There are thousands of people who are looking for a way to generate more wealth for retirement. Hyper-funding a cash value life insurance policy (i.e. Indexed Universal Life) is one way to accomplish this. How to get tax-free income in retirement by borrowing from life insurance and then re-depositing into the life insurance to accelerate the growth of your nestegg.
Hyper-Funding an Indexed Universal Life (i.e. Cash Value Life Insurance)
Very few people, including financial planners, have ever heard of hyper-funding an Indexed Universal Life policy. However, this is an effective and potentially risky way (full disclosure) for someone to receive additional income that will be tax-free when they reach retirement by using a hyper-funded insurance policy. This could be a solution for the millions of people in their 40’s and 50’s that, due to the stock market volatility or unemployment, are not where they need to be when saving for retirement. Financial advisors need to use caution when suggesting this method of building wealth for retirement planning because there are aspects of this strategy that are risky, but overall it can work well the majority of the time.
Is it possible to hyper-fund every type of cash value life insurance?
As long as the insurance policy contains a variable loan option and is linked to the S&P 500 index or another variable investment return, there will be an opportunity to hyper-funded the policy.
How to Hyper-Fund a Life Insurance Policy?
The best way to explain how this works is to use a hypothetical scenario. Let�s say there is a 50 year old individual who has $40,000 available each year to fund a life insurance policy for retirement planning over the upcoming 10 years. He also strongly believes that using life insurance is the best way to generate wealth for retirement planning. For the first two years, he will pay the premium of $40,000 per year. In the following years, he wishes to kick it up and hyper-fund the Indexed Universal life insurance policy.
This is done by actually taking a loan from the current policy. In this case, we will say that he takes a loan of $25,000 from the policy. Instead of using that money for something else, he adds it to the premium he is already paying, making the premium for the year $65,000 instead of $40,000. This is what he plans to do for the next few years until the tenth year.
After the initial 10 years, he will only pay $25,000 to the Indexed Universal life policy, the same amount borrowed from the policy, as a premium for years 11 through 20. You may already be confused and not understand why anyone would borrow from a policy only to return that money as a premium payment. The reason is because of the advantages from the variable loan.
To recap the hyper-funding of the cash value insurance policy:
$50,000
| Year of Funding Cash Value Life Policy | Amount Funded | Amount Hyper-funded (i.e. borrowed) from Cash Value Life Insurance | Total Funded into Cash Value Life Policy |
|---|---|---|---|
| 1-2 | $40,000 | $0 | $40,000 |
| 3-10 | $40,000 | $25,000 | $65,000 |
| 11-20 | $0 | $30,000 | $30,000 |
In the past, the S&P 500 has consistently fared better than the rates that have been tied to insurance policy loans. In fact, the S&P 500 out won these rates by more than 2% annually.
The individual borrows an amount of $25,000 from an equity indexed life insurance policy and will incur interest on the amount. However, the client in the example is taking that money and placing it right back into the policy, allowing it to continue to grow at the same rate as the S&P 500 index. The individual loses no money when hyper-funding the cash value life insurance in regards to the interest because the interest is paid internally. In other words, the S&P 500’s return is greater than the variable loan (by an average of 2%). However, the caveat is when the cash value life policy dramatically underperforms the variable loan.
Variable Loan Advantage of Indexed Universal Life
The variable loan option is an important aspect of an indexed policy. This one factor can help the individual make even more money when they reach the age of retirement when funds are borrowed from the policy. Based on the example mentioned, we will say that the money the individual has in the cash value life policy will return 7% and the lending rate is 5%. This means that he will make some dramatic gains on the amount that has been borrowed.
Hyper-Funding Cash Value Life Policy vs. Not Hyper-Funding
Again, referring to the example, this individual will be paying $40,000 into the policy for the first two years. From the 3rd year to the 10th year, there will be $65,000 ($40,000 funded by him plus $25,000 borrowed from the cash value life policy) paid on the premium and then only $25,000 for the following 10 years (i.e. from the 11th year to the 20th year). The amount of income that can be received after doing this when the client is between 61 and 100 will be about $157,380 of retirement income tax-free. However, if the policy is not hyper-funded, the amount would be less, coming in around $122,500 of retirement income tax-free.
Basically, hyper-funding the cash value life policy will provide 29% more tax-free income in retirement every year or, in this example, $35,380 tax-free retirement income every year!
For the example, we used a return rate of 7% and the borrowing rate on the loan was 5%. Many insurance companies will use software that will show different rates, with the return rates as high as 9% and borrowing rates between 2% and 2.5%. Obviously, if use more aggressive assumptions, it results in a more promising outcome, but would rather lean to the conservative approach.
Is Hyper-Funding an Indexed Universal Life Risky?
This can be very risky. Returns are never guaranteed. You should be aware that you will not have a guaranteed, specified amount of returns. It is always possible for either the policy or the S&P 500 to underperform or outperform. While each will produce slightly different results causing a risk, the principle will never be at risk due to fluctuations in the market. So you are still protected if the S&P 500 drops 40%.
However, hyper-funding into a cash value life policy can be advantageous and it is a viable option for some good life insurance policies. Make sure advisors fully disclose all information so you can understand the risks involved if you are considering hyper-funding a policy for retirement planning.
Please contact Estate Street Partners at (888) 938-5872 and see how we can protect your assets and maximize your returns in retirement.