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Bank on Yourself: Using Life Insurance as a Source of Liquidity

Understanding a new way to invest long-term

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The Downsides

The concept works very well for some people, but it’s not a magic wand. Even with dividends, which aren’t guaranteed, the internal rate of returns available on these policies is very modest – especially in a low-interest rate environment.

  • It’s not for people who don’t need or want a permanent death benefit.
  • It’s not for people who can’t afford a term premium to protect their families.
  • Expenses are front-loaded. The agent and insurance company can eat up half of the first year’s premium
  • It’s not for people with an unstable source of income.

Situations Where Such A Strategy May Be Appropriate

Banking on yourself could be the select strategy for people in a variety of circumstances, such as:

  • People who believe income tax rates will be higher in the future than they are now.
  • People who are concerned they may be the target of lawsuits: Life insurance cash value often receives substantial protection from creditors, depending on your state.
  • People who want to save money for college while preserving their child’s or children’s eligibility for financial aid under the federal method of calculating a family’s expected contribution.
  • People who want a portion of their portfolio allocated to modest but guaranteed growth.
  • People who like the features of a Roth IRA and who would contribute large amounts of money to one if they could.
  • You don’t want to have to wait until you’re 59 ½ to be able to access the money.
  • You want assets to bypass probate at death.
  • You expect to have an estate tax liability at death, or at the death of your spouse, if he or she survives you.

Two Dirty Little Secrets

Any decision on the part of a mutual insurance company not to practice direct recognition of loan balances creates a kind of prisoner’s dilemma: Policyholders that don’t borrow against their policies are in effect subsidizing the activities of those that do. Which means that not everybody can take advantage of this strategy and tap their policies to finance large purchases at the same time! The more well-marketed this strategy is, the less effective it will become.

The second dirty little secret is that not every life insurance agent carries or wants to carry a securities license. Which means the only solutions in their arsenal they can present to someone who wants to put a lot of money aside for the future involves overfunding whole life, universal life, variable universal life or equity-index universal life policies. When all they have is a hammer, the danger is that everything might start looking like a nail.

There is nothing wrong with the strategy in its place, for the right individual. The concept is sometimes sold to people who have trouble keeping up the premiums for whatever reason, causing the policy to lapse – a disaster for the consumer unless there is already substantial cash value in the policies – a process that could take years.

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