What does financial planning entail…and what does it get wrong? See, the financial planning industry has long been perpetuating misleading ideas about retirement, savings, and investments. And a “plan” can only get you so far—assuming everything goes according to plan. Yet life so rarely does. That’s why I advocate for a financial strategy, with enough flexibility to navigate whatever life throws at you.
The foundation of this financial strategy is savings, because having access to liquid cash is the difference between scarcity and true Prosperity. The question isn’t necessarily in how much you save, so much as where you save and how you do it. If you’re using financial planning for retirement, for example, accessibility and tax benefits must be considered.
So much of the typical financial planning industry is about projections and assumptions we can’t possibly predict. Thus, it gives people a false sense of confidence without the necessary dose of realism—that unexpected things can and do happen all the time. In this article, I want to break down the industry myths and give you the confidence that you’ll be prepared for the unexpected. I want you to not just survive but thrive using Prosperity Economics.
Financial Planning Myths
I, myself, got my start in the typical financial planning industry, and I quickly realized it was all based on enormous assumptions. The questions and answers we were prompted to ask helped us build a relationship and create trust with the client, but did we deserve their trust? It’s absurd to imagine we could actually predict their future income, along with taxes, inflation, their children’s college plans, and the market!
When do assumptions hold true for 25, 30, 40+ years? Who hasn’t had their “best-laid plans” disrupted by realities they didn’t see coming?
Inside, I knew I couldn’t guarantee their financial success any more than I could guarantee the weather. So I turned my business model upside down and struck out on my own to support assets I believe in. In addition, I chose to start breaking down the financial planning myths that have saturated the market for too long, and kept people from true wealth.
And I want to share some of those financial planning myths with you.
1. More Risk Equals More Reward
Typical financial planning assumes that you will lose money, and that the more you’re willing to lose, the faster your portfolio is likely to grow. But is this true?
We have been conditioned by risk assessment profiles to think “safe” or “predictable” equals a low return on investment, and high risk equals high reward. But perhaps… the more we’re willing to tolerate losing, the greater chance we have of loss!
We’re conditioned to believe we must take bigger risks if we want a chance to earn higher returns, but again, is this true? Or are there alternatives to stock market risks or cash equivalents that grow at a snail’s pace?
In fact, my husband’s financial software is designed to show what most financial planning software does not—the whole truth about money, risk and reward.
My personal risk tolerance is ZERO. I have no tolerance for losing money, be it my own or my clients’.
2. You Have to Follow the Crowd
We’ve been conditioned to be skeptical towards the financial choices that actually make MORE sense, but not to question the options that offer investors poor or unpredictable results.
When you’re faced with a decision to sink your hard-earned dollars into stocks you can’t control and funds stuffed with financial instruments so complex it takes multiple PhD’s to comprehend, remember your mother’s question:
“If everyone else jumped off a cliff, does that mean you should, too?”
You’re made to feel like you’re doing something “risky” or even foolish if you insist on controlling your own money! But is it really risky to insist on providing your own financing, starting a business to build your own income, or buying assets you can see and understand? Is it really risky to put your money in an asset designed for protection of wealth?
3. You Must Max Out Your Qualified Plans
If you follow the admonitions to “max out your 401(k)” or other government-approved qualified plan, you’re actually losing control of your assets to the government, the stock market, and the rules of your employer.
You defer income taxes until retirement (when you can afford it least), give up what could have been lesser capital gains taxes, and pay layered and overblown management fees which drain enormous amounts of money from your retirement plan.
Just how much will you pay in fees and taxes? As I explain and illustrate in depth with Truth Concepts financial software in Chapter Six of my book, Busting the Retirement Lies, you will likely pay more in income taxes than your total contributions to your retirement plan!
This is because deferring taxes in a qualified plan means that you’ll pay taxes on the harvest rather than just the seed.
These are just a few of the financial planning myths that pervade our culture today. So why do they persist?
The Alternative to These Financial Planning Myths
Wealthy people have always practiced what we call Prosperity Economics. Therefore, it is helpful to look at how the wealthy have built wealth prior to the existence of the financial planning industry to see what went wrong.
Prior to the rise of the financial planning industry in the 1970’s, the most-used strategies were “savings accounts, whole life insurance, and the home mortgage,” according to Steve Utkus, director of the Vanguard Center for Retirement Research, as quoted in the book Pound Foolish
Were Americans more financial savvy then? They didn’t need to be, because the typical family’s finances—and financial products—were less complicated.
Nobody needed to know the difference between index funds and exchange-traded funds, hedge funds and target-date funds. And nobody needed to understand the dangers of derivatives, credit-default swaps and collateralized debt obligations.
Stock brokerage accounts were primarily for the upper-middle class and the wealthy—those who could afford to take some risks with their money. The cost of entry to the stock market was higher, and the average person did not yet have the sort of “easy and automatic” access to stock market and mutual fund investing that exists today.
People tracked their savings instead of their credit card debt. People focused on home ownership and leverage rather than paying down a mortgage. And the foundation of it all was whole life insurance designed to protect and build wealth.
The Myth of Saving and Investing
The secret to savings that last is whole life insurance with a mutual company, which offers liquid savings, tax benefits, guaranteed growth, and much, much more. Financial planning with insurance isn’t new, either. It’s one of the most traditional wealth-building vehicles used by the ultra-wealthy.
It has been said, “numbers don’t lie,” although they can be used to tell half-truths. If you have heard or read negative information online (often put out by those not even licensed to give financial advice), I urge you to set aside your preconceptions and get the facts.
The numbers reveal that whole life insurance cash value outperforms other safe and liquid financial vehicles when held long-term. When tax benefits, dividends (while not guaranteed, have a century old history of being paid every year) and the death benefit are factored in, the returns often beat that of the stock market. And when distribution strategies are compared, once again, whole life insurance surprises with its efficiency, especially compared to more investment-based retirement accounts. If you’re looking for financial planning without investment management, and hence without the risk, whole life insurance is a great foundation.
One of the oddest things about life insurance discussions is the focus on death. Who wants to talk about death? No one! So even though we’re talking about life insurance, it’s really a post about living and thriving. As one friend puts it, “The first beneficiary of your life insurance policy should be YOU.” It offers living benefits that make financial planning for retirement more certain.
Life insurance is one of the oldest financial products around, yet is also one of the most misunderstood. People debate its efficacy from every angle, but rarely is it championed. That is, until recently. After more than twenty years of business inside the financial services industry, we have only recently seen a few positive notes in the press about whole life insurance being a good place to store liquid cash.
Typical cash vehicles such as savings accounts, certificates of deposit, and money market accounts lack the flexibility and advantages of life insurance. And for several years now, rates have bottomed out near 1% or less in many savings instruments!
Whole life has proven itself to be a safe haven for cash that can out-pace inflation as well as a smart choice for permanent life insurance. And because whole life insurance policies come with a permanent death benefit, they are “self-completing” saving instruments. You begin funding your policy, and the insurance company finishes, further increasing the value of life insurance as an asset.
Unfortunately, whole life policies are too often underutilized, or worse, surrendered because the policy owner has no “owner’s manual” to tell them how to use the policy effectively.
The TRUTH is that the suppositions of financial planning are based on a combination of guesswork, mathematical projections, and wishful thinking.
The TRUTH is that even when people believe they are “on track,” they are generally under-saving.
The TRUTH is that even millionaires who have followed typical financial advice are now afraid to spend their principle for fear they will outlive their savings.
The TRUTH is that most people only have enough in savings to live the lifestyle they’ve grown accustomed to for a decade at most before they become dependent on the government or their family.
The TRUTH is that most “typical” financial planners and brokers cross their fingers and pray that the stock market doesn’t crash, because they don’t know what else to do.
Who Can Benefit from Life Insurance?
Life insurance is often equated with the death benefit alone and spoken of as something you “need” only if you have dependents. This is a limited understanding of permanent life insurance and its living benefits. Sadly, even many certified financial planners have a poor understanding of the potential power and uses of a properly constructed life insurance policy. In fact, whole life insurance is a great asset to have when financial planning for college or growing a business.
In contrast, corporations and banks understand exactly how to use life insurance for their benefit! It is a telling state of the financial industry that the financial corporations do one thing with their money while advising Americans to do something else with their money, but perhaps we can learn from the example. COLI (corporate-owned life insurance) and BOLI (bank-owned life insurance) are used to increase liquidity and grow money in a tax-advantaged environment, as well as fund employee benefits and compensation.
Of course, life insurance isn’t just for banks and corporations, even though banks and corporations put billions of dollars into life insurance for good financial reasons. Neither is life insurance just for parents with children or other dependents, even though insuring breadwinners provides an important protection for families. You also don’t have to be a high net-worth individual wishing to transfer wealth to heirs in order to benefit from life insurance, even though it is often used by those who wish to protect gains, gifts and inheritances from avoidable taxes.
You can learn to use life insurance to your benefit. In most cases, the strategies and concepts in this book can apply to men and women of all ages, health situations, and financial backgrounds. Whole life has been used by presidents, middle-class single parents, business pioneers, senior citizens, and financial planning for millennials. The ways that life insurance can be used to increase financial security for yourself as well as your beneficiaries is only limited by your imagination.
How Much Insurance Do You Really “Need”?
Starting from a basis of “need” is actually misleading. Instead, we like to approach life insurance from the standpoint of Human Life Value. Human Life Value (HLV), according to Solomon Huebner, is “the value of your future earnings.” Many life insurance companies use various parameters to evaluate this, such as fifteen times your income or one times your gross net worth. Everyone has HLV, even if they are stay-at-home parents or retired volunteers living only on social security payments. You are important in this world, and HLV is only one way to measure that importance economically.
Insuring yourself for your full Human Life Value changes throughout your life. It is important for your family, but also for your own use. In this article, we also discuss how to use your life insurance death benefit (not just the cash) while you are living, to increase cash flow and make better use of the assets you have built along the way.
The needs-analysis approach, so often used in the life insurance industry, is mathematically incorrect. With car or home insurance, there is no assuming of various interest rates and inflation rates, nor attempting to perform a “needs analysis,” yet it’s done with life insurance all the time. Insurance is designed to indemnify or “make whole” something that is missing.
For example, if you drive a $50,000 car, you insure it for $50,000 — not what you “need” to insure it for, because you only “need” to drive a car worth maybe $20,000. You want the $50,000 car and you want to insure it for the full amount.
Properly understood, life insurance is a want. You don’t “need” life insurance, your family may need it, but you can use life insurance, especially since the triggering event is guaranteed. Because death is guaranteed, you know there will be a benefit from the insurance as long as it is in force when you die. No other insurance works this way.
No one wants a guarantee that they’ll use their car, home, liability, or even disability insurance. We’re sure no one wants a guarantee they’ll use their life insurance either, but if you knew it would be used, wouldn’t you want it for the full amount?
Saving vs. Investing: What’s the Difference?
Everyone seems to be chasing after the next hot stock, the next big idea, and other “sure things.” Common financial advice says to “max out your 401(k)” and sock your money away in mutual funds, often even before a solid emergency fund is built. But there are problems with this idea.
First of all, savings should come BEFORE investing. In my book Busting the Financial Planning Lies, I describe the Prosperity Ladder and the steps that lead all the way from poverty to prosperity. Just like walking comes before running, saving must come before investing if a person will have financial stability. Otherwise, investments must be liquidated—sometimes with penalties, taxes, and a lot of inconvenience—every time unexpected expenses arise. That is no way to build wealth! Financial planning without investment management, at least at the beginning of your journey, is a good path to follow.
Saving money means putting money where it is SAFE! Saving, not budgeting, creates the foundation for wealth (here’s the difference between financial “planning” vs. budgeting). Saving allows you to invest, knowing that your investments can grow without interruption should you want to tap into your money. Saving money is where wealth begins, and it’s a habit that the truly wealthy never stop practicing.
Savings vehicles do not subject dollars to risk. As long as the money remains in the mutual funds, you run the risk of another 2009 (or 2020), when retirees and those soon-to-retire found their nest eggs cut in half. As it turned out, those who lost so much in the last economic downturn weren’t “investing” after all… they were speculating. Speculating is what we do when we don’t KNOW what an investment will earn. We’re just guessing. Or hoping. (However, if you are preparing to invest, here’s what we recommend.)
Roth IRAs and 401(k)s are typically invested in mutual funds, in which case they suffer from most of the same problems as other qualified plans: volatility, inflexibility, and inability to borrow against.
Financial gurus preach “Buy term and invest the difference,” even though many rich and successful people throughout history have done—and still do—the opposite. (Sometimes, the appropriate answer to the whole life vs. term debate is “both.”)
Retirement is assumed, instead of the possibility that people might be passionately productive at any age.
Saving money is different from investing, and it’s certainly different from speculating. Saving has nothing to do with market timing, nor does it require your time, attention, or lost sleep. Savings, as opposed to investments, are guaranteed.
Why Life Insurance?
There are numerous benefits to using life insurance as a cornerstone of your wealth management. We’ve mentioned a few already, such as the stability of this asset class through every economy. Yet you have many choices when it comes to financial vehicles and places to put your money. What is unique about life insurance that makes it our favorite place to grow and store cash? Here are seven things we love about whole life insurance:
1. Custom-Designed for You.
Life insurance requires little money to get started. You simply begin with monthly payments tailored to your capability, whether that is $50 or $5,000 per month. (And should your situation change, there are ways to adjust your out-of-pocket requirement.)
Life insurance can help those who wish to start saving with small payments on a “starter” policy or a child or grandchild’s policy. It also provides tremendous advantages for anyone who wants to move larger sums of money into a private, secure, tax-advantaged environment, without the government restrictions and contribution limits.
There is no lump-sum requirement to start. You can choose monthly payments if the annual payment is not in your budget, and if necessary, you can adjust payment frequency as you go along, or skip some of your optional paid-up additions.
Your life insurance policy is designed to fit you. Your policy can be structured to maximize cash or death benefit (we typically recommend the former, but there are exceptions.) You can fund a policy in as little as 7 years or as much as a lifetime. In some situations, you don’t even have to be insurable! And you can be a policy owner even if you are not the insured.
2. Competitive Returns.
When held long term (beyond 10 years), the internal rate of return of a life insurance policy typically out-performs bank savings accounts and CDs, money market funds, fixed annuities, T-bills and other cash equivalents and “safe money” vehicles.
Whole life insurance is a safe and reliable vehicle for long-term savings with a surprisingly impressive cash-on-cash rate of return. Current interest rates at banks are just above zero at this writing, while the internal rate of return (net) for whole life policies held long term is hovering about 4% – 4.5%, net of fees. This is historically low, as the rock-bottom interest rate environment has had an effect on life insurance as well as other economic environments. When bank rates rise, cash value rates of return tend to float higher as well, typically a few points higher than whatever rate savings accounts are paying.
3. Flexible Funds or Collateral.
One problem with many savings and investment vehicles is that you are limited as to when, how, and for what purpose you can access “your” money. When you have life insurance cash value at your disposal, you don’t have to wait until you are 59-1/2, pay penalties, ask permission from an employer, or prove that the funds are only being spent on healthcare or college tuition.
Whether you want a new roof, a down payment for a rental home, or a honeymoon vacation, your cash value provides the means. Financial planning can help you buy a car, or act as collateral on your mortgage if you’re buying a house.
You can withdraw it or borrow against your cash value, using it as collateral. Borrowing against it is often a better choice when looking at the big picture of your personal economy, but it’s liquid and it’s your money!
4. Privacy and Asset Protection.
Cash value accounts and their growth are not reported to the IRS, nor are they counted as “assets” on a FAFSA student aid application. Policy loans require no credit qualification and are never on your credit report. Additionally, in most states, life insurance offers protection against lawsuits and creditors. This asset protection may be absolute or limited, depending on your state’s regulations.
Some people find the ability to grow and store cash without the prying eyes of banks, the IRS, other federal agencies or creditors an important reason to prefer mutual insurance companies over banks when it comes to storing cash!
5. Tax Advantages.
As long as you don’t cancel the policy, under current tax law, there won’t be any income taxes on the cash value within the policy, the death benefits, or money borrowed against them. You can also receive income from a policy through dividends (up to basis) and policy loans without reducing your social security benefits. This is because policy loans and dividends (up to the amount that you have paid in premiums) are not considered taxable.
Whole life policies can also be used to gift money with no income taxes or gift taxes while you are living. (Exceptions apply for wealthy families.) If tax laws change, you still get all the other benefits.
It is interesting to note that Roth IRAs have been a hot topic. However, life insurance cash value, which is governed by similar tax law, is liquid and is not tied up until age 59 1/2. These cash value accounts grow tax-free while in the policy, can be used as collateral for tax-free policy loans, and unlike most retirement accounts, won’t give up a dime in a downturn.
6. A Financial Legacy.
In spite of many attempts to do so, you cannot compare any sort of retirement account, mutual fund, income or savings vehicle “apples to apples” with life insurance for a simple reason that life insurance critics seem to conveniently neglect: life insurance provides a death benefit!
When you put your first contribution into an IRA, 401(k), or 529 savings plan, your future estate’s net worth doesn’t magically increase by tens or even hundreds of thousands of dollars. Yet this is exactly what happens when you pay your first premium on a whole life policy!
From the very first payment, life insurance policies are “self-completing” saving instruments. Should something happen to you three months from now, your policy will provide a legacy for your loved ones and/or the causes you care about. And should you live to age 100 or more, your policy will provide you with even greater financial options for you and your family.
Life insurance has so many uses and benefits that sometimes we forget that it is also life insurance.
7. Personalized Protections.
In addition to the death benefit, life insurance can provide other benefits and protections through optional riders:
- The Paid-Up Additions (PUA) Rider increases both your death benefit and your cash value.
- A Guaranteed Insurability Rider relieves concerns about your ability to qualify for additional life insurance in the future.
- An Accelerated Benefits Rider allows you to receive a portion of the death benefit in cases of terminal or chronic illnesses.
- The Waiver of Premium Rider keeps your policy and all of its benefits in force in the case of total disability.
In summary, your life insurance policy is a custom-designed financial vehicle with personalized protections that provides competitive returns, can be utilized or borrowed against, offers privacy and tax benefits, and creates a legacy benefit.
Many people view life insurance as a black hole where money goes and that someday someone gets a benefit and it isn’t you; or worse, you pay for years, then see nothing. This view almost likens financial planning and budgeting…and no one likes to budget.
However, once you learn how to use your life insurance, you’ll see that it’s a perfect place to store cash that you will use for financing vehicles and other assets, as well as investment opportunities and your emergency fund.
We use what we call the CLUE Method of a dividend-paying, whole life insurance policy. This method is so valuable that almost everybody should own one for their own benefit—whether you’re saving for retirement, or financial planning as a young adult.
The CLUE Method
The CLUE method is a method of evaluating assets, and more importantly, dividend-paying whole life insurance. So how to do you get a CLUE? It stands for:
C = Control
L = Liquidity
U = Use
E = Equity
The cash value is your CLUE account. Cash value and death benefit are 100% in control of the owner (not the insured), and the cash value is 100% liquid. You (the owner) can use both the cash value and the death benefit while you are living, and they work like equity in real estate — with one major exception: they can never go down, only up.
Let’s look more closely at each point:
CONTROL: You own it, you control it. You say when, how much, who, how often, and why. It is YOUR money–not your employer’s, the government’s, not even your beneficiary’s (as long as you’re living).
Contrast this to other types of accounts that do not give you full control:
- A qualified retirement account may offer government-blessed tax deferrals… but a loss of control! You are told when you can use the money and for what purpose. You will even be told (later) how much tax you will have to pay to access your money, as future tax rates are also not in your control!
- Health savings accounts and education savings accounts can only be used for approved reasons without suffering tax consequences and penalties.
- An UTMA or UGMA Custodial account or a 529 account (generally used when financial planning for college) becomes automatically controlled by the child when they turn 18-21, depending on which state they reside in.
LIQUIDITY: Almost all of your account is liquid within ten days or less at most insurance companies. You can withdraw it, borrow against it, or simply let it grow. (Note, there may not be much net cash value in the first few years of the policy, but whatever is in there is available up to your company’s limit, typically about 95% of cash value.)
Cash value accounts cannot lose value and their value won’t “roller coaster ride,” as stocks, commodities, and real estate are known to do. Your gains are locked in each year.
It is also important to note that cash value accounts are not leveraged and fractionalized by the financial institution as are savings accounts at a bank. Insurance companies are not allowed to lend out the same dollar again and again and again. For this reason, banks purchase billions of dollars of permanent life insurance to hold as part of their “tier 1,” or highest quality, assets. (Insurance companies give banks liquidity, too.)
USE: Because cash value is under your control and liquid, you can USE it in countless ways! Like a Swiss Army knife or a smartphone, it can serve many purposes. Your cash value is an “all-purpose” account that can be used as:
- a short-term savings account to make planned purchases like a car
- a long-term savings account for financial freedom or inheritance
- financial planning for college tuition and expenses fund that isn’t counted as an “asset” on the parents’ FAFSA.
- an emergency fund
- an opportunity fund (for investments)
- an account to leverage against for capital expenditures or a business loan
- saving and financial planning for retirement
- and any other use you can think of!
Even if you never move a dollar, your cash value account is the single most-efficient and effective wealth management tool for storing and saving money. It’s efficient because it grows in a tax-deferred manner (taxable only if you cancel or withdraw cash above the basis). It’s effective because you can borrow against it while it still grows at the gross value. Both capabilities are not available in 401(k)s and other tax-deferred accounts. In fact, when you die, this cash-value account (now turned death benefit) will pass on to your heirs without any income tax paid at all, under current law. It’s the best place to store “peace of mind” money.
EQUITY: Just think real estate. Equity in real estate is leverage-able, you can borrow against it, but the underlying asset just keeps on growing unaffected by the debt. Life Insurance cash value works the same way, yet this is the single most misunderstood aspect of this product. You borrow against it, but you don’t take it out. The net cash value is what is left over to still borrow. For example, if you have $100,000 of gross cash value and you borrow $40,000, your account will still grow as if it were $100,000, not $60,000.
If you are borrowing against your cash value to invest, that interest should be deducted against that investment’s earnings. However, if you are borrowing against the cash value to pay premiums (for an Automatic Premium Loan) or to go on vacation, then that interest is not deductible. (And here’s what we think about financial planning to pay off debt.)
Unlike real estate equity, cash value accounts do not require you to qualify to withdraw or borrow against your own asset. Your credit score or income status is irrelevant. This is equity that’s under your control, it’s liquid, and ready to be used when needed or desired!
PHASE 1 — The Start-Up Phase
(Years 1–5 of the policy)
This is the hardest part, deciding you want to adopt this more effective yet lesser known way of handling your finances. It’s like starting a business; not only do you have to work against the naysayers, but you have to write checks, write checks, write checks, and only then do you see any benefit.
During this phase, you are converting cash to cash value plus putting an immediate, and growing, death benefit in place. Both can provide tax-free income when used properly. And both are wonderful things to have, yet hard to start. However, one start-up (though you may have many) equals a lifetime of benefits.
It’s very important during this start-up phase to remember that “you finance everything you buy.” This quotation from Nelson Nash, author of Becoming Your Own Banker, indicates the accurate but rarely discussed fact that you either pay interest to someone for the use of their money or you give up interest you could have earned by using your own money. You either pay interest, or you pass up interest. Life insurance gives you a way to more effectively finance the things you buy.
Many people want to save for their next car, home down payment, their future college students, or investment. They save then spend, save then spend, and are always starting over from scratch! When you begin to think of the big-picture, long-term view of your personal finances, you will understand that saving in order to create a long-term asset that you can borrow against (while it keeps growing) is a much better strategy.
PHASE 2 — The Leverage Opportunity Phase and Investment Capability Phase
(Years 6–30 of the policy)
This is the phase where you begin to USE your life insurance. It can begin as early as year 2 or as late as you like. Taking full advantage of paid-up additions can help you start this phase sooner than later. (They are optional, yet they help your policy build cash value faster.) Utilizing your life insurance in this phase can enable you to make better use of financing and investing decisions.
Now that you are past the start-up phase, you can see that every dollar you put into your policy is turning into more than one dollar of cash value. Not only does this increase motivation to keep funding the policy, it also gives you opportunities for leverage and capabilities for investments.
PHASE 3 — Spending Other Assets
(Years 20–40 of the policy)
Typical ages of those insured during this phase are the 60s, 70s, and 80s, and how you use your life insurance at this point will depend on how long you’ve had it, as well as how many dollars are currently borrowed against it.
If you knew that when you reached age 80 or so you would be given a large sum of money or a guaranteed stream of income that would last the rest of your life, would you act differently between ages 60 and 80?
Of course you would! You might do any or all of the following:
A. Spend down the rest of your assets
C. Give away more to charity to increase your tax deductions
PHASE 4 — Using the Death Benefit or Face Value
(Years 41–50 of the policy)
There are seven ways you can use your death benefit or face amount while you are living. These can be combined or used as stand-alone strategies.
Life insurance helps people from a wide variety of financial backgrounds. For modest income earners the premium payments become an important strategy for forced savings. Also, medium income earners end up with more dollars saved outside the policy because of the CLUE account flexibility and the lack of a financial roller coaster impacting them. Lastly, life insurance helps those with larger amounts of money as they head into retirement age by enabling them to spend their own assets more efficiently. This last group could have $1 million or $1 billion, but the concepts are still the same.
Following are seven examples of how to use your life insurance death benefit while you are living. As you read them, consider how having many smaller policies is actually better than one or two large ones, because you can do all seven of these strategies with that number of policies.
1. THE SPEND-DOWN
Typical retirees spend only interest, leaving their principal in the hands of the financial institutions. Guess who benefits from this? The institutions and the government do, and you don’t! This happens in a tax-deferred account as well; it’s just less dramatic since we don’t see it happening every year, because the problem is deferred.
Instead of leaving your dollars at the mercy of taxes and fees, you can purposely take out interest and a portion of principal every year in what is called a spend-down or a pay-down. When you do this, you receive more money, pay less tax, and leave fewer dollars in control of the financial institution.
This strategy should first occur with all qualified plan monies like 401(k)s and IRAs, as well as any SEPs, Simple IRAs and 401(k)s. Believe it or not, the Qualified Plan (IRA, etc.) is the last asset you want to die with! Many advisors recommend continuing to defer these accounts, and for some that may make sense, but every client whose situation we’ve looked at will end up with more money to spend and more to give away if they will pay down these accounts.
Secondly, spend down all taxable accounts like CDs, money markets, stock accounts, mutual funds, bonds, etc. If you are unsure of your time frames, we suggest you take an 8 percent withdrawal. Most planners would suggest 3 or 4 percent, yet this is not sufficient to remove enough principal. If 8 percent won’t zero out the account in twenty years or so, then we suggest using an even-higher interest rate.
This spend-down strategy requires a Phase 4, which is what to do after you’ve spent all your money and have nothing left in liquid accounts. The various options in Phase 4 are the following ways to use your death benefit while you are living. Again, you could use them separately or together. This can be a tricky concept to understand, so get help from someone who can clearly explain it to you before you are ready to make decisions. If you are in your 20s, 30s, or 40s, all you need to remember is: “I can use my life insurance death benefit when I’m in my 80s.”
2. REVERSE MORTGAGE
Remember, the value of a house is two-fold: a place to live and a potential asset that can be sold, leveraged against, or passed on to children or grandchildren. If you combine a reverse mortgage with life insurance, your cash flow will increase, and your heirs will be better off (with more flexibility) after you pass on. Implementing a reverse mortgage to obtain a tax-free income from your paid-off (or almost paid-off) home is an efficient use of a lazy asset — if you can see the benefits and stop worrying about paying off your home.
This strategy increases your debt, but also allows for the life insurance death benefit to then pay it off, if you choose. Some people struggle with the moral ramifications of the concept or their own expectations of having a “paid off home,” even though it’s been a viable strategy for years.
Not all mortgage brokers are familiar with these loans, so look before you jump. (We can make a recommendation if you can’t find a broker who is experienced with reverse mortgages.) Also be well aware that even if your mortgage payment vanishes or turns into an income stream with a reverse mortgage, you will still be responsible for property taxes, homeowner’s insurance, and maintenance.
3. TAKE LIFE INSURANCE DIVIDENDS OUT IN CASH NOW
This is a strategy to use later in life. Switch from using dividends to purchase paid-up additions to having them paid out in cash. This can supplement your income, which may mean the difference between a trip in the car and a trip in a plane — or more importantly, the difference between just surviving and really living.
The annual dividend can be taken in tax-free cash, up to your basis. “Basis” is defined as the total amount of money you’ve paid as premiums and paid-up additions. If you exceed your basis, then your dividend (if taken in cash) will be taxable, although you could switch to loans at that time and avoid having the income stream taxed, according to current I.R.S. law. We suggest you still make the premium payment every year to enable the dividend to keep rising and keep up with inflation, but depending on your circumstance, this may not be necessary.
4. PENSION MAXIMIZATION
This suggests a strategy for those of you with defined benefit-style pensions whereby you must make a choice between taking income during just your life (single-life payout) or during two lives (joint-life payout). If you have life insurance in force, you can take the higher payout (single-life), knowing that when you die, your spouse will get the death-benefit money and can turn that into an income stream (to replace what may have been the pension income).
There are situations where this pension maximization strategy can be used with social security payouts as well.
5. LEVERAGING THE BENEFIT BY SELLING IT
The purchaser can be a public company or a private party, or you can use it as collateral. In the first instance, you sell your policy to a life settlement company, which specializes in buying death benefits for more than the insurance companies pay for them. Typically, life settlement companies are looking for policies of someone with in their 80’s or beyond with a life expectancy of 1-7 years. Universal life policies are popular with these companies because they tend to have low cash values, therefore they can be bought for less.
The amount your insurance company would give you is the “current net cash value surrender amount,” which is the cash-value account you’ve been using all along. The life settlement may be more, depending on your age and health at the time. Likewise, you could do the same with a private party or a family member who was willing to take the risk. (We always recommend discussing decisions with your children, they may make you a better offer in order to keep the assets in the family!
Selling your death benefit to a company or a private party ends your control of the policy in any form, just as selling a deed to a real estate asset ends your control of the property.
Lastly, you could also use the death benefit as collateral. Remember, at this point, we are discussing the phase of your policy when you are in your 80s, 90s, or beyond. So, at that age, you could go to a bank or private individual and assign to them some or all of your death benefit in exchange for lending you some cash. This would leave you in control and with the ability to pay them off at any time and gain control over your policy again. Finally, when you die, they would be paid off and your family would receive the rest of the death benefit.
6. THE CHARITABLE REMAINDER TRUST (CRT)
This is a way to sell a highly appreciated asset (like stocks, real estate, or a business) through a charity without paying as much capital gains tax as if you sold it directly. Here’s a very simplified CRT process:
1) Give the asset to a charity;
2) Get a deduction for the gift;
3) Let the charity sell the asset;
4) The charity then invests the money and
5) Pays you an income stream.
6) The charity gets the remainder of the money when you die, and
7) Your family gets the life insurance instead.
In this process, step 5 would be the way you’d use your death benefit while you were living. Most people wouldn’t follow this strategy if it meant their family would get nothing, but by having your life insurance in place, your family is made “whole” in step 7.
Charitable Remainder Trusts can work especially well with homes, businesses, and assets that are “hard to share,” particularly if heirs live in different parts of the country and have varying interests. By utilizing life insurance as an “equalizer,” this strategy can help prevent family feuds as well as reduce taxes, provide income, and contribute to a worthy cause.
7. ANNUITIZE THE POLICY
You can annuitize the policy with the insurance company that is providing it. Most insurance companies will provide this option, but it’s one you’d want to do quite late in life as it’s irrevocable, and with some types of annuities, the older you are, the more monthly income you can receive.
You will pick a timeframe: 10 or 20 years, life expectancy, or life plus a certain amount to the beneficiaries. Then, the insurance company will guarantee you a certain amount of income for the timeframe you pick. It would be an alternative to selling it to a third party like a life settlement. This strategy also works well when you have multiple policies.
PHASE 5 — Setting Up the “Family Bank”
(Years 51+ of the policy)
Ideally, you’ll die late in life with (1) most of your assets used up and (2) your entire net worth, at its highest point, paid to your family and charities in the form of an income tax-free death benefit from the life insurance you own. Do remember the “right” amount of life insurance is fifteen to twenty times your income – your human life value—or one times your gross worth, whichever is greater.
With proper estate-planning documentation, this lump sum of cash could create a “family bank” whereby your grandchildren and great-grandchildren could borrow sums of money to pursue opportunities. This is the way wealthy families stay wealthy for generations — they replace their assets at each generation’s passing and buy life insurance at each baby’s birth. Not only are you transferring your wealth, you’re also transferring your skills and knowledge to your children and grandchildren. It’s easier to ensure your legacy continues when you raise financially responsible children. This kind of strategy involves your whole family and requires strong communication with your spouse, children, and any other family members who will benefit from this banking system.
How specific you wish to design your family bank is up to you. And the legal document itself that governs the family bank is generally a changeable trust until you die, at which point it becomes irrevocable. You can also leave specific amounts of the death benefit to charity or particular family members based on your desires.
A New Outlook on Financial Planning Myths
Our hope is that you’ll now begin to see financial planning, and the financial planning myths, a little differently. Whole life insurance is not just an asset to have in death, but something to utilize all throughout your life. Not as a policy to sit in a drawer, but as a tool to make your life better. It is something to be funded and used, not denigrated and viewed as a necessary evil.
If you’re seeking out where to start financial planning, the trick is to ditch the plan and start building flexible strategies that work FOR you! For help with your own financial strategy, email us at email@example.com. To stay current on financial planning myths, subscribe to our newsletter.