Digging deeper into insurance as a tool for money management

Penicillin

Like Penicillin, sometimes the best ideas are discovered by accident. This was the case when I stumbled upon an insurance hack to money management.

Up until this point, I’d been mostly talking in hypotheticals, but this turned out to be the real deal.

I wasn’t trying to optimize my finances when I bought my participating whole life insurance – it was just a fortunate coincidence.

My original goal was much simpler:

1. To make sure my family would be cared for if something happened to me.

2. To force myself to save some money while my financial situation was good.

3. To earn a small yield in return for stability and safety, and

4. To have the money available as a last-ditch loan in case of emergency.

To this end, I bought a couple of whole life insurance policies in 2007, and sat on them.  It took me more than 7 years to realize what a powerful tool these policies were for stashing, growing, and investing my money.

lightbulb

The most exciting phrase to hear in science is not “Eureka,” but, “That’s funny. . . “

Here’s how it all went down.

In 2010, we bought an investment condo, which happened to come with a loan at 5%. I thought, well, if my policy could loan me 5%, and I used all that money to pay down part of my mortgage, I would be helping my insurance company make a bit more money, and I’d get to share in a tiny piece of the pie.

Seemed reasonable enough.

Over the next 3 years, I started to notice something strange happening. Even though I had emptied out my policy’s cash value by taking the loan, the policy continued to grow unabated at 3-4% a year. Hmm.

Additionally, over time I found that the policy’s 5% led to less interest than what the bank’s 30-year amortization schedule would have cost me, even though I was paying exactly the same amount every month compared to what I would have paid the bank. Double hmm.

I wasn’t too interested in all of this at the time, as I was busy with work and life, and I assumed it was an error the life insurance company would automatically correct.

Fast forward another year. The same trends continued: the cash value was mostly gone; the growth was continuing; the interest due was consistently lower.

This was my “aha” moment.

It took several phone calls and multiple spreadsheets, but I finally realized that all this time I had been the owner of a high-performance sports car that I’d been treating like a storage locker.

To understand exactly how to take advantage of this, read my post about how to earn money through insurance, but here are some of the highlights:

* Your money will grow in a safe place for the medium to long term. Through the 2008-09 financial meltdown, my policies kept growing their cash values.

* Dividends and cash values will grow even when all the available cash value has been borrowed, as long as the policies are active.

* Your money will be available at any time as a preferential loan, where the principal is paid off first rather than the interest. This saves you about 10% or so in interest, depending on the term of the loan.

* There are no taxes on the growth in cash values since you are paying your premiums with after-tax dollars.

* There are no taxes when withdrawing cash value or borrowing against the policy.

* You will have a death benefit to protect your loved ones (which I now see as the icing on the cake, rather than the cake itself).

* You can demand a loan at any time without having to jump through hoops. No credit check, no home appraisal or other collateral, nada. Yes, I said demand, not request, because your insurance company cannot decline you the loan.

* There is no risk of having your home foreclosed or other items repossessed by a lender, because a policy loan is secured against your death benefit. You DO have to make sure you are current on premiums and annual interest owed, however.

 

While this may sound like modern financial wizardry, it’s just boring old “whole life insurance,” one of the oldest products out there.  This guy wrote a great piece on it, explaining the history, including where the phrase “bought the farm” came from. He doesn’t delve deep enough into the math, so his analysis is a little flawed, but he is correct that this kind of system isn’t for everyone – if you have a ton of credit card debt, you’d be better off paying that down first.

However, if you have a modest amount of “good” debt at a reasonable rate (such as a mortgage on a rental property), and have the ability to save a little each month, this system of saving and managing your money through insurance can really turbo-charge your finances.

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