If You Build It, They Will Sum

Money, sex, pictures, future events, past regrets — a complete mathematical model of a life insurance policy offers all of this and more.  Let me know if you find one.  For now, you will just have to settle for mine.  Hey, it's free.

For the record, here are the source data and assumptions used to build the models:

• the full text of my policy (AD95, non-smoker, OPP rider)
  
  
• my annual statements and other feedback from NYLIC
  
  
• policy illustrations
  In all cases, premiums are due for the life of the policy.
  • age 42, $1764/year out-of-pocket for 12 years (the "real" one)
  • age 42, $158/month out-of-pocket for 12 years,
    $1764 annual thereafter (expected to come from policy earnings)
     
    
  • age 34, $1147/year out-of-pocket payments for 14 years
  • age 34, $1250/year out-of-pocket for 12 years
    $1147 premium + $103 OPP bought 12 times to reduce out-of-pocket years
     
    
  • age 26, $818/year out-of-pocket for 16 years
  • age 26, 948/year out-of-pocket for 12 years
    $818 premium + $130 OPP bought 12 times to reduce out-of-pocket years
    $38 one-time out-of-pocket in year 27 of policy !!!
    
    Hopefully in an illustration for a real policy, the agent would catch this.  Charge a few extra bucks up front, for heaven's sake!
    

  ("out-of-pocket" is projection, not guarantee)
  
  

• 30-year flat term policy in T+I models
  The premiums are $485/year for 30 years, based on an age 42, non-smoking male in Florida.  This policy is based on a quote provided by a friend who viewed the first model.

• 6.75% future return on the invested portion of the T+I strategies
  It does not make sense to compare 8%, 10%, or -30% equity returns with a whole life policy.  Apples-to-apples, remember?  (Someone who wishes permanent insurance but with equity-market risks and returns should choose some sort of Variable Life policy.)  Since my policy is real and somewhat affected by ongoing bond rates, I chose a real bond fund to compare with.  This is VBIIX from Vanguard.  Past years reflect its actual total return, and future years assume the 6.75%.

• T+I investment accrues tax-deferred up to age 70
  It is within a normal IRA.  Not everyone is eligible to obtain Roth IRA's, and they don't model a life insurance policy very well in their tax rules.  But if a Roth were used within the model, the T+I strategies would do a bit better overall.

• beginning age 71, T+I investment is slowly transferred
  US tax law requires that distributions begin by age 70.5 from an IRA.  So the models move the investment to a tax-free municipal bond fund in annual installments over a 20-year period.  Each transferred amount is exposed to income tax, and I model a 15% tax rate.  Once within the muni-fund, there is no more tax, even when passed to heirs upon the death of the investor.  An earnings rate of 6.25% is used for this unspecified, far-in-the-future fund.

Since my life insurance passes to my beneficiary tax-free, I believe a large degree of equivalence has been established within the models for comparison of my whole life policy with T+I strategies.  If distributions are withdrawn from any model, taxation is similar as well.  I.e., up to what was paid ("cost basis"), money withdrawn is not taxed.  Money withdrawn above cost basis is taxed as normal income.

I cannot state that the model is perfect.  Here are some known inequalities:

1. Once transferred to the muni fund, the T+I earnings will not be taxed again. Policy earnings will eventually be directly taxed if I don't die first.
2. Loans can be taken on the policy, but not the IRA. (If I die with an outstanding loan, the policy escapes taxes, but the loan will have been paying interest to the NYLIC.)
3. The 15% tax rate during the BTID transfer is probably a little low. The 6.25% earnings rate on the muni fund may be a bit high. (Both are so far in the future, it is really hard to know what will end up to be reasonable.)
4. Investment in a mutual fund involves an account owned by the investor.  With Whole Life, the account is owned by the policy.
5. T+I allows the investor to control his investments at any risk level desired.  He can change his level of risk over time.  Whole Life cash value remains conservatively invested for the life of the policy.

Thanks to many on the "misc.invest.financial-plan" newsgroup for providing invaluable feedback.  The primary discussions about my modeled strategies can be read at:

("BTID" is the common abbreviation for "T+I".  I did not know that when I started this site.)