How to Use Whole Life Insurance as Your "Own Bank"
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- Опубліковано 14 лис 2023
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#Finance #WholeLife #Insurance
This isn't technically a scam. It's just not an apples to apples comparison. In order to make it a fair comparison, you had to have a whole life policy, which means that on the left you had assets! And you could have borrowed against those assets using an asset backed line of credit! And you could have chosen when to pay that back! And those assets would have kept growing/compounding while you were borrowing the money, just like in the Whole Life policy example! And, and this is the kicker, no matter what the market is doing, over the long run, those assets will grow faster than the cash value of the whole life policy. Also, if the thing you bought was an investment, you get a tax deduction, which do you get that with the whole life policy?
Fine, you say, you will get a whole life policy for the short run. Nope! That doesn't work either. See, in the short run, you won't have any cash value in the whole life policy, unless you overfund it. Fine, you will overfund it. Ok. Hope you like being poor! Because the insurance company is taking out fees. Those fees might seem small. Say they are only 1% annually of the assets. (BTW, how do you think the life insurance company is making your cash value go up? They are turning around and investing it, in EXACTLY the same assets you could have invested in yourself, like public markets and low cost stock index funds.) Well, if you do the math, 1% annually over say, 30 years, yeah, that ends up being almost a third of your wealth! (It turns out it doesn't matter when you take the money out... For more info, google "safe withdrawal rate" and you'll see that 1% is about a third of everything that's safe to withdraw!)
Whole life has a place in your financial toolbelt. It's an obscure tool that's mostly useful for obscure situations, like niche estate planning for very wealthy folks. It's mostly a product designed to be hack to get through loopholes in the tax code that were closed in the 1980s under Ronald Reagan. It's mostly not a useful tool any more. That's ok. Today, we have low cost stock market index funds and new tools. Tools that don't back you into a corner and tie up your money in high cost products for your entire lifetime.
Life insurance companies cannot invest in the stock market, btw. They have legal reserve requirements, so everything they invest in must be liquid and safe, so they typically will invest in corporate and government bonds. Even their indexed products (say IUL or Indexed Annuities) are NOT invested in the stock market. They invest in the bonds, then use the guaranteed coupon payments to buy stock options.
Tax deduction? Only in a traditional retirement account, which is not even close to a similar comparison here with all of their restrictions.
Yes, you can get an asset-backed line of credit. Yes, you can get a HELOC. They will function in very similar ways. The biggest difference is that whole life insurance will always increase in value. You are borrowing against an appreciating asset, not a volatile asset. And, you can do this with much less money than you typically would beed for an asset-backed line of credit. Even a 401k loan is somewhat similar, but you usually have to sell the assets to get the loan, thus actually defeating the compounding. The flip side of that is the interest you pay is actually put into your 401k account.
This is not supposed to be looked at as an investment, but rather more like a savings account. 4% tax free on cash long term? That seems pretty good for the person who wants their cash growing in a safe spot. Sounds terrible for an investment, because it is. This is a great tool for the right context.
@jonasmeyer411 You got most of it right. To address your first point, you can leverage a whole life cash value as collateral for a loan with the bank, yes you are giving up control over loan terms; however, the collateralized asset is the general account of a highly rated insurance company which enables you to get a very low interest rate on that loan. Since its a 3rd party and not a direct policy loan, the interest can be deductible if used to purchase an investment (direct whole life policy loans are never tax deductible). Back when mortgages were around 3% (2021), I was presented with a few options including a 5 year 2.75% loan through M&M Bank which was unheard of when finding capital to purchase non real estate assets. Unlike an asset backed loan with underlying assets tied to the market, the cash value never goes down so you will never be assigned or required to put up additional capital if the assets in your asset backed line of credit lose value.
Secondly, the fees for a cash value policy are applied to the premiums that are paid into the policy, not the cash value itself. Once the premiums have filtered through into cash value (ideally as over-funded paid-up additions), the cash value grows at the dividend rate provided by either the contract or the company's stated dividend rate (if a mutual company).
At the end of the day, I can't find a better asset-backed loan than one that is backed by whole life.
Question about how does recognized and non-recognized rule affects compounded interest on whole cash value ? are they different ?
In a non--recognized contract, the policy's interest/dividends don't change regardless if you take a policy loan or not.
In a "direct recognition" contract, the policy's interest/dividends is adjusted to reflect either the surplus or deficit the insurance company would be incurring if you were take out a loan. For example, a policy with a 5% dividend could have a guaranteed fixed interest rate of 8% (there can be a lower variable interest rate, but we'll just used the fixed rate for now). If you take a policy loan, the insurance company direct recognition contract acknowledges that they are charging you 8% interest and will adjust the policy's dividend to something like 7.75% with the 0.25% spread representing the cost of servicing the loan. The inverse can also be true, if the variable loan interest rate is say 4%, they'll reduce the policy's dividend to 3.75%.
I've heard arguments for and against both. I prefer direct recognition because I'd rather have a more financially sound insurance company than being able to play games to boost my returns (plus i would do a 3rd party collateralized loan instead of a direct policy loan, but that's just me). Direct recognition prevents the insurance company from taking advantage of policy holders and prevents policy holders taking advantage of the insurance company from profiting on the spread between the policy dividend and policy loan interest.