Life insurance exists to provide a death benefit if someone dies prematurely. The proceeds can replace income, pay off debts, and finance future education. However, using life insurance as a bank account is not profitable or wise. When you buy life insurance, you should only use it as life insurance. So, as one of the 99.9% of people who buy life insurance, you could create more problems for yourself and your family by playing games with your life insurance policy.
Without a few million dollars to back it up, you gamble away your family’s security by neutering your life insurance coverage.
The only exception is if you are an extremely high net-worth individual and have exhausted all other tax-sheltered vehicles. Those people probably don’t need life insurance for the death benefit like most people.
Separate Banking and Insurance
Insurance and banking are two financial instruments that should not involve risk. They should be safe places to put your money where it won’t lose value because it’s not exposed to risk.
Neither should turn you a profit — that’s not the nature of those products. Savings accounts and CDs pay a pittance compared to stock market investing.
On the other hand, investing in stocks, bonds, ETFs, mutual funds, and the like is where you can take a calculated risk with the opportunity to profit.
In short, treating life insurance like a bank account is a fool’s errand promoted by unethical people selling insurance products.
The type of life insurance they hawk with this strategy pays them very high commissions. So, they are looking out for their bank account, not yours.
Buyer beware.
How Using Life Insurance as a Bank Works — Theoretically
There are two primary life insurance products: term life insurance and whole life insurance. Term life is pure insurance, lasts for a specified period, and ends. You either outlive it, or your family claims it. It’s a lot less expensive and uncomplicated.
Whole life insurance is a hybrid of pure insurance and a savings account. Final expense, variable life (VL), guaranteed universal (GUL), index universal (IUL), and variable universal (VUL) all fall under this product line. However, they cost much more than term life insurance because of the cash value account and duration.
1. Buy the right policy type
People use a specific type of policy for this “life insurance bank” scheme: whole life insurance issued by a mutual insurance company. This product type is also called “participating life insurance.”
Mutual insurers are like the credit unions of insurance because they pay non-guaranteed dividends to the policyholders instead of the shareholders. In other words, you may get a little money back each year when they turn a profit.
2. Overpay the premiums
Some money goes into the cash value each time you pay the premium. Then, that account receives interest from the insurance company, which is taxable income.
When you pay more than the required premium, the excess goes into the cash value account and accumulates interest.
3. Buy additional insurance with dividends
Next, you can choose how you want those dividends paid to you:
- Cash
- Reduce premium
- Accumulate interest in the policy
- Reduce the number of premium payments
- Paid-up additional insurance
Suppose you own a $100,000 whole-life policy, and the mutual insurer issues a dividend.
You opt for additional insurance. It would increase the face value above $100,000 and the cash value incrementally.
Essentially, this option makes more room in your accounts for more money.
4. Take loans against the cash value
That’s right–I said loans. The insurance company charges interest to take cash out of your insurance policy.
You’re paying interest to borrow your own money.
Do you see where this is going?
The Financial Consequences of Cash Value Games
Insurance companies do not like when policyholders use their products in ways they didn’t intend and will punish you for it.
1. You’ll pay interest using your own money
If you eventually repay the loan, you’ll pay more than you took out. Unlike a bank account, you pay interest for every day you hold from the cash value.
2. Interest rates probably aren’t in your favor
You have no control over what interest rate the insurer pays your account or what it charges for loans. You’ve already lost the game if they charge you 5% interest but only provide a 2% benefit.
3. The death benefit drops by the loan amount
Taking out cash value neuters your life insurance benefits. While the loan is unpaid, it reduces the death benefit payout by the loan and interest amounts if you croak tomorrow.
And if you take out too much, the insurance company might consider a surrender, meaning they cancel the policy. If the cash value isn’t there to support the cost of the life insurance, the policy is dead, and you wasted a lot of time and money.
4. Loans become taxable if the policy stops
If you stop paying the premiums on the life insurance, it will surrender the policy. Then, the loans you took out become taxable income.
5. Overpaying can reverse tax benefits
If you put too much money into the cash value, it can flip a switch from being a tax-deferred account to a Modified Endowment Contract (MEC). Then, the IRS will come knocking with a new penalty for you.
It’s a dangerous game to play.
6. Whole life insurance is forever
Unlike term life insurance, you’ll pay your whole life policy premiums until you die. Suppose $1,500 a month is affordable while you’re working. But how do you pay the premium if you lose your job or become disabled?
The policy is gone, and you’re stuck with bigger tax bills.
It’s Not a Scam, But It Feels Like One
While the cash-value bank-account game is a legitimate and legal activity to avoid Uncle Sam, it’s just a bad idea.
There are better ways to stash your cash without steep penalties and tax debacles.
Look into high-yield savings accounts, CDs, and money market funds if you need to hold cash.
For the longer term, 401ks, 403bs, IRAs, TSPs, and other tax-qualified plans offer better options with lower fees and risks.
Insurance is one of the easiest ways to play defense against life’s most unpredictable events: catastrophic health emergencies, devastating property losses (like a home or car), and premature death.
But don’t put your safety net at risk by taking advice from someone unethically pushing expensive life insurance products as an investment or bank account alternative.
Sign up for LifeLock today and get up to 20% off the first year. Terms apply.
Final Thoughts
Can anyone make a life insurance bank account? Yes, of course. It’s legal. If you can qualify for a whole life insurance policy, you are free to play games with the product’s cash value aspect.
However, you should not do this without the guidance of an experienced fiduciary advisor, such as a CFP (Certified Financial Planner). Be very careful with the people selling courses on doing this. This post was written by Am7creative on Fiverr, she’s a writer, but also has been selling life insurance since the 1980s. Another insurance perspective can be read in Insurance as an Investment written by a different Fiverr insurance writer with much fewer years of experience. I always find it’s best to have several perspectives and the reasons behind why people have the perspectives they have. Take time to make decisions about anything that’s going to have a long-term investment. Subscribe for more business, sales, and investing posts. Have a lovely day.
