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Using a Maximum Over-funded Life Insurance Policy For Your Emergency Fund

In this post I am going to stray a little bit from The Double Play theme and talk about emergency funds. Before anyone gets started investing, whether in real estate or anything else, it’s a good idea to have a emergency fund of liquid cash. The fund should be able to cover 3 to 6 months of living expenses.

There are lots of different options available for saving. But its important to understand that you should choose an asset that is both liquid, meaning it can quickly and easily be converted into cash, and low risk, meaning the money will be there when you need it. 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 asset selection is important because you want to maximize the growth potential while maintaining liquidity and minimizing risk.

Keep reading to learn why I believe this and some advantages of doing it this way.

 Goal 

The goal of this post is to demonstrate that a maximum over-funded life insurance policy is the best place to store your emergency fund because it maximizes the return potential while maintaining liquidity and minimizing risk.

I’m going to start out by comparing some of the different options that are typically recommended 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 that’s not the case in a Maximum Over-funded policy. I’ll then finish up by showing you a neat little trick that offers tremendous 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 

While most experts recommend having enough cash to cover 3 to 6 months of living expenses, this all depends on your age and financial situation. 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.

CategoryCash ValueSavings/CheckingCDMoney MarketBonds
RiskLowLowLowLowMedium
LiquidityHighHighMediumHighMedium
ReturnMediumLowLowLowMedium

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.

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 if the funds were needed. Because bonds are sub-optimal in all respects, I don’t believe they are the best option for an emergency fund.

Be aware that Bank CDs are very low risk, but they are also very low return. And worse, they are not liquid because a bank CD keeps 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.

Understand that the cash value of a maximum over-funded life insurance policy is the best option because it offers a relatively 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.

Now, you might be thinking to yourself “but what about the fees in a life insurance policy?” When you read the next section, you’ll realize that the fees are outweighed by the opportunity to earn higher returns.

 Pros and Cons of Using A Maximum Over-funded Policy

In a properly-designed, maximum over-funded policy, the fee ratio is about 15% of each premium dollar.[2] Each dollar of premium should result in about 85-cents of cash value. So 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%?

In case the answer is not obvious, this chart should help visually explain:

This chart compares the growth of $1,000 going into a savings account versus $1,000 going into life insurance premium. As you can see, at the beginning of Year 1, there is about 15% less cash available in the life insurance policy than in the bank account. But because the cash value is assumed to be growing at a much higher rate, it catches up to the bank account balance during the 4th year.

If there was an emergency during the first few years of saving, this would definitely result in a shortfall compared to the amount saved.  One has to weigh this shortfall against the fact that 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. 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 in your policy to cover your expected emergencies, you can continue to fund the policy and leverage the cash values for investing in real estate (or any investment for that matter. Just be careful). 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]

 One Neat Trick 

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.

Life insurance is a little bit different. You access the cash value by borrowing against the policy, not by actually withdrawing it. What this means is that when you take a policy loan, it is a loan of the insurance company’s money that is secured by the cash value in the policy. Some people incorrectly think that they are borrowing their own money when they take a policy loan.

If you have to tap into your emergency fund, you do it by borrowing against the policy’s cash value. Because the cash value never leaves the policy, it continues to earn dividends even with the loan against it. For all practical purposes, the loan and the accruing interest is secured at all times by the ever growing and compounding cash value. Stated more simply: this means that you can leave the loan on the books until the day you die when the death benefit will satisfy the loans before the beneficiary is paid.

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 how the cash value of a maximum over-funded life insurance policy is the best way to save an emergency fund. Because an emergency fund needs to be both liquid and low risk, life insurance represents 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!


[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.

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