Whole Life Insurance: Borrowing Against Your Policy
“If you must play, decide upon three things at the start: the rules of the game, the stakes, and the quitting time.” — Chinese proverb
So last week, Tony Forcucci at The Anthidote Report left this interesting comment on my Sitting Pretty post that mentioned the debate between Term Life insurance vs. Whole Life insurance. If you don’t know the difference between these two insurance products, then click here for a primer.
There are two schools of thought and I personally, subscribe to Suze Orman’s team with regards to term life insurance. She advises, “Keep it simple and buy term life insurance; it’s good only for a specific number of years and then expires. That’s okay — life insurance wasn’t meant to be permanent; it’s there to protect your family before you’ve had a chance to accumulate enough funds (through investments and savings) to do so.
But Tony provided a different perspective that I had never heard of or considered. I’ll let you read it first and then I’ll add a few comments below.
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First of all, I’d like to say up front to my comment that I do not sell any financial products nor do I sell life insurance. I am NOT in that business. I also recommend that anyone reading this go to their professional financial advisor for advice and not rely on this below comment as coming from someone in that line of work – I am not. Having said that I’d like to shine a light on something you may not have ever been explained about Whole Life Insurance.
Most people do not know how to approach or USE this product in the right way. There is a concept known as the velocity of money. The idea here is to use the same dollar 3, 4, 5 times. A way (maybe the best way) to do this is to do it through Whole Life Insurance. Look here:
What does a bank want? Your money. How much of it does it want? As much as possible. For how long does it want it? For as long as possible. Keep this idea in you mind as you read the below.
Most people in their 20’s or 30’s look at life insurance the wrong way – they want as much coverage for a little as possible. The reality is however that statistically speaking the chances of you dying at this age are pretty low. What you need in this stage of life is financial power to build upon. Here is how you use Whole Life Insurance to pump up your ability to grow your net worth.
Open up a $500,000 or a $1,000,000 policy and this will cost you about $6,000 to 10,000 per year in premium. Let’s use the $1,000,000 policy for my example.
In five years time, how much have you put into a Whole Life policy? $10k x 5 = $50,000. For the first 5 years, your cash value is always worth less than the amount you put in. But around year 5 or 6 it breaks even then continues to grow. OK. Now the way to approach this is to not only put in your $10,000 premium but to double fund it and put in an additional $10,000 per year (all of which is always immediately yours at full value). This is called a PUA (Paid Up Addition). Now after 5 years you’ve got $100,000 in your life insurance policy (cash value). What now?
You can borrow against this without touching your specific money. You borrow against this to purchase appreciating assets (a rental property for example).
When you borrow money from your policy you have effectively become your own bank. So let’s say your borrow $20,000 to get into a $200,000 rental. The interest rate may vary from company to company but the policy I’m familiar with lends money at 8% and rebates back to you 7% for a net cost of 1% money. Remember – you are not using your money from the policy, it is coming from an enormous pool of billions of dollars. This means you borrow at 1% while your policy money continues to work for you. You buy a rental for $20k down on $200k property. Even if this property appreciates at the rate of inflation (3%) you are ahead of the game 2%.
Buy let’s say you rent this property – now you’re doing great. On top of that you get to depreciate this property. Now you’re doing really great. Now let say this property in 5 years is worth $300,000. You are up big time all using the same dollar 3-4 times. You leveraged the purchase, you borrowed at effective 1%, you rented it, you depreciated it, it appreciated, and you sold it for a profit. It all started because you “super-funded” your whole life policy and used it as the way to acquire property, all the while maintaining its ability to continue to grow for you.
You can do this more than once. Later on in life, when you actually NEED a death benefit, the policy is worth quite a lot and when you start making withdrawals, the money comes out Tax Free (unlike many retirement vehicles such as a 401K or a traditional IRA).
The up front sacrifice is no doubt hard ($20k per year for 5 years) – but why would you want to give your money to an institution that will not let you have it back for 30/40 years? They are using your money to do exactly what I explained you can do with it.
Suze Orman and company are against a Whole Life policy because most people do not have the up front kind of money it takes to make this worthwhile (a $1,000 annual premium is not gonna cut it if you want to be serious about this). Plus Suze is certainly against the up front big commissions the salesman makes. But who cares? Look what you can do with just 5 years of putting your nose to the grind.
There are different ways of looking at wealth planning and as I said up front, you nor your readers should rely on my two cents as replacing professional guidance in this area — it’s just something I’ve come across in my world that I’d thought I’d share with you.
Tony Forcucci
The Anthidote Report
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Tony makes some valid points but I’m still skeptical. I would like to read the fine print of the company’s policy that lends money at 8% and rebates back to you 7% for a net cost of 1% money. That seems too good to be true. Let’s assume this was true then I like his “use money to make money” approach by borrowing against the policy to purchase appreciating assets, specifically rental properties.
But borrowing could be tricky so I would caution people to read the fine print and do their research. Kathy M. Kristof at The Los Angeles Times warns readers: Borrowing From Life Insurance Can Have Dire Consequences. Click on the article to find some horror stories that will scare anyone.
At MoneyInstructor.com you’ll find the same cautionary tone but agree that it’s an option if you need the money. They write:
“If you do have enough equity in your life insurance policy, you may be able to use it as collateral for a loan, or cash it in outright. As a loan, you must pay it back as you would any other type of loan. Because the loan is secured against a solid asset however, you are likely to be able to get an attractive interest rate, and this may offer you a major advantage”
“The first thing to consider is the cost of money. If you are in need, what are the alternatives to leveraging your life insurance, and what will those alternatives cost? If your credit is sterling enough and you can obtain a low-interest signature loan without using your life insurance as an asset, then take the signature loan and leave the insurance policy unencumbered. However, if the only way you can raise money is by getting advances on credit cards that carry interest rates of 18 to 24 percent, it’s likely you’ll be better off borrowing against your life insurance.”
“When you first purchase your life insurance policy, think ahead and decide whether you may need to borrow against it in the future. Policies will differ, but most will have a loan clause that will allow a loan to be taken against it for as much as 90 percent of the policy’s cash value.”
But the above is not an apples-to-apples comparison. Needing money is different from leveraging money and this is Tony’s point. I agree with him in principle, I’m just still skeptical in his specific approach. However, his idea makes me consider how my money is working for me and I’m in favor of people broadening the scope of this conversation.
I’ve run the numbers and permanent insurance (WL, EUL, VUL) can make sense if you shop for a fixed dollar commission policy and then overfund to the max the IRS allows. The math is pretty simple — what used to be X% commission becomes 1/10th the percentage. And at a certain threshold, the tax benefits (tax deferred growth, tax free loans) overcome the commissions + additional expense ratio and can produce better returns than a taxable portfolio.
However, this option still gets whipped by HSAs, 401Ks, IRAs, Roth IRAs, etc. Only go the permanent insurance route after you completely max out traditional retirement accounts and hit your allocation % for low-turnover, low-dividend index funds in taxable accounts.
I found this post timely, as I just put life insurance in place for my kids. I am posting about it on Friday, and gave a little shout out with links your way for the great info here!
Search for “Infinite Banking”. This is a concept that was originally promoted by R. Nelson Nash who continues to teach it across the country. Although students of Nash say it works best with dividend paying whole life, it works equally well with fixed, and equity indexed universal life. The key is to overfund the policy up to what is called the MEC guideline.
Lots of life insurance agents either don’t or don’t like to recommend this approach because it cuts into their commission (anything over the target premium or anything funded into the paid up additions rider is normally VERY VERY light on commissions to the agent because all of the excess is going into the policy owner’s cash value). The benefit clearly lies with the policy owner.
The low interest loans you are skeptical about are called “preferred loans”. They are legit, and are available from some companies. What they will do is if you need a loan, they will cut you a check for the amount of money you need (i.e. if you need $5,000 and you have it available in your cash value, they’ll give you a check for $5,000) and charge you, say 3% for the loan. Then the insurance company takes the ($5,000) from your policy cash value and puts it into a fixed interest account that earns 3% so that the net cost to you is 0%. Sometimes the loan interest is 6% and the fixed account that they put the money from the policy into pays 4%, so the net cost of the loan is 2%. It depends on the insurance company.
>>>However, this option still gets whipped by HSAs, 401Ks, IRAs, Roth IRAs, etc. Only go the permanent insurance route after you completely max out traditional retirement accounts and hit your allocation % for low-turnover, low-dividend index funds in taxable accounts.
I wish to respond to the reader who wrote: “this option still gets whipped by HSAs, 401Ks, IRAs, Roth IRAs, etc”. I cant tell you how many “financial advisors” have left meetings with me with their repective tails between their legs.
When we compare taxed ernings vs tax free earnings, there is no comparison. I have run illustrations where the qualified plan is earning up to 14% and the properly structured life insurance policy is only earning 7%, and the life policy beats it severely.
What people need to realize is that taxes will have the biggest impact on their retirement dollars. Financial advisors can speak of “The Time Value of Money” or inflation; however nothing will have a larger impact on your retirement than paying 15%-28% of Federal income tax.
Some believe they will be in a lower tax bracket when they retire. That is no longer axiomatic. I know of many retired people who are paying the same, if not more, income taxes then they were during their earning years. For example: they have paid off their mortgages so they no longer have that deduction, their children have grown and dont have that deduction anymore and they are no longer contributing to qualified plans so that deduction is gone. Technically they may be in a lower tax bracket; but without the deductions they once had they are paying just as much, if not more, in taxes.
For conservative long term investing, a properly structured life insurance policy will outperform any tax deferred option available. I can back it up anytime with real mathematical calculations.
Tony Forcucci and Andrew are absolutely correct! I am a Registered Rep at Guardian Life and I love the possible big gains you can get in securities! But I have to tell you, after I learned about the way the wealthy use whole life insurance, I never viewed it the same! It truly is an awesome product due to the advantages and versatility it offers. I use Roth IRA’s and retirement plans also, but a properly structured dividend paying whole life policy is a great foundation and it also creates a second estate (the death benefit)-which allows you to spend down your other assets(401k,IRA’s, real estate,etc) while you are in your prime retirement years without fear of living too long and running out of money because—-when you die the death benefit will replace your spent assets(beneficiary gets tax free benefit) and if you live longer—you now have a very nice build up in your cash values to use!!!!!
Think about it yourself and you will see…it is awesome to be able to have access to your whole principal and interest of your retirement assets instead of just living off interest/income of 5% or whatever your financial advisor tells you is safe because you don’t know how long you will live! I know its a radical concept and it took me a while to mentally adjust to it after chasing stock returns(I was a day trader)! When it comes to the protection and financial advantages of that old boring whole life policy….you will understand why the big mutual life insurance companies like Guardian are doing just fine (the company is currently paying it’s policy holders the highest dividend payout in its 146 year history!)…because the people in America who have money know where to put it—and you know that. But don’t just take my opinion or Suze tv host’s……think for yourself and check into it..read the details…and decide for yourself.
Stephen Weik
Financial Representative (Tampabay Area)
(727)254-1196
I’m actually with Guardian as well.. Small world! I think the most important thing is to make sure your Whole Life policy comes from a Mutual company paying dividends (There are only 4 true mutual companies left). The other consideration that needs to be emphasized is that that of the MEC (Modified Endowment Contract). If your insurance rep structures your policy in the wrong way, many of these tax-free benefits found in life insurance may deminish be it in year 1 or 60…although tax defferred growth developes. Otherwise, where else can you get the GUARANTEES found in a whole life contract? Not in a 401K, IRA…. etc.
And lastly, if a financial rep. is putting their commissions before their client’s’s best interest, they have no business being a financial rep.
And a thing to remember about Suze,
Suze Ormand makes some good points about families budgeting their money. But remember, Suze is not selling the American public anything other than her celebrity personality and building a following to sell books, commercial air time, and watertight boxes after Hurr. Katrina!
Andrew
alamkin@cox.net
One comment in the original posting is not correct. If cash value earns 7% dividend and loan interest rate is 8%, then, you would need to earn at least 8% from your outside investment to break even. It’s because if you kept the money in the policy, then, the money would earn 7% while you need to pay 1% for loan.
Actually, dividend for the loan amount could be lower than the rest of the cash balance. So, most likely, you need to make more than 8% from your investment to just break even.
In conclusion, his comment, “Even if this property appreciates at the rate of inflation (3%) you are ahead of the game 2%” is not correct. But then again, he is talking about 10 to 1 leveraging, so, 3% gain means 30% gain on his investment. Then, he is way ahead, provided it’s in a year.
I agree that one should “keep it simple”. The problem is what one means by “simple”. For famous radio and T.V. personalities, it means painting everyone with the same brush al la Suze Orman and Dave Ramsey…but worse than that, it means either being ignorant of or hiding the history of life insurance.
I’ve found a few instances where term may work really well. However, if a proper plan is being implemented, it is truly hard to beat whole life.
REF: http://www.twintierfinancial.com/the_uncommon_cents/2008/06/term-life.html
I’m trying to get a cash value loan from my life insurance policy. WEhat do I go into for Texas Life loan?
ncorrect spellimg on previous message. Trying to get a cash value loan from my texas life insurance policy.
Great article, I will say up front that i use dividend paying whole life as my personal banking system. There is a very important point that is left out here- you have to make sure that whoever is setting up your policy know exactly what they’re doing…you can’ just go get a traditional whole life policy from a mutual company and expect it to break even in year 5. without the correct structure and riders on the policy the policy will not break even in year 5. The policies that Suze and Dave Ramsey talk about are traditional policies not set up to be used as banking systems.
but when structured correctly you WILL break even in year 5 – even if you aren’t contributing 10k per year…i’ve seen people contribute 1,000 per year…its all about getting your money out of the tax path and into one of the safest vehicles available. Whole life gets beat up a lot because it isn’t understood, think about this: wells fargo currently has about 19 Billion dollars in cash value life insurance. Banks and corporations use this same model with their capital, must be a pretty safe bet.
Suze Orman and Ramsey would not recommend this Life Insurance product strategy because most of their listeners do NOT have the patience nor discipline to execute properly. The loan strategy is real and works just fine. Overfund the policy, get the lowest death benefit you need to qualify as an insurance product, and don’t overfund too much to change the policy to a taxable MEC. Many companies will refund your payment if it places you over the limit into a mec category…but you need to ask your agent about that. This strategy blows away the best kept secret for the FED of people using an IRA or 401K. These products benefit the Gov’t more than the individual…Taxes kill ya. Why would anyone want a product that issues a tax penalty for withdrawing money before you reach 59 1/2, or tells you when you can have access to it, and HOW MUCH you can take without penalty when you do reach retirement age?
The Whole Life strategy avoids all of that, and when you overfund, you minimize your insurance costs…remember,the death benefit is icing on the cake, the real benefit is to establish your own financial banking system.
If you want one of the best easy to read books on this subject – order “THE PIRATES OF MANHATTAN”.
You will walk away understanding the best kept secret that all the lenders understand and don’t want you to know about.
As dividends continue to fall, people with these strategies will start to realize what a mistake they have made. While some companies have reduced their loan interest rates, this ultimately further reduces dividends. Borrowing against permanent insurance risks policy collapse and reduces its performance even if non direct recognition. If having a permanent death benefit isn’t the reason for purchase, whole life is always a mistake. The fact that some are recommending this instead of Ira or 401k shows why people need slogans about avoiding permanent insurance.