The Pros & Cons of Cash Value Whole Life Insurance

Rose Sarko - Keystone Financial Group |

September is Life Insurance Awareness Month, and as this is one of the most misunderstood financial tools (both by financial advisors and by the general public), we wanted to take this opportunity to share some useful information about the unusual benefits provided by this unique financial vehicle.

There are many different types of life insurance, but the most commonly used are Term Life, Whole Life, and Universal Life

Term insurance is generally used to provide a death benefit for a specified period of time - or term. You can learn more about term insurance here.

Universal Life is also quite popular, but due to its potential variability in both growth and premium costs, we don't usually suggest this vehicle as a financial planning tool except in very specific cases. You can learn more about the differences between Universal Life and a properly structured cash value Whole Life insurance plan here.

In this article, we will be discussing cash value Whole Life Insurance, which is often the subject of much confusion. Just to be clear, we are focusing on cash value Whole Life insurance from a non-direct-recognition, dividend-paying mutual life insurance company. (It's no surprise that confusion abounds about these types of insurance plans, as they are so often called by various mysterious-sounding names, including 770 accounts, "Rich People ROTH" accounts, 501k plans, 702j plans, Infinite Banking®, and most popularly, Bank On Yourself®.)

When properly structured using an appropriate insurance company, these types of policies can provide many useful benefits that are difficult (or impossible) to find in other financial vehicles. When set up and used correctly, Bank On Yourself-type policies can offer the combined benefits of the safety of a CD with the liquidity of a savings account, the tax benefits of a ROTH IRA, and conservative but respectable long-term growth.

These policies can also avoid many of the downsides of these other financial products, although, of course, they do have their own limitations as well, as we will discuss below.

The Pros of Cash Value Whole Life Insurance

Here are a few of the unique benefits of the so-called "Rich People ROTH", or Bank On Yourself plan:

  • Liquid access to cash value via penalty-free loans or withdrawals
  • Protection from market volatility
  • Guaranteed long-term growth*
  • Tax-free growth within the policy
  • Tax-free distribution options at retirement**
  • Protection from creditors and lawsuits***
  • Competitive interest rates on policy loans
  • Unstructured loan repayments
  • Excluded from federal financial aid calculations for college
  • Uninterrupted compound interest growth - even while taking policy loans
  • Fixed premium costs
  • Excluded from provisional income tax calculations for Social Security
  • The ability to leave a legacy to your loved ones via a death benefit

Other potential benefits may also be available through riders that you can add to the policy for an additional cost, such as long-term care benefits, children's or spousal insurance riders, and others.

Another important benefit that is worth mentioning is that these plans do not have the income and contribution limits that Roth IRAs, for example, are subject to, which makes them particularly appealing to the wealthy. For example, in 2020, if you make over $139,000 as a single individual, or $206,000 for a married couple, you can't even contribute to a Roth IRA at all. Even if you do qualify, the maximum you can contribute per year is only $6,000 - $7,000, depending on your age and income.

For cash value life insurance, there are some limits to how much you can contribute, and these will be set by the insurance company when you set up the policy. Limits may depend on a variety of factors, including your health, age, sex, and income - and usually will be some multiple of your annual income. Regardless, they will be MUCH higher than that of a Roth IRA.

However, this doesn't mean you can't contribute to a Bank On Yourself-type plan if you aren't wealthy! On the contrary, this is an extraordinarily useful tool for middle-class savers as well.

The Cons of Cash Value Whole Life Insurance

As many benefits as these plans have, every financial tool has its pros and cons, and in the interest of fairness, you should also understand that even the most advantageous plan isn't right for everyone. Here are a few of the drawbacks to be aware of when looking at a cash-value whole life insurance plan:

  • You're paying for the death benefit - whether you need it or not.

    This is especially problematic for those using traditional whole life policies, where much of the cost goes towards the death benefit up front and you often do not see much cash value growth at all in the first few years, so you may not see significant growth until closer to retirement unless you start the policy when you are fairly young. However, Bank On Yourself-type policies are structured to minimize the death benefit up front, and therefore have significantly more cash value in the early years than traditionally structured policies.

    Regardless, you should view this as a long-term retirement savings plan - not as a short-term investment. A well-structured Bank On Yourself plan may not "break even" in cash values for 8-10 years, depending on your age, health, and funding level. However, remember that you CAN still access and use the cash value even in these early years, and will still receive the other benefits mentioned above.
     
  • Policy could lapse with tax consequences if not managed properly.

    While you are not contractually obligated to pay back your policy loans, it is in your best interest to do so. Remember that simple interest will accrue on any policy loan. Should you borrow out most of your cash value and not pay it back, your loan will continue to grow each year by the interest amount. Over time, this could be substantial, especially if you have borrowed a lot. Should you then stop paying premiums, the policy may "eat up" the rest of your cash value and lapse, causing a potential taxable event.

    To prevent this from happening, we always recommend that 1: You pay your loans back if at all possible, and 2: You NEVER allow the policy to lapse! (There are provisions where you can opt to make the policy "Paid-Up" and stop paying premiums. Consult with a licensed Bank On Yourself professional on your options if you find yourself unable to pay your premiums.)
     
  • If the policy is not set up or utilized correctly, you may lose some or most of the benefits mentioned above

    You can find thousands of comments online about how whole life insurance "does not deliver" the benefits listed above. In nearly 100% of these cases, it is obvious that the policy was NOT structured properly, or was set up using the wrong type of policy, or the wrong type of life insurance company. Other times when a policy may not perform as advertised may, quite frankly, be attributed to "user error" (see previous point above).

    Remember that a whole life insurance contract is a contract between YOU and the insurance carrier. This means that you both have obligations. If either party does not live up to the obligations, the contract will not perform as predicted.

    The insurance company's part is to faithfully deliver the benefits above. (And there are laws in place to make sure this happens.)

    YOUR part is to pay your premiums as illustrated. If you pay less than the contract premium (there are ways you can do this if needed for a period of time), or stop paying (take a Paid-Up Policy), keep in mind that this will impact your results, and the policy will not perform as originally projected.

Is Bank On Yourself Right For You?

There is no such thing as a one-size-fits-all financial solution - and this also applies to whole life insurance.

These types of insurance plans are particularly advantageous to anyone who:

  • Wants to take control of the financing function and create wealth while funding your current lifestyle
  • Wants to avoid market volatility while still achieving competitive growth in your savings
  • Would like to have a tax-free** income stream for retirement
  • Is playing "catch-up" with retirement savings and have maxed out your other retirement account limits
  • Makes too much money to contribute to a Roth IRA - OR wants to save more than the annual limits allow on a tax-advantaged basis
  • Wants to leave a tax-free legacy to your beneficiaries

On the flip side, if you find yourself in any of the following situations, this type of plan may not be right for you at this time:

  • You don't have enough cash flow to save at least $200/month.
  • You have so much consumer debt that all or most of your cash flow is spent on bills.
  • You spend all the money you make each month and can't see yourself sacrificing any present lifestyle expenses for the sake of future financial security.
  • You want to keep all your money in the market in hopes of potential higher returns.
  • You don't need or want to pay for a death benefit of any kind (in which case, there may be other financial strategies which would be a better fit and still provide some of the benefits listed above).

If you would like to learn more about using the Bank On Yourself strategy with cash value whole life insurance, be sure to consult with a qualified Bank On Yourself Professional to make sure you are getting correct advice, and that your policy will be correctly structured to maximize the potential benefits.

Contact our office for a free initial analysis at 614-300-9498, or fill out our contact form and someone will contact you shortly.

 

* Dividends are not guaranteed. Each individual policy has its own guarantees which are provided by the insurance company. Before purchasing a policy, you will be presented with an illustration of future values, including guaranteed as well as projected (non-guaranteed) performance.

** Assuming policy is correctly structured and properly utilized. Consult with a qualified advisor and a tax attorney regarding any potential tax consequences for your particular situation.

*** In most states. Consult a qualified tax advisor or attorney for your state to be sure.