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Hi smolkod,

Does anyone have an opinion on using life insurance annuities as a vehicle for saving - for vacations, emergencies, college tuition, just about anything?

Annuities are generally (always?) offered by life insurance companies, and of course cash-value life insurance is offered by life insurance companies, but its not common to refer to either product by the combined term "life insurance annuities."

Is your friend actually recommending annuities, or cash value life insurance... do you know?

He claims there is no risk,

Risk is like energy, it cannot be destroyed, only focused, repositioned, or dispersed... but it is always present in one manner or another.

you can always make 4% per year with the ups and downs of the stock market. Is that really true?

Maybe. There are longterm fixed annuities offering crediting rates at or near the 4%s....

There are also fixed rate cash accounts in cash value life contracts offering a guarantee of 4-6% (depending on the product.)

There are no market loss risks... but this is because the insurance companies hold sufficient statutory reserves to contractually guarantee that they are protecting you from the market risks (same as banks with CDs and guaranteed investment contracts.) The risks to you, therefore, are not tied to the market, but to the strength of the insurance companies directly, and to the state insurance association (which holds reserves as a backstop for the local companies) indirectly.

Cash value insurance contracts that offer strictly fixed or indexed crediting rates are required to be backed by no less than 90 cents on every depository dollar (as opposed to banks, which are only required to carry reserves of about 10 cents on the depository dollar.) The highest rated insurers carry 105 cents to 125 cents liquid reserves for every depository dollar... so the safety against market loss is near absolute, and the safety against company (and backstop association) failure is generally strong.

Of course, TANSTAAFL, and the way that the insurance companies generate enough internal returns to both pay out higher rates than you'd get on a DIY basis, *PLUS* cover the costs of keeping sufficient reserves to guarantee you against market downsides, requires long-term illiquid positions on their internal trading account. Since they bleed when their long-term trades are prematurely unwound to liquidate for early withdrawals, they pass the costs on to the account holder in what are known as "early surrender fees" if the customer pulls more cash, more quickly, than a predetermined amount that the insurance company can safely liquidate without costs.

Surrender fees are usually declining over a period of time... from 3-15 years, depending on your product selection (with the longer commitments naturally offering the higher rates of returns.)

Fixed insurance products are also usually front-loaded on their business/admin/sales costs, but end up generally cheaper (or a lot cheaper) than equivalent alternatives that charge as-you-go *IF* you stay the course and stay to the product plan and design. There is a trade-off in rate of return versus time commitment of liquidity. If the plan doesn't fit your liquidity needs, and you unwind it too early, it can end up very expensive.

Is that helpful?
Dave Donhoff
Leverage Planner
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