The Engineering of a Whole Life Policy for IBC
As I discussed in my previous post, dividend-paying whole life is the best place to store your wealth. This is because a whole life contract with a good mutual company is the same as your own private asset fitted for your personal banking system. You’re storing your wealth with a company mutually owned by free citizens instead of, let’s say, investing in the stock market with companies whose principles, politics, and morality often don’t match up with our own. In order to understand why participating whole life is the warehouse for wealth, we need to look at how a whole life contract is engineered and learn some vocabulary. As always, this is not a replacement for reading R. Nelson Nash’s books Becoming Your Own Banker and Building Your Warehouse of Wealth. You can find them at Amazon, Life Sucess and Legacy’s website, or at the Nelson Nash Institute’s website. At their website, you can find NNI practitioners like my mentor Mike Everett at LSL in the U.S. and Canada to coach you.
Intelligent businessmen came up with insurance as we know it in the 1600's in England. Insurance protects you from financial loss of an asset, in the case of life insurance it is your most valuable and profitable asset. Since all are guaranteed to die, consumers demanded more than term, and whole life was born. Your house and car are insured if some specific calamities occur. In life insurance, the asset loss is a matter of when. Term insurance is merely renting the death benefit, so you receive no financial benefit in return if you live past the term. Again, since the loss of the asset of your life is guaranteed, the death benefit must be as close to guaranteed as possible (at least that should be the goal). It is a guaranteed asset. As said previously, your equity in the death benefit is the capital owned by you, and the growth of your equity is also guaranteed by contract. The only non-guaranteed items are your own actions in nurturing the policy and future dividends (the previous dividends are guaranteed and can’t lose their value). If you share the same economic values as me, it should be becoming clear why whole life is a fantastic place to store capital no matter what the financial gurus like Dave Ramsey say. I also remind you that life companies are required by state law to have 100% of their expenses in their reserves (unlike federal banks who can practice fractional reserve banking at…10%!).
So here are the basics. First think of purchasing a whole life contract like starting up a (banking) business from scratch. One benefit you have, though: all of the help is already hired. For example, take a good mutual company that is friendly toward IBC giving the most freedom and rights to the owner (there are multiple, some better than others), has been in existence for at least 100 years, and has paid a dividend in each of those 100 years. The hired help uses what’s called a CSO mortality table so that the actuaries can engineer policies by determining the statistics of how many insured persons will die at what time given their health and age (eventually 100% will die). They can’t tell you who, but statistical analysis is a good measure of how many will die. This also means that by definition the price of insurance increases every year you get older as well as being affected by any serious health events. The contract must endow at a certain time since we don’t live forever. At this time, the age of endowment is 121 in the U.S. (it used to be age 100 but people are living longer). This is important to know because the cash value of the policy must equal the death benefit at the age of endowment. More on this later. Next, the rate-makers determine how much premium they have to charge in order for the company to pay the purchased death benefit. Then legal contracts are made and then sold by an agent to the policy owner.
This is what happens behind the scenes at a life insurance company, though all we need to know is that the company is our trustee putting our premium capital to work. It is important to realize the premiums are not bills like the conventional financial world would have us think. They are capitalization payments. Every time you pay a premium, you are further capitalizing and growing your equity in your death benefit. You own the capital so it’s not a bill sent to someone else’s bank!
As Nelson said, we need to know who the characters are in the play. The company is your hired help, or trustee. Then there is the policy owner. This is the person who owns the contract, the one who makes payments, and the one who directs the company in handling the policy. Then there is the insured. This is the person whose age and health determine the price of insurance because it is their life that is insured. When they die, the death benefit is paid. Much of the time the insured person is the same as the policy owner but not always. Lastly there is the beneficiary. They are the ones who will receive their portion of the death benefit tax-free when it is paid. Out of all these characters, the protagonist of the story is the policy owner. He controls the entire scenario because he owns the contract.
Who owns the capital in the policy? It’s not the company, it is the policy owner. Who earns “interest” on his premium capitalization payments (guaranteed cash value)? The policy owner. Who earns dividends? The policy owner. Who determines what happens to the dividends, who the beneficiary is, when to take loans against the policy, how or if the policy loan is repaid? The policy owner. The policy owner has complete control.
Now, on to details of a whole life contract. Suppose you’re 21 years old and you purchase a whole life contract with a good mutual company. You will be paying annual (there are other modes) premium for a number of years. Let’s just say you pay the premium until age 75. At age 75, your policy is “paid-up” meaning no more out of pocket premiums are payable into the policy, but your policy will remain in force until you die (when the death benefit is paid to the beneficiaries tax-free) or reach endowment age. In the U.S., the policy endows at age 121 which is just to say that if you lived another 100 years (because you’re a 21 year old), then the company would give your death benefit as cash to you. This leads us to cash value.
This is to say, the cash value of your policy must equal the death benefit at age 121 because cash value is just that: the value of your death benefit in cash at the present time. At age 121, your death benefit is worth the same amount in cash. That is the basics of cash value and how it must grow over time. This is guaranteed by contract, and if done correctly will eventually grow to more than the total premiums you have paid. How much and how fast the cash value grows depends on your age, health, and how much death benefit you purchased. The higher the death benefit, the faster the cash value must grow in order to reach that higher number at age 121.
Next are the dividends. Dividends in a whole life contract are properly classified as a “refund of premium” or “return of capital” which means they are not taxed (that is, until you receive dividends in the amount greater than the total premiums you’ve paid in…hmmm…I thought whole life insurance was a bad place to store your money? Why is it that you can be taxed on gains as ordinary income if it’s such a bad place to put money?). In a future post, I will be explaining why this refund of capital is in fact a good thing and cannot be properly understood by the trope of “they’re just overcharging you and giving you your money back!”. Notwithstanding, suppose you’re ok with a company handling your money well and returning your own capital to you. The question arises, “What do I do with it?” You could take it as cash, use it to reduce your premium, or other things, but the best recommendation is to funnel it back into the policy by purchasing “Paid-Up Additions” (or PUA).
PUA is merely buying extra death benefit. That’s all it is but it’s very important. When you buy PUA, you buy more death benefit, but it is “paid-up” meaning there is no more premiums required for that extra death benefit you just bought. Suppose you purchase $1000 worth of PUA premium which I will arbitrarily amount to $4000 of death benefit. That $4000 will be added to the death benefit check when you die (or if it endows if you amazingly live to 121 years old), but that $4000 is “paid-up”. That portion requires no more premium to be paid in the future. Since the cash value of your death benefit must equal the death benefit at age 121 by definition and contract (that’s why I keep reminding you of endowment age), then additional death benefit means increased cash value as well as increased cash value growth rate. How so?
Remember that the life company is the trustee of your capital. The more capital they have, the more work they can do for you. When you purchase a whole life contract (called the base policy because it is your foundation), you pay premium for a number of years (e.g. until age 75) until it is paid for (that is, paid-up). It takes the company a number of years to amortize the cost of acquisition of a new policy (because of the overhead cost to employees, commissions, and the obligation to pay the benefit at any point). That’s why cash value is smaller in the early years, and because cash value is the value of your death benefit minus the cost of future premiums yet paid. When you buy PUA through dividends, you are essentially buying a mini-policy with each PUA purchase. However, using the previous example of $4000, that $4000 is paid for: no overhead cost, commissions, or future premiums. If the $4000 benefit cost $1000 of PUA premium, then the current cash value of that very $4000 benefit is essentially $1000. By definition, because you’ve added death benefit, you’ve added that $1000 to your cash value immediately dollar-for-dollar. You have also slightly increased the growth rate of your cash value because you’ve increased your death benefit which must equal the cash value at age 121. But it’s even better than that. Cash value is capital that you own. The trustee (life ins. company) must put that capital to work for you to make the contract work. When you buy PUA, you’re simply adding to your capital base for your trustee to work with. This means your dividends will increase even more in the following years, and these increased dividends can buy more PUA which will increase the cash value and its growth, and this will increase the dividends even more…and so on. You’re creating perpetual motion and increased energy of your capital (not possible in physics but it is possible in finance!).
This only matters if you can access this capital. The problem with investing mania is that you lose access to, control of, and halt the growth if you do access your capital. IBC is not an investment. It is an asset to grow and store your capital from which you have the opportunity to finance your investments (this is the next post). With a good whole life contract, you have an ever growing capital base in an asset you own and control which leads us to the policy loan. The company must lend out your capital at a cost in order to make your plan work. Their safest investment is you because if you die, they’ll subtract the debt from the death benefit check. Though this is your banking system, there’s no actual money in your policy. Cash value is simply that: the value if taken in cash. In order to allow you access to this capital without ending the policy or reducing it permanently, the company allows you to collateralize your death benefit and borrow their money up to the amount of your cash value. That way your policy continues to grow, you get to use your capital for your financing needs (and therefore 3 uses of your dollar), the life insurance company continues to earn the same return (for the sake of your policy), you’re paying interest to an entity you own instead of someone else, and your death benefit stays in force. It’s a win all around. Most importantly you have taken control of the banking function for you and your family. And the best part is, loans are not taxed. Your cash grows tax-deferred but it’s completely accessible tax-free. Also there’s no credit check, W2, or paperwork to know what the loan will be used for or even if you’ll pay it back. That’s a topic for another time.
Lastly, we need to talk about the PUA Rider and a Modified Endowment Contract (MEC). The only time government got involved in life insurance was in the 1980’s. Essentially, because Uncle Sam didn’t want to miss out on taxes, they meddled with whole life insurance because of its tax benefits. They defined a MEC through something called a 7-pay test. Basically when you pay too much premium for death benefit (and therefore cash value increases too much under Big Brother’s arbitrary eyes) a policy becomes a “MEC”. Once a policy MEC’s, it is always a MEC, and every distribution is treated as LIFO (last in first out), meaning every withdrawal is treated as taxable income. It’s not the end of the world, but should be avoided and can be if the death benefit is high enough (this doesn’t mean one should get creative in getting the highest cash value in the first few years of a policy; principle #1 of IBC is “think long range”).
It’s the MEC rules that lead to discussions of “structure” in the IBC world which is just the base premium amount-PUA premium amount from the PUA Rider. A rider “rides” on the policy with some options and stipulations. A PUA Rider gives the owner the ability to buy PUA death benefit out of pocket for a certain number of years. How many years depends on the structure but the purpose in the IBC world is to create cash value for the purpose of financing your life as well as increasing your capital base to grow your banking system long term. Essentially you’re buying a base policy far away from the “MEC line” (see the image in BYOB), but then buying a bunch of mini single-pay policies within which draw the policy closer to that MEC line without crossing it.
These are the basics of IBC-style policy engineering, and understanding it and believing it by following the principles of IBC will lead to a much better financial situation. Until next time.
For more information, check out the Righteous Wealth podcast on Spotify, Apple podcasts, YouTube, and GabTV. Check out the Life Success and Legacy webpage to learn more about IBC and how it can work for your family and business. Contact us to start educating yourself. All financial coaching is completely free of charge. You can also find Becoming Your Own Banker on Amazon, Kindle, and as an audiobook. Check out the Nelson Nash Institute for more information about IBC.
Disclaimer: All content is for informational purposes only. Please consult your tax professional before taking any action.
