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Should I Invest in S&P 500 Index Through an Indexed Universal Life Insurance (IUL) Policy?

If you depend on Warren Buffet for financial advice, you’ll know he’s been telling people to buy index funds so they can get a solid return on their investment. That’s because the S&P 500 index (Standard and Poor’s) is a reflection of overall market performance and it is considered a good indication of the health of the U.S. stock market. A particularly attractive feature of the S&P is that returns an average rate of about 10%, which is a nice return on an investment.

History of the S&P 500 Index

The S&P was created in 1957 as a way to track the overall performance of the stock market. The 500 refers to the 500 of the largest corporations traded on the NYSE (New York Stock Exchange). It reflects the health of the stock market, and really, you could say it reflects the health of the economy. If the economy is unstable, the S&P fluctuates wildly. If economy is strong, the S&P 500 can return as much as 30% in a given year. Don’t get too excited, though—it won’t return 30% every year, and actually if the country is suffering economically, it can lose money. Overall, though, investing in the index is a good way to get into the stock market while mitigating some of the risk.

You may have heard of other indexes, such as the Nasdaq 100 and the Dow Jones Industrial Average. The S&P is considered a broader reflection of the market, because while the S&P is made up of 500 companies, the Nasdaq had 100, and the Dow Jones just 30. 

Ed Slott – a renowned tax expert – on tax benefits of IUL policies

Compare quotes of 30+ IUL products

What Companies Make Up the S&P 500?

The S&P is made up of 500 of the biggest corporations, across 11 industries, called sectors. Here is the breakdown of what the eleven sectors are and how much of the index they make up:

  • Communication services: 9.9%
  • Consumer discretionary: 10.2%
  • Consumer staples: 6.7%
  • Energy: 6.0%
  • Financials: 13.7%
  • Health care: 14.9%
  • Industrials: 9.7%
  • Materials: 2.5%
  • Real estate: 2.7%
  • Technology: 20.8%
  • Utilities: 2.8%

Some companies you’ve heard of, like Apple, Amazon, and Facebook and some you probably haven’t, like ONEOK and Henry Schein. They are all chosen based on certain criteria, such as financial health and monthly trading volume. 

Why Should I Invest in the S&P 500 Index?

There’s a reason investing in the S&P is popular with investors, even first-time investors. The S&P returns an average of 10% annually if you hold onto the fund for a long time. If you invest in the index, you’re buying a tiny amount of 500 companies, which means you have less risk because a poor performance by just one or two companies won’t affect the index fund much. And it’s extremely unlikely that you’ll go bankrupt.

Index funds are usually cheaper, because they’re passively managed. No financial wizard has to figure out what to buy and what to sell, which lowers investment costs. 

Investing in S&P 500 Index is usually a long term investment strategy, especially for retirement planning purposes. If you invest $1,000 a year in an S&P index fund for 30 years, assuming an average annual return of 8%, your investment account will grow to:

  • $123,300 total
  • $118,700, after deducting all fees,
  • $94,900, after paying all long-term capital gain tax. Long term capital gain tax is 20%, or $23,800

$1,000 investment each year in an S&P 500 index fund will allow you to cash out $94,900 after 30 years, assuming a reasonable average annual return rate of 8%.

If you invest $10,000 each year in an S&P 500 index fund, you will be able to cash out almost $1 Million, or $949,000 to be exact, after 30 years; after paying $238,000 in long term capital gain tax.

How do I Invest in the S&P 500 Index?

You can’t actually invest in the S&P 500 index itself, but you can buy an index fund that tracks the performance of the S&P 500. You would really need to purchase 500 single shares of each of the S&P companies to create your own S&P mini-index. Or you can just invest in an index fund that does the same thing for far less money. 

To invest in a S&P 500 index fund, following the simple steps below:

  • Open a brokerage investment account at one of the popular brokers: Vanguard, Charles Schwab, TD Ameritrade, or E-Trade
  • Pick an index fund that you want to invest in. Below are some best index funds that you can choose from:
    • Vanguard 500 Index Fund Admiral Shares (VFIAX): This is probably the granddaddy of all index funds. It gives you a diversified exposure to the largest 500 US corporations. Minimum investment requirement is $3,000 and expense ratio is 0.04%
    • Schwab S&P 500 Index Fund (SWPPX): This is probably one of the cheapest index funds available in the market, only 0.02% and it doesn’t require any minimum investment.
    • Fidelity 500 Index Fund (FXAIX): This is another cheap index fund for investors, especially beginning investors, the expense ratio is only 0.015% and it doesn’t require any minimum investment amount.
    • T.Rowe Price Equity Index 500 Fund: This is another competitive index fund available for beginning investors with no minimum investment requirements and low expense ratio of 0.02%

Another way is to invest in exchange-traded funds (EFT), which are very similar to index funds, but with a few key differences:

  1. There is often a minimum buy-in to invest in an index fund, whereas you can invest whatever you want/can afford in an EFT. For example, Vanguard requires a minimum investment of $3,000 for all of its index funds and T.Rowe Price requires a minimum investment of $2,500. On the other hand, you can invest in ETF’s with as low as $25.
  2. EFT’s prices fluctuate throughout the day as they are bought and sold, whereas index funds can only be traded at the end of the day. 
  3. Tax efficiencies: Thanks to the way it is structured, owning shares of ETF’s is more tax efficient than index fund. When ETF shares are traded, they are sold and bought among the investors. Cash comes directly from the buyers to the sellers and only the buyers are responsible for paying capital gain tax. On the other hand, If you want to sell your shares in an index fund, you must redeem it to the fund managers. Fund managers have to sell securities in the market to pay you cash. When the sale incurs for a gain, the net gain is passed on to all investors in the index fund. Each and every investor with a gain has to pay capital gain tax. So, you might owe capital gain tax each year even if you don’t sell your shares.

Investing in S&P 500 Index Fund Through a Indexed Universal Life insurance Policy

If you are also in need of life insurance but are intrigued with the idea of investing in an S&P 500 index, you should consider indexed universal life insurance (IUL). This is a popular type of permanent life insurance policy. It comes with a cash value account, which earns money by reflecting the S&P 500 index, just like an index fund. That is the reason why it is called “indexed” universal life insurance. Essentially, buying an indexed universal life insurance policy is both i.) buying a permanent life coverage and ii.) investing in a S&P 500 index fund with “safer measures” in place. You achieve both important goals: financial protection for your family and retirement savings with one policy.

Indexed universal life insurance usually comes with caps and floors. A cap is a limit on the amount you can earn, and a floor is the absolute minimum you’ll earn. A cap is typically set at 10% or 12%. If the market outperforms this amount and returns 29% (which actually happened just recently) you’ll earn 12%. On the other hand, if the market performs poorly and loses money the floor will prevent you from losing money. A floor rate is usually set at 0 to 2% depending on the insurance company and the product. Here is the in-depth analysis of 6 best companies for indexed universal life insurance.

IUL usually builds cash value at a better rate than whole life insurance does, for a much lower cost. This is similar to investing in a S&P 500 index fund is always earning higher interest rates than putting money in a savings account. The average annual return rate of S&P 500 index fund is 10.1% in the past 30 years vs. 0.5% being the average annual interest rate of savings account.

With this policy, you’ll leave a tax-free benefit for your heirs, and you can also tap into the cash value to supplement your retirement income, also completely tax free. You can withdraw up to the cost basis (the amount you spent on premiums) and then take out a loan for the rest. Both withdrawals and loans are completely tax-free, making IUL a very good investment indeed, especially for retirement savings purposes.

Compared to investing directly in an index fund, buying an indexed universal life insurance policy has an advantage of not paying long term capital gain tax when you withdraw money from the policy.  

If you buy an indexed universal life insurance policy at 30 years old, and pay $10,000 a year into the policy for 30 years, you will have permanent life insurance coverage of up to $1.5 million and access to a cash value account of $1.1 million when you are 65 years old. If you want to withdraw money from the policy to supplement your retirement income, you can withdraw up to $135,000 a year for 25 years, from 66 to 90 years old, and still have a death benefit of $300,000 for your beneficiary when you pass away. In 25 years, you will receive a total of $3,375,000 in your retirement income, completely tax free. This is the power of free tax advantage of an indexed universal life insurance policy.

Ed Slott – a renowned tax expert – on tax benefits of IUL policies

Compare quotes of 30+ IUL products

If you are interested in learning more about investing in an indexed universal life insurance for your retirement savings plan, schedule a free 30-min consultative phone conversation with our licensed advisor.

>>MORE: How to Use Indexed Universal Life Insurance in Your Retirement Planning – A Case Study

Last Thoughts

If you’re a new investor, investing in the S&P 500 is very appealing. It’s relatively low-cost and it carries less risk than picking and choosing your own stocks (which requires quite a bit of research to do well). Also consider IUL products, as they are a perfect blend of long-term investing and permanent life insurance coverage.

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