In this post I am going to stray a little bit from The Double Play theme. I want to tell you about Cash Value Emergency Funds. I believe that the Cash Value of a Maximum Over-funded Life Insurance Policy makes the best Emergency Fund. Investors should realize that it’s a good idea to have an Emergency Fund of liquid cash. These funds should ideally be able to cover 3 to 6 months of living expenses.
While there are lots of options available for saving, and Emergency Fund should be held in an asset that is liquid and low risk. This will ensure that the funds are available quickly if and when needed Remember 2006 when both Real Estate and the Stock Market were down? It took until 2012 for the stock market to make up those declines. The stock market is not an ideal place to hold your Emergency Funds. The asset selection is important because you want to maximize the growth potential while maintaining liquidity and minimizing risk.
Keep reading to learn why a Maximum Over-funded Life Insurance Policy is the best asset for your reserves.
Goal
The goal of this post is to demonstrate that a maximum over-funded life insurance policy’s Cash Value is the best emergency fund. A Cash Value Emergency fund maximizes the return potential while maintaining liquidity and minimizing risk.
I’m going to start by comparing some of the different options for an Emergency Fund. And because you may think of the “high fees” of a Life Insurance policy as a potential deterrent, I’m going to show you why that’s not the case in a Maximum Over-funded policy. I’m going to finish up by showing you a neat little trick that offers tremendous added value for policy owners.
I’m not going to cover any of the Life Insurance fundamentals in this post. If you want a primer in life insurance or an overview of The Double Play, check out the resources in this footnote.[1]
Comparison of Options
It’s important to know that most experts recommend having enough financial reserves to cover 3 to 6 months of living expenses. Because the funds need to be available immediately, you want to make sure they are financially liquid. Financial Risk is the likelihood of an asset’s value to be less than what is expected at the time an owner needs to sell it. That means risky investments are out.
| Cash Value | Savings/Checking | CD | Money Market | Bonds | |
| Risk | Low | Low | Low | Low | Medium |
| Liquidity | High | High | Medium | High | Medium |
| Returns | Medium | Low | Low | Low | Medium |
Credit
In addition to these asset classes, credit is also an option for handling emergencies. Home equity and credit cards are two options that could be utilized. While using credit is certainly an option, I’m going to focus only on savings for this analysis.
Traditional Assets
Within the bond category, I would eliminate anything with longer than a 3 to 6 month maturity. Transaction costs could make a regular savings account a much more attractive option. Because bonds are sub-optimal in all respects, I don’t believe they are the best option for an emergency fund.
You should also be aware that Bank CDs are very low risk. The problem with Bank CDs is that they are also very low return. And even worse, they are not liquid. Bank CDs keep your money tied up for a period of time. For these reasons, I would not use it for an emergency fund.
Savings, Checking, and Money Market assets are all very liquid and very low risk, but the trade-off is low returns as well.
Cash Value as an Asset for Your Emergency Fund
It’s important to realize that the Cash Value of a maximum over-funded life insurance policy is the best option. Cash Value offers a higher return potential, is very liquid, and is very low-risk. For these reasons, you should find that it is the best option for an Emergency Fund.
You might think, “But what about the fees in a life insurance policy?” When you read the next section, you’ll realize that the opportunity to earn higher returns outweighs these fees.
Pros and Cons of Using A Cash Value Emergency Fund
Cons
The fees will consume about 15% of each premium dollar in a properly-designed, maximum over-funded policy.[2] That means each dollar of premium should result in about 85-cents of cash value. It’s important to realize that this is much lower than a traditionally-designed policy.
Pros
The question you have to ask yourself is this: would you rather have 85% of your savings growing at 5.5% or 100% of your savings growing at 0.5%? Do you understand the power of compounding interest?
In case the answer is not obvious, this chart should help visually explain:
This chart shows $1000 over time with two growth assumptions. You can see that at the beginning of Year 1, there is about 15% less cash available in the life insurance policy. But because the Cash Value is growing at 5.5%, you can see that it catches up to the bank account balance during the 4th year.
It’s important to realize that for the first four years, the savings account would be better. However, it’s important to point out that the Cash Value Emergency Fund performs much better over time. That means you have to weigh the potential shortfall against the higher long term returns. We don’t want the reserves to be sitting idle. If we were to project this out for more than 10 years, we would begin to see the exponential growth continuing to widen the gap between the savings and the Cash Value.
Yes. Life Insurance does have fees. But we need to understand that there is a big difference between the fees in a normal, minimally-funded policy and the fees in a properly designed, maximum over-funded policy. The fees in a maximum over-funded policy are much lower.
Again, would rather have 85% of your money growing at 5.5% or 100% of your money growing at 0.5%. You need to be aware that the cash value WILL catch up in just a few short years. I believe there are a number of additional advantages that easily and completely outweigh the fees.
Death Benefit
We also need to consider the Death Benefit. There is value in making sure that our financial plan is completed in the event of an untimely death. You don’t want to put a non-working spouse in dire financial straits.
Life Insurance Retirement Plan (LIRP)
Is there a difference between a LIRP and your emergency fund?[3] Not really! You can just keep on saving once you have enough to cover your expected emergencies. A maximum over-funded life insurance policy definitely has a place in anyone’s retirement plan. The beauty of cash value is that it can generate income at about an 8% ratio to the Cash Value at the time you retire. 8% is better than the usual 4%-Rule!
This means that you can get about 2 to 3 times the income than you could from other common retirement assets classes. So even after the 15% haircut, you should be aware that the remaining cash value is capable of generating more retirement income from that day forward. This makes the decision to utilize life insurance for an emergency fund even easier!
The Double Play
There is one more big advantage of using a maximum over-funded life insurance policy for an emergency fund. Once you have enough Cash Value in your Emergency Fund, you can continue to fund the policy. This will allow you to leverage the Cash Values for investing in real estate. This allows you to put your money to work in two places at one time. The combined rate of return from both the Life Insurance and the outside investments should exceed the return on your investment alone.[4]
The Advantage of a Cash Value Emergency Fund
One thing that is important to realize is that if you save up your emergency fund in any other asset class, once you tap into it for an emergency, the money is gone. You will have to save more and replenish the fund or reallocate some of your investment dollars into more liquid assets.
Policy Loans
Life insurance operates differently. You access the Cash Value by borrowing against the policy, not by withdrawing it directly. When you take a policy loan, you borrow the insurance company’s money, secured by your policy’s cash value. Some people mistakenly believe they borrow their own money with a policy loan.
To tap into your emergency fund, you borrow against the policy’s Cash Value. The Cash Value remains in the policy, continuing to earn dividends even with an outstanding loan. The ever-growing and compounding cash value secures the loan and accruing interest at all times. Put simply: you can keep the loan on the books until your death, at which point the death benefit will satisfy the loans before paying the beneficiary.
The Cash Value Keeps Growing Even With A Loan
Here’s the neat trick: if you leave the loan on the books forever, understand that this liability creates a “hole” in the Cash Value that can be filled back in. This means that IF money goes into the policy to repay the loan, there are no policy fees and expenses taken out! This gives you options.
One option is to continue to pay premiums on the policy AND make extra payments to pay down the loan. Maybe it’s been a few years since you bought the policy and you are making more money now and want to save more. This is a way to get more money into the policy without buying a new one or changing the existing one.
Another option is to simply stop making premium payments and use the same amount to pay off the policy loan. Again, the beauty of this approach is that the money used to pay down the loan is not hit with the same fees as premium dollars going into the policy.[5]
Conclusion
I’ve showed you why a Cash Value Emergency Fund is the best way build financial reserves. Because your emergency reserves need to be both liquid and low risk, a Cash Value Emergency Fund is the best way to do that and achieve a good rate of growth.
I’ve also shown that the high growth potential on the Cash Value more than makes up for the fees of the policy. The premium only takes a 15% haircut in a properly-designed policy and this is more than made up for by the growth rate on the cash value. The policy can also continue to be funded after the reserve requirement is met. The cash value in a Life Insurance Retirement Plan can generate 2 to 3 times as much income from a similar amount of savings. This means the remaining cash will still generate more income.
And finally, I showed a neat little trick that allows you to get money into the policy without any fees and charges. This is done by paying down the policy loan instead of paying premium into the policy. But you can do both if you want!
Notes:
[1] My Life Insurance 101 YouTube Video
Life Insurance 101 Web Page (Downloadable Document Available)
Intro to The Double Play YouTube Video
Intro to The Double Play Web Page (Downloadable Document Available)
[2] This assumes that each subsequent premium will be carrying the load of the fees for each subsequent year. The cash value from the first premium grows unimpeded by any fees.
[3] LIRP stands for Life Insurance Retirement Plan. This subject is too complicated to explain here. I’ve covered it in other blogs and videos. Just understand that this easily makes up for the 15% haircut that your premium dollars take. The remaining 85% is still capable of generating more income than most other retirement options.
You can access more information and videos here: https://innovativeretirementstrategies.com/resources/income-from-life-insurance/
[4] This concept is called The Double Play. This website is nearly devoted to The Double Play, but you can get a primer video here.
[5] I understand that these might be some hard concepts to grasp from a written explanation. You can always use this appointment link to set up an introductory call with me. I can answer any questions and fill in any gaps in your understanding.
