In this post I discuss how to get the most cash value in a permanent life insurance policy. What makes a policy a maximum over-funded life insurance policy? How do you know when it is maximum over-funded? What does having a maximum over-funded policy design allow you to do?
This is important because a poorly-designed policy may not be better than simply taking your money and investing directly in real estate (or whatever you were going to do with your money). That’s what The Double Play really comes down to:
Am I better off taking my money and putting it into a maximum over-funded life insurance policy and then leveraging the cash value to make investments in real estate or just simply taking my money and investing directly in real estate?
So if you are interested in learning how to leverage the cash value of a life insurance policy for investing in real estate and want to know that your policy is designed properly, this article is for you! Keep reading!
Introduction
Because it is so important to the The Double Play business model, it is critical that the policy has as much cash value as is legally possible. At best, a poorly-designed policy will result in it taking a much longer time for The Double Play to reach the cross-over point where you will be better off. At worst, it could be a waste of your money if you didn’t have a need for the life insurance death benefit anyway.
The goal of this article is to show you how you can identify a properly-designed, maximum over-funded life insurance policy and how the agent should be designing the policy to maximize the cash value. We’ll also take a look at the differences in policy design between Whole Life and Universal Life.
Life Insurance 101
Before we dive into the details, here’s a very simple explanation of the cash value in a permanent life insurance policy.
A permanent life insurance contract is actually pretty simple. The life insurance company is committing to pay a death benefit to a beneficiary if the insured passes away. Most life insurance policies are minimally-funded, not maximum over-funded. A “normal” life insurance policy has just enough cash reserves to meet the obligations of the life insurance policy.
The cash value is quite literally the policy owner saving up their own death benefit over the life expectancy of the insured. The insurance company commits to covering the gap between the death benefit and this “savings account”. In the early years of the policy, most of the risk is on the insurance company, but over time the risk is eliminated.
This is a pretty simple explanation, so if you want more details, download The Life Insurance 101 paper from my website or watch The Life Insurance 101 YouTube video.
Maximum Over-funded Life Insurance Policy Design
An “over-funded” policy is one that has any more cash value than is absolutely necessary to meet the minimum requirements. An upper limit on Over-funding is established by law so that life insurance remains “life insurance” and is not purchased as an “investment” or as a means of skirting the estate tax. Think of a $100,000,000 death benefit policy with a $100,000,000 premium. Since the death benefit is received by the beneficiary tax-free, this would be very attractive for estate planning, right?
A “Maximum Over-funded Life Insurance Policy is one that is designed right up to the legal limit, but not over. A properly-designed, maximum over-funded life insurance policy should have about 85% cash value to premium. This is based on the beginning of year value, not the end of year value, which includes any dividends or interest crediting which may have been paid. The values shown on a typical life insurance illustration represent end-of-year values. The growth projection should be backed out.
So how do you get the most cash value in a life insurance policy? This is not something that can be left to chance. It’s important to work with an agent who understands what he is doing. You cannot simply call up an agent at random and ask him for the price of an over-funded life insurance policy. You must pay as much as legally possible for it. You have to design the death benefit (and the sales commission!) out of it.
More Information on Maximum Over-funded Policy Design
IUL Policy Design
Designing a maximum over-funded indexed universal life policy is very easy. Every Insurance Company’s software enables the agent to select the design criteria. It is very easy for the software to work backwards from the premium the client wishes to pay to the death benefit that is minimum non-MEC. More technically-speaking, the software simply solves for the death benefit assuming that the premium is the Guideline Premium.
The Guideline Premium represents the upper limit on the amount of premium you can pay and still meet the definition of life insurance. If the premium is above “guideline”, the contract does not meet the definition of life insurance. An Indexed Universal Life policy designed to Guideline Premium is maximum over-funded. You cannot pay 1-cent more and still meet the definition of life insurance.
Again, if the solve is done correctly, the ratio of cash value to premium, before accounting for first year growth, should be about 85%. There will be slight company to company variations. Risk factors like age and tobacco use, for example, will impact this ratio.
Learn more about the internal charges in a Life Insurance Policy
Only companies that offer some sort of Early Cash Value Rider should be utilized. An early cash value rider eliminates the surrender charges so that all of the Cash Value is accessible to the policy owner. Normally, a charge would be assessed against the cash value if the policy was surrendered during the first 10 to 15 years. A policy without this rider would not work for The Double Play. While the policy owner could certainly leverage what cash value there is in the policy, it does not meet our primary requirement:
Am I better off taking my money and putting it into a maximum over-funded life insurance policy and then leveraging the cash value to make investments in real estate or just simply taking my money and investing directly in real estate?
Whole Life Policy Design
Designing a maximum over-funded Whole Life is much more difficult. A maximum over-funded whole life is a work of art. A typical Whole Life policy is minimally funded. A maximum over-funded Whole Life policy is typically a blend of a smaller “Base Policy” combined with Term and Paid-up Additions. This is only a generalization, some companies have different names for these components or bundle them together with different names.
The “Base Policy” is a generic or typical Whole Life. Since most of the commission is in the Base Policy, it is a good idea to keep it to a minimum. Adding a term insurance rider to the base policy increases the death benefit for very little additional cost. The additional death benefit provided by the term must be reduced or dropped eventually because its cost is going to get more and more expensive with every passing year as the insured gets older.
Once the total death benefit of the policy has been increased, the policy can accept more premium which is made in the form of Paid-up Additions. So the idea is to blend these components together in a way that maximizes the cash value without violating the definition of life insurance or the MEC limits
The agent must not only know how to blend these components so as to get as close to the MEC limits as possible, they must also know which underlying chassis is the best choice. A typical Whole Life policy is one where the policy owner will pay premiums for life. However, the contract itself may actually stipulate until age 120. Most companies have other products to shorten the premium paying period, such as a 10-pay, or a Pay to Age 65. The idea behind these products is that they can be over-funded so that they reach the point where they are fully “Paid-up” after 10 years or by Age 65. Paid-up just means that the cash value and the Death Benefit have reached that minimum corridor where there is that statutorily-defined minimum amount of death benefit over the cash value.
Conclusion
Let’s face it, life insurance is not “the perfect” vehicle to put your money to work in two places at one time. It’s got fees and expenses that must be kept to a minimum so that you get the most cash value for every dollar of premium that you put into the policy. As you are thinking about getting a policy for The Double Play, you need to know that you are not wasting your money with a poorly-designed policy. You want to get the most “BANG” for your “BUCK”.
The fees determine your “handicap”. Your money will be growing at a faster rate, but how long it takes to catch up to where you could be is directly related to how much cash you start with. In this session, I’ve discussed how to keep the costs to an absolute minimum in both Whole Life and Indexed Universal Life policy designs so that you can get the most out of your premium dollars. I’ve also shown you how to know that your policy illustration is designed properly. If the policy is designed right, the answer to our fundamental question will most often be yes.
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No Rendering of Advice: The financial content in this document is provided for your personal education. It is not intended for trading purposes, and cannot substitute for professional financial advice. Always seek the advice of a competent financial advisor with any questions you may have regarding a financial matter. Information in this document is not appropriate for the purposes of making a decision to carry out a transaction or trade nor does it provide any form of advice (investment, tax, or legal) amounting to investment advice, or make any recommendations regarding particular financial instruments, investments, or products.
The sole purpose of life insurance is for the death benefit protection. Any other benefit is ancillary.
