Is borrowing from your insurance cash value a good idea? (Article)
Is borrowing from your insurance cash value a good idea?
Have you seen one of those Facebook ads that advertises tax-free retirement income NOT using a Roth IRA or 401(k)? If so, it is probably touting the concept of using an insurance policy for a strategy called “Infinite Banking”. The name certainly sounds appealing, but is it, really?
Before I go any further, I need to say that every single insurance policy is different…offering different guarantees and fees. This description is general in nature. Infinite banking is a marketing title for the practice of taking policy loans using the cash surrender value in a whole life policy as collateral. If you have a whole life policy with $50,000 in cash value, for example, and a need for money, you can take a loan from the insurance company using the cash value as collateral. Typically, these are interest only loans just like a home equity line of credit (HELOC). In fact, we think it is fair to compare the two loans. The advantage of an insurance cash value loan over a HELOC is that there will be no credit check and you can get the cash much faster than waiting to close on a HELOC. Interest rates can be very similar.
If you are looking at it for income that you don’t pay back, the “tax free nature” doesn’t work as well and introduces risk. The reason the income is “tax free” is because you aren’t taking money out of the policy. You are borrowing money from the insurance company. The hope is that the cash value generates enough interest to pay the interest on the loan. When you die, the death benefit pays off the loan and there is no tax and no death benefit for the beneficiary, very much like a reverse mortgage. This is not guaranteed and if the total of the loan and interest balance exceeds approximately 90% of the cash value, the policy will surrender triggering the tax bill anyways.
If you have a need for permanent insurance, it is fair to say that this concept works for short-term borrowing. For a long-term investment for tax-free income, this strategy inserts uncertainty. For example, if something happens and you are unable to pay your premiums, the premiums will be paid from the cash value, which can again lead to surrender. Virtually any little hiccup in the returns or your ability to continue to pay premiums creates the potential for surrender. For the large majority of people, we think term insurance is best for protecting your family. It is less costly than permanent insurance allowing you to invest the rest and self-insure. This makes a lot more financial sense.
You’re Just Getting Started
MoneyAdvice@Work® is an employer-sponsored financial wellness benefit designed to connect employees to financial professionals who educate, advise, and coach without the sales pitch. Learn more about our service offering here. The summary/prices/quotes/statistics contained herein have been obtained from sources believed reliable but are not necessarily complete and cannot be guaranteed. Past performance results are not necessarily indicative of future results. MoneyAdvice@Work® is offered through Francis Investment Counsel, a Registered Investment Adviser with the SEC. Francis Investment Counsel does not provide tax or legal advice.