Today let’s look at a simple explanation regarding whole life insurance: how does it work.
Insurance companies create mortality tables that determine the premiums required based on the risks that are associated with an individual. Those risks include things like occupation, age, weight, medical conditions, medications, etc. The riskier the client is to take on the higher the premiums.
Premiums then go towards a cash value component that helps the insurance company guarantee a specific death benefit. The company also guarantees a modest interest rate for the cash value growth which is based on the total value paid in(usually in the 4-5% range).
Participating in whole life insurance policies also has the chance of gaining dividends which are a return on premium as far as taxes are concerned so not taxable and can be paid to the individual in several ways. They are not guaranteed so should be viewed as a bonus.
A whole life policy endows
Most whole life policies made now have an endowment age of at least 100, up to 121. What happens if you reach this age is that the policy ends and the cash value is given to the policy owner and it also creates a taxable event. There are a number of ways to extend the policy or ways to use it but that’s for another article.
Paid-up
A paid-up policy simply means that all premiums required to ensure the policy stays in force without any more premium payments necessary have been paid. Most straight life or standard whole life policies require payments until one passes or reaches the endowment age.
10, 15,20 pay options
These options can help you to reduce the number of years needed for premium payments though it increases the premiums during that time period. That should actually encourage you not deter you.
The reason for that is because you are able to create cash value in the policy faster with these options allowing you to leverage or use the cash value sooner, with more of it available.
Loans
When I first started learning about whole-life policies the idea of taking loans against them sounded very silly and scary. However, after reading a few books and hearing about the idea in the first one several times it has encouraged me tremendously.
They do not work the same way you view a normal loan from a bank. Let’s look at it in simple terms though to start with. Think of the cash value part as a savings account where you are simply taking an additional step before using your money. Don’t think of it as an added expense that you won’t ever get back or use. It’s another step you are taking that builds up over time.
Secondly when you take a loan, what is actually happening is the insurance company sends you money but does not actually remove it from your cash-value account. You are in essence writing an IOU to yourself here. The powerful thing is that money is still earning interest and possible dividends. SO you literally doing 2 things at once with this money.
Now for an example, you could then take that money and buy inventory for your business, a real estate investment, a website, or another item that generates income for you to powerfully maximize the growth of your cash value.
Paying back loans
When paying back a loan now you get to think of yourself as the lender because you are lending yourself this money and in choosing to pay yourself back you get to increase the cash value a little bit based on the interest rate that you choose to pay yourself within reason (something similar to what the rest of the market is loaning money at).
The other thing that is great about loans is you get to determine all the terms of the repayment to a degree. Meaning that if you use it for a car loan then you would want to make terms that are similar to what an auto loan would be anywhere else. Doing this allows you to also avoid the possible problem of creating a modified endowment contract or MEC.
Whats a MEC
A modified endowment contract or MEC as its commonly referred to simply means that the policy loses its tax-advantaged state and now you have created possible taxable events. Now I call a MEC a possible problem because depending on how you are using the policy it may make sense, however that’s outside the scope here.
Premium payment method or mode
Lastly how you choose to pay your whole life insurance policy has an impact on the risks associated with it and the cash value accumulation you can create. As well as how soon you can make policy loans.
The four types of payment methods available are monthly, quarterly, annually, and single premium payment.
if at all possible I highly suggest the annual payment because it reduces the expenses (risks), of the policy for the insurance company quite a bit and helps you create some immediate cash value. In many cases this allows a new policyholder to make a loan within the second year if not the first year when the policy is focused on max cash value accumulation.
There you have it guys and gals. Now you know about whole life insurance and how it works. For a personalized illustration to see how you can implement such a powerful policy in your life get a hold of me here.