Whole Life 101 – Frequently Asked Questions

Whole Life Frequently Asked Questions:

1. How long should I contribute to the policy/cash value account?
   As long as possible, remember the goal is to get as much money in as possible. You can stop premium or PUA (paid-up additions) payments if needed, but your goal should be to keep funding. However, one can stop in about 7 years if maximum PUA’s (paid up additions) have been added during those first 7 years.
2. What is the Internal Rate of Return on the cash value?
   If you buy a policy at age 0 to 40 or 45, approximately 3.5 to 4.0% according to the 2018 dividend. If you are older, the return decreases since insurance costs are higher so 3.0% for age 50 to 60, and lower for purchase ages 60-80. There is not a specific year or cut off, just a gradual change. Remember this is just for the current year, as dividends change annually.
3. What is the difference between 3% and 4%? It looks like only a 1% improvement.
   Think of this calculation: $100,000 cash at 3% for 30 years = $242,726.25 yet at 4% it will = $324,339.75 because 3 to 4 is a 33% improvement.  You’ll need a financial calculator (like the app for www.TruthConcepts.com) to make the calculation.
4. What is a Paid-Up Addition (PUA) rider again?
   Extra cash that you can put into your policy that goes to increase cash value and death benefit. The insurance company sends you a letter annually stating the minimum ($100 or $120) and the maximum PUA. It’s your choice every year how much you contribute to your PUA rider.
   On most policies, the minimum PUA is $100 to $120, the maximum is whatever is specified by the MEC limits (see below), usually 1 to 2 times the base premium. If your base premium is $10,000 per year, your maximum PUA will be $10-20,000 per year.  So your total contribution will be $20-30,000 per year. This is affected by age. (But do pay attention – the allowable paid-up additions will fluctuate as the death benefit rises.)
   Since it is the Paid-Up Additions that really build the extra cash value, you’ll want to aim to fund the maximum contribution rather than the minimum base premiums. Every dollar above the premium becomes a PUA dollar, and it is very advantageous to overfund your policy with PUA’s up to the MEC limit.
5. What’s a MEC again?
   MEC is a Modified Endowment Contract, and if an insurance policy is funded too quickly or with too much cash, it becomes a MEC, which means that you cannot borrow against or withdraw the funds without tax consequences. The MEC limits are set by the IRS and interpreted by the insurance companies’ illustration software and can identify your limit (maximum contribution) annually.
6. What are the guarantees?
   There is a guaranteed premium that never changes and should be paid for as many years as possible, but there are options to stop paying it. There is a guaranteed cash value that is a dollar figure (not an interest rate). And there is a guaranteed death benefit. That being said, since most insurance companies have paid dividends annually for decades, you can be confident in focusing on the non-guaranteed columns.
7. Are dividends guaranteed?
   They aren’t guaranteed to be paid, but once a dividend gets paid it becomes a part of the guaranteed cash value. That means there is a new floor set every year for your cash value.
8. What is the interest rate on the loan?
   Some companies charge variable rates (currently 5-7%) some fixed (6-8%). This interest rate is paid back to the insurance companies annually. You pay back principal on your own time frame. If you want to pay a loan back with extra interest (as Nelson Nash suggests in his Becoming Your Own Banker book), then that “extra” interest goes to your cash value in the form of PUA (paid-up additions) contribution.
   Your gross cash value continues to earn the dividend, unaffected by the loan, offsetting the impact of the policy loan interest, but not “netting” it. These are 2 separate accounts, cash value and loan.
9. How safe are insurance companies if this is my place to store my cash?
   Mutual insurance companies (owned by their policy holders) have been around since the mid 1800’s. Remember the insurance industry is a 100% legal reserve environment, unlike the banks that operate on fractional reserves. It is also state regulated whereas the banks are federally regulated.
10. How do I borrow against my cash value? (Notice you borrow “against,” not “from” a whole life policy.)
    Call us or the company. There is no paperwork unless the loan is greater than $50,000. You’ll have the money in 7-10 days. The interest is charged up front for the first year, and then billed to you annually thereafter. You’ll receive back a pro-rated portion of interest if you pay loan off mid-year. You pay back principle as you want. We say “against” to remind you that while you have the insurance company’s money in your hands, your gross cash value is still earning dividends uninterrupted by the loan. For more detail about this, read our articles:
    “Borrowing Against Life Insurance: Why It Pays to Become Your Own Banker” https://prosperitythinkers.com/borrow-against-life-insurance-becoming-your-own-bankerand “Should You Borrow Against Your Cash Value or Withdraw it?” https://prosperitythinkers.com/borrow-cash-value-withdraw
    
11. Can I insure my children and grandchildren?
    Yes, you’ll be the owner, they’ll be the insured. Just remember that you can only get about 25% of the death benefit the parents own (not the grandparents) on a child. Example: Parent owns $1,000,000 (term and whole life) so child could get about $250,000, and either the parent or the grandparent can own this child’s insurance.
12. What’s the benefit of insuring children or grandchildren?
    There are three main motivating benefits:
    First, qualification. People like to own insurance on children sometimes because they cannot qualify themselves. It also insures that their grandchildren will have some life insurance, regardless of health or circumstances.
    Secondly, a better internal rate of return. If the grandparents do qualify, and they are older, the internal ROR may be 3% on their policy, but the grandchild’s may be 4.0%. Typically, the grandparents are the beneficiaries, but the motivation is to improve the internal Rate of Return on the cash value. The grandparents may be 65 or 70 but expect to live decades longer.
    Thirdly, life insurance policies are also a fantastic estate planning and asset transfer strategy. Although there are limits to the insurance you can get, once you have the insurance, you can gift life insurance (both cash value and death benefit) to the insured in unlimited amounts. Life insurance is the only asset you can give income tax free, to the insured (the person the insurance is on) though there are some gift tax issues to be aware of.
    The caveats: The policy would be small in most cases unless there is substantial family wealth. The child’s parents have to get involved because you can’t take life insurance out on a minor without the parents’ approval. And generally, the parents of the child have to be insured for at least 4 times, what the child is insured for. If the children are old enough to work, they can be insured for 15-20 times their salary.
13. How much can I put into a child’s policy?
    The death benefit, premium, and PUA rider are all proportional. Meaning that since the child’s death benefit is low, the premium is low, so the PUA rider is low. Example: A 5-year-old boy (gender does matter, though not by much) might have a $100,000 death benefit, an annual premium of $700, and a maximum PUA of about $700.As the policy owner, you’ll have full use of the cash value. And, of course, you can make anyone but the insured, the beneficiary.
14. How does cash value grow?
    The guaranteed cash value grows based on the schedule in the illustration. 100% of the dividends get added to that when the “applied as paid up additions” option is selected. Then, starting the second year of the policy, your premium gets added to your cash value, and of course, your PUA rider, too. All these things cause your cash value to grow – yes, even the premium!
15. Are there taxes?
    Life insurance is a “tax on the seed” account (versus a “tax on the harvest” account like a 401k or IRA). So, while you pay taxes going in, there is no tax on the growth of the cash value (or the dividends when purchasing PUA’s) or the death benefit. However, the death benefit is included in your estate, and subject to any estate and inheritance taxes that may apply.