Whole Life Insurance Explained

Many people are losing money because of typical financial planning. This is why it's important to have a financial formula that works so that you can keep more of the money you make and have financial peace of mind. Today we're going to be talking about the financial formula and one of the key components to that formula, which is life insurance. But it's not just any type of life insurance, it is whole life insurance. Also in this video, I will be giving you a tip on how to maximize the cash value of your life insurance, not just when it's in the policy, but when it comes out of the policy so that you can create perpetual wealth. Let's get started. Whole life insurance, sometimes it's called straight life, ordinary life, or traditional life insurance. What that means is that the policy will have a guaranteed death benefit for the life of the policy and it will also have a cash value that will build over time. Now at the maturity date of the policy, the cash value and the death benefit will be equal and the death benefit and the cash value will continue to grow as long as you continue making the premium requirements that the policy has or as long as you keep meeting your contractual obligations, the insurance company will continue with theirs. Whole life insurance specifically pays a benefit on the death of the insured and accumulates a cash value. Here's what it looks like. I have a chart here of the whole life insurance and this is just from an illustration. So what we're going to do is to put this into graph format so that we can see how the policy works as a picture. So here's the death benefit. And notice that the death benefit starts out high and remains high for the life of the policy. Then we have premium requirements. Now premiums on whole life insurance policies are paid at a level rate for the life of the contract. And with the premiums, we have cash value. Now notice this cash value starts accumulating from the first and then grows to meet that death benefit. This is traditional of whole life insurance. Now notice on this policy that the premiums and the cash value, the premiums are high but the cash value isn't really accumulating all that fast. And that's because this is a traditional whole life policy. So it takes this specific policy 19 years in order for the amount that you've paid in premium to be less than the cash value accumulated. So what if there was a way to expedite this? Let's take a look at these components that are working inside the whole life insurance policy so that we can see what's happening and where we might be able to make adjustments to make this policy more efficient. Again, we have this chart of the policy and now we have the premium, we have a cash value, the death benefit, and then something called paid up insurance. Now notice when we first pay the first year's premium on this policy, it's a $10,000 premium, the cash value is zero because this is traditional whole life insurance. The death benefit starts out pretty high at about $700,000 and the paid up insurance is zero. Now the paid up insurance part is part of the death benefit. So when there is a value in the paid up insurance column, you're not getting both the death benefit and the paid up insurance. Let me, let me show you. So here we have the second year and the premium is still $10,000. Notice there's a cash value this year. The death benefit stayed level and now we have some values on that paid up insurance. It's because of this paid up insurance here that we have a cash value. Whole life insurance is like renting to own. You make a payment and you can live in the house, but you don't own it. Same with whole life insurance. You make a payment. The insurance company is willing to give you a death benefit, but you don't own it. As you pay more premiums, you start building what's called paid up insurance. And this portion of the policy is what you actually own. So you own the paid up insurance. This is the part of the death benefit that you personally have purchased. Now the death or the paid up insurance part is also, it dictates how much cash value this policy can have. Since you own this portion of the policy, the insurance company is willing to loan you some of their money and hold this paid up insurance as reserve. Just like this. Now here are the rest of the years of the policy. Notice that the death benefit stays level, but the paid up insurance is increasing. And so is the cash value. So now if we look at the paid up insurance column, what if there was a way to accelerate this part of the policy and get this type of insurance faster so that the cash value could grow faster? Well, there is a way to do that, but to do that, we have to take out some of the death benefit. And when we take out some of the death benefit that we're renting, it allows us to have more death benefit that we own. And it looks somewhat something like this. This is called single premium insurance. And here's a chart of how it looks. Notice that this gentleman is paying $100,000 in premium the first year. He has a cash value of $86,000, almost $87,000. And the death benefit for that amount of premium is relatively small at $373,000. This is because most of the death benefit is paid up insurance, letting him have such a large cash value in year one. Here's the chart illustration. The rest of the chart, you can see he has no more premiums, but the cash value continues to grow and the death benefit stays level. Now, here is the way that this looks in graph format. We have the death benefit. We have one premium, and that premium is quite large compared to the death benefit. Then we have a cash value, which also starts out quite high and grows to reach the death benefit as any whole life policy will. Well, this works so well that many people started doing this because it was a way to put a one-time payment and get a large amount of cash to work with. And because of the nature of whole life policies, the cash inside the policy is tax. You can use it without tax penalties or fees. It was so good that in 1998, or 1988, excuse me, the IRS said, this is too nice. We are getting cut out of these taxes. People are putting their money in these types of policies, and we don't get to tax it the way that we should. And so the IRS labeled these policies MEC policies in 1988. And what this did to the policy is it made anything that was above what these people had paid in premiums, any growth above that, became taxable. So here's that depiction. So the insurance companies now needed to find a way to take this single premium concept and try to blend it with a regular whole life policy to see if they could make something that was still tax favorable for their customers, but not start all over just with a traditional whole life policy because people liked this type of growth. That's when the paid-up additions rider was born. So here's the chart of a policy that has a paid-up additions rider. And I'm going to put up the graph again of the traditional whole life policy with the death benefit, premiums for life, and the cash value. What the rider, the paid-up additions rider did was purchase a single premium life insurance policy on top of a whole life policy. That's the concept. So here we have the death benefit purchased by the paid-up additions rider. And we had some premiums for the paid-up additions rider. And the cash value on the paid-up additions portion starts out high and grows very quickly. When we blend it all together, it looks something like this. Death benefit, premiums, and cash value. And this was a very favorable way for a policy to be written. It is still tax favorable. And you can have your cash value working right away year one. Notice that this policy only takes eight years for the cash value to be greater than what you've paid in premiums. This is a sign of an efficient policy. This is a good thing. Now let's take a look at some other options. Dividends. When we talk about whole life insurance at life benefits, we're specifically talking about participating whole life insurance. And when we say participating, we're referring to the fact that the policy is eligible to receive dividends. Now insurance companies make profits. And when they make a profit, they split it up and share it with their stockholders. And so when we work with mutual companies that have participating policies, instead of the profits going to the stockholders or the shareholders, those profits get shared with the policyholders, which is us and you if you own a participating whole life insurance policy. So the first dividend option that we can elect when we purchase the participating whole life insurance policy is the dividend option to increase your death benefit. Now you can increase the death benefit like this. And what happens is when the dividend comes in and the insurance company shares it with you, they just buy some more life insurance so that your death benefit increases. Obviously, since the death benefit and the cash value are tied at maturity, that will increase your cash value also. Another way that you can have the dividend paid to you is in the form of a check. The insurance company will write a check out and send it to you. When you choose this option, it's like getting extra cash out of the policy without affecting the growth of the policy. Another dividend option that you have is for the dividend to go towards paying premiums. So your dividend can be applied towards your premium next year and help lower it. And as your policy becomes more efficient, chances are the dividends could actually pay for the premium. It doesn't start out that way, but it can end up that way in future years. Another dividend option is to have the funds, the dividend funds, accumulate in account bearing interest. You'll pay taxes on the interest that that account earns, but the dividend can be earning in that account. Our favorite way at Life Benefits to have your dividend allocated is the paid up additions. So when we purchase paid up additions with the dividend, this is what it looks like. This is the traditional whole life policy with a paid up additions writer on it. And now we're allocating these dividends because it's a participating whole life insurance policy. We're allocating the dividends toward paid up insurance. When we do that, the death benefit grows because the dividend is purchasing paid up insurance, which has to buy a little bit of insurance and a lot of cash value. So now we have death benefit increase. And when death benefit increases on a policy, cash value also has to increase because the two have to equal each other when the policy matures. So with that, now we have some extra cash value in the policy that we wouldn't have had before. And once the dividend is paid, it cannot be taken away from you. So this is like being able to buy more insurance, even if you're uninsurable in the future and have more cash value that you can work with. So that's why we like the paid up additions option so much when it comes to dividends. Here's an actual dividend statement. And I want to take a look at these numbers so that you can see firsthand what's happening when the insurance company pays the dividend. So this particular policy is about seven years old. And in 2019, it received a dividend of about $24,000. That dividend was purchasing paid up additions. And so this gentleman got an extra cash value in the policy of $28,299. The death benefit also increased. And the death benefit increased by over $61,000. Over the years, this policy is about seven years old. This gentleman has seen an increase in cash value of about $159,000 because the dividends are buying paid up additions. He's also seen an increase in death benefit of about $408,000 due to the dividends. Since this policy is still considered a baby policy, since it's only seven years old, can you imagine what these dividends are going to look like in the future? Because dividends increase over time as you own more and more paid up insurance. This is a good thing. This is very neat. And this is why we like that paid up additions dividend option. Now let's talk about accessing money in the policy. So let's say you've had this policy for five years. So you see there's $46,000 of cash value there. Now suppose you need to borrow $23,000. You need to use $23,000 for something. So you want to access the cash value of the policy via a loan. There's $46,000 here. So the insurance company knows they can loan you $23,000. You submit the loan paperwork and the insurance company takes that $23,000 and sends it over to you via check or via direct deposit or wire transfer or however you prefer. Then on the insurance company side, they subtract the loan from your available balance to tell you if you wish for another loan, then you'll only have $23,653 available. Now what happens though if you were to die while the loan was out? We get this question. Some people wonder will the insurance company pay the death benefit because I have a loan bar. The short answer to that is yes, they will. And here's how they calculate how much to pay. They look at the death benefit. They translate that over onto their death benefit claim form. Then they take a look at the outstanding loans on the policy. They see, oh, there's $23,000 that this person has borrowed. So we subtract that $23,000 from the death benefit. This is going to leave about $371,000 in this policy. They take that money and they send that to your beneficiaries. But because you've already borrowed the $23,000 and maybe you've used it for something that your beneficiaries will have or maybe it was just something that you had borrowed out and then hadn't had a chance to use yet, the beneficiaries have that capital too. And so your beneficiary really needs to add the two of those together, the $23,000 and the benefit that they received from the insurance company. And that creates the death benefit, which you can see matches what's in the policy. Now all insurance companies charge interest when you take a loan. So depending on how long you've had the loan out, the insurance company is also going to subtract the interest that is due to them if you were to pass when you have an outstanding loan. So that part has not been figured into this equation. Just remember there will be an interest charge and it's dependent on how long you've had the money, how long you've had the money out of the policy for you to use. Earlier on in this video, I said I would give you a tip for another component of the formula that we're talking about. Prescription for Wealth was written to detail how you can use the loans from the policy efficiently to create perpetual wealth outside of the policy in addition to having the growth of the policy working for you on your side. So I highly encourage you to get this book. You can find it on Amazon or you can get it as a free download on our website. I'll have the link in the description box for you. Now let's talk about withdrawals from a policy. So instead of a loan, let's suppose that you needed to withdraw the money. You might need $26,000 and in year three, there is $26,000 of cash value. So let's take that $26,000 that you need and instead of loaning it from the policy, we're actually going to withdraw it. So we take the money, the insurance company will subtract $26,000 from what's available. They'll send that to you either in a check, direct deposit, wire transfer, however you want to receive it. And then the amount that's left in your policy after this transaction would be $5. But because this is a withdrawal and not a loan, your money is actually being pulled out of the policy, not leveraged in the policy. So you're going to lose the growth of this money working in the policy when you withdraw it from the policy. So in order to figure out just how this affected the policy, we have to look at the paid-up insurance that is attached to this cash value that you just withdrew. On this particular policy, we take the paid-up insurance that matches the same year that you withdrew from and the paid-up insurance that was tied to the $26,000 that you needed was $105,000. So we're going to subtract that from the amount of paid-up additions that you started with this year. This leaves about $20 left in the policy of paid-up insurance, which is going to affect the way the policy performs in future years. Now here's the death benefit on this policy. Because the paid-up insurance is part of the death benefit, we also have to subtract from that to figure out what the new death benefit will be. So we're going to take the same paid-up additions or paid-up insurance figure, subtract it from the death benefit, and here's our new death benefit. Now we'll complete the chart for the remaining couple years of the policy. And you can see the cash value is extremely low the year that you withdrew because you actually took those funds out of the policy. The death benefit decreased, the paid-up insurance decreased, and now the next year it has to kind of essentially start over creating paid-up insurance and cash value for you. So in some situations, a withdrawal can be necessary, but it's not our first option to choose from. By borrowing from the policy instead of withdrawing from it, you're keeping options open in case you do need to withdraw from the policy later, but you're also not killing the growth of the policy prematurely. Now let's talk about some non-forfeiture options. Non-forfeiture options came about because the insurance company wanted to protect a way to keep the policy alive as long as possible if premiums were not received. So the first option that we're going to talk about is the reduced paid-up option. The reduced paid-up option works on the paid-up insurance that you have in the policy. So let's assume that this policy is going to RPU, reduced pay-up, in year six. So here we are in year five and we see that the paid-up insurance is $176,000. When the policy becomes a reduced paid-up policy, this amount of paid-up insurance, the part you own, becomes your new death benefit. The insurance company just transfers this value over to your death benefit column and fills in the columns from there on out. The paid-up insurance column is going to stay identical to the death benefit because this is all the insurance that you own in the policy and because that's now the death benefit, the columns are identical. The premium column is going to zero because when a reduced paid-up option is elected, the policy can no longer accept premiums. So you just have what you own at that point. The cash value notice continues to grow. Why? Because the cash value has to equal the death benefit at maturity. This policy is not a mature policy. It's just a reduced paid-up policy. So the cash value continues to have to grow at a reduced rate, of course, until it reaches that death benefit at maturity. There are three ways that you can get to reduce paid-up status. One, through non-forfeiture, meaning if you don't pay the premium in one year and you have elected the non-forfeiture option as reduced paid-up, the insurance company will automatically do this in order to keep the policy from lapsing. The other way that you can get a reduced paid-up status is by electing it. You can contact the insurance company and say, hey, I'd like to stop paying premiums. Make my policy a reduced paid-up policy. And they will. The third way to get to reduced paid-up status is to let the policy get there naturally on its own. All policies will, all whole life policies will. Some get there at age 75, some at age 95, some at age 100, and some at age 121. So it just depends. But all policies will get to this status on their own if you let them. One thing that you will want to be aware of is that any time that you either elect the reduced paid-up option or the insurance company makes the policy a reduced paid-up policy as a non-forfeiture option, any time that that happens, if the policy is not at least seven years old, it will change its tax status. So instead of having favorable tax status, it will become a modified endowment contract and have a MEC status, a taxable status. So just keep that in mind. If the reduced paid-up option is elected or happens to the policy any time within the first seven years, it is changing tax status as well. The next non-forfeiture option that we want to look at is the automatic premium loan. The way that the automatic premium loan works is the insurance company says, okay, here we are in year three. The cash value in this policy is about $26,000. And we haven't received any premium on this case. And it's about to lapse. So instead of lapsing the policy or putting it to reduced paid-up insurance, what they're going to do first is take a look at the cash value. Now, the premium on this policy is only $10,000. We can see that right here. The cash value is $26,000. So is there enough for the insurance company to borrow from the cash value to pay that premium? Well, yes, there is. So they take the cash value and they look at the premium and they subtract and they pay the $10,000 premium from the cash value. Now, this creates a loan on the policy. This is not a withdrawal, a loan. So this loan is going to be an interest loan. It's an interest-only loan. And if you don't pay the interest on the loan, it will compound over time like any loan does. There are a couple ways that you can get to the reduced paid-up or the automatic premium loan. Number one, it can be a non-forfeiture option. Whereas if you don't pay the premium, the insurance company is automatically going to check the policy for a loan. Or you can elect the automatic premium loan by calling the insurance company and saying, please take my premium for this year from the policy's available cash value. Another non-forfeiture option that we have to look at is the extended term insurance. Now, this is default on all whole life policies. So this is the default option. So you should understand how it works. With extended term insurance, the insurance company is going to look at the cash value of the policy. And they're going to take this cash value and they're going to buy death benefit with it in a term insurance policy for as long as possible. So in this particular policy, the death benefit is almost $400,000. So they're going to use this $46,000 of cash value to buy that death benefit for as long as possible. Death benefit and they extend it. What happens to the rest of the policy now? Because now it has been essentially converted from a whole life policy to a term policy. Well, the premium, of course, goes to zero. The cash value is used up, so it goes to zero too. The paid up insurance goes to zero. Now you don't own any of this policy. You're just renting death benefit. With the extended term insurance, the policy will lapse at some point. And this particular policy, it will lapse between year 15 and 16. Kind of like buying a 15 year term policy. This extended term insurance is, like I said, the default option for most whole life insurance policies as a non-corporate option. So you can have extended term with a non-forfeiture option if you don't pay the premium. Or you can elect it. You can call the insurance company and say, hey, I don't want my cash value anymore. I don't want to pay premiums. Make my policy an extended term policy and they will. At Life Benefits, we have seven guidelines when it comes to designing policies. Number one, we want the policy to be comfortable and affordable for you. If it's not comfortable, you won't do it. And if it's not affordable, you can't do it. And so we don't want to ever put you in a position where you can't afford the premiums or you don't want to afford the premiums because of comfort and affordability issues. We always include a paid up additions rider on our policies. Now in some cases, the underwriter at the insurance company will not allow the paid up additions rider. But that rarely happens. So as default, when we go into underwriting, we're always designing that policy with a paid up additions rider to maximize the cash value inside the policy. We also are designing policies that are not max. We don't want modified endowment contracts because we want your money to be able to grow inside the policy without having a taxable status. Some people come to us requesting modified endowment contracts because they have a little different way that they plan to use the policy. That's fine. We have sold a few modified endowment contracts, but it is not the way that we design the majority of our policies. So we always want to have that favorable tax status unless someone specifically requests for something else. We also want to have the policy have an automatic premium loan feature so that if for some reason you miss a payment, either it's late in the mail or something happens, the insurance company is going to check your cash value to see if they can borrow money for the premium from the cash value. If the policy does go to non-forfeiture status, we want to elect that reduced paid up option. So instead of keeping the default option on our policies, we change that to the reduced paid up option. Six, we always have the dividends purchased paid up additions for obvious reasons. As you saw, the dividends can be quite large and powerful, especially during later years. We want to maximize that efficiency. There are other dividend options and you can choose them or elect them at any time you own the policy. But to start out, we're going to select purchase paid up additions for efficiency. And then finally, we encourage all our clients to take loans from their policies as opposed to withdrawals. In the future, you may need or want to withdraw money from the policy, but let's not hinder the growth by withdrawing from it first, first thing or right off. Because when you withdraw, you're pulling money out of the policy and keeping it from working to create more value inside the policy. When you loan, you're accessing the insurance company's money, leaving your money inside the policy to do its thing. If you've enjoyed this video, I really hope you'll pick up a copy of Prescription for Wealth. You can get this book on Amazon or you can go to our website and get a complimentary audio or e-copy of this book. This is the book that has the tip about how to use the life insurance cash value outside the policy to create perpetual wealth. The links are in the description box below.