In this article, we’re going to discuss a strategy whereby someone can take advantage of overfunding their dividend whole life insurance policy for the purpose of then using this cash accumulation to grow and preserve wealth.
During our discussion, we’ll focus on some of the pros and cons of overfunding life insurance, as well as identify when implementing such a strategy may be in one’s best interest.
So, let’s take a closer look at what it means to “overfund” life insurance and see if doing so might make sense for you.
What is Overfunded Life Insurance?
Overfunded life insurance (OLI) is a popular option for anyone looking to build substantial savings in a tax-favored account, via cash value life insurance.
Sometimes referred to as a LIRP life insurance retirement plan, these overfunded life insurance policies are designed to offer maximum early high cash value accumulation along with the asset protection and tax benefits of life insurance.
Overfunded life insurance is essentially permanent coverage such as
Overfunded life insurance is using one of these permanent products to contribute additional cash into the policy to immediately boost the policy’s cash value.
This added cash grows tax free in the policy’s cash account and can be accessed via cash withdrawals or policy loans.
With that introduction aside, let’s get to the advantages and disadvantages of overfunding your life insurance policy.
Overfunded Life Insurance Pros and Cons
We have many articles covering the advantages of life insurance throughout the site, so please take time to read any of the links provided in this article for more on the benefits of cash value life insurance.
The benefits of overfunded life insurance can be summarized as follows:
Tax-favored account growth:
Funds in the cash value account of a permanent life insurance policy such as IUL, VUL, or WL grow income tax free, which enables you to build up a larger amount of funds in such accounts for long-term savings goals than taxable accounts, all else equal.
Overfunded whole life insurance policies offer annual life insurance dividend payments that can be used for a variety of purposes, including increasing your policy’s cash value and death benefit.
Flexible investment options:
Overfunded indexed universal life insurance policies enable you to move your cash value into subaccounts linked to stock market indices such as the S&P 500, the NASDAQ 100, or a more conservative fixed interest rate option, while overfunded variable universal life insurance offers subaccounts which invest directly in a variety of stocks and other securities.
Market downside protection:
One of the primary benefits of an IUL policy are that since your funds aren’t directly invested in the market, but rather in subaccounts which mirror the movement of a market index, you are protected from losses if the market declines in an indexed universal life insurance policy. These subaccounts typically set a floor of at least 0%.
While a variable universal life insurance policy typically provides a greater potential upside than an IUL, because VUL subaccounts directly invest in market securities they don’t offer the same downside protection if the market declines.
No contribution limits (with certain exceptions):
Unlike retirement plans such as 401ks, there are no yearly or other caps on the amount you can contribute to an overfunded life insurance policy.
The only limitation is that the excess cash added to the policy over any 7-year period must follow certain rules to avoid the policy being labeled a MEC modified endowment contract and losing its tax-favored status. Policy’s that are considered a MEC will lose some of its tax advantages.
Tax-free withdrawals up to account basis:
Whether you take a partial withdrawal from your overfunded life insurance policy or a life insurance loan, funds can be taken from your cash account on a income tax free basis up to the point where withdrawals exceed contributions. This is due to the first-in, first-out tax status of insurance policies.
No age-based liquidity restrictions:
Funds can be taken out of an overfunded life insurance policy before age 59 ½ for any reason without government-imposed penalties, unlike IRAs and 401ks (see 401k withdrawal rules).
Note, depending on the type of policy you have, there may be surrender charges for early withdrawals. Typically, an overfunded whole life insurance policy does not have surrender charges but universal life insurance may.
Unlike funds held in traditional investment accounts and trusts, assets held in a overfunded life insurance policy are protected from legal claims and creditors.
Different states have different bankruptcy and creditor protections so be sure to inquire into your specific state.
Tax-free payout of death benefits to your beneficiaries:
In addition to offering the ability to build up funds for retirement or other purposes in a tax-sheltered vehicle, these policies offer tax-free transfer of death benefit proceeds to your beneficiaries upon the death of the insured.
Availability of a disability waiver:
Many overfunded life insurance policies have disability waiver or premium riders which enable you to convert them into a form of living benefits if you are injured or otherwise unable to work.
Additional living benefits include long-term care riders and chronic illness riders. Living benefits allow you access to a portion of the death benefit for a qualifying chronic condition.
Your life insurance and any existing policy loan is private and does not appear on a credit check.
The drawbacks of overfunded life insurance can be summarized as follows:
While overfunded life insurance can offer a number of benefits, such as being able to set aside funds in a tax-favored vehicle, these types of policies are not for everyone.
Some of the potential issues to consider when looking into purchasing an OLI policy include:
Permanent life insurance policies used to fund OLI typically feature higher upfront fees than term life insurance. However, OLI policies offer benefits such as tax-deferral, loss limitation, and asset protection as have been described.
Additionally, as the cash value in your account rises the impact of the fees on your funds as a percentage declines, making these policies most appropriate for those looking to set aside significant savings over a period of time greater than 10 years.
In some overfunded universal life insurance policies, especially those funded for VUL, there may be surrender fees for withdrawing too much money out of the policy in the first 8-10 years or so of its life.
Policy lapse danger:
When borrowing from your life insurance using your cash value as collateral, you must take care to pay policy premiums to avoid lapsing your policy.
If your policy lapses, your coverage will be cancelled and you may be subject to taxes on the money you borrowed from the insurance company.
Who Should Consider Overfunded Life Insurance
Those Looking To Practice IBC
Infinite banking uses overfunded whole life insurance with a paid up additions rider for early high cash value growth that can be borrowed against as collateral for a loan for buying real estate assets. You would then use the cash flow from your real estate investment to pay back your loan to the whole life insurance company.
High Net Worth
Overfunded life insurance is also well suited for higher net worth individuals such as business owners, corporate executives, or others who are capped out in their 401k contributions or do not qualify for a Roth IRA and want to set aside funds in an alternative retirement savings vehicle.
This is especially true if you have delayed retirement planning and are trying to make up for lost time by currently setting aside as much money as possible.
Because OLI is not subject to the contribution limits placed on government-supported retirement plans such as 401ks, you can generally set aside more significant sums of money in an OLI, and why cash value life insurance has been coined the “Rich Man’s Roth.”
Glorified Savings Account
Such overfunded whole life insurance policies and universal life insurance policies (excluding VULs) also work well for anyone who wants a chance to realize returns equal to some portion of the upside of the stock market without the downside risk.
This scenario may apply to executives at public companies or other investors who have a significant amount of money at risk in the stock market.
The ability to pull living benefits from an OLI policy makes such plans an effective way to help protect your current income while setting aside funds that can provide you with additional income in retirement.
Additionally, having the sums you set aside in such a policy grow tax-deferred is a benefit of OLI, as discussed previously.
Overfunded Life Insurance Example: Jim Harbaugh
An example of how OLI can be used to provide tax-advantaged income along with a death benefit payout for a person’s beneficiaries comes from the contract signed by Jim Harbaugh which, using figures compiled by USA Today, made him the highest-paid college football coach in the country.
His contract featured a package including deferred compensation in the form of an overfunded indexed universal life insurance policy.
Split Dollar Life Insurance
This cash value policy will enable him to save millions in tax-free retirement benefits in conjunction with a split-dollar loan agreement funded by the cash value of the IUL.
The split-dollar agreement specifies that the University of Michigan will pay a total of $14 million in loan advances, in seven payments of $2 million each, into the life insurance policy.
Establishing such a policy means that Harbaugh will not need to repay the policy loan prior to his death, at which point the coach’s beneficiaries will get the remaining death benefit.
During his lifetime, Harbaugh can borrow money from the insurance company using the policy’s cash value as collateral without paying income tax. It is estimated that this approach will enable Harbaugh to start receiving $1.4 million each year from the policy income tax free starting at age 66.
There are few, if any, savings vehicles that offer the benefits of life insurance. If you are looking for a safe bucket for your assets or desire to “become your own banker” using life insurance, then overfunding a cash value life insurance policy is an amazing vehicle to help you achieve financial independence and security.
If you are interested in learning more, please check out our resources or give us a call today for a complimentary strategy session to see what we can do for you.
Interested in overfundedwhole life insurance. Need to know interest rate
Hello Patricia, your question is a common one and the average right now for most life insurance companies is about 5%. I encourage you to dig deeper because there is a lot to consider in addition to interest rates, such as margin lock kinds of benefits. Let us know if you’d like to connect with Barry, our IBC expert.
Best, Steve Gibbs for I&E.
info about overfunded whole life insurance policy (p.u.a.)
Hello Monica, thanks for commenting. Feel to reach out to email@example.com for in depth overfunded life insurance feedback.
Best, Steve Gibbs, for I&E
I had build up sizable cash accumulation in employer provided GUL and then my employer changed their provider from A to B. This had forced me to withdraw funds from my cash accumulation account to the extent of cost basis given by provider A.
However at the end of the year, on 1099-R that I received Provider A has shown Taxable gain due to withdrawal of money from CAF.
How this works?
Hello, thanks for commenting. Our expert in GULs is Jason Herring and you can reach him directly at firstname.lastname@example.org.
What is the max you can put into a whole life policy before it becomes a taxable event or a Modified endowment contract? Thanks, Paul
Hello Paul, that number will depending largely on how the policy is designed. Best next step is to connect with our Pro Client guide team to get specific details based upon your goals and budget. You can email Barry to request a call at email@example.com.
Best, Steve Gibbs for I&E
Hello! I’m very interested in OLI and would like to talk to someone about it. Thank you.
Hello Daniel, thanks for connecting and a great way to schedule a conversation is to email Barry Brooksby at firstname.lastname@example.org to request a meeting.
Best, Steve Gibbs for I&E
I have done some research and was curious about payments after the full 5 years are funded. Do your payment go down… substantially?
The example I saw was that a client put in 40K for 5 years. Total of 200K. During those 5 years the insurance company did give him some interest credit of 200-400 a month but the insurance and “other charges” were more than the credit… the 4th and 5th year the cost was about $450 a month. It is my understanding that these early years we are pre paying the costs. If we are pre paying… what will the monthly cost drop to after it is fully funded? The rule of thumb I have heard is after 5-7 years your cash value will match the amount you originally put in. The only way I can see that happening is if amount credited every month is substantially higher than the cost the company pulls from your cash balance (like in the early years) or the costs per month go down. Which is more accurate?
Thanks for some clarification.. Chris
Hey Chris, very fair and educated question. Unfortunately, the best way to get it answered is to connect with one of our experts and actually have illustrations run for your specific premiums, age, health rating, etc. Illustrations will show both the guaranteed and non-guaranteed cash accumulation at various time periods. A great first step is to request a call from Barry Brooksby at email@example.com.
Best, Steve Gibbs for I&E
I will be turning 69 soon, Is this strategy available or beneficial for older persons?
Hi Tommy and thanks for commenting. The short answer is yes, there are options depending on health and situation for someone who is age 69. The way to know for sure is to connect for a video conference and see what is available given your situation. To get started, connect with our Pro Team if you haven’t already by requesting a call from Denise Boisvert at firstname.lastname@example.org.
Best, Steve Gibbs for I&E