Max Out or Minimize? Overfunded Life Insurance Option Comparison

What if we told you that your permanent life insurance policy has to be designed correctly if you want to benefit from it?

When you overfund your life insurance policy, you can get the most cash value and use it early, but with minimized death benefits. The main advantage of doing this is paying your premiums early and gaining access to a higher cash value.

We covered everything you need to know about overfunded life insurance, and we will take it one step further with this article.

Did you know that not every overfunded life insurance policy needs to be funded to the legal maximum amount? What does that mean?

Let’s find out!

Table of Contents

    Understanding Minimally Funded Life Insurance Policy

    First of all, you need to understand the minimum-funded life insurance policy. Before we compare them to their maximized counterpart, we will look at the basics, benefits, and drawbacks of these life insurance policies.

    The Basics of Minimum Overfunding in Life insurance

    Minimally-funded life insurance aims to provide the highest death benefits for the lowest premium.

    To do this, life insurance companies set the premium at the least amount they need to pay to keep their contract.

    Companies that sell whole life insurance and guaranteed universal life insurance often offer this type of policy to attract customers. The monthly price is low, so many people get hooked on that. 

    With the minimum premiums, the permanent life insurance policy stays in place and covers the insured person for the rest of their lives.

    But do the low monthly premiums provide enough benefits in the long run? 

    For example, a man who is 35 years old buys a $500,000 whole life insurance policy with a $50 minimum monthly payment. The policy will cover the rest of the insured’s life, and the death benefit will remain the same, regardless of how long the insured lives. 

    Permanent life insurance policies usually come with higher premiums than term life insurance. However, you get permanent coverage for as long as you’re paying your dues, and the policy has a cash value component that grows over time. 

    And this cash value is what you want to use all of the perks that an overfunded life insurance comes with. A death benefit is the minimum of what permanent life insurance offers. 

    Here’s a little reminder. 

    When you pay your monthly premiums for a permanent life insurance policy, a portion goes towards the death benefit, while the rest is for the cash value. 

    In the case of a life insurance policy that is only partially paid for, the majority of the premiums are used to pay the death benefit. At the same time, only a tiny portion is designated for the cash value. 

    Because of regulations, the moment the cash value is close to equaling the death benefit, the amount of coverage is also supposed to go up by a legally defined minimum amount. But in this case, it takes years for something like that to happen. Maybe even decades. 

    In other words, minimally funded life insurance is only a good option if you’re looking for nothing more than a death benefit for you and your loved ones. But as you’ll see later in this article, overfunded life insurance offers much more. 

    All of this happens because your life insurance company is trying to offer you a lower premium so they can keep you as a customer.

    And this is precisely why your life insurance policy might not be designed to work in your favor. 

    illustration of minimally-funded life insurance

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    Benefits of a Minimum Overfunded Policy

    It’s not like a minimum-overfunded life insurance policy is all that bad!

    There are still a couple of benefits you can look forward to if you want to use this type of policy. 

    Most of the advantages that come with a maximum funded policy can also be found here. But the thing is, the scale on which they can be applied is much smaller. 

    Cash Value

    For example, these overfunded policy types let you build cash value. However, when one has more cash value, the maximum overfunded one, they can use it for more investment options, higher loan amounts, and overall more significant cash accumulation. 

    If your cash value grows too slowly, you can’t create true cash flow.

    Lower Premiums 

    Ultimately, a minimum overfunded life policy has no unique benefits. The only thing we could count as a benefit is that the premiums are lower. The policy itself is also easier to design, but that’s a plus for the life insurance company.

    Drawbacks of Minimum Overfunding in Life Insurance

    Even though minimum overfunding in life insurance comes with certain benefits, there are also many things you’ll be at a loss for. 

    Here’s what you should know before you opt for a policy designed like this. 

    Policy Lapse

    To build a life insurance policy with minimum premiums, you must know the cash value and how much you can take out. 

    The biggest issue with this type of policy is the increased risk of a policy lapse. When you take out too much of your already small cash value as a loan, you risk losing your policy.

    Your policy must be fully funded at all times, so you must be extra careful when it has a smaller cash value. 

    Not a Lot of Cash Value

    Besides that, as we mentioned before, minimum-funded life insurance often doesn’t have a significant enough cash accumulation to even become a policy you can use to take out a policy loan for your financial plans or even in case of an emergency. This makes it a bad option if you want living benefits besides the rest.

    Understanding Maximum Overfunded Life Insurance

    Overfunding your life insurance policy doesn’t have to be minimal. You can also go all out. 

    But what happens when you put the more significant part of your premiums towards the cash value while the smaller portion is used for the death benefit?

    According to LIMRA’s study, as of 2022, about 52% of people in the United States possess life insurance. However, not all of them use it in the best way possible.

    U.S. Life Insurance Ownership By Type 2011-2020

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    Here’s how maximum overfunded life insurance works, what you can expect, and what you gain or lose if you opt for this insurance type. 

    Maximizing Overfunding in Life Insurance

    In the case of maximum overfunded life insurance, the more significant part of your premiums is for the cash value, while the rest goes towards the death benefit. 

    This makes a policy where the cash value grows faster, thanks to the interest rate that builds on itself and future payments. And when the cash value grows almost as much as the death benefit, the coverage itself is also bound to grow. 

    To get the most out of overfunding in life insurance, you’ll probably need to add more riders to your policy. There are no hard and fast rules when it comes to policy design, but a paid-up additions rider and a term rider are frequently included. 

    This makes the premium payments slightly higher because you’ll have to pay for the base policy, the paid-up additions rider, and the term rider. The policy’s cash value only depends on the base policy and the paid-up additions. 

    But in the end, you get a high cash value that keeps growing. And you can take out policy loans against that cash value and pay yourself back. 

    That’s why having maximum overfunding on your life insurance policy makes using it for more than just the death benefit possible. It can become the perfect place for retirement planning or any other financial plan. 

    However, you can’t just put as much money as you want in your policy. If you go over a certain limit, your policy turns into a MEC (modified endowment contract), and you lose all the tax advantages and have to assume tax liability.

    Minimizing the Policy Charges

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    What is a MEC? 

    People started using cash-value life insurance policies only to avoid taxes and save, which the IRS found out in 1983.

    They would invest in a low-value life insurance policy. Instead of paying the annual premiums, they would put a lot of funds into the cash value account of the policy and take advantage of the tax benefits.

    Because of this, they capped insurance rates and added government-imposed penalties. There’s no yearly limit, but there’s a seven-year one. If you overfund your policy by more than the set amount, it will become a MEC. This will make the whole life insurance policy an income tax liability.

    The limit for every policy is different and depends on the face value of the policy and the good health and life expectancy of the policy owner. 

    Modified Endowment Contract (MEC)

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    The Advantages of Maximum Overfunded Life insurance Policy

    A maximum overfunded insurance policy has a lot of benefits besides those that usually come with a typical whole life insurance policy. 

    That means you’ll get the death benefit, cash value from favorable tax treatment, dividends, etc. But you’ll also get something else. 

    Higher Cash Value 

    When most of your premiums go toward the cash value, it grows faster. This creates a bigger fund for you and opens doors for many new financial opportunities and better living benefits. 

    A higher cash value is also connected to the lower mortality cost and higher death benefits.

    Also, in most cases, you won’t have to pay income tax on interest rate gains generated from your whole life policy or universal life policy!

    Illustration of Higher Cash Value 

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    Better Options for Investing

    More cash value also means more options for investing. This also depends on the type of policy you’re using. For example, an indexed universal life insurance policy or a variable universal life insurance policy offers a lot of flexible investment options. 

    The biggest advantage is that you can access cash to borrow money from yourself. Do you want to pay your mortgage? Retirement plan? Fund your children’s education? It’s all right here! 

    No Age Restrictions

    Unlike IRAs or 401(k), an overfunded life policy lets you access cash no matter how old you are. It doesn’t matter if it’s whole life or universal life.

    Asset Protection

    Depending on the state you live in, the assets in your life insurance policy are legally protected from creditors, market declines, and other legal claims. The loans also don’t appear on your credit report.

    This isn’t the case with a regular savings account, where there’s no asset protection of this kind.

    Illustration of Asset Protection

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    Disadvantages of Maximum Overfunded Life Insurance Policy

    Overfunding life insurance has a couple of disadvantages you should consider. 

    Extra Fees

    When you add up the base policy and the riders used to create an overfunded approach, you’ll get some higher costs you’ll need to pay. But if you’re ready to invest in your future, this means nothing to you. 

    But if you get a policy in the early years of your life, when you’re in good health, you won’t need to pay the higher mortality cost.

    Policy Lapse

    Even when you overfund your life insurance, you must be careful how much money you’re taking out. The policy can lapse entirely if you take out too much cash value. 

    Modified Endowment Contract 

    A MEC is the only limitation you have. As mentioned, there are contribution limits within a certain time frame. This means you’ll lose all the tax benefits if you go over the limit and turn your policy into a tax liability.

    Choosing Between Minimum and Maximum Overfunded Life Insurance

    At the end of the day, what truly is the better choice for you and your finances? 

    To own a life insurance policy that only provides death benefit coverage, or to own an asset that allows you to build and grow your wealth? 

    How to Choose the Right Policy

    Choosing the right policy depends on what your financial goals are. 

    If you want a permanent life insurance policy with a death benefit, getting a minimum-overfunded life insurance policy from an insurance company might be a good choice for you. 

    When people approach us and they can’t afford a policy designed for maximum cash value banking, we advise them to get something else for the beginning.

    Coverage is coverage, and you need to secure yourself and your family. From there on, you can work on your mindset and financial knowledge and get to a place where your everyday actions and decisions strategically contribute to your big financial goals.

    If you want to build wealth and invest more money in your future through private banking, the maximum overfunded policy opens many more doors. 

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    Best Options When to Choose Minimum And Maximum

    When it comes to overfunded life insurance policies in general, people sue them in many cases. 

    You can use your overfunded insurance policy for private banking, investing, buying real estate, and even saving money for retirement. 

    But if you want to do all that, you need a policy with a substantial cash value. And that’s what the overfunded maximum policy is for. 

    One of the main reasons why policyholders overfund life insurance is because they have a high net amount and don’t qualify for a Roth IRA or have exceeded their 401(k). 

    Or they can also use it as a savings account. Well, as long as it doesn’t become a MEC.

    Top reasons for owning life insurance

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    Why Maximum Overfunded Policy Works for Money Accumulation

    Choose a maximum-funded one if you want to build wealth with your life insurance policy. 

    The reason is simple. When you have an overfunded whole life insurance policy, you can let the policy’s cash value grow, take policy loans out of it, and pay yourself back. 

    However, this only works for maximum overfunded life insurance policies because minimally overfunded policies take much more time to build cash value life insurance and become something you can use to reach financial freedom. 

    To own your lifestyle, you should use the maximum overfunded life insurance. Always make sure that your policy is designed so that it works for you! 

    When you put your money in a maxed-out whole life insurance policy, the more significant part of your premiums goes towards the cash value, but you still keep the death benefit. And also, the additional death benefit will increase along with the cash value because it has to follow the regulations.

    Cash-value life insurance is golden because, when you learn how to use it correctly, you get many new opportunities.  

    Also, this doesn’t work for all permanent policies. You need to have overfunded whole life insurance

    Do you want to know exactly how that works? 

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    So, what are your lifestyle goals? Do you just want to have a policy that’ll provide you with a death benefit, or do you want to create something more? 

    With a permanent life insurance policy, it is very possible to build wealth and protect your financial future.