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    Letters to the Editor

    To the Editors:

    I thoroughly enjoyed Peter Katt’s “Variable Life Illustrations and the Problem of Stock Volatility,” (July 2005 AAII Journal) and I wanted to share my opinion on a similar product being sold to many small business owners.

    The product claims to be an alternative to allow small business owners to have a deferred comp plan through variable life insurance. In my past and current job, I ran across “employee benefits” professionals who advocated the following insurance scenario:

    • Over-fund a variable life policy,
    • Reduce the insurance component to the legal minimum,
    • Take out withdrawals (loans, I think) tax free, and
    • Maintain the necessary insurance and keep the policy funded.
    The problem seems to be that when the policy gets “cash lean,” the inevitable down market (volatility) could force a person to have to fund this policy to keep the policy active (avoid taxes).

    When I asked the sales person about the volatility, the answer was simply that you have to think about the long run—and they kept repeating that the long run return is 8% to 10% for the equity markets. I do not think that they quite understand volatility and its impacts on a cash lean policy. If you are running cash lean for five to 10 years, you are going to have problems. It seems that if someone ran a Monte Carlo analysis of these policies, it would reveal that “the king is not wearing any clothes.”

    If I am missing something I would greatly appreciate knowing it, but it seems that these “retirement life insurance” products have a potential to “blow-up.”

    Steve Reh
    Via E-mail

    To the Editors:

    I wish to comment on Jonathan Guyton’s “Withdrawal Rules: Squeezing More From Your Retirement Portfolio,” (August 2005 AAII Journal).

    The main problem I have is his assumption in Table 4 that his portfolio will have a return of 3% in excess of inflation for years 2004 to 2012. Based on the past five years, this seems overly optimistic. To put the following information into perspective, I have been retired for a couple of decades and am 83 this year. We are New Jersey residents in the New York metropolitan area. I am fortunate to have a defined-benefit pension, and neither my wife nor I have had major medical costs in the past five years. Also, our lifestyle has remained relatively constant during this period.

    I have looked up data for the past five years and determined the five-year change for six categories of expenses that remain fairly constant (as opposed to optional items, like major purchases): food (+16.9%), state and local taxes (+19.1%), medical costs not paid by Medicare (+15.9%), utilities (+7.1%), home and car insurance (+11.1%), and gasoline (+16.3%). The weighted overall increase in these six categories is 15.1% in these five years.

    My sources to fund these basic costs have not kept up. My pension has had a slight adjustment, but is only 116% of these basic costs in 2004, versus 132% in 1999. Social Security payments (after Medicare deductions) have gone up just 10.8% in these five years. The stock market has done poorly, with the Dow up 11%, but the S&P 500 down over 9%. I have a professionally managed IRA with about 40 stocks and a 1% commission, which has decreased in value 24% from the end of 1999 to the end of 2004. (My average required annual minimum withdrawal was 5.7% during this period.)

    So how do we cope with the cost of living going up faster than income?

    It is by being more careful with optional expenses. We have two cars, and typically keep a new car for 10 to 12 years. Currently, there is much anguish over gasoline prices, but for us, gasoline cost is inconsequential. With the amount of driving we do, care maintenance costs more than fuel. The Bush cuts in federal income tax have also helped.

    My point is that it seems impossible for us senior citizens to keep up with recent inflation, and all signs point to increasing inflation resulting from the recent doubling of crude oil prices as happened in the late 1970s.

    James D. Bushnell
    Via E-mail