The Detailed Guide on Funding Life Insurance Policies – Episode 558

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[00:01] Welcome to the Prosperity Podcast. Prosperity thinkers, welcome to the podcast. These next couple of episodes are going to be deep dives. Yes, you’ve heard it. We’re diving into the complexities or the simplicities of life insurance policies. Now I list both because there are some pieces that you have to do in order and you have to have the right mindset to do it. But if you have the principles, as we always talk about in order, then it’s actually pretty simple. Kim, you’re better at explaining this than I am. So set the stage and then I’m going to kick off with the first initial questions. Sounds great. Well, I first have to reference that everybody’s getting a little preview of the backstage.

[00:49] So I don’t have my screen today, I just didn’t grab it. And so this is a perfect way to look at the life insurance, right? We’re seeing the backstage. In other words, you go to a play and it’s, you know, in front of the curtain, right? All the stuff that you’re supposed to see. But now we’re pulling back that curtain and you’re seeing, I didn’t even clean anything up. Like I’m in our office, we have a kitchen in the office, Todd’s office is down the hall, the dog is over here on the floor. Like this is the backstage and this is really what we’re going to be talking about the life insurance, using the book, live your life insurance, which I wrote eons ago. And there is a second version and maybe there will someday be a third version.

[01:34] And I tell people all the time, that is your owner’s manual. You want to be reading that once a year. And boy, as soon as your kids are in their teenage years, I would encourage them to read it. Now I got it. All they want to do is watch video. There will be a day when we can get an AI to create a really awesome video of that book. But between now and then it’s a short 80 pages. You can get through it in less than a couple hours and we’re going to talk about it today. I’m totally looking forward to it. Excellent. Okay. So assuming this one, we’re going to have to set the stage with language for any of our new listeners. Kim is very intentional with language. We’re going to use words like traditional and typical.

[02:14] We’re going to be specific in the language that we use as a disclaimer. I will probably get some of it wrong. Kim will not, but that’s okay. So first we’re going to talk about the policies themselves. And there’s often two things that happen here, which is the underfunding and overfunding. Let’s start at that because that feels very much like a baseline. And then we’re going to jump into other pieces. Sounds great. So this is the first act, right? It’s you taking money out of a checking account or a savings account or a money market account and giving it to the life insurance company. And therein lies our very first problem with a word because it’s called a premium and we tend to think of the word premium as we do our car and our home insurance,

[03:00] which is just cost. However, premium with whole life insurance builds cash value. If you get nothing else from this podcast, remember that premium builds cash value. Now you chose to use an interesting word that we often use, which is overfunding. So technically if your premium is, let’s just call it a thousand a month and you want to put more money in, you want to overfund it. You’ve heard on the internet that if you put extra money in, it’s going to be super duper special. There’s some truth to that. Let’s say you want to do call it twenty two hundred total. So you have a one thousand a month and the numbers are all relative. It could be a hundred. It could be eight million. It really doesn’t matter.

[03:45] A thousand a month base premium, twelve hundred a month. The overfunding is called paid up addition. It’s another term. You just got to remember it’s a weird word. Paid up addition builds cash value. Paid up addition also increases the death benefit and it must do that. That’s a question that comes up a lot. I don’t want to buy more death benefit. Yeah, I get that. And in order to keep all that cash value not being taxed, that death benefit has got to rise. Now, you also use the word underfunded and technically with whole life, there isn’t really such a thing now with universal life and other types of policies, they can be underfunded. But in my view of things, underfunding means something’s not going quite

[04:34] right now with whole life insurance, that thousand a month, the premium, you can not pay it. And maybe that’s really what you meant. You can borrow against the cash value to pay it. You can use the dividends to pay it. When your later years, you can do all kinds of different things. So you do have the flexibility of literally twenty two hundred a month all the way down to zero and everywhere in between. So if that’s what you meant by underfunding, then that’s accurate. OK, perfect. So there is one issue with the overfunding that we have to talk about because it is something that can cause a serious problem. Also, it’s where an advisor comes into play and says, hey, let’s make sure that we put up the bumpers while we’re playing the game

[05:18] and then we don’t strike out. So what is that? So there is something called a modified endowment contract limit that is set by the IRS and it’s referred to as MEC, MEC, Modified Endowment Contract. This happened in the late 80s. The IRS sets the limit. Each insurance company interprets it. They’re all in the ballpark. IRS rules, right? Basically means you can’t put in an unlimited amount of money unless you also have an unlimited death benefit. So go back to my earlier example. If we tell you that a thousand a month is your minimum premium, your maximum over scheduled, overfunded. There’s a bunch of different words that different insurance companies use. Paid up addition is the bottom line is your twelve hundred.

[06:05] Then that means that that twenty two hundred dollar figure is right up under that MEC limit, just under it. And this is not overly difficult to figure out. I know there’s a lot of Internet personalities that make it sound like they’re moving heaven and earth to give you the maximum unscheduled or overfunded paid up addition. But it’s really just click a box on the insurance company’s computer to thereby determine that twenty two hundred. Now, again, it’s all relative based on age, based on the amount of death benefit that you have, even based on gender a little bit. Nevertheless, you do not want to go over the MEC limit. MEC is also analyzed every single year. So it’s not only a first year issue, it’s every single year.

[06:52] It’s also analyzed differently with just a slightly different nuance of the law every seven years. So there’s basically two parts of the test, an annual test and a seven pay test. And so you just want to check with us or your insurance company what here’s your big question. Remember this, write it down, stamp it on your forehead, whatever you need to do. What is my maximum paid up addition under the MEC limit? And we actually even recommend that people pull that off by about 10 percent or so, because it is an estimate. If you do go over accidentally, you have 30 days to fix it. So it’s not the end of the world. Nevertheless, nobody wants the extra paperwork and hassle factor of fixing it. So premium plus paid up addition right underneath the MEC limit.

[07:39] And that is your funding mechanism, either monthly or annually. OK, perfect. That’s clear. I’m going to circle back to one other piece, which we’re going to take underfunding that terminology there. We’re going to use it in a different area, which we’re just going to say is for more general ears on this. And we’re going to see underfunding can be if you’re looking at the same, ah, you know, I really want to become my own bank or I really want to do this thing here. But what’s the least amount of capital that I can utilize? I’m going to use it in that term there. And then we’re going to jump to the next stage is the timing. So. Frankly, bluntly, whole life insurance is not for you if your goal is to put in as little as possible.

[08:34] That would be like finding the most amazing savings account in the world, right, because this is not an investment that earned you a really solid rate and had fabulous tax benefits and could be used for any emergency and any opportunity that you wanted. And asking yourself how much little, how little, how small could I build this thing, make this thing, contribute to this thing? If that’s your question, then just please go buy some cheap term insurance on the Web and be done with it. This is pretty well said. If you happen to follow certain that snowball people and you’re trying to not have any debt at all and do whatever else that is, read between the lines. That’s where the question typically comes from.

[09:23] So now let’s jump to the next, which is this timing. So someone decides they want to set this up. They’ve paid their paid up additions. They’re all in line. Should they even be thinking about utilizing and becoming their own bank? The first year or the second year? I’m glad. Great question. Not in my opinion. Timing really should be in this order. The first job of your cash value is your emergency fund. Now, for some people, they absolutely will have that handled in their first year, or maybe they’re using the current structure that we set up to help people with cash flow control. Maybe they’re using the current structure for their emergency fund. Well, then the second job of the life insurance policy,

[10:09] which for them will be the job, is your opportunity fund. You want to get that policy built up so that it has emergency money and opportunity money in it. So that does not mean borrowing against it for vacation in the first couple of years. Does not mean borrowing against it to pay expenses. I want to die every time I hear somebody saying, well, can I like run my business expenses through here? No, it is not designed for that. It’s designed for opportunities. Now, have I used my ability to borrow against my cash value to make payroll when necessary? Absolutely. But that’s not my goal. That was because there was no other source of revenue at the time. Not ideal, but it happens in business. Really, that opportunity should be out there.

[10:53] Second, third, fourth year. You know what? I’ve got clients that have built policy cash value for 10 and 20 years before they borrow against it for opportunities. And some of them never borrow against it again. So that is a fallacy that is out there on the Internet, which says that you must be borrowing against it and you must be borrowing against it quickly and often in order to really make it do its job. No, good entrepreneurs, good investors are always in a position of cash. And this is your place to store cash. So do not be trying to borrow against it in the first year, even maybe the second year, even maybe the third or the 10th year. But again, if you have to do it quick, let’s get it out there a good 12 to 18 months.

[11:38] Hey, hallelujah. How about that? That was solid. So there’s one little piece inside of this, which is going to run a couple of different scenarios. And that’s why we really want to stamp down some of these principles. So here it goes. Depending on your financial situation, and as you’ve mentioned on the podcast many times, it’s just put a different zero, OK? Like some people have, you know, again, a policy, it’s a thousand or ten thousand or a hundred thousand, or it could be a hundred. Who knows? Doesn’t matter. OK, so we have someone, they’ve done well with their career or their business. They have a policy that’s set up for themselves and for their spouse and their children. Now, let’s say they’ve set up multiple policies for themselves,

[12:26] for their spouse, for their children. And they say, hey, my business is doing so well that I want to use this capital somewhere else. What does that look like? Absolutely. Who else should they be setting it up for? Tell me. OK, OK. Well, that I need to clarify, then that’s two different questions. So what else should I do with my cash value for opportunities? Or should I be buying insurance on to broaden my foundation? Buying insurance on, because here’s the call the situation. You’ve already set it up for yourself, your spouse and your children. And maybe you went multiple. Now it’s like, no, this works. Let’s go all in. Yep. So your next step is key person. But before we go there, I just want to clarify, I own over 20 policies.

[13:15] There are so many people that think you can only own one policy on yourself, which is just categorically wrong. Who knows where they get that in their heads? So typically you’re going to buy policies in your 20s, in your 30s, in your 40s, in your 50s. And you might have three or you might have ten on yourself. And as you’ve indicated on your spouse and on your children total 20, 30. You know, really, there are some upper limits, but it takes quite a while for people to get there. And the limits are more from a death benefit standpoint, not a cash going in standpoint. So setting all that aside, your next vertical, if you will, are key people. So as a business owner or as an investor, you may have business partners, you may have key people in your company.

[14:08] They may have a variety of different titles. And what’s really fun about this space is you are the only one that can identify whether a person is key or not. So, for example, I have a relationship with our bookkeeper, both personal and business bookkeeper that has existed for close to 30 years. I own key person insurance on her. Now, she’s not even an employee, but she is integral to our operation. And if she had died yesterday, I got a mess on my hands. Now, thankfully, she has a few other people in her company, so they would be able to take over. Nevertheless, there would absolutely be a transition cost. So that life insurance policy that would pay the company if she passed on is also building an asset that is the company’s.

[15:01] And so key person, the asset is typically on the balance sheet of the business doesn’t always have to be. And there are some nuances that are not relevant to our discussion today. But key people, business partners, like if you go in joint on a real estate deal, that person is a business partner. I will state that you cannot ensure nieces and nephews unless they are a business partner. So if you have a niece or nephew that you want to ensure, go find a piece of real estate to buy with them. And let’s also go the other direction, right? We went down to kids. Of course, you can go even further to grandchildren or great grandchildren. What about going up to parents? Todd and I own life insurance on his parents.

[15:44] My dad owns insurance on himself that I keep an eye on and help with from time to time. And so that is a very viable strategy as well. Really, when you look at your asset base, we always think real estate and businesses and, you know, the table in the back room. But what about every single human that is in your direct lineage and your family in terms of their physical body being an asset for you to build another asset on top of called cash value of life insurance. And because those human bodies have a guaranteed death, you will have a guaranteed death benefit associated with that event that will pay income tax free into whoever the beneficiary of that policy is. I love it. So let’s talk one layer deeper of detail on this, which is timing.

[16:45] So listener has decided they want to do this. They’ve gone through the process. At what point does it make sense to say, OK, spouse and children? Is that one of those get familiar, wait a while, or is it let the clock start ticking? So it really depends on the situation for people that are fairly new. I really want the breadwinner and the spouse, if the spouse is not a breadwinner, insured. Like, that’s the level that should be started with. And there are definitely people call to say, I just want to go straight to insure my kids. No, the insurance companies won’t allow that. You’ve got to have that breadwinner insured. There are people that are really just so new to it that that’s where they should stop.

[17:33] There are other people that come in and they’ve really done the homework. They’ve done the research. They really are ready to go. And there’s quite a bit of extra cash flow. They can go all in. They can get themselves insured, their children insured. If they are older and they have adult children and grandchildren, they can go all three generations. They want to flip upwards and grab that fourth generation of parents. That’s also viable. But that’s a pretty big job. There’s a lot of moving parts to that. I will say that Teresa in our office is skilled at that. We know how to get insured to sign paperwork and owners to sign paperwork and coordinate all that. Nevertheless, I would say for most people,

[18:14] it’s kind of a two generational step at a time, like me and the kids and spouse of me and spouse and the kids. And then without a doubt, at some point, those other generations. But really depends on the level of activity and preparation of the person. OK, that makes sense. So here’s what we’re going to do next episode. We’re going to be talking about what happens after the policy is in place, meaning tax implications. We’re going to be talking about the protections of it, all of those bits and pieces. So if you haven’t listened to this episode, meaning you’re just coming in at the next episode, you got to go. These two go together again. This episode seems like all of our episodes like you can just pick

[19:00] and choose, sometimes, you know, putting the Lego blocks in in order. Help out. So next episode is definitely about tax advantages and the protections. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you. Visit ProsperityThinkers.com