Be Your Own Banker by Using Life Insurance as a Source of Liquidity
If you are an affluent investor, then life insurance is definitely an investment worth considering, whether you want to make investments to secure your future or simply have an added reserve for your existing estate, as well as a solid retirement plan.
Books like “LEAP” by Robert Castiglione, “Be your Own Banker” by R. Nelson Nash or the more recent “Bank on Yourself” by Pamela Yellen go to great lengths to explain the concept of investing in life insurance as a source of liquidity, and death benefits too.
How Does Life Insurance Act as an Investment?
These books lay emphasis on the concept that a life insurance policy is an ideal investment in an economy where people pay through their teeth to general creditors, and as interest on multiple loans for a house, car or even education, no matter how financially affluent the individual and their family.
Even affluent individuals benefit by investing in various life insurance schemes that provide not only the necessary liquidity required to fund essentials such as car, house, education, but also guarantee permanent death benefits in the end. All this without accumulation of interest and paying excessive funds to banks!
Benefits of Investing in Whole Life Insurance
For individuals considering retirement planning or making investments for liquidity’s sake throughout their working career, life insurance is a great investment. Here’s how:
1. Death Benefit – Like every other insurance, it provides the main motive of an insurance policy which is a guaranteed tax-free death benefit for loved ones in the sake of a premature death.
2. Cash Reserve – A whole life/permanent insurance has a cash reserve component, which grows within each policy. It also has a guaranteed minimum crediting rate, as a matter of fact, with no risk of market loss.
3. Tax-Free Growth – The whole life insurance account grows every year in the form of compounded tax-free growth, and not the average rate of return which can be manipulated.
4. Tax-Free Withdrawals – Individuals who invest in whole life insurance can withdraw funds against the cash reserve that grows in the policy, which becomes a partial surrender to the net cash value.
5. Tax-Free Loans – This kind of loan does not reduce the value of the cash reserve but charges a standard variable interest rate.
6. Annual Dividend Payments – While it’s not guaranteed, there is a chance to get tax-free dividends year on year if the policy is through a company that’s been around for a long period, e.g. 100 years.
Even with such wonderful benefits in place, whole life insurance is really not for everybody. The entire concept of permanent (whole) life insurance is designed for a specific set of people with a set need base. Only with the help of a financial advisor can an individual work out whether it really is the ideal policy for them.
Life Insurance, Historically
Life insurance goes back to the 1980s, when farmers used the concept to make ends meet. At the time, farmers needed to borrow funds in order to purchase farmland that they then cultivated, again with the help of borrowed funds. Only with a successful crop did they manage to pay off their debts and mortgages.
In those days, aggressively saving in an insurance policy meant liquidity and a death benefit, although most farmers did not manage outlive their mortgage.
Why Whole Life Insurance Works
There are two basic points to consider here:
1. Mutually-Owned Life Insurance Company – Here, policyholders are the ones in ownership of the company and not the shareholders, and hence the profits go directly to the policyholder. This in turns boosts the company’s returns and helps to subsidize the costs of the policies too.
2. Direct Recognition – In direct recognition, borrowing happens against the general fund and not the cash reserve. Hence, this approach involves merely paying dividends on the leftover cash value after the loans have been taken out. Dividends are only paid on the leftover value and the guaranteed crediting rate.
Arbitrage Opportunity
The arbitrage opportunity helps to create affordable credit by arbitraging the difference between the minimum credit rating on the cash reserve, dividends, interest rate charged on the loans, etc., making life insurance a very affordable source of liquidity.
Downsides
It’s important to remember that everything has a downside, and the downside of whole life insurance is that it doesn’t make sense for anyone who doesn’t really require death benefits, let alone being able to afford a whole life insurance policy (considering it’s an expensive proposition with front-load expense, making it a bad idea for those with an unstable source of income).
Situations Where Such a Strategy May Be Appropriate
Using life insurance as a source of liquidity is a win-win for affluent individuals looking to make investments in order to save up and have increased access to funds (for education, housing, etc.), alongside a well-endowed portfolio that grows in value. Of course, staying protected from potential lawsuits and making provision for estate tax on death are other major draws for investors.
Two Secrets
Individuals looking to invest in whole life insurance policies must look out for two things, first, that their insurance agent has a certified securities license and is not getting you to overfund the policy only to save their own interests. Second, that policy owners avoiding direct participation subsidize the activities of those who do, which signifies decreases in terms of advantage for large purchases.