Everything you should know about overfunded life insurance

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Unfortunately, life insurance is a subject usually perpetuated by myths and not well-disclosed facts. Many people think that the death benefit of life insurance isn’t worth the monthly payments, but they aren’t aware of the advantages policyholders can utilize.

According to LIMRA’s study, as of 2020, about 54% of people in the United States possess some type of life insurance. However, not all of them are using it in the best way possible.

Overfunded life insurance can seem like a complex theme, but we’re here to help. In this article, we’ll explain:

  • What is overfunded life insurance?
  • Is overfunded life insurance the right choice for you?
  • What are the advantages and disadvantages of owning an overfunded life insurance?
  • How can you own your finances using Infinite banking?

We hope that this article will help you in your journey to selecting life insurance and building your financial freedom.

What is overfunded life insurance?

To put it simply, an overfunded life insurance (OLI) is insurance that the holder pays a higher amount for than if they had regular insurance, and some even fund it to the maximum. There are a couple of reasons and benefits to this procedure, as we’ll explain later in the article.

When it comes to regular term life insurance policies, the entire amount you pay goes towards the death benefit and the administrative fees. This, as the most affordable option for life insurance, covers just a pre-determined period. If the holder passes away outside of the span of the term policy, the policy won’t pay the beneficiary.

On the other hand, permanent life insurance policies cost more, but only a portion of the funds goes toward the death benefit and the administrative fees. At the same time, the rest is deposited into an incorporated savings account, also known as cash value life insurance. This type of insurance covers your entire life, and it comes with living benefits and death benefits.

Utilizing the cash value to take tax-free loans out of your savings for various purposes is one of the main benefits of overfunded life insurance. Depending on which insurer you use, the payback of the loans can have lower interest rates and be partly modified to your requirements. These policies could also earn interest and potential dividends, ensuring cash value growth. We’ll get into more details about this later, but to simplify it, this way you can become your own bank.

Overfunding your life insurance isn’t straightforward or available for all policies, but the two most common types of policies are overfunding of universal life insurance and whole life insurance.

Universal life insurance

Universal life insurance possesses a set amount of minimum payment the holder has to deposit monthly for the death benefit and administrative fees. Any additional funds are deposited into the cash value.

If you can’t meet the monthly payment, the deduction will be taken out of the savings. The premiums you pay for universal life insurance aren’t mainly restricted if you don’t violate the Modified Endowment Contract. This is one of the most flexible insurance options, but not all universal life insurance policies are the same.

Whole life insurance

The main difference between whole life and universal life insurance is that whole life insurance has established premiums the policyholder must pay. Utilizing the paid-up additions rider, a benefit exclusive to whole life insurance, to gain excess premiums in cash value lets us accumulate more funds rapidly.

Whole life insurance policies aren’t as flexible for overfunding as universal ones, but they can be functionally manipulated.

Is overfunded life insurance for you?

Establishing an overfunded life insurance has plenty of benefits, but that doesn’t mean it’s adequate for everyone. The first question you need to ask yourself is whether you even require life insurance.

Do you want to utilize it just for the death benefit? Or do you want to access the cash value?

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Accessing the cash value

Technicalities regarding accessing the cash value depend on access time, so we’ll cover all options here.

Not accessing the cash value

Cash value is one of the main benefits of utilizing the overfunding of your policy. If you don’t have an objective to access that benefit, there’s no need for you to overfund your policy. Instead, if you still require the death benefit, opt for term life insurance or universal life insurance.

Accessing the cash value immediately

In this case, opting for an overfunded life insurance policy may be the best idea. The policy you should be looking for is the Legacy High Early Cash Value (HECV).

This policy variety has a slow growth over time and is best utilized in the first five years of establishment.

Accessing the cash value after ten years

If this is your plan, you should know that most policies don’t possess convenient benefits after the first year. Most have a higher cash value and lower death benefit during that first year.

Accessing the cash value for retirement

Utilizing an overfunded life insurance policy for retirement income is best done if you plan on accessing the cash value early in the policy. However, if you don’t require the cash value immediately or if you’re 50-60 years old, we’d recommend choosing a traditional limited pay style policy.

Check the age of your policy

Before opting for overfunding, check how old your policy is. Some senior policies, especially from the ’80s, retain benefits regarding cash accumulation that you can’t find today.

If you want to adjoin a paid-up additions rider to this policy, you may have to forfeit the already existing benefits.

Reasons why people overfund their life insurance

There are two main reasons why policyholders overfund their life insurance.

High net worth

Policyholders with high net worths, like business owners and CEOs, utilize overfunded life insurance to accumulate retirement funds. In most cases, they either don’t qualify for a Roth IRA, surpassed their 401k or delayed retirement planning.

Savings account

Overfunding your life insurance and building up the cash value is an excellent way to establish a savings account. This way, your assets will be protected from the market, income taxes and you can utilize the living benefits.

Advantages of overfunded life insurance

Possessing an OLI has plenty of benefits and these are the most common and valuable ones.

Dividend payments

If you hold a whole life insurance policy, you’re likely to get paid dividends by the insurance company. You can utilize these to accumulate cash value and death benefits.

Tax-favored growth and payouts

One of the main benefits of OLI is tax advantages for growth and payouts. It’s simple to build cash value because the funds are tax-deferred, making them a superb alternative to regular savings accounts. Additionally, any withdrawals of the funds are tax-free.

Death benefit

The original objective of life insurance is the death benefit. One of the additional advantages an OLI has is the utterly tax-free payout of the policy to the policyholder’s beneficiaries. According to the Insurance Information Institute, insurance benefits and claims totaled $76 billion in 2020 alone.

Living benefits

If you have a qualifying chronic condition, you can access a segment of the death benefit as one of the living benefits.

Early policy payoff

Overfunding your policy enough means that your policy can never be defaulted or denied by the insurance company, so your loved ones will be safe.

Improved investment options

Some types of OLI, like Indexed Universal Life insurance (IUL) or Variable Universal Life insurance (VUL), offer more flexible investment options by letting you store parts of your cash value of the policy in subaccounts linked to the stock market.

Protection from the market

Because you can choose the amount of the cash value that goes into the subaccounts related to the market, you don’t have to worry about losing everything when the market goes down. Whenever the market goes down, the cash value account is vested and protected by the OLI.

No contribution restrictions

Compared to some retirement plans, like the 401k, OLI doesn’t have significant restrictions on the contributed amount of money. However, if you contribute too much in seven years, your policy may become a Modified Endowment Contract (MEC) and lose its tax-favored status.

No age-based restrictions

Unlike with 401k or IRA, the funds from the cash value can be withdrawn before the policyholder reaches a certain age without any penalties.

Protection of the assets

Depending on the state you live in, funds held in your OLI are protected from creditors and legal claims, unlike those in traditional savings accounts.

The downside of life insurance overfunding

Of course, not everything is perfect. There are a couple of disadvantages and dangers to overfunding your life insurance.

Extra fees

Even though overfunded life insurance comes with many benefits, policyholders certainly have to pay for those. Even regular permanent life insurance has higher fees than the more affordable term life insurance, but the payments add up in addition to all the premiums.

However, people usually overestimate the cost of insurance.

It’s crucial to research the insurance company before overfunding to ensure they possess fees adequate for you. In some companies, the higher your cash value grows, the lower the fees’ impact on your funds, percentage-wise.

The danger of policy lapse

If you want to take out policy loans from your overfunded life insurance, always check to ensure that you don’t take out too much. Your policy has to be fully funded at all times or it will lapse, be canceled and you’ll likely have to pay taxes for the loans.

Modified Endowment Contract risks

The complete opposite of the disadvantage previously mentioned happens when the amount you contribute to your OLI is too much, this creating a Modified Endowment Contract (MEC), which doesn’t have tax benefits.

Considering the money in the OLI’s cash value s tax-favored, plenty of people tried to use them as tax shelters. This is why the IRS modified the tax code, so the policyholders’ contributions to OLIs are limited in seven years.

This limit depends on the insurance you possess and any paid-up addition riders you may utilize, and if you surpass it, your policy will be subject to MEC testing by the IRS. Your insurance agent will likely notify you about this.

Own your finances with whole life insurance

In addition to the many benefits of overfunded life insurance listed above, one of the most significant ones is that you can use it to own your finances entirely and become your own bank.

We’re here to teach you about the concept of Infinite Banking.

This concept can be used to help you secure your financial future and bring you additional benefits. If you want to try Infinite Banking, you first need to own a Whole Life insurance policy. Here are some of the crucial aspects of this concept you should know about.

To put it simply, Infinite Banking means being your own banker. With this method, you can strategically use your Whole Life insurance policy to create an endless banking system.

Owning a Whole Life insurance policy has many benefits, one of them being that you can borrow money from it using your policy’s cash value and repay it later. This way, you borrow money from yourself instead of a bank, and you pay it back to yourself with the rate of return, thus becoming your own bank.

With the Infinite Banking method, you can access your financial goals and gain complete control of your finances without dealing with banks and fees.

Infinite Banking involves:

  1. Overfunding (with after-tax funds) a high cash value whole life insurance policy from a life insurance company.
  2. Accumulation of Cash Value (tax-free) throughout the years you are a policyholder of your Whole Life insurance policy.
  3. Tax-Free Loans taken out against your whole life insurance policy’s cash value to use for your financial expenses.

All of these aspects culminate in creating your own bank. You borrow from yourself while your Whole Life insurance policy still earns dividends even though you’re using those funds elsewhere.

No matter what your financial objectives are, Infinite Banking can help you reach them. Entering the Banking Business gives you better control over your finances and helps you build wealth using the life insurance policy.

Final thoughts

Hopefully, this article helped you understand all you need to know about overfunded life insurance. Additionally, we hope that finding out about Infinite Banking and Whole Life insurance made you realize that you can learn how to take control of your finances utterly.

If you want to learn more about Whole Life Insurance and improve your personal finances, you can sign up for our premium membership! We are looking forward to seeing you at the Wealth Nation community!