When people hear an advisor say, “You can take money out of your policy and still earn interest on it,” they are inclined to think that the benefits of a permanent, cash value life insurance policy are too good to be true. And rightly so. It does on the surface, seem too good to be true, but I have found a useful way to illustrate this policy concept that makes the benefit easier to understand.
A Policy is Like a House
If you purchase a home for $100,000 and then it appreciates to $200,000, you have two primary ways of accessing the $100,000 increase in value. First, and most common, is to sell the property. Depending on your objectives this may be the best strategy, but there are at least three drawbacks to this approach.
The first drawback is; you have created something called a “taxable event”-it sounds as bad as it is. To the IRS, you have realized your gain and now it’s time to share your winnings with Uncle Sam. Second, you now cannot enjoy the use of the home, whether that is living in it or renting it out for income. And third, you forgo any additional future appreciation in value.
What if I told you there was a way to gain access to the $100,000 increase in property value without paying taxes, giving up use of the property, or losing out on future appreciation? It would sound too good to be true, right?
Here is how it works: if instead of selling the home, you decide to refinance and cash out the equity or use a home equity line of credit (HELOC). You can take 100% of that gain (subject to what lenders will lend to you) because you have not sold to create a ‘taxable event’. In the US tax code, loan proceeds are not considered taxable, even though to you, proceeds are gains from your investment. Because you still own the home, you can still live in it, rent it out, and are able to enjoy any and all future increases in market value. In short, the additional loan balance does not affect in any way how much you can charge for rent or the rate at which the home appreciates in value.
Borrow Don’t Sell
This same logic applies to the cash value in your whole life insurance policy. When your policy cash values increase (think appreciation), then you have two ways to access it. You can surrender the cash value (think sell). Just like with a home this “sale” attracts the attention of the IRS and they could soon be knocking on your door. Or, you can borrow against the increased value via a policy loan (think HELOC).
It’s important here to understand that in the latter case, you have not taken the money out of the policy, but have merely borrowed against the value (just like a HELOC). Because loan proceeds are not a taxable event, the tax collector is off your back. Since you have not sold the asset, you get to continue to enjoy the future benefits. For cash value, this means you get to still collect your annual dividend and enjoy the future growth of the policy. Just like a home refinance, you have not done anything to affect the future benefit potential of the asset.
Hopefully this analogy can help you understand how it is possible to ‘have your cake and eat it too’ by being able to access your policy’s cash values without interrupting its dividend and growth.
If you would like to know how to set up a permanent, cash value insurance policy with these benefits, or when it would make sense to use a policy in this way, contact one of our experiences agents by clicking here.
Brad Gibb
