Life insurance as a bank? If you’ve never considered the living benefits of a life insurance policy, you’re not alone. The majority of people who purchase life insurance do it for the death benefit. So, it might surprise you to learn that you can use certain types of life insurance to help fund major purchases like college, real estate, or even your own retirement.
Banking with life insurance isn’t a new strategy. In fact, people have been using life insurance as a bank dating back before the Civil War. It’s even built into the U.S.Tax Code and receives favorable treatment by the IRS. Today’s best policies are backed by top-rated mutual insurance companies and can be customized with more options than ever before to fit your financial goals and budget. Here’s what you need to know about using life insurance as a bank to grow and protect your wealth.
LIFE INSURANCE AS A BANK: THE CONCEPT
Think about your current banking interactions. For most of us, we make regular deposits into a checking or savings account, withdraw money when we need it, and use banks to finance business or personal loans. When you use life insurance as a bank, you can do all of these things—but with better interest rates and tax advantages.
First, understand that in order for life insurance to work as a bank, it needs to be a cash value whole life insurance policy, ideally purchased through a mutual insurance company. This type of policy is called a “participating policy”. What makes it so special is that it earns a guaranteed rate of return PLUS non-guaranteed dividends. Other permanent life insurance policies don’t offer this, and unlike term life insurance, you don’t have to worry about outliving your policy.
With participating whole life insurance, when you pay your premium—monthly, quarterly, semi-annually, or annually—a portion goes toward covering the death benefit and any administrative costs. The remainder is reflected in a built-in savings account called Cash Value. You can make withdrawals from your cash value or you can borrow from it to finance business or personal loans at any time. Like any permanent life insurance, when you pass away, your death benefit will go to your beneficiary tax-free.
So, why use life insurance as a bank instead of a regular bank?
The biggest advantage of using life insurance as a bank is that you can recapture interest on all your loans: student loans, mortgage loans, business loans, credit cards… you name it. By taking out a loan against your insurance policy instead of a loan from the bank, you pay interest to your insurance company while they pay you a guaranteed rate of return and non-guaranteed dividends simultaneously.
Think about this: When you withdraw money from a bank savings or checking account, you cease to earn interest on that money. Of course, when you take out a loan, you owe interest on that money. But participating whole life insurance policies allow you to do both actions at once—earning and borrowing.
UNDERSTANDING POLICY LOANS
To really understand the key advantage of using life insurance as a bank, it’s important to understand policy loans. You can take out a policy loan at any time and typical factors like your credit don’t play a role in whether or not you are eligible for a loan. The only requirement is that you have sufficient cash value in your policy.
Policy loans are preferable to withdrawals from your cash value because they won’t affect your death benefit and the money you borrow is yours to use tax-free. (Withdrawals may be subject to tax on investment gains.) Even better, your policy continues to earn a guaranteed rate of return on your cash value, regardless of any outstanding loans. To put it another way, you can borrow a dollar from your cash value and earn interest on that dollar at the same time.
Other benefits of policy loans include:
- Flexible pay-back terms (if you don’t pay back the loan, the balance and interest are deducted from the death benefit)
- No paperwork or credit applications
- Interest rates typically lower than banks, credit unions, or other outside financing
- Tax benefits (Policy loans are tax-free)
- Liquidity (Policy loans can be taken out at any time for any reason, provided cash value is sufficient to cover the loan amount)
Your insurance company will charge interest on your loan, but the interest rate your insurance company charges is typically less than what a bank would charge and less than the interest on a credit card. Any unpaid policy loans, plus interest, are deducted from your death benefit when you pass away.
Here’s an example at how effective interest rates work with policy loans:
Say you take out a $10,000 policy loan and your insurance company charges 6% interest. Meanwhile you’re earning 5% interest annually from your insurance company (your guaranteed rate of return). Therefore, your effective interest rate is only 1%.
Now let’s assume the full cash value of your policy at this time is $20,000. If you’re earning a 5% guaranteed rate of return, that equates to $1,000. Subtract your $600 loan interest (0.06 x 10,000) and you would hypothetically still earn $400 in cash value. See why policy loans are advantageous compared to typical bank loans?
LIFE INSURANCE AS A BANK: IN PRACTICE
With a properly structured policy, whole life insurance can be used as your personal bank over and over again. Pay off your policy loans instead of paying a bank and use your policy to finance major life purchases, investment opportunities and more in perpetuity. Here are some examples of how policy loans can be utilized to grow and protect wealth:
Life Insurance for College Tuition
Using the cash value of a participating whole life insurance policy to pay for education can help you or your child avoid the high interest of student loan debt.
Life Insurance for Real Estate
Whether you’re purchasing a primary residence or investment real estate, policy loans allow you to remain competitive against cash offers in a seller’s market, increase your down payment, or buy time to shop around for the best mortgage rate.
Life Insurance for Business
Both personal whole life insurance policies and policies on key employees can be used to increase cash flow and business capital while creating a business succession plan.
Life Insurance for Retirement
Using policy loans to fund retirement is an interesting strategy that offers protection against market volatility and can increase your income in retirement. Essentially you access tax-free income while you’re living in the form of policy loans. When you pass away, your loans and associated interest are deducted from your death benefit. While this strategy may not leave a sufficient death benefit for your heirs, it’s a safe option for individuals without the need to leave behind a financial legacy.
At Paradigm Life we can customize a policy to fit your financial situation. Our expert Wealth Strategists are available to answer your questions and show you customized illustrations, outlining an individual plan of action to help you achieve your goals. , no strings attached.
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