Effects of deductions versus distribution costs

When an insurance intermediary tries to sell you a policy, he/she will have to show you the benefit statement (BI). Both the effect of deductions and the cost of distribution figures must and must be found and accurately reflected in the BI.

Most brokers don’t want to talk about the consequences of deductions because it always paints a very bleak picture of the true cost of the insurance policy. Most agents prefer to illustrate distribution costs when questioned by their prospects.

Cover the distribution costs:

– the total commission paid for the policy to the broker and his agency for the next 5 years (depending on the commission structure)

– the insurance and administration costs for taking out and preparing the policy

Consequences cover deductions:

– distribution costs (as above)

– death costs and general costs for your insurance cover

– selling fee for ILP funds (for ILP only)

– annual management fee for ILP funds (for ILP only)

– all other annual or monthly fees (for ILP only)

– also consider the opportunity cost of the fund that you could have grown if you left it in an investment with the same growth minus the costs

You should now realize that the effect of deductions is an extremely important factor to look at when choosing between Investment Linked Policies (ILP).

Some oppose the use of securities deductions as it also takes into account the opportunity cost of the fees paid and annual valuation. Some financial advisers believe that makes the numbers appear exaggerated.

My take on this is that what you save on should be included as it will help you accumulate wealth. That is essentially what the time value of money is all about.

That said, I wouldn’t recommend comparing ILP to traditional policies as ILP will look unfairly expensive. There are additional annual management fees and costs to sell the underlying funds, but at the same time there is much more upside potential by comparison. When choosing between a traditional and an ILP, one should not use the effects of deductions or distribution costs, but instead look at the product characteristics.

In short:

– If you’re just looking at investments, go straight into stocks or Unit Trusts if you don’t have a lot of money. It is pointless to go into ILP and let insurers earn the insurance coverage and be served by agents who are better at insuring than investing.

However, if I was buying insurance for my retirement and protection, I would choose an ILP over a traditional plan.

– Flexibility to withdraw money if needed

– Looking at a 20 year time frame for any given period, the stock market will definitely outperform 3-4% of a traditional policy.

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So personally I would

– use term life insurance to cover my protection needs until I am 65 or when my dependents become financially independent

– ILP for disciplined saving and growing money for my retirement needs over 20 years later. In the last 5-10 years I will move to less aggressive funds and at least 50% in bonds and fixed income.

A final caveat: Some insurers don’t charge a sales fee, but charge significantly higher annual management fees than the market to distract and confuse consumers. However, when you look at the effects of deductions, everything is taken into account and you can compare costs effectively and accurately