Talk to your friends, coworkers or even family members about money and their financial plan for the future, and there is a good chance that the topic of life insurance is not coming up in the discussion. I have found two main culprits that I pose as reasons for this. The first is simple and understandable; most people just don’t like to think about their own death and mortality, let alone talking about it with friends and coworkers. The second reason is that life insurance isn’t sexy to most people. It is viewed as just another bill that would come out of their account every month which provides no “in the moment” sizzle or benefit, unlike the latest stock tip or hot new mutual fund which carries the potential of big, immediate returns. To most people, insurance is synonymous with the phone bill or cable bill. We need to change this type of mindset as it is flawed and inaccurate. The truth is, by dismissing life insurance as just another bill, you are seriously missing out on the many financial benefits a permanent life insurance policy can provide while you are alive, specifically cash accumulation, dividends, tax advantages and the ability to produce multiple income streams. In essence, your policy would not just serve as protection against the unexpected, but also, now a serious financial asset that is a key component to any solid portfolio or financial plan. It is time to open your minds to the all the wondrous potential that building your own bank can offer.
How it Works:
You will recall in part two that we discussed the difference between a temporary (term) policy and a permanent policy. Remember that with a permanent policy, no matter if it is Whole or Universal, the premium you pay not only provides death benefit protection, but also allows you to accumulate cash value in a totally separate ledger within the policy. This cash value builds up and grows over time based off of a determined interest rate, and you can use it at your desire while you are still living. The interest rate and manner in which the cash value grows depends on the type of policy you are contributing to. Some Whole Life policies even pay dividends on top of the normal cash value buildup in a given year, which adds even more equity and liquidity to your policy. If you don’t want the dividend put back into your cash value, you can always have the insurance company mail you a check at the end of the year. Your advisor/agent should be able to help you figure out which type of policy and option best suits your goals and needs.
The beauty of this type of asset comes when you decide you want to use some of the cash value that you have built up in the policy. Any of us who have ever tried to get a personal loan from a bank or try to finance a major purchase, know what a hassle and torturous process it can be. Not only do we have hope that our credit score is sufficient, but we also have to worry about loan terms and high interest rates to pay back. If you have “built your own bank” through a permanent life insurance policy, however, you won’t need to go through any of this hassle. It is YOUR money, and there are a variety of different ways to withdraw/borrow the money and to pay it back to your policy if you choose. It is this flexibility, combined with tax benefits that make it a wonderful alternative to regular banks or pulling money out of other assets/investments.
Taxes – A big advantage of a cash value life insurance policy is the tax treatment of the money you withdraw/borrow. Life insurance policies build up cash based on interest rates and dividends, however in most cases, you are not paying taxes on the money you are withdrawing from the policy. The federal government views withdrawing money from your insurance policy as a use of your premiums that you already paid, and therefore those monies are not taxed. Keep in mind, there may come a time when you take out so much of the cash, that you are dipping into the interest/gains that have been paid to the policy, and that money will be taxed. But for the most part, you will not be taxed on any money you withdraw up to the amount of premium you have already contributed. The first money that comes out in withdrawal is considered the premium and the later money down the road is what is considered interest. It is this “First in First Out” taxation method (FIFO) that allows life insurance policies tax advantages over other investments/assets in which the opposite is true.
Withdrawals – This is a simple method in which you just remove a portion of your cash value from the policy. By doing this, you reduce the cash value and also the death benefit. At times, depending on the policy, the death benefit can get reduced as much as dollar for dollar based on your withdrawal, and even more in some instances. It is important to understand the impact that a withdrawal will have on the face amount of the policy that will be paid out upon death. Again, your advisor/agent should be able to make you aware of this impact.
Policy Loans – This is probably the most common, and most recommended method for using your cash value in the policy. You simply are taking a loan for a specified amount of money, and then paying it back over time. The interest rates vary depending on the type of policy, but tend to be a little lower than banks, credit cards and definitely lower than some of those high interest rate personal loan institutions that are all the rage these days. The beauty comes in the different options with which you can decide to pay back the loan. You can pay a monthly installment of both principal and interest like a normal loan. You can let the interest be paid out of the remaining cash value in the policy if you don’t feel like paying out of your pocket. You can even just pay back half of the loan if you want. What bank is going to allow you to do that?? Keep in mind, this is YOUR policy, so you don’t even have to pay back some or even all of the loan. However, any unpaid loan or interest will obviously decrease the future cash value and death benefit that gets paid out when you die. This is not something I recommend, but it just goes to show that many options are there if you need them depending on the circumstances. The most important point is that once you pay back the loan, THE MONEY IS BACK IN YOUR POLICY CASH VALUE TO BE USED AGAIN AND AGAIN in a similar manner. IT IS YOUR MONEY STILL. IT DID NOT DISAPPEAR OR GO TO THE POCKETS OF TD BANK OR WELLS FARGO! You can see why building your own bank and using a permanent insurance policy to fund investments or major purchases can be a great alternative to banks and other assets. Let’s take a look at a common real world example to illustrate.
Using Your Cash Value: A Real World Example
The process of buying a car can be painful in many ways, from getting the hard sell from a pushy salesman to having to negotiate numbers and haggle with the finance manager. The final numbers can cause the most pain, as depending on your credit score, the interest rate can be anywhere up to 13-14% when you finance the car. Let’s look at an alternative to financing through the bank and, instead, use the cash value from your insurance policy. Picture yourself on the car lot and after all of the searching and research and test drives and number crunching, you have finally found the car you want. After taxes and tags etc, the final purchase price comes out to $20,000. Let’s assume, for argument’s sake, that you have decent credit (call it a score of 700) and to finance it through the bank/dealership for 48 months, you are being charged an interest rate of 7.5% apr for a monthly payment of $483 per month. This is not too bad, although these numbers will change with a lower credit score, but for now let’s do the math:
$483 x 48 months = $23,200
In other words, at the end of the day, after the car has been paid up, you will have paid $23,200. Good news, after four years, you own the car. But let’s take a look at how those numbers would look if you used your cash value from your insurance policy. Instead of financing through the bank, you decide to take a policy loan of $20,000 out of your cash value. The insurance company interest rate varies by company and type of policy, but 6% is a good average number. So you walk in, pay the $20,000 for the car and drive off. Now the business of paying back the policy loan comes into play. Keep in mind, we can create a flexible payment structure to reflect a variety of different terms and options, but for now, let’s assume the same time table. We will be paying back this loan over the same 48 months. Now with a $20,000 loan and 6% interest rate, you will be looking at about $470 a month for 48 months. Obviously the point of this example was not to illustrate the $13 a month difference in payment, so let’s do some more math:
$470 x 48 months = $22,560
This doesn’t seem like much of a difference either, right? At the end of the 48 months we will have spent $22,560 for the car, not even a $700 difference from financing it. The difference lies in what happened to that money that we paid. By financing the car, we are paying the bank $23,200 over four years. That money is gone, and we will never see it again. USING A POLICY LOAN, WE ARE PAYING OURSELVES BACK THE ORIGINAL $20,000 THAT WE TOOK. THIS MEANS THE MONEY IS STILL OURS TO USE AGAIN! The only amount that actually was lost for us was the interest that we paid to the insurance company for the loan. The rest of it went back into our insurance policy cash value.
$22,560 – $20,000 = $2,560
So if $20,000 went back into our policy and is ours to use anytime we want, THE ONLY REAL COST OF THE CAR, AT THE END OF THE DAY, WOULD HAVE BEEN $2,560, which represents the interest to the insurance company. Now, once it is paid off, you can use the $20,000 for something else if you would like, maybe a down payment on a home. This is a simple, yet strong example of the power that your accumulated cash value has when used to invest and make large purchases. Think of the world of possibilities that exist out there using this method. This is what is so exciting about the concept of building your own bank. Whether you are buying real estate, investment properties, starting a business, buying a car or paying for your kids to go to college, having your own bank with which to draw funds from to finance these purchases makes life a lot easier in the long run and allows you to grow more and more equity and net worth over time. In the fourth and final part of this series, we will look into contribution amounts to fit your budget, and also some more advanced ways to use your permanent life insurance policy to build wealth, create multiple income streams and finance the life you have always wanted for yourself and your family.
Peace and Wealth 