My favorite tool for retirement planning is permanent life insurance. Many people view life insurance simply as “insurance”. That you are paying for something that will benefit the next generation. They think of the premiums as an expense.
Most people don’t realize how powerful life insurance is for creating tax-free retirement income. Did you know that dollar for dollar, a Life Insurance Retirement Plan (LIRP) will provide about 2 to 3 times the income than a traditional retirement plan? EVERYBODY asks me: “How do you get income from Whole Life or Indexed Universal Life?”
The answer is very simple: because you are not “withdrawing” the money, you are borrowing it. And more importantly, you are borrowing it from the insurance company, not your policy. Financial pundits like Dave Ramsey like to state: “Why would I pay interest to access my own money?”. The premise behind this statement is that he thinks you are borrowing your own money. Right?
When I tell you how insurance policy loans really work, you will think it is too good to be true.
Imagine that you invested $100 in a hot stock and turned it into $100,000. Awesome, right? But now you will owe the IRS about $25,000 to in capital gains taxes if you sell. If you sell, you will only net about $75,000.
But what if I told you that I could show you a way that you could get $100,000 cash and not owe any taxes?
“I don’t know Tom. That sounds pretty hard to believe”
Believe. Let’s say I have a lender who will loan you $100,000 with your stock as collateral. Now you will have $100,000 that you can spend as you wish. And you still have your stock!
“Yeah, but now I’ll have to pay interest on that loan Tom”
That’s true, but since the lender is absolutely confident that your stock will appreciate at least as much as the interest rate on your loan, the lender will just loan you the money to pay the interest and they’ll add it to the amount you owe.
Way! You can keep the money for as long as you want and simply pay it back whenever you decide to sell your stock. The lender is that confident that the collateral will secure the loan.
Are you still reading? Does this sound believable? If you have followed the math to this point, you are probably thinking that the problem now is that when you sell the stock you will still have to pay the capital gain, but you will owe $100,000 on the loan, right?
This IS too good to be true. But this is where life insurance cash value is even better than what I’ve described above. Life insurance policy loans do exactly what I’ve described here.
First, if you look into the insurance statutes in each of the 50 states, you will find language that requires insurance companies to make loans to their policyholders that are secured by the cash value of those policies.
Does that sound like they are letting you borrow your money? No. It means they are required to loan you their money with your cash value as collateral.
Now, since the cash value in insurance policies offer principal protection and even guaranteed rates of return, these loans are not exactly a bad investment for the insurance company. They know your cash value will grow and will secure not only the loan but also the interest on the loan.
This. Is exactly what happens in a life insurance retirement plan. Your cash value remains in your policy and continues to grow and earn dividends/interest even while you start taking loans for income. And do you have to pay the interest on those loans every year? No.
Just as I stated in my fantasy example above, the insurance company is loaning you the money to pay the interest and you’ll just pay off both the loan principal and the interest when your policy matures (read: you die).
“Ha! But how do you pay the taxes?”
Remember how my “too good to be true” example fell apart because the capital gains tax would have to be paid when you sold the stock? Well, because life insurance death benefits are received tax-free, these loans are simply paid back from the cash value and death benefit of the policy.
The bottom line here is that policy loans are very cool. They give you the ability to access all of the gains on your cash value with no tax penalty. For all intents and purposes, it looks like and smells like a tax-free distribution from your policy. Smart planners don’t think of their insurance premiums as an expense. They understand that they are funding their retirement.
And because your cash value is still growing even while you are taking loans for income, the cash value is capable of generating 2 to 3 times the income of traditional retirement savings strategies. Remember: your monthly statements from your broker are just numbers on a piece of paper. They don’t pay bills or put food on the table.
At some point you need to annuitize your savings and start withdrawing assets for income. And I assure you, that amount will be about ⅓ to ½ of what you can get from the same amount of cash value.
I’m always happy to walk anyone through the math. Just ask.