How to Calculate the Actual IRR of Whole Life Insurance (Simple Formula)

Hey everyone, welcome back to the channel. It's Demetrius, wealth strategist and team lead here at better wealth. And in today's video, we're going to be talking about one of those buzzwords that you hear a lot when you're doing a little bit of research about whole life insurance or more specifically overfunded or high cash value whole life insurance. And so when people think about the word rate of return, they're usually thinking about what their money did this year. Like was it up 5%? Was it down 10%? And in many ways, that's kind of what we're conditioned to look for. That's what we're conditioned to watch for. But when it comes to life insurance, especially policies that are designed for high levels of cash value, there's actually another number that tells you a much more complete story, which is the internal rate of return or IRR. And while that might sound a little bit technical, perhaps it's actually one of the most honest and straightforward ways to understand what your money is doing over time. So before we talk about internal rate of return or IRR, let's start with something that most people are probably a little bit more familiar with, which is just net growth percentage. In other words, when people say rate of return, they're typically thinking what happened from last year to this year. And so not to cause any confusion, but when we look at that in the example that I share with you, they're going to call that net growth percentage. So net growth percentage tells you how much your cash value grew this year after accounting for your contribution. So in other words, it answers this question. It answers how much more do I have this year than I had last year after making my contribution after putting in more premium, right? And so the formula for this is actually pretty simple. You take your cash value increase minus your premium paid, and you divide that by the prior year's cash value. So let's take a look at year 10 of an illustration. So as we can see here in this example, we have a premium outlay of $100,000 per year. And so what we're going to be doing is we're going to zone in on this 10th year, just to kind of give you an idea of how the math really works out when we're looking at this column right here called net growth percentage. So the net growth percentage, as you can see here is 5.26%. And so how do we go about doing the math there? So we see that the cash value increased by $155,103 in that year. You take that figure and you subtract it from the contribution that you made your premium outlay in that particular year. That gives you the change in cash value less your premium outlay, which is $55,103. And then you're going to want to take last year's cash value. In other words, the amount of cash value that you ended up with at the end of the previous year, which is $1,047,582. You're going to divide it by that figure. So we're taking $55,103 and we're dividing it by $1,047,582. What you're going to find is that you receive a number of 5.26%, which is exactly what you see in the illustration right here, 5.26% here net growth percentage in that 10th year. So anyone can run this calculation with a very basic calculator because it's very approachable and it doesn't take a lot of complexity to understand how it actually functions. Hey guys, I just want to interrupt real quick. If you're watching this and have an indexed universal life policy, a whole life policy, have any type of insurance policy in general. And you're like, I want to know if I'm on the right track. I want to know if this is set up properly. We at BetterWealth want to help you that we want to give you a free policy analysis and show you, are you on the right track? Is there some things that you potentially could be doing better? And so we have a link down below that you will have access to. We would encourage you if you have a policy and you want to see if you're on the right track, check that out. And if you're someone that's watching this and you're like, I want to talk to someone that may be setting up a policy for myself or I have questions, we would love to serve you. You can also see a link to have a call with someone on our team. Back to the episode. Now let's zoom out a little bit. Okay. Internal rate of return or IRR. What that does is it asks a completely different question. It asks if I put money in over time, what is the steady or the level rate of return I would have needed to earn every single year to end up with X number of cash value, right? It's pretty much like averaging out your performance across the entire journey, starting from day one. So in year 10 of the same policy, the internal rate of return, as you can see is 3.33%, which is lower than the 5.26% net growth of that same year. Why is that? It's because IRR or internal rate of return, it includes all the early years when the policy is what we call capitalizing and you're taking care of those early costs of a permanent product like life insurance. So what it shows us is a true average over time. And if you're curious about how IRR gets calculated, you can actually run it yourself as well. But instead of using a basic calculator, you'll need to use what's called a rate calculator. So what I'm going to do here is I'm going to take that same policy that we're looking at. I'm going to plug in the figures up to that point on the 15th year, right? So we were talking about year 10 before in this particular case, I'm going to look at year 15, just as an example. So in year 15, so we're talking about 15 years, we're going to keep the present value at $0 and in the payment or the annual premium, we're going to put in $100,000. The future value is nothing more than the cash value that you see in that 15th year. And so in this particular case, we're looking at $2,138,176, right? And so, voila, as you can see, we're seeing 4.31%. Just by plugging that into a rate calculator, which is the same internal rate of return on cash value that you see in year 15 of the exact same policy. So that's how you go about calculating the internal rate of return on not just life insurance, but any sort of storage of capital that you're utilizing. And I think it's important to note that because I think what can happen is when people do learn a little bit more about what IRR is, they almost as like, well, that's a calculation that the life insurance company does that I have no ability to do for myself. So they're hiding something behind closed doors. And that's not the case. You actually can with the right tool, calculate the internal rate of return on your cash as well. And it's important to remember something that I just wanted to bring back home. It's like net growth percentage and IRR are not the same, but they're also not competing, right? Net growth percentage shows you what's happening this year. Okay. IRR shows you what's happened since the very beginning. And so it's kind of like looking at your pace in a marathon versus your average pace for mile one. Both are going to tell you something that's useful, but only together. Can they give you the full picture of your race? And here's the important part. I think a lot of people end up missing, right? Internal rate of return is not a scoreboard. It's not about beating the market. It's not about comparing your policy to someone else's, because for example, your, your policy could be four and a half percent internal rate of return. Well, someone else's maybe three and a quarter, and that doesn't make your policy better than the other person because different people have different ages, different health profiles, different contribution levels, different goals. Overall, some want early liquidity. Some care about long-term legacy planning. Some care about the access and control more than they do about maximizing the return. Some people just want to balance between it all. So yes, IRR is useful. It's honest, it's measurable, but it's just one piece of the entire picture when you're looking at overfunded whole life insurance. And if you'd like help understanding what internal rate of return could look like for your situation or how we'd structure a policy around your specific goals, go ahead and click the link below to schedule a time with our team. We'll walk you through it step-by-step and help you make sense of the numbers without getting lost in them. Thanks for watching.