Borrowing from accumulated cash value

[fud10]

I feel like I already maximize my available tax advantaged investment vehicles (Roth, employer sponsored retirement savings plan, etc) and I already have both term and whole life policies. I am employed now but expect to be self employed several years in the future. I also expect the need to borrow money from myself; when opportunity knocks I like to have dry powder. I'm entrepreneurial by nature, but business loans involve red tape and personal loans aren't the best rate around. I'm attracted to the idea of tapping into the accumulated cash value of a permanent life policy as a loan to myself, but when I started my current whole life policy, my only goals at the time were diversification away from the market while also grabbing a healthy death benefit. Borrowing from it wasn't on my radar. To that end, the accumulated cash value earns at 4.5%; however, borrowing from it costs 7.4%. Clearly this isn't structured in a way that it would EVER make sense to borrow from my whole life policy unless it was my absolute LAST option and I couldn't qualify for ANY other type of loan. Borrowing from my whole life policy offers me only flexibility, but at the cost of an 11.9% spread. That is pretty barfy. If my objective for an additional policy is to beef up the total death benefit to my beneficiaries while also being able to "be my own banker," is universal the way to go? It seems like there are a lot of different flavors of universal, and it's not as simple as deciding between VUL and IUL. I have a harder time doing an apples to apples comparison between companies since the universal policies appear to have a lot more variables to compare than whole life policies. If universal is the way, I'd appreciate any recommendations where to find a policy that aligns with my intent: to increase the death benefit while being able to borrow from myself in the most favorable terms possible.

 

[sonriseforever]

@fud10 IMO, WL is the way to go, primarily for the reason you mentioned; diversification away from the market. If you go with VUL/IUL you're just putting everything right back into the market, and if there are some down years when you get old the policy could blow up.

Who is your current WL policy with? 7.4% borrow rate right now sounds very high. Most of them are at 5%.

Even if we use your example, though, consider the difference between paying simple interest vs. earning compound interest.

Say you borrow $50k at 7.4% over 5 years. You will pay a total of $9,971.39 in interest over that time period.

However, during that same time period, your $50k cash value will compound at 4.5% resulting in a gain of $12,309.10.

This is a difference of +$2,337.71 you would come out ahead in the end.

If you decide to "pay yourself back" at a higher rate than the 7.4% required, the additional would be used to buy PUA's (depending on if your policy is designed this way) which increases the cash value more and helps earn even more over that time.

Just some things to consider...

 

[fud10]

@sonriseforever The policy is with USAA. Don't get me wrong, I plan to keep the whole life policy, I'm just not planning to use it to borrow from. Your math has me confused. The way I understand the policy, if I borrow from the accumulated cash value, only the net cash value remaining continues to earn 4.5%, so in your example, the 50k I borrow ceases to earn interest. Additionally, the way I understand it, the 7.4% I pay in advance for the year and again on the anniversary each year for whatever I still have borrowed and that money goes to USAA, not to my account. I can pay back my accumulated cash value at whatever pace I want, or not pay it back at all, but I continue to pay 7.4% of whatever I still have borrowed until it is paid back. I called to ask how loans are structured and was very specific in my questions. Unless I dearly misunderstood their answers or the rep was very mistaken in the terms, that's why I couldn't imagine borrowing from it. The amount I borrow stops earning 4.5% and I pay 7.4% on top of that. That's the 11.9% spread I mentioned. By the way you worded things it sounds like the entire accumulated cash value continues to earn as if I hadn't removed it for a loan. Is that how it's supposed to work?

 

[sonriseforever]

@fud10 That depends on whether your policy is a Direct Recognition or Non-Direct Recognition policy. NDR will not recognize that you have a policy loan outstanding, and it will pay interest on the full amount of your cash value.

It's not YOUR cash that you're using when you borrow. It's the insurance company's. Your cash, the entire amount, continues to earn interest because it's still sitting in your account untouched.

Again, this depends on the type of policy you have and how it was designed. DR policies still pay something on the borrowed amount, but they just have different rates for it.

If your policy actually doesn't pay ANYTHING on the borrowed amount, well then that frankly isn't a very well designed policy IMO.

How long have you had it? How long has it taken the cash value amount to grow?

A well designed policy for using in this fashion would provide about 90% of your premium paid available as cash value immediately. Badly written policies can take 5 - 10 years before they start gaining much vash value at all.

So it really all depends on your policy and how it was designed.

 

[fud10]

@sonriseforever Mine takes 2 years to accumulate cash value. I started it in May 2020. I have a hunch that it's direct recognition but I don't see anything in the contract that uses that term or about a different rate for the borrowed amount. This is what got me thinking about getting an additional policy for borrowing

 

[futuredreamer]

@fud10 Oh, a WL only 2 years in. Are you overfunding this? (Paying more than the actual cost of the death benefit?) or are you just making the minimum payment to pay for the death benefit. If the 2nd option, then the cash accumulation isn't going to be a lot, and your access to it in the first 5-10 years may be limited.

 

[fud10]

@futuredreamer I was mistaken. It appears to be a non direct recognition policy. I am not sure about the 4.5% though. I think it is less. See my lengthy recent reply for the math on it

 

[fud10]

@sonriseforever Yeah you were right and I gave you bum scoop. The borrowed amount does not effect the interest earned by the cash value so it appears to be NDR. Seemingly I was also mistaken about the 4.5% though. See lengthy math reply below

 

[futuredreamer]

@sonriseforever The only problem with your justification is

if there are some down years when you get old the policy could blow up

The same risk applies to Whole Life, with the exception of the fact that there is only ONE company that needs to have a down year, whereas an index is diversified and the market has always out performed the dividend rates of Whole Life. There is the odd year that WL might have had a higher ROR like 2001, 2008, but any actual stretch, the indexes squash WL returns like a bug. Example last year alone. Indexes maxed out the caps at 9-12.5%, dividends were around 5.5%. Market averages 7.5% over time.

You aren't putting money IN the market in an IUL, its credited on the performance of an index, with a FLOOR rate of ZERO. So if the market does -32%, you lose zero because of the market, only the admin fees & costs of insurance...which are lower in IULs than they are in WL. A whole life would blow up before an IUL.

IULs have a loan rate usually about 2-4% tops, and they credit back that rate at 2-3%, so its almost essentially a wash. Some IULs are an actual wash, others equal out to .25%, and others maybe up to 2%.

Also, both IUL and WL, the money you are lending out, is still earning on the performance, so using small numbers. If you had a cash value of $100, and borrowed $10. When the policy earns the crediting (WL or IUL), your entire $100 gets credited on the growth, not $90.

The policies themselves should be built so you aren't expected to pay back the loan, the death benefit just reduces by the loan amount after you die basically paying it off. You do always have the option to pay it back, but usually unless you over funded it, its not advisable, no matter what "Infinite Banking" stories you hear about.

 

[dreadedskyprophet]

@sonriseforever So the 7.4% interest doesn’t go to the company you get the plan through? It goes to my cash value for me to do with whatever I please later?

 

[sonriseforever]

@dreadedskyprophet No, that's not what I said here.

The interest you pay goes back to the insurance company the same as paying interest to anybody else you borrow money from.

What I broke down here was how your cash value continues to earn interest separate from the loan interest you are paying and you will end up better off once the loan is paid off then you would have had simply paying cash.

 

[sonriseforever]

@dreadedskyprophet To follow up on that, some will say you are " paying yourself back " because the dividend you receive is partially from the interest that the insurance company earned by lending out cash.

You are a part owner of the insurance company, so if you are paying the insurance company interest then in that way you are paying " yourself " back.

You're not going to see that full rate paid back into your account each year though. The efficiency of the account in later years is what makes the overall internal rate of return the equivalent of 4 to 6% or so annually over that time.

 

[resjudicata]

@fud10 You need to ask your agent about “direct recognition” and if their company does that. Basically it will offer you a higher dividend rate if you have a cash value loan. So it reduces the spread and gives you a lower effective interest rate.

Becoming your own banker is a really good concept if you need to have liquid cash but you also want to earn a higher interest rate than what the bank offers. Let’s say you are a landlord. You need to keep money set aside from each rent check for vacancy and long term costs like a new roof. Instead of keeping this money in a normal savings account like most landlords do, you could put it in a cash value policy and earn 3-4% instead of

 

[fud10]

@resjudicata Mine is a pay until 65 policy. If I understand it correctly, I am not able to overfund it's but I guess I need to verify that. Also, If I understand it, my accumulated cash value does not offset the amount that the bank is"on the hook" for the death benefit. Instead, my accumulated cash value increases the size of the death benefit in the event if a payout for my demise.

 

[resjudicata]

@fud10 You can over fund it up to the point that it becomes a mec. Then you. You you could see premiums reduce in future years. The over funding, along with dividends being applied as paid up additions will cause the death benefit to increase over time.

There is a guaranteed cash value growth rate. Look at the age 65 year when the policy is paid up. The death benefit and the cash value are guaranteed to be the same number. Which should be close to the original face amount of the policy.

If you factor in dividends and puas, the death benefit and cash value will be higher. What it will be is unknown at this time. But you will at least have the guaranteed.

 

[fud10]

@resjudicata It seems Iike the policy I have, which is described on the title as simplified whole life, does not fit into the mental model that everyone is describing. This particular WL policy is a 250k death benefit. When I turn 65, I will have paid 88k in premiums. The accumulated cash value will be 111k, so no they are NOT guaranteed to be the same number. If I pass on that particular day, I understand the death benefit will be 361k. The same would be true for any point before or after 65, the death benefit would be the combination of the face value plus the accumulated cash value. By the way you and and others have described it, this policy seems very non standard, but not necessarily in a bad way. It just seems bad for the purpose of borrowing from in the future.

 

[resjudicata]

@fud10 I am not familiar with USAA or their simplified whole life. So I don’t know what to tell you.

 

[fud10]

@resjudicata That's understandable. It seems like this thread went on a bit of a tangent anyway because in my original post I tried to indicate that I'm not really looking to dismantle the existing policy so much as I am looking for a recommendation for where to get an additional policy that is better suited for my goals

 

[resjudicata]

@fud10 Ok. Sorry for my earlier tangent. Here is exactly what I did.

Full disclosure, I work for a mutual life insurance company so my answer is obviously biased.

In my mid 20s, I was maxing out 401k and Roth every year. I still had money left over that I wanted to invest. But most permanent policies are drastically expensive. I liked the concept of owning whole life but not the cost. At my age, I wanted to invest in something that had more risk and a higher rate of return. I decided that real estate was the way to go.

So here is what I decided to do. I would buy a $1million 20 year term policy from a mutual company (guardian, NML, NYL, Mass mutual). (I bought one on my wife as well, so together we had $2m of term). I purchased 2 riders on this policy. The first was the waiver of premium rider. This means if I became disabled, the premiums would be waived and I would still have the coverage. The second rider was the extended conversion rider. Most term policies can only be converted in the first handful of years. But white this rider, I can convert to whole life any time within the 20 year life of the term policy.

What this did is it allowed me to have cheap term insurance for 20 years. This means I have more of my monthly paycheck to invest in real estate and make moves. This typically has a much higher rate of return than the cash value performance in any type of permanent policy. I mean look at the housing market since covid started! Sure it might correct and crash, but that’s a different topic.

So every time I would buy a new rental property, I would put enough cash down (30-60% of property value) to have a significant monthly cash flow from rent. This means that I have a lot more cash coming in compared to expenses like home insurance and the mortgage payment. Instead of putting cash aside in a bank account to save for when repairs and big ticket upgrades were needed on the property, I would go to my term policy and convert a little sliver of coverage to whole life depending on the amount of cash flow that I wanted to hold aside for the property in the future. This typically meant that the converted amount of death benefit would be $100k-250k. These slowly start to accumulate cash value. The cash on cash rate of return is not much in the first few years, but after about 5 years or so, it should be around 3-4% (tax free) with dividends.

So if you are able to buy 5-10 properties over 10 years, you will have 5-10 whole life policies at various stages of cash value growth. You take all these policies to a bank and assign them to the bank and set up a cash value line of credit. You can use this as your emergency fund, an opportunity fund (say you see a crazy deal that a traditional home lending won’t touch, you can use the line of credit no questions asked), or some combo of both.

So if you buy the right properties in up and coming areas, hire good property managers, and have good tenants, your costs are lower and you are more profitable. I know we are in weird times right now, but it’s crazy to see the performance of home values. Again these are highly risky when you think about 2008. But if you put a lot of cash down and you have a significant amount of money in cash value, you are able to enjoy the high rates of return in housing and use the cash value and high initial down payments as a conservative balance against the risk.

 

[fud10]

@resjudicata While I was very mistaken about the cash value increasing the death benefit, in this particular policy, the cash value when I stop making payments is under half of the face amount (and my total premium payments to that point another 23% less than the cash value). Those aren't fantastic returns by any means but the cash value continues to grow until the maturity date (100 years old) without any additional premiums. I also receive no dividends and I can not make any PUAs.