When you hear "life insurance," what comes to mind? Do you think of the monthly premiums as the "necessary evil" nobody wants to pay? Or does it remind you how you should get life insurance, but you still haven't done it? Did you know the right kind of life insurance can be an effective vehicle to protect and grow your savings?
Conventional wisdom suggests when it comes to life insurance, you should buy term. Then save or invest the difference that you would have spent on premiums if you'd bought a more expensive whole life policy. Here's why: Most people allow their insurance policies to lapse. Most people also fail to set up a whole life insurance policy correctly or maximize its financial advantages, so their cash value never exceeds the amount paid in premiums. The result is a negative return on their savings.
If you follow conventional wisdom, buy term life insurance and save the difference in your IRA or 401(k), you have no guarantee. If you incur a loss on that savings, nobody is going to reimburse you. And with term insurance, there is no utility while you're living. The solution is simple: Get help selecting the right kind of life insurance, set up your policy correctly, keep it, and use it.
If we were going to design the perfect vehicle to save and protect cash, what would that look like? We'd need to include the following attributes:
- Secure returns
- Control and liquidity
- Easy to manage
- Tax-free and inflation-proof
- Privacy and protection
A number of savings vehicles are strong on some of these, but weak on others. Gold is a great hedge against inflation, but it's not liquid and is subject to capital gains tax. The money in your IRA or 401(k) is easy to manage, but it's subject to seizure in lawsuits, the returns aren't secure, and it may become taxable.
Look again at that list of attributes describing the perfect savings vehicle. A properly structured whole life insurance policy through a privately held mutual insurance company offers all of them.
With a whole life policy, you can literally purchase a secure wealth position for the future. When your policy is issued, you are guaranteed to have a cash value at least as much as the amount quoted at the time the policy is underwritten. If you're under age 55, you have the option of a "waiver of premium" rider, which will pay all premiums for you if you become disabled.
The solvency record of privately held mutual insurance firms is nearly unblemished. Compare that to banks. Life insurance companies are required by law to guarantee their ability to pay obligations to policyholders. Unlike a bank, an insurance company must first have the funds on hand before issuing a (policy) loan. This emphasis on actual cash reserves gives you confidence your money is secure.
Control and Liquidity
When you utilize an IRA, 401(k), or 403(b) as a savings vehicle, you can't touch the money in those accounts until age 59 ½ unless you meet some very exceptional conditions or you're willing to incur a penalty, plus pay applicable taxes on any gains within the account. You also don't own the account. You're a custodian or beneficiary of a government-sponsored plan, which means they can change the rules and there's nothing you can do about it. In this scenario, who has the control?
With a whole life insurance policy, access to capital is as simple as making a phone call to the insurance company to ask them to issue a loan against your cash value. No applications, no credit checks, and no processing fees. You own the policy and you decide the payback terms. There aren't any taxes or penalties for accessing that cash value.
Easy to Manage
For any savings plan to be effective, you have to deposit money consistently, without interruption, over an extended period of time. This happens when you pay the monthly premiums consistently over the life of the policy. Arranging an automatic draft from your checking account every month puts your savings on autopilot. Your cash value climbs as you pay premiums and as the annual dividends compound.
Tax-Free and Inflation-Proof
Your bank might pay you a fraction of 1% annual interest on your account balance, which has you falling behind inflation, plus it's taxable interest income. Your whole life insurance policy will pay an annual dividend, usually around 5% tax-free, helping to hedge inflation.
If you use your annual dividends to purchase additional life insurance, your increasing death benefit is another hedge against inflation. Your growing cash value is not a taxable gain, even when the cash value exceeds how much you've paid in premiums, which usually occurs around year seven or eight in the life of the policy. If you decide to take your dividends as cash, they're also tax-free up to the amount of premiums you've paid into the policy.
Privacy and Protection
Many cops get sued at some time in their career. Money in your bank accounts can be seized as a result of a creditor's judgment or civil lawsuit. Your whole life insurance policy, however, and the cash value within, are private and protected from lawsuits in most states. (Consult an attorney to find out if this applies to you.) This protects your savings today and your financial legacy for future generations.
Borrowing from Yourself
Besides the benefits of whole life insurance as a savings strategy, there are practical ways to utilize your policy's cash value. Here are a few ways I've maximized the financial advantages of my whole life policy by using policy loans:
- Private lending
- Covering major car repairs
- Replacing my home's air conditioning unit
- Funding the start-up of my own home business
Why would I want to use policy loans instead of cash out of a bank savings account or a bank loan? Privacy, flexible payback terms, and because of how compounding works.
When you withdraw from a savings account, you lower the balance, and thus the amount of interest you earn. With a whole life policy, you don't actually withdraw cash from the policy. You take a loan from the insurance company against the policy's cash value. You are still paid a dividend on the full cash value, even while your loan is outstanding. You never interrupt the compounding cycle.
With a bank loan, failure to pay results in damaged credit and a possible judgment or asset seizure that could affect your heirs. If you don't pay back a policy loan, there's no damage to your credit while you're alive, and your heirs still get a death benefit, just minus the amount of the loan and interest, as long as you kept your premiums current.
To be clear, utilizing life insurance as discussed in this article is not an investment strategy, where you risk money for high returns. This is a savings strategy, with very conservative returns. We're talking about secure savings, long-term growth of capital, and keeping your financial information private. More than a dreaded expense or a necessary evil, a well-designed whole life policy is a smart choice for some cops.
Did you get value from this? Do you have questions? You can email me: [email protected] and I will personally respond. It's my mission to help my law enforcement family master their money and enjoy life more.
Adam Doran is a 15-year veteran police officer from the Kansas City area. You can e-mail him directly at [email protected].