How Life Insurance Loans Really Work and How It’s Problematic to ‘Bank on Yourself’

Michael Kitces discusses the various risks and benefits involved with life insurance loans and why it’s better not to ‘bank on yourself’.

The article beings as follows:

A popular feature of permanent life insurance is that it accumulates cash value that can grow over time – ensuring that if the policy is surrendered, the policyowner will still have something to show for it that cannot be forfeited. However, this “non-forfeiture value” of a life insurance policy has an important secondary benefit as well – it gives an insurance company the means to provide policyowners a personal loan at favorable interest rates, because the cash value provides collateral for the loan.

Yet even as cash value life insurance operates as collateral for a life insurance policy loan, it also remains invested, earning a rate of return that slows the erosion of the net equity in the policy and allows a policy loan to remain in place for an extended period of time. And with some insurance policy loan strategies – such as the popular “Bank On Yourself” approach, there’s even a possibility that the cash value can out-earn the stated interest rate of the loan, allowing the loan to compound ‘indefinitely’.

The caveat, however, is that in the end a life insurance policy loan is still really nothing more than a personal loan from an insurance company, using the life insurance cash value as collateral. Which means even if the net borrowing cost is low because the cash value continues to appreciate, that’s still growth that the investor might have enjoyed for personal use, if the loan was never taken out in the first place. Or viewed another way, trying to bank on yourself doesn’t work very well when ultimately the loan interest isn’t actually something you pay back to yourself, it simply repays the life insurance company instead!

Find the full article here

Posted by Pooja Shivaprasad, Associate Editor, Wealth Strategies Journal

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