Wealthy Americans like Walt Disney and Ray Kroc often invested in overfunded life insurance, a little-known banking strategy. Contrary to common views, overfunded whole life insurance provides unique wealth growth opportunities.
This guide covers overfunded whole life insurance basics: its workings, benefits, and differences from similar insurance types.
Whole life insurance, always paying the death benefit, lets consumers pass wealth to heirs, unlike term life. However, whole life insurance also differs from term in one very important way: its cash value feature.
The cash value of a policy is what the insurer pays you if you cancel before death. A whole life insurance policy’s cash value works something like a savings account. Each premium payment funds the policy’s death benefit and boosts the cash value account. Those funds earn interest and are available for withdrawal at any time. Importantly, you can use the cash value as collateral for low-interest loans, serving as a liquidity reserve.
To maximize that cash value, you’ll need to overfund the whole life insurance policy. You pay premiums above the required amount to maintain the death benefit and deposit the excess into the cash value. Building up cash value faster enables earlier compound interest benefits and loan opportunities. This is often termed infinite banking and it has a number of advantages for financial planning.
Here are some of the primary reasons to use overfunded whole life insurance.
#1 – A Way to Grow Your Money Tax-Free
The most attractive benefit of overfunded whole life insurance is its ability to grow your money tax-free. Interest earned within the cash value accumulates tax-deferred, meaning you owe no taxes as long as you make no withdrawals. Taking loans for investments means no withdrawals from cash value, avoiding taxes over the policy’s life.
#2 – A Way to Take Loans, Essentially Interest-Free
The loan is “safe” because you can deduct any remaining balance on it from the policy’s death benefit. Passing on wealth, while not the main purpose, remains a useful benefit of overfunded whole life insurance. The named beneficiary almost always receives the death benefit tax-free, helping to minimize estate taxes and simplify the probate process.
How it Works
Buy a policy, maximize your cash value, and take out loans for investments. Sounds fairly simple, right?Infinite banking requires attention to detail and correct execution of each step for success.
1. Start by Choosing the Right Policy
Not every insurance policy is suitable for infinite banking. First of all, it needs to be a permanent policy, whether that’s whole or universal life insurance. Term life insurance does not have a cash value component.
Secondly, you’ll want a policy large enough to fit your financial needs. To maximize the cash value you need a policy with high premiums and thus a higher death benefit. They’re more expensive, but necessary if you want enough capital to leverage for investments.
Most importantly, you’ll want a policy with a paid-up additions rider (PUA). A PUA allows you to purchase more life insurance. This, in turn contributing more in premiums and increasing both the death benefit and available cash value. Without a PUA, your cash value remains smaller, giving you less money to invest in the long run. To further explore the benefits of using your policy strategically, consider leveraging your life insurance to further expedite your financial success.
2. Build Up the Cash Value
This is the most important part of using whole life insurance but also the most boring. Make your payment every month and pay as much as allowed. It’ll take a few years to build the cash value to where it’s sensible to borrow against it. This is where the PUA is especially important. It won’t speed up borrowing against cash value but increases the available amount when you do.
There are some limitations to overfunding your cash value. In the late 1980s, Congress recognized that overfunded whole life insurance policies were being used as tax shelters. So they limited the amount that a person can contribute to their policy while still receiving favorable tax treatment. The 7-pay-test rule requires spreading contributions over the first seven years to a set max, not lump sums, for compound interest.
3. Take Out Loans
So far we’ve treated overfunded life insurance as nothing more than a tax-advantaged savings account. You pay your premiums, those premiums are split between the death benefit and cash value, and the cash value grows with interest.
To turn an insurance policy into an infinite banking vehicle you need to borrow against the cash value. Interest rates on the policy loans taken from the insurance company are usually on par with the cash value’s growth – essentially interest-free financing.
Taking a cash value line of credit (CVLC) from another bank, using the policy as collateral, can lead to an arbitrage by borrowing at lower rates than the cash value’s growth.
This is where things get a little more interesting. Once you’ve built up the cash value and taken out loans against it, you can start investing in strategies, like cash flow banking, that will increase your cash flow. That could be anything from purchasing rental properties, leasing out equipment, investing in someone else’s business, or starting your own.
5. Pay Back the Loans
Though technically not necessary, since any outstanding loans are simply deducted from your death benefit, paying back the loans with newly purchased revenue-generating assets is the way to continually grow your wealth with infinite banking. Once those loans are paid back, you can borrow more, to invest in other endeavors that’ll increase your cash flow.
When investing with the proceeds from overfunded life insurance there’s no timetable to pay it back. This added flexibility is incredibly useful when starting a business or investing in other projects that have intermittent cash flow issues or take several years to start earning a profit.
Who is Overfunded Whole Life Insurance For?
Overfunded whole life insurance is particularly well-suited for individuals who prioritize flexibility, tax efficiency, and long-term wealth accumulation in their financial planning strategy. This includes:
Investors Wanting Flexible Options
Many tax-advantaged investments come with some strings attached that prevent you from accessing money when you need it. With an overfunded whole life insurance policy you can make a withdrawal at any time. However, money in the cash value account grows over time, so a better option is to take out a policy loan, which is approved almost immediately and allows your money to grow while you’re borrowing.
People Who Start Saving for Retirement Later
Whether you’ve delayed contributions to your retirement accounts or already maxed them out, overfunded life insurance can be a great option for building long-term wealth. The policy’s tax advantages are similar to Roth IRA accounts, but without the strict contribution limits, allowing you to accelerate the growth of your savings while maintaining liquidity. Another essential way to grow your financial freedom is to take the time to make a wealth creation plan, this will help you devise a specific way to start making money.
Anyone Seeking to Minimize Taxes
Growth within a whole life insurance policy is tax-deferred, so you only need to pay if you make a withdrawal on that growth. Taxes can be avoided entirely by taking out policy loans when you need investment capital, with the interest on the loan being tax-deductible. Your policy’s death benefit is also tax-free, so your beneficiary will never need to pay for the growth accrued throughout your lifetime.
How This is Different
With so many life insurance products to choose from, it’s difficult to know which is suitable for your financial needs. We’ll cover three types of life insurance and how they relate to overfunded whole life insurance.
Term Life vs. Whole Life Insurance
While both types of insurance provide a death benefit for your loved ones, term and whole life insurance fulfill very different financial goals. Term life insurance coverage is for a specific period, usually twenty years. Premiums are inexpensive for those who are young or middle-aged, as the chances of policyholders dying are quite low. Only 1% of term life insurance policies pay out.
As a person gets older, term life insurance becomes more expensive or unavailable, especially if they have major health problems. Whole life insurance also takes age and health into account, but premiums are relatively expensive at any age since the chance of the policy paying out is 100%.
Many whole life insurance policies offer a cash value, the amount that would be paid to the policyholder if they were to relinquish their insurance. Term life insurance never has a cash value and all premiums are held by the insurance company, whether because the policyholder lived through the entire term or they chose to cancel their policy.
Term life insurance is an inexpensive option for hedging against the unexpected, while whole life insurance is a financial planning tool.
Universal Life Insurance vs. Whole Life Insurance
One of the more attractive benefits of whole life insurance is that regardless of age or health status, the premiums stay the same. Predictability is an asset for many consumers, however life circumstances change and some buyers might prefer a flexible premium and death benefit.
Universal life insurance offers just that, but with the caveat that the cash value’s growth is not guaranteed. Many universal life insurance policies are tied to stock index funds, which are less volatile than individual stocks, but still subject to fluctuations in macroeconomic conditions. Universal life insurance policies offer greater rewards and more flexibility but with heightened risk.
Whole Life Insurance vs. Overfunded Whole Life Insurance
With traditional whole life insurance, the death benefit is the focus. Most policies offer some form of cash value accumulation, but it is secondary to providing for a beneficiary after the policyholder’s death. Overfunded whole life insurance turns this around, the cash value growth becomes the main focus and the death benefit is a secondary advantage. Overfunded policies use a unique structure to accelerate cash value growth, making it possible to leverage for investments sooner.
Using This Type of Insurance for Investments
Your policy is a safe place to store your money with predictable growth and numerous tax advantages, but the overriding purpose of life insurance is to use it as a vehicle for investment. Few financial products offer the flexibility and low-interest rates of an overfunded life insurance policy. However, there are a few things to keep in mind when using one for investment purposes.
Never Withdraw Money from Your Policy
While you can make withdrawals from the cash value at any time, and that flexibility could be advantageous in emergencies, it’s not a great strategy for investment. The balance of the cash value determines the policy’s dividends; the higher its value, the more dividends you receive.
Rather than withdrawing from the policy, you leverage it, securing loans against the cash value. Hi Josh, for the list, is it also helpful to add links to Instagram accounts as in ones that are interior design
Invest in Assets that Increase Your Cash Flow
You can invest loans made against your policy’s cash value in income-generating assets like rental properties, equipment leases, or starting your own business. By investing with policy loans or a cash value line of credit you can:
- Growth your wealth while borrowing
- Deduct the loan’s interest on your taxes
- Generate income from your investment
Benefits
Overfunded whole life insurance has a range of benefits, all of which can significantly improve your financial situation with long-term predictable growth.
- Overfunded life insurance policies offer several tax advantages, with tax-deferred growth on the cash value, tax-deductible interest on policy loans for investments, and tax-depreciable assets purchased with those loans.
- Overfunded life insurance policies provide liquidity without creating taxable events. “Withdrawing from an IRA or similar account incurs penalties and treats the withdrawal as income. However, taking policy loans does not count as income, allowing your money to continue growing while you borrow.
- Overfunded life insurance policies provide more flexibility than other investment vehicles. You can buy income-generating assets like rental properties or equipment leases, beyond traditional stocks and bonds.
- Overfunded life insurance policies are perfect for passing on your wealth. Beneficiaries receive death benefits tax-free and protected from creditors who might claim against your estate during the probate process.
Wise Money Tools and Overfunded Life Insurance
Overfunded life insurance is a complex subject; just finding the right policy for infinite banking requires a fair amount of research and not everyone is up to the task of wading through mountains of financial information. At Wise Money Tools, we specialize in shepherding you through the policy-buying process and teaching you how to use life insurance to achieve your financial goals.
Not only do we offer a comprehensive and free tool kit with strategies for maximizing your wealth through infinite banking, but we also provide one-on-one guidance for a more personalized experience. Contact us today to learn how Wise Money Tools can start growing your money today.
