When to you use your cash value for a policy loan and when not to?
- Bank on yourself,
- Infinite banking,
- Cash flow banking,
- Utilizing your cash value for future money decisions that you’re going to make anyway.
You’ve heard this from me, it’s on our blog, and it’s in our book. But when strategically do you use the cash value for a policy loan, and when do you not?
Two things to consider:
- The economics.
- The sleep test.
You’ve heard me talk about the sleep tests before. The number one reason we want you to put cash into these whole life insurance policies, with that paid-up additions rider to build cash value quickly, is because this is cash that you want to make sure that it’s guaranteed, protected, and liquid. You build to get that cash in that policy to where it exceeds six months of personal liquid expenses, both personally and in business.
Let’s say you have a $5,000 a month personal and a $10,000 a month business. That would be $30,000 personally and $60,000 for your business, so that’d be $90,000 that you’d want to have as a baseline inside your cash value of your life insurance policy that you don’t touch no matter what.
You don’t touch the cash; you don’t use it for anything unless it’s an emergency.
You get to define what an emergency is.
That peace of mind is the sleep test. Having large amounts of cash, (minimum of the six months personal and business) that you’re storing up that you don’t touch so it protects your peace of mind.
With the sleep test in place, we start to look at other economics. Where is the highest and best use of your cash?
We are in a low-interest-rate environment right now. We’re not always going to be in a low-interest-rate environment. When Wendy and I first got married in 1993, we closed on our first mortgage January of 1994, and the interest rate was 8.75%. We thought we were getting a smoking rate at the time. Today, we’re building a home, and our one-time closed construction loan is 3.75%. This is one example of how we are in a low-interest-rate environment.
To take a policy loan, you’re going to pay between 4.75% and 5% for the money. Remember, the life insurance company is lending you their money and putting a lien against your cash value of your policy. So, if we can get that cash from the bank or financial institution for less than the 5% it would take to get a policy loan, then let’s use their money, and let’s keep our cash in the policy growing at the guaranteed 4% plus the potential dividend. Again, the dividend is not guaranteed over and above the 4%, but it’s very predictable because they’ve always paid the dividend over and above the guarantee for the last a hundred and fifty years.
If you can get cash at a lower interest rate somewhere else, let’s use their cash now, this is the sleep test, but it always depends.
There’s always the ‘depends’, where else do I have cash? You may have some cash outside your life insurance policy that’s in a money market or savings account somewhere earning 1% taxable. If it’s 1% taxable and you don’t have it earmarked for anything, then that’s going to be your lowest opportunity cost.
Do you see why?
1%, maybe your net rate of return on that is 0.6% after paying tax on the 1099 gain of the 1%. So, your 0.6%, versus 5% for a policy loan from the life insurance company or 3.5% – 4% from the local bank. It would make sense to use the 0.6% from your money market account economically.
But does it pass the sleep test?
Let’s say, you have $100,000 cash inside your money market account, and you have your cash value. Now you want to take a loan for your business, some sort of capital for your business. Does keeping that $100,000 in your money market personally outside of your life insurance policy gives you the peace of mind to be able to sleep at night?
Maybe it does.
That peace of mind, we call the economic value of certainty. We can leverage the economic value of certainty in our life.
If so, keep it there, even if it’s going to cost you 5% for the policy loan for the life insurance company or 3.75% from your local. If that $100,000 gives you the peace of mind, it gives you the power to continue to produce at the highest level in your business, let alone the peace of mind of the quality of life personally, well, then, you know the answer. You leave that cash because it gives you the peace of mind.
There’s the economics and there’s the sleep test.
If you have any questions, please reach out to email@example.com and ask us specific questions. As you use it a few times, you will get to know when to use it and when not to.