Borrowing From Your Policy When It DOES DOESN T Make Sense IBC Global

All right, in this video, we are going to answer an excellent question that I hear all the time, which is, does it make sense to borrow from a cash value life insurance policy if the interest rate I am going to pay to the insurance company exceeds what I am actually earning on my cash value? Does it make sense? The quick answer is, from a pure interest rate perspective, if I'm uncomfortable with that, with that negative spread, then no. A lot of real estate investors we work with look at that and say, hey, I can get a loan better elsewhere by leveraging my cash value. I'm going to do that. When I say leverage it, leverage it through a cash value collateral loan. We're going to look at an example of that in this video. But then on the other side, some individuals prefer it. I remember a doctor years ago when we first started working together, he has a large policy stated, I don't care what the interest rate is. I know I can take my policy elsewhere, or I should say, he said, I know I can get a better interest rate elsewhere, but I don't care. I am sick and tired of working with banks, lenders, I don't want to do it anymore. I'm comfortable taking the loan for my policy, even though the interest rate is higher right now, because in the future, I do believe the earnings rate will just continue to compound and it will get better and better. But the point is, he wanted the control, whereas a real estate investor or other individuals do look at the interest rate and it's important to them. So seeing the different options is really where one would answer this question differently. But let's go through this in detail, because what I want to go through here is how the growth on a policy actually works and then the loan interest, how does that actually work? We're also going to address the topic of compound versus simple loan interest and how that actually works too. So with a whole life insurance policy, the growth rate versus the loan rate. If I have a company with a 6% dividend rate, is that what I'm earning on my cash value? Because so often we see, and you may have heard, hey, you've got a life insurance policy with a 6% dividend rate. So then you can borrow at 5% and you've got a positive 1% spread. That's not true when you look at the actual earnings rate on a life insurance policy. So the dividend rate, something to touch on here, is that this is always, always a gross rate that is credited after the company's insurance expenses and mortality charges. We're going to get into more detail on that. The loan interest rate, we'll assume is 5% in this example, which is very common. So if we just start off with a dividend rate and we think we're earning 6% on our money and a loan interest rate of 5%, how it would work is like this. I've got cash value of $100,000. If I don't touch it, I receive that dividend rate of 6%. Now, if I decide to borrow from a life insurance policy, a unique feature to a cash value life insurance policy is if I let the money sit and grow or if I take a loan against it, I will continue to earn dividends on any money in cash value, so that same 6% and any money outstanding in loans, that same 6%. So what's happening here is even though I pulled money from the policy, they're still paying me dividends as if I had the full $100,000 in cash value. We're going to look at a specific example demonstrating this in this video. So what happens is I've got $50,000 remaining in cash value or equity earning that 6% dividend. Then I have this loan balance of $50,000. However, there is a cost to borrow, loan interest of 5%, which goes where? Insurance company. I do not pay that loan interest rate back to myself. Now, if I stop there and say, hey, you've got a dividend of 6% and a loan interest rate of 5%, makes it look fantastic, doesn't it? Here's the reality. The dividend, again, is not our actual earning rate. It's not. For full transparency, what we want to look at in this scenario is the net internal rate of return. If we look at that, we will see what the policy is actually growing by, what we're actually paying in loan interest and then can look at them side by side and see, okay, am I positive or am I negative here? Because often what happens is individuals purchase a policy under the belief that they're earning 6% or whatever that dividend rate is but then they look at their cash value, the first year it's negative, no matter how well you structure it, maybe we've got a 10-90 split maximum cash value but still it's negative right off the bat and say, okay, like if I borrow, I'm going to be paying more interest than what I'm earning, especially in the early years. So when would it actually make sense? So we're going to look at an example here and this example that I just described assumes non-direct recognition. Quick side note, direct recognition, we talk about this sometimes with companies like Guardian, Northwestern Mutual, MassMutual even does this with their direct recognition contract where they increase the dividend on borrowed funds when I take a loan, that would result in a slight increase in my net internal rate of return as well. But regardless, if the policy is non-direct or direct recognition, I still want to look at the pure IRR compared to the pure loan interest rate. What am I paying? What am I earning? Full transparency. So let's take a look here to dig into this. With a life insurance policy we've got cash value. The cash value does compound over time. I've got compound interest. Now let me ask a question here, have you ever heard the saying with a cash value life insurance policy your cash value is always compounding, constant compounding and then the loan interest is simple interest? When I first got into this aspect of the industry, whole life insurance policy is designed for cash value. Remember my sales manager at the office, my boss at the time, would say, hey you're earning compound interest on a life insurance policy and the interest accrues at simple interest. I'm like, okay, that sounds great. And we hear it all the time, see it all the time in marketing. The reality of it is, is that loan interest on a life insurance policy accrues at annual simple interest. So it's only simple interest for 1 year and if we do not pay any loan interest over the course of a year what happens is it then compounds on itself. We're going to look at an example on this but specifically accrues at annual simple interest and if it's not paid, compounds, it becomes compound interest. So what I mean when I say annual simple interest because that can be confusing sometimes to many, was to me, is if I take a $10,000 loan out at 5%, that's what? $500. How that would actually accrue with a life insurance policy is I would want to take that $500 and divide it by 365 days because life insurance loan interest technically or it does accrue daily. So if I divide that by 365 days that will come out to what? About $1.37 per day. I only know that because I've done that calculation a million times. I can't crunch that in my head. I wish I could with more repetition maybe. But that would be the loan interest each day. That would accrue each day on the policy no matter what. Meaning, it does not first accrue at $1.37 then my loan balance is $1.37 and then it compounds on itself. No. Every day $1.37 tacked on to the balance unless I pay any of it off but it accrues at simple interest over the course of the year. Each day it's not compounding on itself. If at that policy anniversary date when the loan interest statement comes and it says, please pay now. If I don't pay it then it will add to the balance and begin to compound. We'll look at an example on this because that can be confusing. So what we're going to look at here demonstration with policy loans. Paying back the loan. Fully paid back. That's a best-case scenario but we're going to measure the internal rate of return and compare that to the actual loan interest cost. Paying the interest only and then taking loans and not repaying it. We're going to look at 2 examples here. First we're going to look at an age 45 male, more of a generic case study than an actual case study of an older individual, 58-year-old male. Who actually brought up this to me when he said, you know, as I'm looking at different options everybody always tells me that I can flow money through a policy, earn this great dividend rate, borrow against it, and I've got a positive spread. And they'll always look at the annual internal rate of return. Some did look at that but nobody ever looks at the average IRR and that was important to him. And he mentioned, you're the only one who did that when looking at the actual loan interest cost versus the average internal rate of return, the net growth rate in the policy. And it's important to him. He was looking at $500,000 per year. But you cannot mess around with that amount of money even if it's a $5,000. You've got to be transparent with this kind of stuff. Sorry, I don't mean to get so emotional. Let's have some fun with this and look at the 45-year-old male first. So what we've got here is a policy with a dividend rate, let's touch on this point first, a dividend rate of 6.2% with a $5,000 base premium, $50,000 MEC limit, so the ability to pay up to $50,000 per year but not quite max funding it. He wanted to leave some room to add more money. He's paying in $40,000 per year. Breakeven point, year 5. Okay, that's solid for a traditional long-term performance policy where the company overcharges me in the 1st and 2nd year for the $5,000 base premium. Here's what I want to look at though. Dividend rate, 6.2%. The loan interest rate is 5% in this example. So here I've got a positive 1.2% spread on paper. This is in marketing, advertisements, it makes it look very, very attractive. That dividend of 6.2%. As I look at my cash value, year 1 I pay in $40,000, I have $33,000. I don't care if the dividend's 1,000%. If my cash value is $33,000 after I pay in $40,000, that is a negative internal rate of return in the 1st year, negative 16%. If there's going to be a drawback to whole life insurance, the 1st year is it. I've got a negative hit even with a high early cash value product, I might see between 90% to 95% in the 1st year, it's still a negative hit. If there's a drawback, that is it right there, the 1st year. Now as time passes, this dividend rate of 6.2% is illustrated indefinitely. What happens to my internal rate of return? It's in the 4's, looking good. Tops out if we scroll down here, almost at 5%. 4.99% is as high as it gets. Okay, so that's not bad but that is what I'm earning annually. Not my average IRR, we're going to look at that with the 58-year-old individual. But when I look at the net IRR, year over year, if I take a loan out in year 5, which is what we're going to look at, what am I earning that year? 3.3%, 3.29% to be precise. He takes out a policy loan of $150,000. Now again, when I take a loan from a life insurance policy, the company will continue to credit that 6.2% dividend, which in this case, would be that same net IRR of 3.29% in year 5. And they will continue to credit that on the $150,000 I loaned out. Here's my loan balance and the $43,000 remaining in cash value. Now I just want to add something here. Often individuals ask, how do insurance companies do that? Where they continue to credit you interest on the borrowed money 2 ways. 1, there is a cost to borrow. So the loan interest in this example is 5%. But 2, look at your death benefit. That is what is collateralized there. Dollar for dollar reduction when I compare it to the example without a loan coming out. I took out $150,000, I see it dropped by $150,000. I've got a calculator, you'll see it add up to $150,000. Now, here's what I want to touch on. This is the repayment example. So year 1, what is the loan interest? What is 5% of $150,000? $7,500. That loan interest goes to the insurance company. So to isolate year 5 of the policy, I borrowed $150,000 from year 6. That loan interest is $7,500. That's a 5% cost to borrow and I've earned $3.29. If I want to look at year 6 here, I'm at $3.65%. So what is the spread there? $1.35%. That's the actual net cost to borrow in that year. Not bad, but at the same time I look at it and say, alright, I'm not earning a 6% or in this case a 6.2% dividend or that's not my actual earnings rate. The IRR is what I want to look at. And then I can look at and say, okay, am I comfortable with this? Am I not comfortable with it? Do I just continue to put money in here because it's way better than having money in a bank account? Whatever our strategy is, this for transparency sake is very, very critical to be aware of because frankly, if it's not explained properly, this is where frustration comes about. So next year, I'm sorry, let me conclude policy year 6, we paid $40,000. Now we can pay back policy loans however and whenever we want. We can elect not to pay them back. But here we paid it back. If we tally up our payments, we paid back about a total of $170,000 just under that. So we borrowed $150,000, we paid $170,000 of which $20,000 went where? To the insurance company. Okay, now here's what I want to touch on in the repayment scenario. Repaid in full, policy year 10. What's your cash value? About $469,000, death benefits almost $1.9,000. What is your cash value and death benefit in the example where we never touched it? Fully restored. IRR is 4.1%. I am continuously earning that compound interest on everything. If I had a piece of real estate that was appreciating by 3% to 4% per year and I got a loan from a bank at 5%, this would be the exact same thing. Banks typically loan much lower than 5% today in this ultra-low interest rate environment. But this is the kind of stuff I like to look at. As time passes, it gets better and better. Meaning I get closer and closer to that loan spread. And here's one other thing I want to touch on. This used to make a lot more sense when we would look at ideas of borrowing from a policy, paying loan interest rate. At times we were positive in a more favorable interest rate environment. If interest rates go back up over time, which frankly I think that's going to be quite some time before we see that happen. But if that does happen, that's where we could see internal rates of return trickle up and possibly exceed that loan interest cost sooner. But at the same time, we've got that 5% cost to borrow. So that's where the decision comes into play. Here I can pay it back however and whenever I want with a policy loan but I've got that higher cost to borrow. And when I look at this, okay, it's still attractive. Core benefits of a life insurance policy, safe, liquid, tax-free area to position money. I view it really as, hey, I've got cash on hand that I use for my business, I can use this. And I can borrow direct from the policy but I can also leverage it. We're going to look at that shortly here on the 58-year-old male case study. But to conclude this one, let's look at 2 more examples. Here we repaid it. Let's look at paying interest only. So in this example, exact same thing, the $150,000 loan but we've got the 5% cost to borrow, $7,500 bills and loan interest and we pay $7,500 in loan interest. You will see that death benefit reduce just like the last example. That happens when we take out a policy loan. But what I want to look at here is here my cost is 5% all the way through. I don't want to look at the dividends here because that makes it look like it's automatically better. Let's do this. There we go. Drop in the IRR. Here's what I've got. 5% on the $150,000 only and then at this point in time if I look at year 10, I'm earning about 4.17% on the full $468,000. So in this example, I do want to hit on one other point that definitely makes it a bit more favorable in this particular case we can justify it a little bit more is what I want to look at is, hey, I've got the 5% I'm paying it each year so it is simple interest. 5% on $150,000 $7,500 per year goes to the insurance company. I'm paying 5% only on the $150,000 while I am still compounding on everything at year 10 call it the 4.1% rate. So I'm earning 4.17% call it 4.2% on $468,000 while I'm paying 5% on $150,000. So the overall interest and we can do some deeper calculations here but overall you will see it's much better to earn 4% on an entire bucket of money about $470,000 while we still only pay 5% on $150,000. But if I take more out on a policy loan that spread gets closer and closer. So it's good to look at this kind of stuff. Again, not saying one way is good, bad or different like this is how we drive our business we sell cash value life insurance. But the transparency and properly setting expectations consumer awareness is critical up front. This way we do not run into issues after the fact no one likes those. Let's look at no repayments here we go where we're going to really break down this whole idea of simple interest or compound interest on life insurance policy. So if you service the loan meaning we are paying the loan interest out of pocket every year on our anniversary date it won't compound. It will accrue at annual simple interest so we'll see it gradually accrue over the course of each year but if we pay it that loan balance is not going to increase. If we don't pay it here's what we got. Annual loan $150,000 loan balance $150,000. Next year the $7,500 comes due that is 5% of $150,000 I do not pay it so what happens is the policy will then borrow from itself borrows from the cash value to cover that loan interest. What happens when it takes a loan? Balance accrues to $157,500. Now the next year what happens is annual simple interest begins to accrue on the $157,500 so I've got 5% of that figure compounds again if I don't pay it. That loan interest each year that the policy is covering itself increases. If it's increasing it's not simple interest it's simple interest only for the course of each year. I just want to hit that point home here because it's important to be transparent about that up front. Yet in a case like this so again the 5% loan interest is accruing on the balance but I originally took that $150,000 out which I had plenty of cash value in here I paid in over 10 years a total of $400,000 and here's the internal rate of return on the entire bucket of money. So I'm still earning this IRR on my total cash value. If I come into a windfall and I pay it off at $860,000 what you'll find that cash value will be fully restored to the $590,000. Death benefit will be restored as well. So that was the generic example for the age 45 male. Let's take a look at the age 58 male. This was an actual case study here this one was a lot of fun. We're going to look at the collateral loan here as well. So there we go 58 year old male first and foremost loan and repayment. So paying in $500,000 for 5 years goal was to get $2,500,000 into a policy. Crossover point which really just speaks to the design of the policy between years 3 and 4. We often get the question hey am I too old for a life insurance policy? The answer is no if it is designed properly. That is the key for maximum cash value if maximum cash value is your goal. Annual internal rate of return just like what we looked at in the last video what I'm actually earning year over year and then average internal rate of return. Now this is good to look at because this factors in really the negative years to say annually Steve I might be topping out at just under 5% call it about 4.8% however that's only each year. So for example I could say hey I had my money in the market in 2019 and I earned about 30% investing in the S&P 500. That year annually I earned that much in the S&P 500. Then someone asks me the question well how much did you earn over the past 30 years? Well I averaged out 6%, 8% whatever it may have been. Personally I'm not in the market because it's not my thing but a lot of people we work with do do it. Now here's the point to that annually by age 65 he's at 4.84% per year average he's at 3.07%. This was important for him to look at it's important for everyone to look at to know when I take a loan what does that loan interest cost look like relative to the annual and average IRR. I'd like to see it all this way I can understand it and really make a decision that I have confidence in. Whether I do it or not it's fine but I don't want to do it under false assumptions. That's where again people get in trouble or they're unhappy I should say. Annual loan I want to take out $2,000,000 of the $2,500,000. Now what he's doing in this example loaned it out, loan interest rate was 5.66% he's paying it each year in this example when he takes out the $500,000 per year and then beginning year 6 when he's no longer paying in he pays the loan interest and repays the loan principal balance. So what I want to touch on here on the far right we've got his net interest payments about $450,000 by year 8. He's paid in $2,500,000 and he's got call it $3,000,000. So if I really break this down okay if I pay it back I paid in $2,500,000 it grew to $3,500,000 gain. Whereas over here paid it back net interest payments were $450,000. So there's a $50,000 positive spread there and then just continues to grow. So I've got the peace of mind where there's no lost opportunity cost and that's extremely valuable. I'm a big fan of that myself as well. Aside from the interest just knowing once I've got money in a policy and it keeps on moving forward for me personally I like that because if I just have it in a bank account and use it for something most don't have the discipline or awareness or really the means to actively manage it and care to say okay I'm going to pay it back and put interest in there. If it keeps on moving forward for me that's great. I see the balance restored at the end of the day. But let's look at the other items here. I know we're going deep here with a lot of material. So here we go exact same thing from a growth standpoint but now we've got the interest-only payments. So loan, pay interest only. Here are the exact same loans $500,000 per year. Here's the loan interest rate 5.66% per year. Loan interest each year right so tops out he's paying this out of pocket we see on the right about $113,000 per year in interest payments 5.66%. Annual internal rate of return what's he earning? On his entire bucket of money so he's earning this on the full $2,500,000 and paying the 5.66% on $2,000,000. Average internal rate of return tops out a little over 4% if we continue to scroll down. Again good to look at this stuff up front and we can break this down further to see okay how much is the policy growing by each year? Net of the loans is he keeping up with the $113,000 or did it not make sense to do this? I want to see that up front. We've got other videos in our policy loan section where we really go through this kind of stuff in full detail. Also looked at a no repayment example which is interesting here we see that the amount he loaned out the $2,000,000 so here same $2,000,000 taking that loan interest out that loan interest rate actually changes to 6% if he doesn't pay it that's how that company operates. Loan balance, loan interest compounding look at that loan balance but what happens here? This is under the premium and PUA payment section. It calls for a payment what happens or happened the loan interest is exceeding the interest earned on the policy my cash value is going down so if we ever hear hey you can borrow from your policy and it's a wash effect the interest earned will just wash out the interest due that's due and you don't have to pay anything that typically does not work with life insurance. We see that promoted so, so much with indexed universal life insurance has never seen it actually work in any case whether it's max fund option B whatever it might be it might illustrate it but it never actually happens and this is where consumers get into trouble so, so much when you look at the actual data and history. But here we go he has to pay premiums out of pocket or pay off that loan to get himself covered. If he doesn't pay a lapse will occur in this case that would result in taxes. So his conclusion was all right I like the idea of putting money into a policy because I like safe money this continues to grow I like the tax-free benefit I like the idea of accessing it when I want to take retirement income from it but if I'm looking at it to purchase a house for example doesn't make sense I can get a better interest rate elsewhere that's what he looked at so I can A, try and fight with him and say no, no, no go through the policy loan because you have control. No, like he looked at and said no, it doesn't make sense to me I'm not going to fight him on that. Anyway, I only say that because we see it happen sometimes. Instead, propose different options well, Mr. Client no problem so I mean this is how it would work via loan interest. However, what's also available to you is a cash value collateral loan which is a lot like a line of credit where I can take my policy to a lender institution and say hey, here's my cash value I did not borrow from the insurance company because the loan interest rate is higher than what you guys will offer me right now. What interest rate would you grant me? And the rates depend on the lender the size of the loan all that good stuff. The approval process with most lenders is very, very simple. It's not as extensive as a home or real estate loan there's a lot more that goes into that. So here, what do we see? We did the exact same thing annual internal rate of return average internal rate of return leveraging the policy because the control was valuable to him with policy loans but it was not valuable enough to justify paying that higher interest rate. He said, not my thing maybe down the road but right now, not my thing. Okay, here we go. He leverages his policy the exact same thing he did before there's his loan balance by year 5 interest rate 3% in this example. If this is for a business loan most lenders you can check that off. If it's for a business loan which can generate a tax deduction there as well the lower interest rate and potential tax deduction there. Definitely check with the CPA I'm not a CPA. But I've got my 3% cost to borrow. Here's the interest payment he's paying it out of pocket each year you'll see this match the figures over here and then he begins to repay the loan balance. Net interest payments $260,000. In this example, when we look at it no matter how we spin it if we look at the average IRR or annual internal rate of return we're positive there and it gets better and better. And if we don't like that idea halfway through we can just borrow from the policy and pay the lender off if we're comfortable with the policy at any point in time. Purpose to this options, options that is a long-winded answer to that original question does it make sense to borrow from my policy when I pay more interest than what I am earning? Depends really on a matter of preference. Again from a pure interest rate perspective right now it doesn't. We're going to see we're going to be paying more interest than what we're earning in most scenarios. In most scenarios as time passes based off of historical performance and what we've actually seen occur with cash value life insurance could see what we've seen again in the past occur or maybe it's a wash effect where we're slightly positive. But again what will bring transparency into the picture is the internal rate of return. I don't want to just look at that dividend rate and think hey I am earning more and then find out after the fact not and then it feels like not fun. Hope this one helped. Reach out with any questions. We'll talk to you soon. Thanks again.