need to navigate the retirement maze in the face of potential rising interest rates, inflation, and tax-increases – all during the years when they’ll be tapping into their nest-eggs.  I’ve included this and a few other charts – all much more legible – and additional information you might find interesting, as well.

Click Here!

Retirement in the New World

Fotilla Images

Fotilla Images

Last week PBS aired an excellent program on retirement and how the various generation, including baby boomers, are being affected by their planning – or failure to plan.

It’s an hour-long program entitled, When I’m 65.  The program addresses savings rates, withdrawal rates, investment pitfalls, issues to address, pitfalls to avoid, and even the difference between advisors, including the fiduciary standard – what it means and why it’s different from the ‘suitability’ standard adopted by product sellers.  It also discusses the recent legislation affecting the advisory industry and consumers and even addresses annuities –  insurance-based products widely misunderstood by much of the general public who tend to see things through an ‘either-or’ lens (for additional information on income annuities, you can access a ‘primer’ here).

This PBS program is well worth watching. You may even want to forward it to someone who you think can benefit. You can see it here – scroll down to the video.

There have been questions about the failure of the 401(k) system that have been discussed in the media from time to time since the 2008-9 market meltdown.   This topic was addressed in a Frontline program some time ago and also well worth watching:

I addressed this issue myself in a webinar I recorded last year.  It’s also about an hour long; so, for those of you who aren’t faint of heart, you can access it here.  I think you might find it interesting, as well.

Hope you find all of this worthwhile and helpful.



Optimizing Retirement Income: Combine Actuarial Science with Investments.

6a017c332c5ecb970b017c384ba1fa970b-320wiYou’ve probably heard about “The 4% Rule” – it’s been an ‘accepted’ rule-of-thumb for years that a retiree could withdraw 4% of his or her initial retirement portfolio value each year (increasing for inflation only, not market returns) and could reasonably expect his or her retirement nest-egg to last.

Of course, that’s when the markets seemed to be going up all the time.  In recent years, due to low interest rates and increased market volatility introducing everyone to sequence-of-returns risk, many advisors have dialed back the 4% withdrawal rate to 3.5%

It’s also lead to some back-testing within the industry to determine just what retirees can expect.

Testing with annuities

An FPA Journal paper back in December 2001 by Mark Warshawsky and co-authors John Ameriks and Bob Veres introduced the use of immediate annuities into the retirement discussion.  In his current contribution, Warschawsky  examines  the use of immediate annuities combined with a fixed withdrawal percentage from a total-return portfolio.  The conclusions [1] were:

  • The 4% rule tends to fail when utilized for extended periods, i.e., 30 years, whereas immediate annuities provide continual cash flow, regardless of market or economic
  • A 3.5% or less is often more appropriate than 4% (for obvious reasons).
  • When incorporating an immediate annuity at age 70, the annual payout almost always exceeds the 4% rule and does not risk full income or running out of money – in essence it’s purchasing an unending cash flow that, testing shows, exceeds the 4% rate.

Immediate annuities offer many advantages, but they likely not suitable for those with impaired longevity, liquidity needs, and adequate pension income.  For those who face longevity risk with no pension income, creating a “floor” may make some sense, after all.

Testing with insurance

Industry thought-leader Wade Pfau, in a paper commissioned by OneAmerica, addresses this issue in three scenarios:

  1. Investments combined with term life insurance
  2. Investments, joint and 100% survivor annuity, and term insurance
  3. Investments, single life annuity, and whole life insurance[2]

He compared these three approaches for 35 year-old and 50 year-old couples.  Without getting into the weeds, I just say his study found a “substantive evidence that an integrated approach with investments, whole life insurance, and income annuities provide more efficient retirement outcomes than relying on investments alone.”  It’s not an either/or decision.

Withdrawal strategies vary  beyond what’s  been discussed here, of course, which is why professional help can be very important and the difference of even hundreds of thousands of dollars.

There are some things you should consider before purchasing an annuity.  You can access my report here.    Also, inflation is also an issue worth considering.

It pays to do your homework and have a good guide.  If I can be of help, feel fee to get in touch!

Jim Lorenzen, CFP®, AIF®


Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.  Opinions expressed are those of the author and do not represent the opinions of IFG any IFG affiliate or associated entity.The Independent Financial Group is a fee-only registered investment advisor with clients located across the U.S.  He is also licensed for insurance as an independent agent under California license 0C00742. Jim can be reached at 805.265.5416 or (from outside California) at 800.257.6659. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  

Interested in becoming an IFG client?  Why play phone-tag?  You can easily schedule your 15-minute introductory phone call!

[1] Journal of Financial Planning, January 2016

2 ibid

Taxes in Retirement: A Potential Time-Bomb for Many!

Jim Lorenzen, CFP®, AIF®

No one knows what taxes will be like in the coming years; but, with a debt that’s rising dramatically and an ageing baby-boomer population moving ever-increasing numbers into retirement, this is a collision that isn’t hard to predict.

For retirees, it’s like being in business with a partner who has the ONLY vote on howiStock_UncleSamLiftingWallet_Mediummuch of the company gross s/he gets to take.  And your partner gets it BEFORE you get to pay the overhead with whatever s/he decides should be left.

Not good.

Is it possible to completely eliminate Uncle Sam as a partner?  I think so.  So do many others, including retirement guru, Ed Slott, who many of you may have seen on PBS and who is also a practicing CPA.

But, is it possible for everyone?  Maybe not; but, almost everyone can mitigate taxes dramatically and many can likely eliminate them completely.

Think about THAT!  Wouldn’t it be nice if you lived through retirement without paying income taxes, regardless of what tax law changes Congress made?  Do the math:  That could really add up!

First, a dose of reality:

  • If you’re retiring now, a tax-free retirement isn’t going to happen.  There are no ‘quick-fixes’, but you can take steps to reduce future taxes, and keep more of your own money.  Everyone’s situation is different, but it’s worth pursuing.
  • If you’re more than ten years away from taking retirement income from your retirement plans (you must begin taking required minimum distributions around the time you turn age 70-1/2), then a tax-free retirement may be very realistic!

How do you begin your journey to a possible tax-free retirement?  You might want to begin by reviewing this 12-page outline, 4 Steps to a Tax-Free Retirement.

IFGi_4 Steps to a Tax Free Retirement_001

This will help you understand your situation, provide a framework for your decision-making, and hopefully get you started on your journey.

You can get your copy by clicking here.




Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a fee-based registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Will My Annuity Income Really Increase?

6a017c332c5ecb970b017c37fc6922970b-320wiJim Lorenzen, CFP®, AIF®

Annuities can play a valuable role in a retirement portfolio; but, often they’re somewhat oversold.

Should equity-indexed annuities serve as a substitute for stocks?

Short answer: No.  And, when making historical performance comparisons, you’d be better off comparing them to CDs and traditional fixed annuities.  An equity-indexed annuity is nothing more than an interest-bearing IOU from an insurance company paying an unpredictable interest rate each year… anywhere from 0% up to the “cap”, which these days can be around 4-5%.   So, do the math:  if you get the maximum cap in two out of three years – let’s assume 5% – and zero in every third year, you’re averaging 3.33%.  It’s up to you to decide whether that’s a good return.  It is tax-deferred until withdrawn, but you also have a liquidity issue.

As I said, in some cases, they can make sense for a portion of a bond portfolio because of downside guarantees from the insurance company; but, you should also see if another alternative might make more sense.

 “My annuity Living Benefit is guaranteed to return 5-10% each year!”

Not likely (translation: No).  Too often, people look at the ‘income benefit base’ in the paperwork and assume (because they see a dollar sign in front of the number) they’re looking at real money.  Not so.

Think of the income benefit base as “sky miles” – it’s a number that’s used to calculate the amount of income that will be generated and has nothing – zero – to do with the return on the policy itself.

Technically, many, if not most, annuity offerings state that if the account value ever exceeds the income benefit base, the purchaser will receive a ‘step-up’ in income.  Realistically, however, it’s not likely (translate: won’t happen) these days, considering the spreads and cap rates the insurance companies are using.  As long as living benefit income is calculated on the income base vs. the account value, you shouldn’t expect anything beyond what’s guaranteed on the first day of the policy.

If you’re considering purchasing an annuity, there are seven things you should consider ahead of time.  You might find this short report worthwhile.



Numerous studies have consistently shown than Americans are ill-prepared for retirement.  401(k)s have apparently failed to provide a solution.

You may be interested in seeing just how pervasive this issue has become.

If that weren’t enough, the increasing national debt coupled with increasing entitlement obligations has made it painfully obvious to many that their taxes just might go up during their retirement years – something unthinkable in the past.

So, what can be done?   Many people are look for a different strategy involving  a solution that eliminates both market risk and potential negative tax-law changes in the future.   I’ve recorded a webinar – it’s about an hour long – that may provide some food for thought for many.   I hope you enjoy it.  You can register and access it here.



A Zero Percent Return Can Be Powerful!

6a017c332c5ecb970b0192ac05f306970d-320wiThe financial landscape is known for its complexity; and the plethora of confusing financial products – not to mention the alphabet soup of designations and certifications – can present a daunting task for any normal person to unravel.  And, every time the market changes, the product vendors come out with another solution.

When you add to all this the media gurus who want you to buy their DVD packages instead of ‘throwing away’ a penny per dollar for professional advice – and who can blame anyone for listening when anyone with a license to sell can legally call themselves a ‘financial planner’ – it’s a situation that would make most sane people want to throw up their hands and run to live in the forest.

Of course, consumers do have their share of responsibility for taking the easy route – relying on television gurus and consumer magazines trying to sell circulation – rather than actually laying out money for more academically-oriented educational material or investing in qualified advice.

So, at the risk of appearing as simplistic as the media gurus, I thought I’d just provide some simple mathematical insights.  I hope you might find this somewhat helpful.

Buying back losses is difficult.

It takes about a 43% return to buy-back a 30% loss.  If an investment suffers a 30% loss, dropping from 100 to 70 for example, it would take a 42.9% return just to get back to even (30/70 = 0.4286).

Realizing that, limiting downside exposure can be quite helpful.  For example, take a look at this hypothetical scenario below.   Portfolio A is invested in our hypothetical market and Portfolio B is managed for limiting downside risk (also purely hypothetical).  While our fictitious manager captured only 80% of the upside (never beating the market), s/he was still able to ‘beat the market’ long term by limiting downside capture to only 70%.

Image_Managing for Downside

It’s all hypothetical theory, of course, but it does demonstrate a principle:  Limiting downside loss can be more powerful than upside capture, particularly since most managers do not outperform the market and virtually none consistently outperform the market long term.

Television gurus make a big deal out the fact managers can’t beat indexes, but it’s a false argument.   An index is not a measure of what YOU need to do.  Your GOALS are what’s important, and whether you’re on track.

Indexes do not have expenses and they also don’t pay taxes.   If your house went up in value perfectly tracking an index, would you have tied the index?  Of course not.  An index doesn’t have annual expenses like interest expense on your mortgage, maintenance, repairs, insurance, and property taxes.  If you add those expenses and then compute the return you’d need to ‘tie’ the market, you might be astounded – that’s bigger than `surprised’, but I digress.

What if you could eliminate the downside?

Let’s suppose you could, hypothetically, never lose money with a trade-off than you would have a limit on how much you could achieve as a return each year?   What would that look like?

Let’s suppose you would never lose – if the market lost 5%, your return would be 0%, i.e., no loss, and in exchange you could never make more than 10%.  How would you fare?

Let’s start by taking a look at what was probably the worst ten-year period in history:  The period from 1929-1938 – the crash and Great Depression.

Managing Downside_S&P29-38 vs No Loss w cap_001
Portfolio A, if it had remained invested throughout the entire period, would have seen a $500,000 portfolio reduced to $422,539.[i]  As you can see, our hypothetical ‘no-loss’ but capped at 10% portfolios would have grown to $732,050.  But, what’s interesting are the percentages!

Many companies love to use ‘average’ (arithmetic) returns, which simply add-up all the annual returns and divide by the number of periods, in this case, 10.  Looking at a simple average, we can see the difference is only 0.45%.  But, this isn’t the return percentage you want to see.

The average annual compounded (geometric) returns are more telling.  Those returns tell you what actually happened to the investor!  As you can see, the compounded return for the period was -1.67% per year for the ‘market’ investor, and 3.87% for our hypothetical Portfolio B – a spread of 5.54%!

A little more food for thought

All your life you’ve been told to ‘max-out’ your 401(k).  Should you?

Well, up to your employer’s match, it can make some sense; but,, how about unmatched money?

Suppose you invest $5,000 a year for 30 years (total of $150,000) and average a 6.5% return.  Your total at the end would be about $463,000, depending on timing of your deposits.  But, while your statement may show $463,000, much of it will belong to Uncle Sam.

iStock_UncleSamLiftingWallet_MediumHow much?  It depends on what the tax laws are during your retirement.  If you withdraw $50,000 each year of retirement and are in a 30% tax-bracket, you’ll pay $15,000 in taxes each year.  In ten years, you will have paid $150,000 in taxes; but, the chances of your retirement lasting 20 years or longer is probably very good, which means $300,000+ in taxes.  And, if you’re like many who live three decades in retirement, you could be facing more than $450,000 in taxes!

But, wait!  Your 401(k) had only $463,000 to begin with!  Welcome to longevity risk… and that’s if the tax laws don’t change – good luck.

Another option:  Instead of paying taxes on “the harvest” as we did above, you pay taxes on “the seed”.   We’ll use the same example:  $150,000 invested over 30 years earning 6.5%.  If you pay taxes on the money as you earn it over 30 years, your total taxes paid by the end, using the same 30% tax bracket, now come to only  $45,000!   Big difference, ya’ think?

Your $3,500 annual investment (after taxes) would, depending on the timing of your deposits, would probably grow to around $322,000 – again using the same 6.5% average annual return.

Whether or not you pay any capital gains on realized gains, during the period or at withdrawal, will depend on

(a) the tax laws at the time, and, more importantly,

(b) how the money is arranged and held until retirement.

There are people who do pursue a tax-free retirement strategy.  If you’re interested, you can learn more about that in a one-hour on-demand webinar I’ve recorded, which you can access here.  I think you’ll find it eye-opening, if not helpful.

James Lorenzen, CFP®, AIF®


[i] This does not include any expenses or taxes (indexes don’t pay either) and you cannot buy an index anyway.  You can only purchase shares of an index mutual fund or an exchange –traded fund (ETF).

The Insurance Illustration Landscape is changing

Should You Believe Insurance Company Illustrations?

Fotila Images

Fotila Images

Jim Lorenzen, CFP®, AIF®

Just in case you haven’t heard, Genworth has decided to suspend life insurance and annuity sales.   This decision will leave many agents and their client with questions on where to turn and how to get protected.

Insurance companies seldom discontinue a business segment when it’s either profitable or if they haven’t overextended themselves.  Remember Executive Life?

Before Executive Life of New York went under, they had over 50% of their portfolio invested in less than investment grade ‘junk’ bonds, despite the fact that in June 1987, the New York legislature had mandated that insurance companies licensed to business in that state were to limit their general portfolios to no more than a 20% allocation to such bonds.  Remember, there are no guarantees; there are only guarantors. [Source:  The New Insurance Investment Advisor, Ben G. Baldwin, McGraw-Hill 2002, p. 37.].

A qualified advisor would/should have looked “under the hood” at the company’s investment asset allocation and quickly realized it wouldn’t be used in a client’s portfolio; so, why would anyone use it to back their retirement or legacy planning?  Unfortunately, as all too often happens, insurance companies can take ill-advised risk in order to promote unrealistic return rates to pump-up sales.

Life insurance illustrations have had, for more years than I can count, a well-deserved reputation for less than transparent and amazingly inaccurate projections of what the policyholder could expect in future years.   The unfortunate result is that one of the most amazing financial products on earth – and life insurance does far more than most people even suspect – has suffered from a plethora of negative bias, both in and outside the media universe, and virtually all of it wrong.

A regulatory solution?

A recent regulatory change recently took affect that limits the growth rate an insurance company can use in its illustrations to a maximum that’s based on the company’s current ‘cap’ rate applied to an average rate history going back over 50 years.   The key is that the company can use its current cap – which actually can function as an incentive to keep the caps high, maybe even unrealistically.

This could mean – and what many unsuspecting consumers may not realize –  that it may also act as an incentive to take on additional risk in the company’s underlying general account investment portfolio.   Insurance company actuaries are good at manipulating numerous ‘moving parts’ that can make attractive caps look better than they really are.  Does a company offering a 13% cap on an indexed product really perform better than one offering only a 10% cap?   According to some extensive back-testing I’ve seen, it doesn’t seem  to be the case – expenses often play a more important role

One major problem for the typical insurance consumer is the inability to tell one company from another.  While many truly professional and credentialed independent agents do make an effort to represent only “investment-grade” companies, there are those who will represent the highest commission, which can often lead to selling substandard products for companies that appear to be substantial.  An agent who is also an investment advisor can be a benefit for the buyer.

6a017c332c5ecb970b017c384ba1fa970b-320wiWhat many don’t know

Most of the well-known rating agencies you may be familiar with are actually paid by the insurance companies they rate!   Little wonder many insurance companies that failed actually had good ratings when they went under.

Have you noticed that virtually all insurance companies tout ratings from the same rating agencies in their promotional materials?  Few, if any, however, tout their rating from Weiss, maybe because Weiss doesn’t get paid by the companies they rate – their revenues come solely from subscriber revenue (kind of like Consumer Reports).

For example, according to the September 2002 Insurance Forum, of 1221 life and health companies rated by Weiss, only 3.9% of companies made it into the ‘A’ category.  Compare that with the 54.9% rated ‘A’ by Standard and Poor’s.  At Moody’s, 90% of their list made it to ‘A’ that year.  A.M. Best gave ‘A’ to 56.3% of the companies they rated.  [Source:  The New Insurance Investment Advisor, Ben G. Baldwin, McGraw-Hill 2002, p. 405.].

By the way, Companies with ratings in the A or B brackets from Weiss are considered secure, while some of the other rating agencies will give B and even A bracket ratings to companies considered vulnerable.

Recently, indexed universal life (IUL) policies have become quite popular – both among agents and their clients.  The reasons are many, but two big attractions are (1) transparency – virtually no hidden moving parts.  These products are easy to understand; and (2) low cost – insurance costs are basically like term policies.  Admin costs are also low and, as noted, everything, including costs, is transparent, including performance going forward.

Does that mean the illustrations can be believed?  No, but for different reasons.  To understand the reasons why illustrations can be misleading and how to know you’re comparing apples with apples, it’s important to know how these policies work.

First a caveat:  This is not an exhaustive text on IUL products and there’s a lot more to know than is being discussed here.  This is simply a quick overview highlighting the stand-out characteristics.

6a017c332c5ecb970b01901bb7b3ed970b-320wiIUL basics

IULs are often, but not always, designed as financial tools for maximum cash accumulation in a tax-advantaged vehicle.  In these cases, the death benefit is often a secondary consideration; however, it’s the life insurance that buys the tax benefits – and, for many, these benefits far outweigh the cost of insurance, which is typically priced like term insurance.

Unlike most insurance buyers who want the most insurance for the least amount of money, these buyers want to buy the minimum amount of insurance for the maximum amount of premium they can put in (yes, there’s a limit).  This is because after the minimum insurance is purchased and expenses are covered, the rest goes into a cash accumulation account; and in an IUL, it can be tied to an index with much higher caps than are usually available in an annuity.

The cash accumulation account accumulates tax-deferred, but can be accessed for retirement income later as tax-free loans.   How fast does the cash accumulate?   Interest is credited to the account based on the performance of an outside index.  While there are often many choices, most people tend to choose the S&P 500 index.

To keep this simple, I’ll just quickly cover the simplest approach:  Let’s suppose our policyholder purchased an IUL policy using the S&P 500 index as the crediting option.  The policy might offer 100% participation in the index’s upside moves up to a ‘cap’ during a crediting period, typically one year.  For example, if the index rises 8% by the  policy’s 1-year anniversary date, the policyholder participates 100% in that move and receives the full 8%, provided the ‘cap’ is higher.  If the index rose by 25% and the policy ‘cap’ was 11%, the policyholder would realize a credit of 11%.

So, on a 1-year, 100% participation with a 11% cap, a 25% rise in the index means the policyholder would receive 11%, i.e., 100% of the increase up to the cap.  That amount would be credited on the policy’s anniversary date

The next crediting would take place on the policyholder’s second anniversary.   Note:  It doesn’t matter what happens between anniversaries – only the value ON the anniversary date counts, nothing else.

The good news is that if the stock market index has a drop, the policy loses nothing.  The amount credited is 0.  No gain, but no loss, either.  Another nice thing is that, in our example above, after the 12% gain is achieved, it’s locked-in.  That’s the new floor and that money can’t be lost.

To understand how beneficial a ‘no-loss’ concept is, it’s worth remembering that while a drop from 100 to 80 represents a 20% loss, to get back to 100 from 80 requires a 25% gain (20 points up from 80 is 20/80 = 25%).

How can the insurance company, investing in a conservative bond portfolio do this?  It’s simple.  Again, I’ll oversimplify with rounded numbers just to make the concept easier.  Premium money received by the insurance company might be invested 95% in bonds, and 5% in stock options.  If the market goes down, the options expire; if the market goes up, they execute the options and, of course, the cap on the policy limits their exposure.  So, the pricing of options, as well as the length, impact costs.

Important:  The policyholder is not invested in the market or the options.  The index is only a ‘ruler’ to measure how much the insurance company will credit.  It’s the insurance company’s investment account that is doing the investing, not the policyholder.

Returns and Illustrations

Can  the policyholder really receive stock market-like returns?  Not likely.  The caps limit the upside, and while there is no downside, down years representing no gain will sometimes occur.  So, positioning IULs as a stock substitute is probably not the best strategy.  I would look for returns that are more bond-like – maybe a little better – which means, it’s the bond portion of your portfolio that you’re really dealing with.

And, here’s where illustrations can be a bit misleading.

If one company is offering a 12% cap and another company is offering an 11% cap, but both are showing you an illustration using a 7% crediting rate, saying that the S&P average over all their back-tested periods indicates that 7% is conservative, are you really seeing an apples-to-apples comparison?

Now that new regulations limit the cap that can be illustrated – remember, however, it’s based on  the ‘current’ cap rates for each company applied to historical data, placing an incentive for the company to keep current rates high – it’s probably better to simply ‘level the playing field’.

First, the company:  How have they treated policyholders in the past when they’ve reduced or increased their caps?  Did existing policyholders receive the same treatment as new policyholders?   Believe it or not, not all insurance companies treat their existing policyholders the way they treat their new ones.

Secondly, a decrease in a cap rate isn’t all bad.  Responsible insurers are custodians for client assets and need to act responsibly, rather than chase risky investments to meet caps they can’t pay.  However, a decrease in the cap also can affect your outcome.

Take a look at the chart below.  Notice a 7% illustrated rate for a 12% cap IUL has had a 79.5% chance historically of meeting its projections, based on a 20-year probability study of the S&P 500 at various cap and crediting rates.  If the cap is 11%, the probability is reduced to 60.7%.

IUL Crediting Rates_001

The new regulations stress average results; but, it provides little comfort to know that your own retirement results have a 50-50 chance of being better or worse.

This has less to do with the insurance company than it does with expectations.  It’s important to know, when you’re buying, what you can reasonably expect; and, often, it may not be what you’ve been promised with a rosy illustration.   High quality companies providing investment-grade products will tend to be conservative in their projections – and a good advisor will educate clients on realistic outcomes.

Key Point:  An illustration for a policy with an 11% cap but using only a 6% crediting rate may not look as rosy as the 7% illustration, but the odds of the company delivering on its promise rises to 95%.  This means, it’s virtually certain your policy will perform this well or better.  The 7% illustration will look so much better at the point of sale, but it also has almost a 40% probability of doing worse than promised.

So, when comparing companies, wouldn’t it make more sense to have them all illustrated at 6%?  By doing so, you could see how they perform on a level playing field with a higher success probability.   You can compare high probability outcomes and, more importantly, a basis for comparing costs, as long as the policies being compared have the same features, riders, etc.

The Real Benefits

If someone begins utilizing these benefits early, say in their 40s or 50s, the retirement benefits can be substantial.  As a matter of fact,  it’s a retirement strategy being used by 85% of Fortune 500 CEOs and many members of Congress in order to create a tax-free retirement.  Other proponents of this strategy include retirement and IRA expert Ed Slott, who is also a CPA, and David M. Walker, former US Comptroller General [Source: The Power of Zero, David McKnight].

I’ve created a report on this concept.  You might find it interesting.  You’ll receive it free by going here.  If you’d rather take the time (about an hour) and view the webinar with all the slides, you can do that here.