Today we are going to discuss non-direct
and direct recognition
when it comes to borrowing against
a whole life insurance policy.
We'll talk about the differences between the two
and then specifically how it can impact you
if you already have a policy
or if you're considering one.
Let's begin with non-direct recognition
so with a non-direct recognition policy
what this term means
is that the company will not recognize
think of it as non-direct
they are not recognizing
the fact that you take a loan
against your whole life insurance policy
with respect
to how they apply dividends to your policy.
So we'll assume you've got a policy
with a company
that is paying a dividend interest rate of 5.75%
that is Guardian's 2023 dividend rate
all of the examples I ran
we'll look at the case studies
on the following videos
will be with Guardian policies
but in this example a 5.75% dividend rate
a loan interest rate
we'll assume a variable rate a 5%.
A side note most companies
that have a variable loan interest rate
if they are offering you a variable loan rate
the policy will usually be non-direct recognition.
I say usually because there are cases
where we will see companies
offer a variable loan rate
and still function
as a direct recognition company
Penn Mutual is an example of that
but in most cases
if you have a variable loan rate
that means your policy is non-direct recognition.
So let's assume
with your non-direct recognition policy
you've got cash value of $100,000
and you don't touch it
you don't take any loans, what'll happen?
Well you will receive a dividend rate of 5.75%
whatever the company's dividend rate
is for that year.
A quick reminder the dividend rate
is always a gross rate
that is never the net rate
reflecting what your cash value
is growing by each year
but we've got other videos that cover that.
So if you don't touch it
the dividend rate applied to that cash value
is 5.75%
now let's assume you borrow
half of what you have available in cash value
a $50,000 loan at 5%
what happens?
Well $2,500 would be paid to who?
The insurance company
and you have $50,000 remaining
now because the company again
is non-direct recognition
what this means
is that they are going to apply
that 5.75% dividend rate
still on the full $100,000
meaning they are not recognizing the fact
that that loan is outstanding
so you get the same dividend rate
regardless if all of your money is in cash value
or if you've got 50%
or the maximum amount outstanding in loans.
Another way I like to explain that is like this
you take a $50,000 loan
the money you have not borrowed
receives a 5.75% dividend rate
whatever the company's current dividend rate is
the money that you have borrowed
you're paying 5% loan interest
to the insurance company
but you're still receiving
a 5.75% dividend interest rate on that loan fund
or on those loaned dollars I should say.
You could also break it down like this
you could say I've got 50%
still available in cash value
that receives the dividend rate of 5.75%
and then the 50%
I have outstanding in policy loans
still receives the dividend rate of 5.75%
meaning
regardless if you have a loan outstanding or not
you're going to receive the same dividend rate.
Okay direct recognition
how this works
is the company will directly recognize
the fact that you borrow against your policy
and apply a different dividend rate
to the loaned portion.
In most cases
you will continue to receive dividends
on your entire cash value
let's illustrate
and we'll use the first example here
of a 6% fixed loan interest rate
so if you've got cash value of $100,000
and you don't touch it
what does that mean
you receive the dividend rate of 5.75%.
Now let's assume you borrow $50,000 at 6%
that's $3,000 that goes to who?
The insurance company
how does it work?
Well you've got $50,000 remaining
the money that is not touched
it's still an available cash value
that you can loan against if you want
you'll continue to receive
whatever the company's
standard dividend interest rate is of 5.75%.
The money that you have loaned here
you will not receive
a 5.75% dividend interest rate
instead you'll receive a 6% dividend interest rate
now this is equal to the loan interest rate
and this is specific to Guardian
this is how Guardian treats
direct recognition policies
it's how they've treated
direct recognition policies
for a very long time
where they apply a dividend rate
on the outstanding loan dollars
that is equal to the loan interest rate.
So another way to explain this
is that you are still earning dividends
on the full $100,000
but the 50% that is not loaned
you are receiving a 5.75% dividend rate
and the 50% that is loaned
you're receiving a 6% dividend rate.
If you started a policy between 2016 and 2022
this is likely what you have
if you started a policy during or after 2022
you've got the 5% fixed loan interest rate
and guess what happens?
Instead of receiving a 6% dividend rate
now it's a 5% dividend rate
on the outstanding loan portion
which is less than the current dividend of 5.75%
6% is more than 5.75%
so what does that mean for your actual policy?
Well with a direct recognition policy
when you loan and repay
you may see more cash value
compared to an example
where you just let it sit and grow
or you may see less
it will depend on the company and product
because all companies do things differently
when it comes to direct recognition.
What it means is that they recognize
the fact that you're taking a loan
they often still apply dividends
to your full cash value
but you're often receiving
a different dividend rate
than the standard dividend rate
on the loaned portion
which is important.
Seeing the numbers goes a very long way
and we're going to look at that
in our next several videos
we're going to examine some case studies
which will be a lot of fun to look at
if you like to see specific numbers
and the impact or compare direct
and direct recognition
as that's exactly what we'll do.
We'll have a lot of fun with that
and we'll look at a policy
on a 40-year-old individual
with the same company
same product
and then compare direct
and non-direct recognition.
The example we'll look at is Guardian
but Guardian like other companies
does offer both direct
and non-direct recognition
the timing is important though
which we'll talk about in our next video.
The last point I just want to add
because this is very very important
and often there's a ton of confusion here
which we want to make sure
we're providing a lot of clarity.
Is if you look
at the non-direct recognition example
and you see this
what goes through your head?
A dividend rate of 5.75%
and a loan rate of 5%
what most people feel
is that they have a positive spread of 0.75%
is that true?
When you look at the net cash value
call it the internal rate of return
meaning the net growth rates
not the dividend rate
because that is a gross rate
that does not reflect
the true earnings on a policy
when you look at the net growth rate
this will not be the case.
With a 5.75% dividend interest rate
your net may come out to
call it 4% or 4.25%
the loan interest rate will be the same
so what does that result in?
Well if your net is 4.25%
and your loan rate is 5%
that means you actually have a cost of 0.75%
that's the kind of stuff
that is very very important to see upfront
with both non-direct and direct recognition.
The best thing to do in my opinion
what really helps a lot of individuals
just see it for what it is
is to see what is the cash value growth
every year
and compare that
with what they're paying in loan interest
instead of looking at the rate
when they see the dollar amount
you can simply see
that I receive more in total earnings
both guaranteed interest
and dividends from the insurance company
compared to what I paid them in loan interest
and you can look at it on a yearly basis
you could also look at it on a cumulative basis
if I wanted to see okay
as I pay my loan off over 10 years
what's it look like?
In any event
I hope you enjoyed this video
we'll dive into our case studies in the next video
and as always I hope this helps.
Thanks so much.
Hey guys Steve Parisi here
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