What is it you are looking for whole life insurance for? Do you want the most cash value, highest death benefit, no medical exam, final expense, retirement, key employee, or some other reason?
All of the above options are just some of the things you may be considering looking into a whole life policy for. Due to the different factors involved with creating an illustration for an individual, it’s always best to speak with an agent to make sure it fits you specifically.
There is no one size fits all life insurance policy. There are similarities between all life insurance policies, things that each has in common, and there are things that some companies do differently than each other. For those reasons, it’s necessary to talk things out.
Understanding whole life insurance and max cash value banking
First things first, a standard whole life or straight life policy isn’t great at early high cash value or long-term growth needed with infinite banking(if that’s what you’re looking to do with it). Even though whole life has guaranteed cash value growth and a death benefit, there are specific enhancements needed to supercharge a policy.
There are three guarantees with each policy, cash value growth, death benefits, and monthly premiums. Designing a policy specifically for cash value growth makes a huge difference between a policy that’s essentially really expensive term and one that can be used in the 2nd or 3rd year if not the first.
When picking a policy the first design consideration is getting a policy from a company that offers dividends. These are called participating policies and while dividends are not guaranteed most companies that offer them have paid them every year, many even during the great depression.
Why are you looking for whole life insurance?
A properly structured whole-life policy designed for cash value growth is great at that while also offering liquidity and safety. You can access the cash value through the use of policy loans, and doing so will not reduce the cash value balance. Meaning it continues to earn interest on the full cash value. In addition, your policy is safe from creditors, lawsuits, etc.
While the above sounds great things can be even better when you take advantage of the cash value growth with your own hands. Rather than just letting it grow based on the monthly premiums you can accelerate its growth through those loans which you would be wise to purchase cash flow producing investments. This wealth acceleration process allows you to maintain control of your money and creates a real asset you can use over and over again.
Using your policy in this manner allows you to create a return in two places which is what makes it important to structure it properly so you can build cash value early on.
Growing cash value over time
When looking at policy design we want to maximize its potential for long-term cash value growth. This is the rate of return within the policy and is affected by the premium that you put in plus the costs within the policy. By reducing costs to the insurance company as much as possible we can increase the cash value available and increase its growth rate.
Several things come into play when we talk about accelerating growth. We can do this by buying additional death benefits (called paid-up additions rider), repaying loans so it’s available again, and paying ourselves a reasonable interest rate along with it.
Liquidity vs cash value
As a side note here liquidity in a policy and cash value growth are almost opposite of each other. This is yet another reason that its important to have a conversation regarding your intention behind looking for a whole life policy.
Put simply here you can make the cash value more accessible and somewhat lower the cash value growth or less accessible and increase it. All this means is we need to find a good balance and figure out the proper funding option.
Understanding premium for a whole life policy
Many of us see the word premium and we instinctively just think “extra expense”. Instead what I want you to think is an “extra step”. Meaning that you are going to put your money into the bank and then instead of just taking that money and consuming it, first you will add a step which is funding your whole life policy. Put it in the bank and then through your personal max cash value build a whole life insurance policy.
Each premium payment made actually gets broken down into multiple parts. Part goes to the insurance company for expenses, part goes to pay for your death benefit, part to cash value, etc. Here are 3 important parts to understand.
Base premium
Determines the death benefit which is different for each person based on age, habits, gender, and other factors. The base premium helps establish the foundation of your policy and increases growth through dividends.
Most standard whole-life policies are based largely on base premium which shows a low growth rate over time and sadly this is what gives them a bad name. Based just on the initial illustration you may find little cash value if any the first year and may take decades to build any significant amount.
PUA
The way that the paid-up additions rider works is very simple. While it does increase the death benefit it’s quite small compared to the base premium. However, what you do is fully pay for that growth upfront. Meaning no more premium is needed for that portion that was purchased.
The majority of this paid-up portion goes directly to cash value immediately. Paid-up additions are available at certain points but cannot be the focus of a policy otherwise you lose the tax advantages and a better death benefit.
Term rider
The death benefit is important because it is what helps determine if a policy has broken the life insurance rules and become a modified endowment contract or MEC. So to help avoid issues we include a healthy base premium for the initial death benefit value and then a term rider to help increase the death benefit further while reducing costs to help us boost our cash value growth.
There may be reasons you find that creating a MEC is beneficial but for most purposes keeping tax-advantaged growth is preferable. If cash value breaks the ratios set by the IRS on a 1 and 7-year test then it causes taxable events to occur.
The term rider usually only lasts for about 10 years so the cost is quite minimal. The other thing we do with the rider makes sure that it is convertible.
Balancing base and paid-up additions when looking for whole life insurance
Summarizing where the premium goes we can simply say that getting the maximum cash value up front and over time is balanced by access to that cash up front or later on. This balance is determined based on how much goes towards base premium and paid-up additions.
Mostly base and you get great death benefit with long-term growth while giving up access early. Mostly PUA and you get great upfront growth while sacrificing it long-term as well as a death benefit.
How do dividends affect growth?
When you get an illustration done you will see two columns, one without dividends and one with. The reason for this as stated earlier is because they are not guaranteed to be paid out. The first column is based on interest only and is the minimum contractually guaranteed if you simply pay the base premium. The dividend side will show interest growth plus dividends at the company’s current dividend rate.
A note on dividends being paid. While not guaranteed we work with companies that have historically paid them for the last 100 years or so. This makes it quite likely for them to be paid but at the same time, we don’t know what the future holds so don’t count on it.
Funding your whole life policy
While funding your policy understand that you have several methods of making premium payments: monthly, annually, and single premium.
By far the most costly option is monthly, both for your cash value growth as well as for the insurance company. If you make an annual premium then you give yourself a much better option for creating instant cash value and allow for better cash value growth(with fewer costs involved it shouldn’t be any wonder why).
Additionally when we look at funding policies there comes the idea of creating a good ratio between the base premium, PUA’s, and term. Generally speaking, we can get the cash value availability at around 70% or better and often it is.
While some will say that the sweet spot formula is a certain percentage to base another percentage on PUA and the rest to term, customization is far more important. This brings us back to the idea of having a conversation and making a specialized illustration.
Ratios slightly differ from one company to another, for various reasons individuals want to use it differently, have different means, etc so no easy button exists.
Other dividend options
Something of note for future consideration is the other uses that dividends can be paid out as. Now while we recommend using them to purchase paid-up additions you can also have them paid to you as a check.
To start with your dividends may not amount to a whole lot so having them paid out won’t net you much but certainly can later on. Later on, you may decide in your old age that you want to supplement your income and get a little extra (again not guaranteed) to use as play money, or perhaps to fund another smaller policy.
For the best performance of your policy, it’s recommended to use these dividends for paid-up life insurance to grow cash value quickly and continuously. This is almost like having your money doing 3 things at once for you. By rolling the dividends back into your policy you increase the amount of money that’s earning interest plus dividends and do it over and over again. The 3rd way is how you leverage the cash value by purchasing cash-flowing assets.
Waiver of premium rider
While we are talking about riders it would be smart to discuss a waiver of premium. This is a rider that helps the policy owner in case something happens and they are unable to make premium payments due to disability. This rider can be put together in various ways from just paying the base premium to paying more.
Highly recommend this rider for peace of mind and to avoid potential tragedies from ruining the whole life insurance cash value you spent so long building. While death is tragic because we are never prepared for it, disability can create just as much financial burden on those it occurs to. Having this in place can really help maintain an asset you can use to ease that burden by continuing to increase cash flow to meet any unforeseen expenses.
Maximum cash value time-frames
After discussing all this, when do you get access to all the money you have paid into the policy?
Well, let’s break this down into 2-time frames. To start with though these are general ranges, not exact numbers.
- Cash value growth exceeds premium paid. This time frame usually happens by year five and simply means the cash value growth in the policy is more than the premiums paid that year.
- Cash value exceeds total premiums paid. In this time frame, we see that the policy cash value growth is more than the total premiums you have paid over its entire lifetime. This usually occurs by year 10.
To make an example we can say that you get a policy putting $10,000 into it each year. In year 4 you have a cash value growth of $11,000 and in year 9 its cash value is $95,000 instead of just $90,000. (super simple made-up numbers to give a visual nothing more)
What’s important and what isn’t
The essentials
When looking for whole life insurance there is a lot you see in ads that isn’t important for the policy itself. A good company with a strong history and a properly structured policy that maximizes early cash value growth is all you should focus on.
Smoke screens
Don’t get caught up looking at dividend rates as they are not guaranteed and change from year to year even if they are paid. An illustration shows projected dividends but they can and do change. Also, while a company may illustrate a high dividend this year, it may show a lower premium and another company may do just the opposite.
Another thing you may get caught up on is the interest rate offered. For many, we are used to hearing things like “this market averages X-y%”. The trouble here is that averages are not actual, they have no bearing on what is actually going on in the market. Policy-wise, most companies are very similar with whole life insurance interest rates so don’t jump from one or choose another just because of it (factors may make the rate yours gets equal to a higher or nearly, more important are reducing your policies costs).
Lastly, you may hear about direct and nondirect recognition. A non-direct recognition company they don’t take into consideration the outstanding loans when assigning a dividend. Direct recognition companies do, however in the end they come out basically the same. One may offer fewer dividends because they don’t consider the loans the other does consider them and pays less on the loan part but in the end, they are very similar.
All good companies have their money protected and must have money to pay death benefits and loan requests.
Conclusion
We have covered a lot regarding whole life insurance and what to consider when looking for it. Specifically to get the most cash value short-term and long-term customized policy design is essential. This design includes looking at the proper company product and fine-tuning premiums between base premium, riders, and term. Adding waiver of premium is also a wise idea and fairly common.
To maximize the cash value growth you then want to use loans against your cash value to purchase assets that boost your cash flow. This will improve your wealth creation significantly.
While the above may be the way to maximize your cash value growth it is by no means the only way to utilize it. Some may simply want to leverage it to get out of debt. Purchasing or paying off existing debts is also a viable method for growing your policy.
Regardless of how you decide to utilize your policy, it is important to speak with an advisor to custom create one that fits you.
Contact us today for a no-obligation illustration.