Posted over 6 years ago

Are These Common Myths Keeping You From Maximizing Retirement Income?

A big part of my business is helping sophisticated real estate investors learn how they can accelerate their wealth building by leveraging high cash value life insurance policies to invest in real estate. One of the first things I have to do when I'm talking to someone, is deal with these Five common misconceptions about life insurance.

Most people don't fully understand how permanent life insurance policy's work and how this is possible. Worse, even many life-insurance agents don't fully understand how permanent life insurance policy's work. They use phrases like “take money out of the policy” or “why should I pay interest to borrow from myself”.

This tells me they don’t understand how life insurance policies work. In the case above, for example, you don’t borrow “From” an insurance policy. You get a loan from the insurance company "secured by" your cash value. That’s a huge difference. Its their money they are loaning you, not yours! Again, that’s a huge difference. This is how you can put your money to work in two places at one time.

I show my clients how, if they roll their savings and/or working cash into high cash value life insurance, they can literally put their money to work in two places at one time by taking advantage of policy loans. The cash value on the life insurance policy earns dividends/interest even while it is serving as collateral for loans that can be invested in real estate. It doesn't take a financial rocket scientist to realize that this strategy can build wealth faster. They’re “double-dipping” so to speak.

Permanent life insurance stands on its own merits as a Retirement Planning tool. It makes sense before you even consider the fact that you can use it to accelerate your wealth building by leveraging the cash value as I've described.

These following Five myths are the first “Buts” I hear from people who have negative opinions about life insurance or just don’t fully understand how it works. Unfortunately for them, they are all wrong. Many of these myths are perpetuated by unsophisticated personal financial gurus who do their audience a massive disservice by perpetuating these myths. They are much better at marketing themselves than they are at finance.

Myth 1: “Whole life insurance is a rip off!”

First off, there is a huge difference between a traditional Whole Life policy and a high cash value policy. To understand why, you have to understand how a permanent life insurance policy works. Your premium dollars in a permanent life policy are essentially going to two places: first, the insurance company is using part of the premium to purchase a one term life insurance policy on you. That policy covers the risk to the insurance company in case you die within the next year. Second, the rest of the premium is conservatively invested and represents the “seed” that will grow and a compound over your lifetime to ultimately equal the death benefit when you reach your normal life expectancy. This money actually belongs to the policy owner. The insurance company is “Buying Term and Investing the Difference” for you. This is a bit oversimplified, but it is the essence of what is going on under the hood.

The insurance company is going to great expense to underwrite each policy. As a result they typically limit the policy owners access to the cash value during the first 10 years of the policy. So while it may not look like there is cash value in the first couple of years, it's there. The account has cash value and is earning dividends/interest, it is just not accessible to the policy owner at first.

Myth 2: “It takes forever to build up cash value”

A high cash value policy is an entirely different animal from your typical “whole life” policy. Instead of slowly growing the cash value over a lifetime of premium payments, this type of policy is stuffed full of cash up front so that the policy owner doesn't have to make premium payments for the rest of their life. It’s the same “seed”, it just doesn’t need a lifetime of constant additions to grow and equal the death benefit.

I typically design policies so that the owners are converting their existing savings into life insurance cash value over a five-year period. This kind of policy design allows for immediate and substantial cash value. Up to 85% of the premium may go straight to the cash value account.

While this 15% “load” may seem costly, you must keep in mind that the policy owner has access to a policy loan secured by the cash value. This gets far more cash value working and earning interest/dividends than a typical policy design. Additionally, because of the tax advantage of cash value, the cash value can provide much more Retirement Income than you could get using the typical “4-percent” rule many financial planners use. Its not the ultimate size of the account that matters, its how much income you can derive from it that matters.

Myth 3: “The returns on life insurance are too low”

When I scan the industry, I see current dividend rates from roughly 6% up to over 8%. That’s a heck of a lot better than CD’s and bank rates! And don't forget that the cash value is in a tax advantaged environment. If you are in a 25% tax bracket, for example, you would need to earn 8% in order to net 6% after paying income tax. You would have to make 10.6%, in order to achieve 8% after-tax. 10.6% in a principal-protected asset? That doesn't seem too bad to me. Outside of real estate, there are very few places you can earn a return that high. This is doubly true when you consider the risks you would normally have to take to earn that kind of return.

Myth 4: “Why would I borrow money from myself?”

This is the hardest myth for most people to understand. Again, policy loans are loans that are secured by the cash value. The life insurance company is literally loaning you their money. Your money never leaves your account at the insurance company. You're not borrowing from yourself. Period. You're not paying interest to access your own money. Anyone who tells you different is wrong. Your money is still in cash value and busy earning dividends.

One of two things are going to happen:

  • You pay back the loan plus interest due, or
  • Two, you die and the loan is paid back from death benefit reducing the net amount of death benefit available to your beneficiary.

Now, if you have cash value that is earning interest at 6%, for example, and you take a policy loan at 6%, then anything you put your money into that makes more than 6% is adding value on top of what you are earning on your cash value.

Most people that are only aware of typical "Wall Street" investments, would probably never risk borrowing against their cash value to reinvest in something else. They shouldn't. This is not for them. Real estate investors, however, know that they can safely invest their money and make double digit returns. For them, this arbitrage opportunity represents a tremendous advantage.

The marginal increase in income may not seem like much at first glance, but even 1% or 2% makes a huge difference when compounded out over time. The "Rule of 72" is the most powerful rule in finance. How many times can you double your money over your lifetime?

Myth 5: The life insurance company keeps the cash value when I die

As I stated earlier, part of each premium goes towards the cash value of the policy. And as I further explained, the cash value represents the "seed" that will grow and compound and ultimately equal your death benefit someday. If you live to your normal life expectancy, you will have essentially saved up your own death benefit. The cash value is a component of the death benefit.

I also stated that the cash value belongs to the policy owner. So the policy owner has several options:

  • Understanding that it will reduce the death benefit for the beneficiary, the policy owner can spend the money themselves during their own life time via withdrawal or policy loan. Or,
  • The policy owner can do nothing and the cash value will be transferred to their beneficiary tax-free. This is extremely valuable in cases where the estate would normally be subject to estate tax.

Normally, policy loans are used to provide retirees with tax free income during retirement. Because the cash value is earning interest even while policy owners are taking loans, it is in essence a tax-free distribution from the policy. The loan interest is simply offset by the gains on the corresponding amount of cash value . It's a wash.

Comments (2)

  1. Thanks Gary, I sounds like you are pretty familiar with whole life policy design for maximum cash value :)

    I'd be happy to discuss options for you if you have specific needs. Simply put, you have to be able to qualify for additional insurance death benefit. Since most people do not have enough life insurance, this is seldom an issue. But assuming you can justify the additional death benefit increase, the insurance company will want to take a fresh look at your health before they issue a policy. There are riders that allow you to automatically increase the DB, but those really don't increase fast enough to work for this application.

    A Universal Life has a lot more flexibility to allow for additional premium once you are past the first 7-pay period in a fully overfunded policy.

  2. @Thomas Rutkowski

    Great post Thomas, I look forward to more from you on strategies for using whole life policies to juice returns.

    Maybe a comparison of using whole life vs the refi-till-you-die approach and how it is a much safer approach since payments back to your insurance policy are not required and do not hurt your credit when missed - if you find yourself in a bind form a life-altering-event.

    I would also like to read your description of a base policy and term insurance to boost the limit of paid-up-addition rider to allow for a larger cash infusion at the beginning. And,  follow-on article for what can be done with the term policy after 7 years to expand the upper value limit again without need of an additional medical physical.

    Please keep the posts coming!