Life insurance is a crucial component of financial planning to provide financial security for your loved ones. However, in the world of life insurance, there are buzzwords and catchy phrases that can sometimes mislead consumers. Terms like “Be Your Own Bank”, “Million Dollar Baby”, “Wealth Creation Accounts”, Tax Free Retirement”, etc., have become popular for marketing. In this blog post we’ll break down these terms and clarify what they really mean in the context of life insurance.
Be Your Own Bank: This term suggests that you can use the cash value in a permanent life insurance policy to finance major expenses without relying on traditional banks or lenders. Ideally the policyholder “borrows” the funds from the cash value of their life insurance tax free at a low interest rate. The policy holder pays a low interest rate on the “borrowed” funds from their cash value and has the option to pay it back over time, or in a lump sum, or never pay it back. An interest rate must be charged according to the IRS for the amount to be considered a loan and maintain tax favorable handling. Please note that the amount borrowed from the life insurance policy will reduce the death benefit if it is not repaid and the policyholder passes away. The advantage to taking out a loan and not withdrawing funds is that since it is a loan, the account continues to be credited as if the money was still in the account. Investors and business owners love using life insurance for growing their wealth. They leverage the cash value life insurance to invest to grow their wealth and also continue to receive index credits as if the money was still in the account. In essence they can double the amount of earnings with this strategy.
Wealth Creation Accounts: This term is often used on social media platforms to describe a type of account that “only the super wealthy know about”. What it actually describes is a permanent life insurance policy with cash value. Ideally, it is a well-structured policy to be maximum funded by the policyholder to build cash value as quickly as possible while staying within the allowable limits to receive tax favorable status. There is a cost associated with the life insurance, but the amount paid into a life insurance account above the cost of insurance plus index credits grow the cash value and increase the death benefit over time. The goal is to start with a small death benefit to pay lowest cost for the insurance but pay the largest premium the IRS will allow to grow the cash value. Over time the cash value and death benefit grow, tax free. These are also referred to as “A Rich Man’s Roth Account” since there are restrictions and limitations on how much you can earn to qualify to contribute to a Roth account and restrictions on using the money in the Roth account before age 59 1/2. Life insurance has the advantage that wealthy people can grow their money tax free without these restrictions and the added benefit of the death benefit which is like trading pennies for dollars.
Million Dollar Baby: This is a catchy phrase, and it suggests a life insurance policy for a baby worth a million dollars. These accounts are marketed to parents and grandparents to purchase for young children to later be used for college. While it’s hard not to get caught up in the allure of a large death benefit, the fact is for budget purposes, these accounts generally start off with a much lower death benefit but do increase in value over time. The undeniable benefit of creating a permanent life insurance policy for a youth is locking in their insurability while they are young and healthy. The premiums are lower because of their age (low risk) and these accounts are a great way to set a child up for financial independence. Ideally, these accounts if properly funded can be used for college, wedding, start a business venture, put a down payment on a house, retirement funds, etc. Don’t you wish your parents set one of these up for you?
Tax-Free Retirement: Similar to Wealth Creation Accounts (above), the cash value inside of a permanent life insurance policy grows tax free. The concept is valid by contrasting how funds that grow inside a 401(k) and IRA’s grow tax deferred meaning taxes have not been paid yet and will be owed to the IRS at a later date based on whatever the tax rate is the year those funds are withdrawn. Currently it is April, 2024 and we KNOW that if congress does NOTHING, that the moratorium on taxes will expire and taxes will go back to a higher rate in 2026. Based on the increasing US debt, it is reasonable to believe that taxes WILL be increased even more. Some experts claim middle class earners could pay as much as 50% and that may be conservative. We cannot predict the future, but we know that taxes are currently at the lowest levels they have been for over 100 years. A tax-free retirement account is a great strategy to have funds in a tax-free account that will never be subject to taxes no matter how high they go.
Another consideration is that a 401(k) or IRA account is tied to the stock market. Let’s imagine the stock market plunges by 50% (like it did in 2008) and the $1M 401(k) suddenly becomes a 201(k). (Joking, there is no such thing as a 201(k) but I think you get the point that the $1M becomes $500k). What would you do if you if you were in or near retirement and just lost $500,000 in less than 1 month? It happened in 2008 and took 7 years to get back to where it was. Would you want to draw money from your 401(k) account to cover monthly expenses if it just lost half of its value? No, of course not. Everyone talks about diversifying investment portfolios, but nobody talks about diversifying tax strategy. Life insurance is a great strategy to diversify tax buckets, to prevent spending down tax deferred accounts like a 401(k) while the market is down.
Conclusion: Life insurance carriers discourage the use of these buzzwords and catchy phrases because they can be misleading and create unrealistic expectations for consumers. Life insurance is NOT a “get rich quick” strategy and it’s crucial to understand these terms are not an actual product but social constructs for marketing purposes.
Life insurance is essential for financial protection for your loved ones. Permanent life insurance is a long-term commitment and it’s important not to be swayed by catchy buzzwords and marketing hype. Focus on understanding the benefits and features of life insurance and how it aligns with your financial goals. There is so much more that life insurance can do that is not mentioned in this blog post.
Are you curious if you qualify for life insurance and what it could do for you? Brightside Financial is happy to help. Schedule your no cost consultation and find out if life insurance is right for you.
