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What to Look For in a Properly-designed Life Insurance Policy Illustration For Real Estate Investing

Introduction

It’s crucially important to understand that Real Estate Investors NEED Properly-designed Life Insurance. Anything less than a Maximum Over-funded Policy design will leave money on the table. But how do you know that you have Properly-designed Life Insurance? Understanding Life Insurance illustrations isn’t easy. Even many agents don’t understand this because the focus on selling only the Death Benefit protection.

The goal of this article is to give you a list of things to look for to know that you have Properly-designed Life Insurance for Real Estate Investing (The Double Play).

If you are more of a visual learner, you can check out this YouTube version of this article:

#1 Make Sure You’re Looking at the Full Illustration

You should be aware that most life insurance illustrations have a lot of pages! They are anywhere from 30 to 60 pages long. That means that if you are looking at something less, the Agent probably did not send you the full illustration. It’s important to see the full illustration so that you:

  • Understand the assumptions,
  • Can see the Policy Expenses and Charges, and
  • See the Modified Endowment Contract (MEC) and Guideline Premium calculations.

Moreover, if the Agent isn’t sending the full illustration, they may be trying to hide something.

#2  Cash Value to Premium 

It is important to know that the single best way to know that you have Properly-designed Life Insurance is to look at the Cash Value to Premium Ratio. You want to look at this ratio in Year 1. The Cash Value to Premium ratio should be right around 85%. The ratio can vary somewhat, but it will be in that ballpark if you are healthy, under 60, and do not use tobacco.

You should also realize that this is true whether the policy is a Whole Life or an Indexed Universal Life (IUL). It is also true whether the client is doing a “short pay” of only 5 or 10 years or paying all the way out through age 65. The following table shows what Properly-designed Life Insurance looks like:

This policy is being funded with $100,000 annual premium for only 5-years. It’s interesting to point out that Maximum Over-funded Life Insurance doesn’t require lifetime premiums. That’s what “Maximum Over-funded implies. It means that these policies can run forever because there’s so much Cash Value.

Take note of the Accumulation (Cash) Value in Year 1. You can see that the Cash Value to Premium Ratio is 92.8%. That’s a little higher than the 85% I stated. But you also need to realize that the illustration includes the 1st year Dividend. If the Dividend was 6%, then the starting Cash Value would have been $87,525 or 87.5%. This is a great example of Properly-Designed Life Insurance.

#3 Death Benefit Reduction When Premiums Cease

It’s important to realize that the Death Benefit is the primary driver of the Expenses in a Life Insurance Policy. That means the higher the Death Benefit, the higher the internal fees and charges. For this reason, the Death Benefit should be minimized AT ALL TIMES in a Properly-Designed Life Insurance Policy. Now look at Year 6 and 7 in the example above. Notice how the Death Benefit is reduced from $4.6 Million down to $1.9 Million? That is a $2.7 Million reduction. I want to point out that this reduces the internal cost of insurance by about 70%!

I also want to make clear that this is NOT how most agents design policies. Most Life Insurance Agents cannot fathom why anyone would want to REDUCE the Death Benefit. A Properly-designed Life Insurance Policy must include this reduction.

#4  Look for MEC Limit & Guideline Premium 

One thing that you are not going to see if you don’t have the full illustration is the MEC and Guideline Premium calculations. While these are complicated concepts, you just need to know that you want your premium to be as close to the lower of these two as possible.

The full illustration will show the “MEC Limit” or “7-pay” limit somewhere on the illustration. If you are looking at a Properly-designed Life Insurance Policy, then your Premium should be close or equal to the lower of these two calculations.

This screen capture shows the Guideline Level Premium and the Maximum non-MEC calculations from an actual illustration. Note that the maximum non-MEC annual premium is $57,386 per year. While the Guideline Level Premium is $50,000. Again, the premium must be close to or equal to the lesser of these two calculations. If that’s not the case, it means that the Death Benefit is higher than it needs to be.

Higher Death Benefit => Higher policy charges => Lower Cash Value

“Guideline Level Premium” is the maximum you can pay for the policy and still meet the legal definition of Life Insurance. The “MEC” or “7-Pay” Premium still meets the definition of Life Insurance but will receive adverse tax treatment on loans and withdrawals. A MEC will not work for The Double Play, but it is sometimes advantageous to create a MEC on purpose.1

“Infinite Banking” Policies ARE NOT Maximum Over-Funded

Despite their amazing Brand Identity, you need to be aware that Infinite Banking Policies ARE NOT Maximum Over-funded. Agents intentionally leave room for policyholders to add more premium later to Infinite Banking policies under the guise of “Paying Yourself Interest.”. I have another article specifically dealing with the reasons NOT to use an Infinite Banking Policy for Real Estate Investing. You can read that article here.

It’s critically important to know that Real Estate Investors need as much Cash Value as they can get. They want as much money working in two places at one time as they can get. There is a big difference between having 65-cents of every dollar working and 85-cents. You as much premium up front so that it can be leveraged right away. It doesn’t make sense to add cash to the policy later in the form of paid-up additions. That is very inefficient from a cash accumulation perspective

Whole Life and IUL

It is helpful to know that both Whole Life and IUL will work equally well for The Double Play. This means that the Whole Life Policy needs to be properly. The difference between an Infinite Banking policy and a Properly-designed Whole Life policy is the much higher Cash Value to Premium Ratio (~85%). Your decision on which type of policy to use should be based on your comfort level. A Whole Life offers the stability of consistent annual dividends. While IUL Interest-crediting should be higher over time, it is much more volatile in the short run.2

#5  Level Premiums 

It is important to understand that the Annual Premiums need to be level. This means that you should never put a lump sum of Premium into a policy. Be aware that a large lump sum premium in the very first year drives up the death benefit and all of the costs that go with it. These higher costs take a big bit out of the lower premium that follows in the subsequent years.

It is important to know that the first year premium is used for the Guideline Premium Test for Life Insurance. That means that the Death Benefit will be as low as possible based on that first premium. You do have the flexibility to reduce your premiums if YOU want, but you should strive to keep your policy Maximum Over-funded. The only downside would be that the cost would represent a higher proportion of each premium going into the policy. You just don’t want to do it on purpose. Your Agent should explain the downside risk to you rather than just taking your money.

The importance of Level Premiums is covered in much more detail in the video that I did on the costs in a maximum over-funded life insurance policy. You can also buy my e-book that provides examples.

 #6 Early Cash Value Rider 

You should be aware that IUL policies need to have an Early Cash Value Rider. An Early Cash Value Rider waives the surrender charges in exchange for a small fee. It is important to understand that this Rider is necessary to be able to borrow against 100% of the cash value in a policy. You should also realize that not every insurance company offers an early cash value Rider. This means that it is important to make sure that the company offers this rider before committing to a policy. The Rider cannot be added to a policy after it is issued.

Whole life policies do not need an early cash value rider. The cash value in a Whole Life policy is mostly paid-up additions. Paid up additions are liquid from day one. 

You can see the effect of the early cash value Rider by comparing the accumulation value and the surrender value. You can see that they are both equal. 

#7  “Increasing” Death Benefit Option 

It is important to know that the way to get the most Cash Value in an IUL is to use the “Increasing Death Benefit Option“. You should recall that the Cash Value of a Policy is essentially the policy owner saving up the Death Benefit over time. Thus the total Death Benefit includes the Cash Value. The “Insurance” is the gap between the Death Benefit and the Cash Value. With an “increasing” Death Benefit, the insurance company increases the initial increment of Death Benefit each year by the new Cash Value additions. This maintains the initial increment of Death Benefit.

It’s also crucial to know that the policy owner can reduce the Death Benefit (see #3 above) when they cease paying premiums. Again, reducing the Death Benefit reduces the internal costs of the policy. In a Properly-designed Life Insurance Policy, we would switch to the Level Death Benefit option at the same time. This reduces the amount of the insurance corridor and minimizes policy charges.

You can see all these changes in this graph:

This graph shows the relationship between the Death Benefit and the Cash Value in a Maximum Over-funded Life Insurance Policy. This policy design shows a 45 year old client paying a $100,000 per year premium for only 10 years. You can see that the corridor of risk remains constant for the first 10-years. The policy owner reduces the death benefit to the legal minimum in Year 11. Then you can see that the corridor of risk steadily declines over time keeping the policy’s cost to an absolute minimum.

The following Table shows both the “Increasing” Death Benefit and the subsequent “Level” Death Benefit:

Note the steep reduction in the Death Benefit shown by the Orange shaded cells. The much lower Death Benefit will speed up the Cash Accumulation by reducing the Policy Expenses. The Death Benefit will eventually increase to maintain the minimum corridor of risk.

#8  10-Pay Whole Life 

You may have heard of 10-pay Whole Life. This is a short-pay policy that is fully paid-up by the end of Year 10. It’s important to know that 10-pay Whole Life is not Maximum Over-funded Life Insurance. Don’t buy it for The Double Play. It is simply an “over-funded” policy. A 10-pay Whole Life is for when you want Death Benefit protection and you want to pay it all off in 10-years. One thing I find interesting is that this seems to be the default for Agents who are not familiar with Maximum Over-funded Life Insurance.

#9  Growth Rate Assumptions 

It’s important to know that Growth Rate Assumptions can dramatically change the Illustration. That means that you must use consistent assumptions across any illustrations you are comparing.

You are probably aware that the Growth Rates are not necessarily part of the Policy Design. But they are worthy of mentioning here. If I were to use an 8% assumed growth rate and compare it with an illustration using only 6%, the 8% would obviously look much better, right?

No Agent knows what the real dividends will be. The Dividend Rate depends on the performance of the Insurance Company’s investments. Since nobody has a crystal ball, it is critical that you understand that these rates are just guesses. That means that you should ask every agent to use the same rate. This will allow you to really see where the illustrations differ. It is important that you realize that any differences would be due to the internal costs of the policy and not an inflated assumption.

If you want to learn how I determine a reasonable rate to use, check out this video.

Illustrations do not typically show the dividend rates. If you do not see it, ask the agent to verify it in some manner. 

A universal life insurance policy should clearly state the growth rates that the agent used in making their projections. The growth rates are completely adjustable within a reasonable range. Regulators determine the maximum rate assumption so that Agent’s can’t be too aggressive with their assumptions.

 

#10  Saving Age 

One thing you should know about Life Insurance is that if you are within 6 months of your next birthday, the illustration will use your next age. However, your agent can backdate the Policy to “Save Age”.

The backdated date will be the new policy anniversary. This is important because it means that you can get your second annual premium into the policy in less than 12 months. Just realize that this only offers value if you are paying annually. If you were paying monthly, you could have several months of premium due at issue!

#11  Non-Direct and Direct Recognition Loans 

This is only vaguely within the realm of Properly-designed Life Insurance. I just want you to know that it is super important that you use an insurance company that offers Non-direct Recognition policy loans.

Direct Recognition Policy Loans

It is important to realize that Life Insurance Policies offering Direct Recognition Policy Loans, DO NOT credit dividends on 100% of the Cash Value securing the policy loan. This means that your loan is the functional equivalent of actually withdrawing your Cash Value. This will not work for The Double Play since “Double” implies that your money is working in two places at once.

If you already have a policy with Direct Recognition policy loans, it is not the end of the world. It’s important to point out that you can use a Third-party Cash Value Line of Credit. A CV-LOC is the best way to borrow against your policy, BUT it is always good to have options. For example, a few years ago, when rates were really low, a CV-LOC offered better terms. But a few years later now, CV-LOC rates are MUCH higher than Policy Loan interest rates. It’s good to know that you have the Policy Loan as a backup plan.

Non-direct Recognition Policy Loans

It is important to understand that you really should choose an insurance company that offers a variable, Non-direct Recognition Policy Loan right away. 100% of the Cash Value earns dividends whether there is a loan or not.

Just realize that while you can use a CV-LOC with Direct or Non-direct Recognition loans, it’s good to have the Policy loan as an option.

Why a Variable Loan?

A “Fixed Loan” is not as good as it sounds. The Loan interested rate will very likely exceed the Dividend or Interest Crediting rate. You want a positive Interest Rate Arbitrage.

It’s also important to know that many Life Insurance companies do not offer a Variable Loan option immediately. There is often a delay of up to five years before you can take a variable loan.

The list of insurance companies that offer both an Early Cash Value Rider and a Variable Loan option in the first year is very small. Your agent needs to know which products (very few) have ALL the necessary features. Learn more about Fixed, Variable and Indexed Loan Options here.

#12  Other Things to Consider 

 Additional Riders

It’s important to know that if your goal is to invest in real estate with your life insurance policy, you do not want to put any additional Riders on the policy. Just realize that the additional cost of any supplemental Riders eats into the cash value. If the Riders are important to you, you should consider a separate term or permanent life insurance policy. You will get much more bang for your buck.

Accelerated Benefits 

A very popular feature of many new Life Insurance Policies is the Accelerated Living Benefit Rider. This Rider allows you to advance (accelerate) a portion of the Death Benefit while you are alive. In order to receive the accelerated benefit, you must suffer a specified Critical or Chronic illness.

Life Insurance policies generally include this Rider for free. However, you should get a dedicated policy for it if it is truly important to you. Remember that we need to keep the Death Benefit in properly-designed Life Insurance to an absolute minimum? You need to know that when you reduce the Death Benefit (#3 above), the benefit of this Rider vanishes. To get an idea of what I am stating, scroll back up to the Blue graph in #7 above. Notice the VERY small corridor of risk after the Death Benefit reduction. The rider had value in Years 1-10 only. The value disappeared when the Death Benefit was reduced.

This article provides more detail: Should You Choose a Policy With an Accelerated Benefit Rider?

Agent Tricks 

The last thing I want to briefly cover are Agent Tricks. It’s important to point out that the agent has a lot of latitude in determining the assumptions for an illustration. That means you should review the illustration carefully and look for these:

  1. Make sure that the growth rates are reasonable and conservative.
  2. Make sure that all of the assumptions are the same between ALL your illustrations. You need an apples-to-apples comparison to see the true differences in the policy costs.
  3. Ensure the policy projects the retirement income out to age 120. This is the most conservative assumption and makes sure that you will never run out of income. Some agents like to show income for only 20 years. I don’t know about you, but I hope to live beyond age 85!
  4. “Leveraged” indexing options. This only applies to IUL. It’s interesting to know that in exchange for a fee, you can sometimes buy a higher cap. These indexing options are much more complicated. Only someone who wants to time the market should use them. They offer no value if the market index goes down or doesn’t surpass the old cap.
    • What you need to know is that the Agent may “Sneak” these into the illustration to show greater accumulation. They come with a higher “assumed” rate of growth. Just keep in mind that its called an Illustration for a reason. Its just showing you what the policy would look like IF the assumptions were true. What happens when you assume?
    • Your best bet is to just run every illustration with the same exact growth rate.

Conclusion

I just want to leave you with a reminder that it’s crucially important to understand that Real Estate Investors NEED Properly-designed Life Insurance. Anything less than a Maximum Over-funded Policy design will leave money on the table. My goal was to show you how you can be confident that you have Properly-designed Life Insurance.

Making sense of life insurance illustrations isn’t easy. Even many agents don’t understand Maximum Over-funded Life Insurance.

Lastly be sure to get a copy of my eBook: This Policy Design Mistake Could Cost You Thousands. I dive into just why the Policy Design is so important.


[1] Information on MECs, The Benefits of Creating a MEC, Single Premium Life Insurance

[2] Is IUL Safe For Infinite Banking?


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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.