What if you could be your own bank?
What if you had a source of funds that paid you interest and a return every time you needed cash to fund such things as college education, a new home, a new car or even a new business?
There are little known (yet proven) strategies and tactics that powerful families have built generational wealth you are about to read.
The likes of JC Penney, Walt Disney, and Sam Walton used this strategy and these tactics to create their own bank as leverage to build generational wealth using their own funding source that acted as a bank to finance their respective dynasties.
The strategy is CASH VALUE LIFE, or simply CVL. CVL policies are permanent life insurance policies that also accumulate cash value in addition to providing a death benefit.
As with all insurance policies, there is a policy owner, an insured and a beneficiary (or beneficiaries). Most of the time, the policy owner and insured are the same person however they may be different, it’s important to mention that because the CVL component of a policy is controlled by the OWNER.
Understanding the owner, the insured and the beneficiary is critical to understanding how to build the most effective bank possible.
EXAMPLE: A grandparent can leverage their assets as the OWNER, while takeing advantage of the low cost-of-insurance by making a PARENT the insured and distributing the generational wealth by making THE CHILDREN the beneficiaries. NOTE: This is a rudimentary yet very realistic scenario.
Why? Because insurance CVL (Cash Value Life) policies are given EXTREMELY favorable tax treatment. The cash value will grow tax-deferred within the policy – HOWEVER – if you follow the rules for withdrawals (loans against the policy) and do not let the policy lapse, the cash value is TAX-FREE.
Cash Value Life policies will earn interest, dividends, credits, multipliers and/or bonuses during the policy lifecycle. Depending on the carrier and the policy, the return on the cash value can be substantial.
One great analogy is to consider a CVL policy to like a Roth IRA, or what we call a Super Roth – EXCEPT – a CVL policy has many more benefits than a Roth IRA including;
NOTE 1: CVL policies maintain both a death benefit and cash value, these benefits are used as collateral for loans against a CVL policy.
NOTE 2: IRS code 7702 (as you will read) allows you to either withdraw or take loans from the policy. Loans against a CVL policy provide arbitrage opportunities when the rate of return is greater than the loan rate.
NOTE 3: Modern CVL policies provide powerful hedges within a policy to mitigate arbitrage risk and maximize arbitrage gains depending on market factors – THIS IS ONE OF THE MOST POWERFUL BENEFITS OF MODERN CVL POLICIES, AS YOU WILL READ LATER.
Until 1982 no statutory rule existed that defined the characteristics of life insurance for federal tax purposes. However, in the early 1980s, Congress was motivated to act by the development of a new generation of Universal Life contracts because these new products provided significantly more cash-value build-up than was needed to support the death beneﬁt.
The new generation of Universal Life contracts came packaged with new risk/reward factors, essentially taking a historically safe (conservative) financial vehicle and adding a new element of risk to (hopefully) prop up the gains on these policies.
The late 1970s and early 1980s saw two new products introduced: Universal Life and Variable Universal Life. These new products differed greatly from Whole Life as these new products:
• Paid close attention to a market rate of interest.
• Did not follow the traditional relationship between cash value and death beneﬁt.
• They allowed discretion in the timing and amount of premiums.
• With VUL, they allowed an investment strategy within the life insurance policy (similar to directed IRA’s).
By removing the linkage between the cash value and death beneﬁt, it created the potential that a client could pay a very large premium for a relatively small amount of insurance coverage. This led Congress to enact new laws around life insurance taxation.
Prior to 1982, once again, smart and savvy people leveraged the benefits of life insurance policies to amass HUGE generational wealth, including names like JC Penney, Walt Disney, Sam Walton, and many others.
Tap or click a table below to read more about the evolution of life insurance tax laws;
Life Insurance Tax LawsIn response to UL contracts, Congress enacted TEFRA, or the Tax Equity and Fiscal Responsibility act of 1982. This new act loosely deﬁned a limited class of products called ﬂexible premium life insurance contracts, and it sought to deny life insurance tax treatment to contracts speciﬁcally used for investment purposes. TEFRA was speciﬁcally written as a temporary act pending a more comprehensive solution in the future.Congress enacted section 7702 of the Internal Revenue Code as part of the Deﬁcit Reduction Act Of 1984 also known as DEFRA. Section 7702 restricts life insurance tax treatment to those contracts that provide at least a speciﬁed minimum amount of pure insurance protection in relation to the cash value of the contract. This act essentially shut down what Congress considered an abusive use of the tax code by using life insurance taxation for policies that were exclusively set up as an investment only.The Tax Reform Act of 1986 was a key piece of the Reagan administration’s proposal for a broader tax base by proposing that the build-up of cash-values within a life insurance policy would be taxable. As we all know now, that portion of the proposal was not implemented. One of the greatest positive impacts of the act was it closed down many of the other tax-favored investments and tax-shelters, which left other tax-advantaged products untouched - speciﬁcally life insurance. As a result of this legislation, carriers began experiencing a signiﬁcant growth in single premium products, and some even promoted the fact that life insurance was the last great “tax-shelter” available, much to the dismay of Congress. These aggressive marketing efforts led Congress to further enact laws that resulted in the deﬁnition of a Modiﬁed Endowment Contract, as well as rules restricting the mortality and expense charges allowed in computing the required limits.In 1988, Congress substantially modiﬁed the tax code even further with the introduction of the Technical and Miscellaneous Revenue Act of 1988, also known as TAMRA, which provides us with Section 7702(a) of the Internal Revenue Code. Section 7702(a) basically states that if a policy is not properly structured and funded, all of the favorable tax treatment is lost. To be properly funded and structured the policy must meet the 7-pay test. If the policy fails to meet this test, the policy is considered a Modiﬁed Endowment Contract or a MEC. By itself a MEC is not bad, it is just treated differently from a tax perspective. A downside to owning an MEC is that if your client is planning to use the policy to withdraw income in the future, distribution of gains from a MEC is taxed and if under age 59½ a 10% tax penalty applies. Generally speaking, if you understand how a non-qualiﬁed annuity is treated from a tax perspective, you understand how a MEC is treated for tax purposes.
The evolution of IRS Code 7702 was documented above, but we wanted to add some additional (and important) facts about the code that you should know.
Financial and insurance professionals refer to “The Corridor” within 7702. The Corridor in it’s most simplistic definition simply means; 1) CVL policies must maintain a proportion of life insurance death benefit to the cash value. If cash value EVER exceeds the proportional amount within a policy, then the policy will be considered a MEC (modified endowment contract) and will lose any and all favorable tax treatment – FOREVER (there is no recovery).
There are a host of tests that a life insurance policy must satisfy in order to maintain it’s tax favorable status; i.e. Guideline Premium test, Cash Value Accumulation test, and Seven-Pay test.
For the sake of simplifying these rather complex tests and isolating the one with the most significant impact to you, the seven-pay test may be viewed as follows (this is a very simplistic, yet real, representation of the seven-pay test);
Seven Pay Test – Cash value accrued in a life insurance policy may NOT exceed the premiums paid into the policy over the first seven year period of a policy.
EXAMPLE: Bob pays $10,000 annually into a permanent life insurance policy. After seven years, the cash value of the policy may NOT exceed $70,000 (7 years of premium at $10,000 per year plus any interest/dividends).
Once again, this representation is very simplistic (yet practical and real) of cash value accumulation in a life policy. It’s also VERY important to understand this, as this one feature (test) can help significantly help you understand what policy is best for you!
SCENARIO: If you are researching a cash value life policy for you and your family, one of the factors that can help you decide which policy performs the best (i.e. has the best returns and lowest costs), look at the amount of cash value accumulated after 7 years. Cash value in policies that are closer to the total premiums paid is a signal of performance (this is NOT an end-all-be-all signal, it is a powerful signal though).
The Seven-Pay Test is critical to understand the remainder of this conversation.
The Infinite Banking Concept™ (IBC) was started in the early 1980’s by R. Nelson Nash. The concept was started as a reaction to historically high-interest rates that banks were charging for loans. Coincidentally or not, this concept was launched during the period of years when cash value life laws and IRS codes were being engineered.
These high-interest rates, it turns out, provided fuel to the CVL and Infinite Banking Concept™ for two reasons;
Nash considered the financial mess he’d created for himself, Nash had an epiphany: He realized he could fund Whole Life insurance policies in order to create his own set of “banks,” which would serve as a repository for his savings and allow him access to cash when he needed to make large purchases. By switching his financing needs away from outside lenders and towards his own resources, Nash would take control of his financial world, thus achieving peace of mind and (in a sense) recapturing interest payments.
In summary, Mr. Nash created the concept of being your own bank by leveraging cash value within a life insurance policy. As significant cash value accumulated into these policies, you could leverage your OWN cash value asset to borrow from yourself, eliminating the need for banks.
EXAMPLE 1: Using a top-performing CVL (cash value life) policy that is designed for MINIMUM DEATH BENEFIT and MAXIMUM CASH VALUE, Bob a 30-year-old husband and father of two purchases a CVL policy and pays $300 per month premiums for 18 years. For the first 18 years of the policy, Bob had a base death benefit of about $250,000, after 18 years Bob’s policy had a cash value of $110,025 that could be used TAX-FREE for; 1) Child’s education, 2) Down payment on a house, 3) New vehicles, 4) Start a business, 5) ANYTHING!
The Infinite Banking Concept™ purists insist that the IBC strategy MUST be anchored by participating whole life policies offered by Mutual insurance companies with over 100 years of history producing dividends, dividends paid to policy owners. The purists are UNWAVERING in their insistence (for right or wrong, this concept is central and fundamental to IBC as they know it).
So as to clear up any misconception or uncertainly, a PARTICIPATING WHOLE LIFE policy is one that is issued from a MUTUAL company. In a mutual insurance company, the policyholders are also the company stakeholders. Profits within the company are distributed as dividends to the policyholders, so not only are policyholders customers of the company they are also shareholders!
The traditional Infinite Banking Concept™ is a very conservative strategy for cash and capital management. Think about it, if you want to be your own bank it is CRITICAL that you have access to cash (capital) to fund your life and it’s also CRITICAL that you mitigate the risk and downside.
For this reason, it’s much easier to understand and accept the purist’s insistence on mutual companies with 100+ year history of returning dividends, companies that even have a return during the most trying and stressful financial times (i.e. Great Depression, 2008 Financial Crisis, etc.) Below are some examples of mutual companies;
|Company Name||10 yr average||15 Yr Average|
|New England Financial||5.10||5.40|
|New York Life||6.15||6.32|
WHAT IF THERE WAS A WAY TO INCREASE GAINS AND THE UPSIDE OF A CVL POLICY BEYOND THIS 5-7 %RETURN? – KEEP READING!
Myself, I am VERY fond of participating whole life policies, in the right circumstance for the right person they are VERY powerful.
Over time in due course of researching ‘Top Participating Whole Life Policies”, Foresters Advantage Plus policy hits the radar, almost always in the top 2 policies in the market (Mass Mutual and Foresters are widely considered to be the top 2 participating whole life policies for 2018 and 2019.)
One important thing to note here, even though “the street” widely considers Foresters to have a top participating whole life policy. Foresters’ policies do not satisfy the requirements for the IBC purists, it does not have a 100+ year of history.
While I do 100% believe in the fundamentals of IBC, I also believe that conventional IBC can be inflexible and too rigid. I have engaged publicly and in private with some of these IBC purists, they are completely unwavering in their beliefs and hold steadfast to the principle of only dealing with companies that 100+ years of history.
WHAT IF THERE WAS A WAY TO INCREASE GAINS AND THE UPSIDE OF A CVL POLICY BEYOND THIS 5-7 %RETURN ABOVE?
There is – BUT – in order to find these, we need to know what we are searching for and where to search. VERY similar to the IBL concept of ONLY using historically top-performing participating whole life, the competing strategies MUST be with best-of-breed carriers and policies.
As mentioned above, in the 1980s the government reacted to new insurance vehicles that allowed for proportionally greater cash value accumulation, most notably CVL policies, including Universal Life and Variable Universal Life.
These policies were a double-edged sword in that risk for BOTH the cost of insurance and for the cash accumulation was shifted from the insurance companies to the policyholders. The net result of the growth in Universal Life in 1980s and 1990s led to DISASTER in many cases, with a large part of that disaster being due to the high-interest rates of the 1980s (as mentioned above).
Understanding the difference in CVL concepts between Participating Whole Life and Universal Life is paramount to understanding the crisis.
Participating Whole Life policies are issued with a guarantee on the premiums paid into the policy – FOR LIFE (premiums NEVER go up).
Universal Life policies are issued as renewable annual term policies. The fundamental concept is that you can take advantage of the lower (much lower) cost of term insurance in a person’s younger years.
That lower cost of insurance in younger years assumes that the savings in the cost of insurance early in life can be applied to cash value accumulation and offset the increase of insurance later years. In summary, a critical mass of cash value accumulation is required such that a policy becomes self-funding – AND – provides a substantial cash value growth over policy lifetime.
One of the problems (the major problem) with this assumption is that the cost of the annual renewable term is projectible into the distant future, you can read more about COI (cost-of-insurance) factors here.
While the Universal Life policies of the 1980s and 1990s have proven to be disastrous for many people – AND – provided for countless lawsuits for the insurance companies, times have changed and there is security built-in to provide more confidence in Universal Life vehicles.
Regulators, insurance companies and actuaries have been hard at work to rebuild consumer confidence in Universal Life products.
The evolution and proliferation of Indexed Universal Life (IUL’s) in the mid-to-late 2010s is substantial. Companies and agents alike are aggressively pushing these products with promises of more security, downside protection and higher ceilings on cash value growth.
While IBC concepts are fundamentally sound, “Life Banking” concepts that can leverage vehicles other than participating whole life provide an entirely different risk/reward profile.
If the assumption is that the 2010 generation of Universal Life, or IUL’s, was to follow a similar trajectory to that of the 1980s and 1990s, IBC concepts are a no-brainer.
Fortunately, it’s 2019 and NOT the 1980s! IUL’s are more safe and secure vehicle than the UL vehicles of the 1980s and 1990s.
IF you are considering a CVL policy, I recommend you research all your options before making a decision. While the primary purpose of a CVL policy is DEATH BENEFIT, the IRS Code 7702 provides the significant benefit of TAX-FREE cash value accumulation.
IF you are interested in further researching the risk, reward, advantages, and disadvantages of Indexed Universal Life, PLEASE make sure that do with a reputable and skilled advisor.
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