Surrendering life insurance policies can trigger
tax. In this episode, I'm going to address the question
"What does cash surrender value mean on life insurance policies?" As you learn
this, you're going to understand some things
that even a lot of insurance agents don't know. So, put on your seat belt.
So, my name is Doug Andrew. I've been a financial strategist and retirement
planning specialist for north of 46 years.
I got my insurance license clear back in 1974
as well as a series one securities license which they don't even offer
anymore. But I could sell any stock bond mutual fund
and any kind of life insurance policy or health insurance policy for that matter
that somebody may want. And so, in other episodes, I
address the question, "Well, what is cash value?"
And so, you can watch those to have a greater understanding. But I'm going to
summarize from a chart I use in another episode. Because when we
look at insurance whether it's term insurance
whole life insurance or universal life insurance, they all have a
cost of insurance we call it COI which is inherent in
any insurance policy. With term insurance, what's happening is for a 30 year old, if
this was your age over to age 100, the actuaries know
that for a thousand 30 year olds in America, we're talking about males,
there might be one 1 ½ to 2 deaths per 1,000
in order to have a death benefit of $1,000, if 1,000 thirty
year olds all put a dollar in a hat, you'd have 1,000
bucks to pay out to the 1 ½ or 2 that win that year,
right? Okay. So, that's the actual cost. And the older you get, the more money you
have to put into the hat because more out of the thousand remaining are dying.
There's a bigger percent. That's the pure cost of insurance. Whole
life was designed to pay a level premium
let's say for your whole life. And so, that builds cash value our equity.
What's actually happening here is you're way over
paying for the actual COI, cost of insurance during the early years.
And this creates equity so that you can continue paying this same premium for
your whole life. You have this excess cash value. So,
you're overpaying the early years and you're underpaying the latter years and
that's what builds cash value. Generally, whole life was designed to
calculate well what is the least amount of premium I
can pay to have coverage for my whole life?
Well, when universal life was born, EF Hutton
who was not an insurance company was the brainchild behind it. And they were doing
it for living benefit. Because this cash value in here,
the IRS for over 100 years has treated it like a sacred cow. It accumulates tax
free. You can access this cash value the smart way, totally tax-free.
And then when you ultimately die, it blossoms to the death benefit
totally income tax free. Nothing else in the internal revenue code does that.
And you can learn in other episodes that that's under sections
72E, 7702 and 101A of the internal revenue code that allows you to
accumulate access and transfer your money tax free inside of a cash
value life insurance policy. So, the 2 types
of cash value policies are whole life and universal life. But universal life is
different in this way. You can use it for death benefit if you
want and pay the least premium. Sometimes a lower
premium than whole life. But when it was was first introduced, it was designed to
put in the maximum that you possibly could.
Let's say people wanted to put in a half a million dollars in one fell swoop. Now,
you can put in 100 grand, 10 grand, a million. We have people putting in 10
million. When it first came out, you could put in
this amount maybe clear up to here. And you just put in one payment. And the
million let's say that you're putting in there
is not really there for buying the most death benefit. You want the least amount
of insurance. nd so, the IRS says, "Oh, well then you only you
can self-insure." You put in a million if the death
benefit is a million or a million one hundred thousand, then most of it's
your own money now. You've self-insured. But the actual amount at risk to the
insurance company is only the remaining 100,000.
See, that's how universal life can be designed to create
a tax-free cash cow for living benefit. Well, in 1988 under the Tamra
tax citation which I address in other episodes,
what happened is you had to fund it over over 5 years. Maybe
you put in 100 grand. Let's say that this is a max funded
index universal life policy and you put in 100 grand the first year,
100 grand on the second year, 100 in the third year. And so, you have let's say
500K in that policy. Well, if now if that 500,000
qualifies as part of the original death benefit the IRS said you had to
have which be a million 250,000 if you're 60 years old. Now, you
can buy way more life insurance than a million
250,000 with a half a million bucks. But that's
not the objective. You want the least amount.
So, 500,000 of cash inside an indexed UL at the rates of
return that I've averaged, that will double every 7 to 10
years. So, let's say 500,000 doubles to a million
which it has for me. Many times my money doubles about every 7 to 10 years
tax-free. So, the 500,000 doubles to a million.
Now, the amount of insurance, the cost per thousand is going up.
But the amount of actual risk the insurance company is covering you for
is less. Because now i have a million. The original death benefit was a million
two fifty. So, they're only charging me for the
remaining 250,000. Well, the next seven to 10 years, the million doubles to
2 million. That's more than the death benefit. The
death benefit now grows with my cash and stays about five percent ahead according
to IRS rules. So, I have 2.1 million of life insurance
now. 2 million of it is my own money. The
insurance company is only charging me for the remaining 100,000
and the interest. See, all of this overpayment, if I put a half a million
and it's doubling, it's because all of this cash in here is now
growing at rates of return of 7 to 10 percent tax free.
Just the interest, just a portion of the interest on this
cash covers the cost of the insurance, the COI.
So, have you ever seen an insurance policy that gets cheaper
as you get older? Then you haven't seen one designed like this.
You're actually self-insuring so that when you have a million or 2 million
that every million bucks can generate 70, 80, 100 thousand a year of tax-free income
for as long as you live if you live to be 120.
There is not an IRA 401K that i've ever seen that can do the same thing and give
you that type of predictable income cash flow and you're immune from market
volatility, from taxes. And inflation actually helps you instead of
hinders you. So, how does this all connect together?
So, let me use the metaphor of a bucket which I've used for many, many years.
When i design an insurance policy to be used primarily for living benefits,
I compare it to like a bucket where i'm putting money into it.
So, you have uh this faucet up here and this is the
premium payments that you're putting in there. And as I said before,
you want to maximum fund it as fast as the IRS
allows and take the least amount of insurance. And so,
you can put in let's say a $100,000 a year.
The second year, third year, fourth year fifth year. Now,
this is maximum funding the insurance contract. You don't have to put in that
much. I'm just going to use this as an example.
But if your goal is to be able to put in a grand total of $500,000,
you design or structure it to accommodate that much money and the
fastest you can put it in if you're over age 50 is about
20% a year. And if you do that, the money
that's in that bucket as it grows with interest... See, the
the compound interest is the other thing that's making this bucket grow.
That will be totally tax-free not only as it grows but when you start taking
income. If you put this whole amount in in one fell swoop in the first year,
it will accumulate tax-deferred. But it won't be tax-free when you
access it. To be grandfathered to have tax-free
income, you have to spread out the funding over 5 years with a whole
life policy you have to do it over seven years. So, I
can get money in faster into a universal life.
And actually I can get away with less insurance and I get a better rate of
return. And that's why my preference is
universal life if you're doing it for living
benefits. So, you put in 100 grand a year for 5 years. It's actually
the first day of the first year. So, the last 100 thousand goes
on the first day of the fifth year which is technically
4 years and 1 day later. So now, let's say you have 500 grand in there.
Based on actual rates of return that 500,000 will double to a million and
probably in about 7 to 10 years. The million
then doubles in another 7 to 10 years to 2 million.
I actually have people who started out with a half a million. It doubled to a
million, then 2 million, 4 million, 8 million. And
they have 8 million now that generates about 800,000 a year of
tax free cash flow. They don't even need that much money. In fact, they're only
pulling out 300,000. So, it continues to grow even though
they're taking out 300 grand a year tax free.
Now, the question that I want to finish addressing in this episode is "What does
cash render value mean?" This 500,000 when I put it in there,
that is the accumulation value. And the only thing that's
subtracted off of that is the actual COI. Do you remember
I talked about the cost of insurance? This is like the spigot on the bucket.
But see this is draining out at a certain rate. But the compound interest
that you're earning on this is growing so fast when you maximum fund it
that it way more than covers the cost of the insurance especially as you get it
fully funded. Now, that's the accumulation value. During
the early years of the contract, maybe 10 years or 15 years, there's a
difference between the accumulation value
and the surrender value, okay? The surrender value
only comes into play. Did you hear that? ONLY comes into play if you cancel or
surrender the policy. That would be dumb in many situations
because if my half a million doubles to a million
and then to 2 million, if you surrender the policy,
by then, the surrender fee is waived or gone.
Because a surrender charge is only if you cancel the policy
in the first 10 years or 15 years. It's all dependent. In fact, you have a writer
that waives the surrender charge. And you can have access to 100 of your
money. But if you take it out the dumb way, if you surrender the policy,
if you get back more than the basis. If your basis is 500,000
you put into it, every dollar more than that if you surrender it,
is taxable. Why would you do that? If I have, if this grew to a million,
let's say I have now 1 million dollars in here
and I surrender it, I have to pay tax on a half a million gain.
That would be dumb. What's tax on a half a million? If you're in a 40%
bracket like some Californians, you just had to pay 200,000 of unnecessary tax.
It'd be better to take it out the smart way.
You borrow. You could go in and borrow 90, 94 percent. Let's say 90 of that million.
You go borrow 900,000 and the insurance policy
keeps going. The loan is not doing payable during your lifetime. In fact, if
you do it right, you continue to earn interest on your
full million while they're you're paying a lower interest rate
on the actual loan. And so, if you borrow, you'd end up with uh 940,000.
If you surrender it, you get your million but you're only netting 800,000
or maybe 600. See, you have to pay tax. And so why
trigger unnecessary tax by surrendering it?
That is the dumb way to access money. So, I apologize
if you feel like you're drinking out of a fire hose right now. But this is
why I have authored 11 books. If you want to know more about this, my most recent
bestseller is called The LASER fund. It's a 300-page book. And I want to gift you
one of these absolutely free. I'll pay for the book. You just pay a
$5.95 shipping and handling. And if you go to laserfund...
L-A-S-E-R, fund, ".com", pay $5.95 shipping and handling. I'll fire
one of these out to you. It has charts, graphs and explanations if
you like detail. If you'd like to just learn about how
does it really work in real life, the stories; you flip it over
and there's 12 chapters with 62 actual client stories
of how to design a life insurance policy to be able to double, to increase your
cash value as often as every 7 to 10 years and then create tax
free income for as long as you live. That's the
benefit of a max funded index universal life
insurance policy. Why would you ever want to surrender
something like that?