Introduction
It is important to realize that both The Double Play and Life Insurance Retirement Plans (LIRP) work best with Maximum Over-funded Life Insurance. That means a maximum over-funded policy is optimal for achieving both goals. I think that most people just think all Life Insurance is the same. That could not be further from the truth.
You should realize that if you think that Life Insurance is a “bad” investment or has high fees, then you’ve probably never heard of a maximum over-funded life insurance policy. It’s important to know that a Life Insurance policy can be optimized to get as much death benefit for the lowest price. It’s also important to know that the opposite is true. That means a Policy can also be designed to maximize the Cash Value at the expense of the Death Benefit. It’s also possible to design a policy anywhere you want on the spectrum between these extremes.
If you find yourself wondering what Cash Value, Policy Designs and Maximum Over-funded Life Insurance mean, you may want to check out my Life Insurance 101 eBook or YouTube video before continuing.
Policy Designs – Minimum and Maximum Over-funded Life Insurance
It’s crucial to understand that not all life insurance policies are created equal. You need to know that life insurance policies exist on a spectrum, with two key extremes: Minimally-Funded (Traditionally-funded) and Maximum Over-funded. Most people that buy Life Insurance are interested in getting as much Death Benefit as they can for the money. A few of us want policies with as little Death Benefit as possible so that they have more Cash Value.
Minimally-Funded Life Insurance (Traditional Life Insurance)
It’s important to understand that a Minimally-funded Life Insurance policy is designed for maximum Death Benefit for the money. That means this is what you buy when you want to get as much Death Benefit for as cheap as possible. It’s helpful to know that the fees in a Life Insurance policy are mostly a function of the Death Benefit. In other words, the higher the Death Benefit, the higher the fees. The fees are high as a percentage of every Premium dollar.
The goal of a minimally funded policy is to get the most death benefit for the least cost.
This graph shows the Death Benefit and Cash Value of a Minimally-funded Policy. You can see that the Cash Value accumulates very slowly. The goal is for the Policy Owner to essentially save up the Death Benefit over the Insured’s natural lifetime. It’s important to realize that the Cash Value is an integral part of the Death Benefit. That means that if our “Insured” died at age 79, the Beneficiary would receive $1 Million. You can see from the middle bracket that $500,000 is coming from the Insurance Company’s “Risk Pools” and the other $500,000 is from the Cash Value.
Net Amount at Risk
I want to point out that the Net Amount at Risk is the difference between the Death Benefit and the Cash Value. This is the amount for which the Insurance Company is on the hook if the Insured party dies. You should be aware that the Net Amount at Risk is much higher in a Minimally-funded policy.
The brackets show the Net Amount at Risk. The bracket on the left shows that all of the risk is on the insurance company at the beginning. On the other hand, you can also see that by age 113, the risk has been transferred to the Policy Owner. When the Cash Value reaches the Death Benefit, 100% of the Death Benefit comes from the Cash Value.
As you can see from this graph, there is not much Cash Value and the growth is very slow. This is not the type of policy that you would want to use for Real Estate Investing. Real Estate Investors want as much Cash Value as possible. They want to be able to leverage the greatest amount possible of cash value right away and put it to work in two places at one time.
Check out How Life Insurance Works for more basic information.
Whole Life and Indexed Universal Life for Minimally-funded Life Insurance
Because of the higher risk in a Minimally-funded Policy, the strong guarantees of a Whole Life make it a popular choice. However, the stronger interest crediting potential of an IUL means the Net Amount at Risk would be reduced faster.. The Net Amount at Risk is the gap between the Death Benefit and the Cash Value. It’s shown by the brackets in the graph.
The Insurance Company’s Interests Are Aligned With Yours
One thing that is important to point out is that you can see that the insurance company has an incentive for the Cash Value to grow as quickly as possible. The faster that your Cash Value grows, the quicker it accumulates and removes the risk to the insurance company. In this example, if we shifted the cash accumulation curve upward, then the net amount at risk to the insurance company would be smaller.
Maximum Over-funded Life Insurance
If you’re interested in investing in Real Estate with Life Insurance, you NEED a policy that is designed for Maximum Cash Value. You want as much of your Premium going into Cash Value as possible. These policies are structured to maximize Cash Value at the expense of Death Benefit. The Death Benefit is the legal minimum for the amount of Premium.
The best way to know that your policy design is funded right is to look at the ratio of the cash value to the premium in the first policy year of your Illustration. If it is not 85-90%, then the policy is likely not designed right.
This graph shows what a Maximum Over-funded Life Insurance policy looks like. You can clearly see that, compared to the Minimally-funded Policy, there is very little risk in this policy design. The Death Benefit is as low as it can possibly be throughout the life if the Insured. Less Death Benefit means lower Cost of Insurance and other fees.
Cost of Insurance in a Max-funded Policy Design
Let’s take a closer look at the Costs in Maximum Over-funded Life Insurance. In example above, the policy was designed to have only 10 years of premium. Since the cost of the Death Benefit is the primary cost driver in a Life Insurance policy, we minimize the Death Benefit to reduce mortality costs. You can see in this graph that the Death Benefit is maintaining a steady corridor value for the first 10 years. The true amount of risk to the insurance company remains constant.
It’s important to point out that the Cost of Insurance after the Death Benefit has been reduced is typically under 0.25% of the Cash Value. That means that if the Cash Value were to achieve a 5% growth on the cash value, the net addition to the cash value would be 4.75%.
While you can see these actual costs illustrated on a Universal Life illustration, they are not shown on a Whole Life illustration.
Maximum Over-funded Whole Life and IUL
You should notice that I haven’t labeled the graphs as Whole Life or IUL. The reason is because they will both look the same.
The choice between Whole Life and IUL really depends on your comfort level with each type of Policy. A Whole Life offers the benefit of steady, regular Dividends every year. While IUL interest-crediting should be higher over time, there is much more volatility in the Short Run.
Is Whole Life Dividend Crediting Comparable to IUL Interest-Crediting?
The Spectrum between Minimally-funded and Maximum Over-funded
It is also helpful to know that “over-funded” is not the same as Maximum Over-funded. Over-funded Life Insurance exists on the spectrum between a Minimally (or Traditionally) funded policy and a Maximum Over-funded Life Insurance. Infinite banking policies, for example, are over-funded, but not Maximum Over-funded. Infinite banking policies have more Death Benefit than the legal minimum. The higher Death Benefit allows for the Policy Owners to pretend to pay themselves interest on Policy Loans. The “interest” is really just more premium that could have been added when the policy began.
Infinite banking policies will have a cash value to premium ratio of about 65%. This is what happens in when the death benefit is higher. The policy costs are consuming much more of the premium. As an aside, it is important to understand that the life insurance agent’s commission is tied to the Death Benefit. When the Death Benefit is increased, so are the fees and commissions of the policy.
It is important to understand that an Agent can design a policy that falls anywhere on this spectrum. This allows the Agent to customize the policy design to meet the needs of their client. Just be aware of the trade-off between Death Benefit and Cash Value. As you increase the Death Benefit, you increase the policy expenses increase too. This results in less cash accumulation. This will be apparent when you look at the illustration. The ratio of Cash Value to Premium will be lower than 85%. Any time that the cash value to premium ratio is less than 85%, the policy includes more Death Benefit protection than the statutory minimum.
So when the death benefit is held to the minimum non-MEC amount, the policy expenses and commissions are held to an absolute minimum.
Why you need a Max-Funded Policy for The Double Play
So clearly if you are intending to leverage the cash value of your policy for The Double Play, you want as much cash value as you can get. It’s important to realize that if a dollar of Premium turns into $0.85 of cash value, then you have that $0.85 of cash value earning dividends AND you have a line of credit for $0.85 that you can use for investing in real estate. You are potentially putting a total of $1.70 to work for every dollar you put into the policy.
But what happens with a poorly-designed policy? In an “infinite banking” design that has only $0.65 of cash value per dollar of premium, you are only putting a total of $1.30 to work.
I want to make clear that The Double Play works because it doesn’t take long to make up the 15% that is lost to the policy fees. Your money is working in two places at one time and earning a higher combined rate. When the policy fees add up to 35% of the premium it takes much longer to make up for what is lost. No Real Estate Investor should want to increase the payback period.
Compounding interest is a very powerful force. But realize that when the cash value is starting off at such a deficit, it will take many more years before the model breaks even and looks superior to having simply investing in real estate directly.
Conclusion
It’s important to understand that Real Estate Investors require a Maximum Over-funded life insurance. If you use anything less than Maximum Over-funded Life Insurance, you are leaving money on the table. There is only one way to know that your policy design is funded right to the minimum non-MEC threshold. Look at the ratio of the Cash Value to the Premium in the first policy year of your Illustration. This ratio needs to be 85-90% to be confident that the policy is designed right.
Both Whole Life and Indexed Universal Life may be used for The Double Play.
The fees in an optimally-designed policy are kept to an absolute minimum over the life of the policy. There should never be a time when the Death Benefit can be any lower than it is.
People who think Life Insurance is a bad “investment”, are likely thinking of a traditional, minimally-funded policy. The goal in those policies is death benefit protection, not cash accumulation.
