The Misunderstandings of Whole Life Insurance

Posted By: Jason K. Powers ICOR Blog & News,

I could write a whole book on how many ways Whole Life insurance gets misunderstood. Fortunately, others already have! Assuming you have a basic understanding of the fact that one can borrow against the cash value of a whole life policy, this discussion will make more sense. I would encourage the reader to go back and read previous articles on IBC and Whole Life either way.

Interrupted Growth & Paying Interest

Someone once said to me, “Why would I want to borrow my own money and pay interest on it?” Valid question. Answer: You wouldn’t want to… necessarily. Fortunately, that is not really how it works inside a properly structured policy. Conceptually speaking, what is happening is that you are borrowing “against” the cash value of your policy. You are not borrowing “from” the cash value of your policy.

The Scenario. Maxwell calls his insurance carrier and asks how much cash value he has available to borrow against. They look at his cash value and tell him he can borrow $188,000. Let’s say he borrowed $20,000 and the carrier is going to charge him 5%. It is an unstructured loan, so they let you decide how much and how often you are going to pay that back. Now you think to yourself, “I can get a loan for Bob-The-Loan-Guy for 3% so why would I borrow from here?”

Defining the terms. Uninterrupted compounding is the basic principle where something (your money), and its gains, are growing continuously on top of each other over time. Contrast that with standard compound growth where each time you pull money out, or investment growth declines, that growth is interrupted. Inside of your policy, the cash value is growing uninterrupted. That’s why we use the term ‘borrow against’ instead of ‘borrow from’ when talking about taking loans inside a policy. Since they are loaning you their money, yours will continue to grow uninterrupted.

Back to the story. Our friend, Maxwell, borrowed $20,000 against his policy. But he was 8 years into the life of his policy and it was projected to grow by $25,000 that year. In nearly all outside situations, qualified money included, when you borrow $20,000 from a pile of money, you have then interrupted that growth. Logically, it would only be growing off the remaining $168,000 in the policy, but in fact, it is growing off of the original $188,000. In this scenario his policy grew from $188,000 to $215,000 that year ($27,000 growth!). He was paying a premium of $20,000 per year, so his net growth was $7,000.

Maxwell could have borrowed the entire $188,000 and his policy still would have had a net growth of $7,000 that year. This is the power of uninterrupted compounding. Also, it should be noted that the $7,000 in growth is not taxable by the IRS when used properly.

Maxwell made out in a few ways.

  • uninterrupted compound growth in his policy
  • tax free growth happening inside of his policy
  • loaned his real estate investment business the money thus was able to deduct the interest
  • paid himself back instead of a bank & recaptured that money to use over and over
  • had an unstructured loan to himself and decided his own loan terms
  • had a substantial death benefit tied to the policy that would pay everything back if he had any outstanding loans with plenty left over to leave a legacy
  • will build up a large enough cash value to retire off of his policy, instead of a qualified account

Where else can this be done? Let us show you how.