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Five Secrets to Funding Life Insurance

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Written by: Ben Rovee | Penn Mutual

Despite the important role that life insurance plays as part of a sound financial plan, many people feel they can’t afford it. Let’s face it, money is a limited resource — you can’t go in the backyard and pull money off the money tree.

So, when you look at the cost of living, of educating children, of saving for retirement, a lot of people end up without a lot of disposable income. But I think part of the problem is that people are thinking about their money all wrong.

My goal as a planner is to help my clients optimize their financial well-being. The biggest problem people face when planning for the future is they make their money decisions one at a time, independent of every other money decision. A person might increase their contributions to their 401(k) plan at work, but they don’t necessarily consider the impact of that decision on their mortgage, other investments, insurance policies, or estate. The key is to understand how each piece might be enhanced by coordinating it with the other components of your financial life, and that is an approach that can help free up money to achieve financial well-being. Cash value life insurance can be an important part of that strategy.

I work with people on their financial plans all the time, and I can tell you that there are a number of different strategies that could free up potential funding sources for life insurance you may be overlooking. I’d like to share five of these strategies with you today.

1. Stop Overfunding Your 401(k)

The mainstream media has led a lot of people to believe the best thing a person could ever do is maximize their 401(k) contributions. Maybe…but maybe not. Every financial decision has advantages and disadvantages to it. A 401(k) offers some good advantages – there might be a company matching contribution, it reduces your immediate taxable income, and it is a form of forced savings. Unfortunately, there are also significant disadvantages to a 401(k) plan. It locks up your money until you are 59 ½, and you are taxed on the withdrawals at the prevailing tax rate at the time of withdrawal.

The single biggest advantage to a 401(k) is the company match. You should be contributing enough to take advantage of this free money, but everything over and above what is required to get the company match might mean you are overfunding your 401(k).

Instead, use that excess to fund whole life insurance. Because there’s a tax-advantaged cash value that grows on a guaranteed basis with dividends on top of it, if you compare the after-tax value of the 401(k) at retirement with the cash value of the insurance, you might actually end up with more money in the life insurance. Using the same amount of cash flow, we’ve taken advantage of the company match, provided protection during those accumulation years, and we’re providing tax-advantaged cash for use at retirement–or at any time actually.

2. Free Up Tour “Reinvested Dividends”

If you have investments outside of your 401(k) or other qualified retirement accounts, you are most likely automatically reinvesting any dividends you receive from your mutual funds and stocks. That is a popular investment strategy, but it can sometimes work against you. We’ve all been taught the notion that you want to buy low and sell high, but reinvesting dividends locks you into buying more of a stock or mutual fund no matter what the price is, whether the market is up or down. There’s no control over that money decision, and it may not always pay off.

Rather than reinvesting the dividends, what if we use them to fund life insurance? We’re using one asset to create another; one with both a death benefit and a cash value. It adds much better protection, not only from a death benefit standpoint. If you have a disability waiver, your policy will continue to be funded if you become disabled. Also, in many states, the cash value is fully protected from lawsuits and creditors, unlike the investment account.

3. Use Your Tax Refund. or Better Yet, Change Your Withholding

Most people that I meet get a Federal income tax refund. Often, they look at their tax refund as a form of forced savings. The reality is they’ve essentially given the government an interest-free loan for the year. If you are getting a tax refund, it may make sense to adjust your withholding so you have more take-home pay. This is another potential source of funding for life insurance which, if structured properly, will provide a decent rate of return. It’s a much better use of the money than giving it to the government as an interest-free loan.

4. Use Money Sitting in Your Bank Account, Earning Little to Nothing in Interest

Since the stock market crash of 2008, people have gotten a little gun-shy of the market. You see a lot of people stuffing money into savings and money market accounts. These are safe, but they offer a very low rate of return, maybe 0.0025 percent. Cash value life insurance offers a guaranteed minimum return on whole life of 3.5 percent. The money that is currently sitting in your bank, earning effectively nothing, could be repositioned to achieve a better result.

That said, I am an avid believer in the idea that people should have an amount equal to 50 percent of their income “in the bank.” I’m putting “in the bank” in quotes because the idea is to have the money in a safe and easily accessible location. It need not be a bank.

If someone is well on their way to having that 50 percent of their income in the bank, then it could potentially be a very appropriate funding source. By the way, the cash value of a whole life insurance can act as part of that 50 percent savings. The money needs to be safe, not risk-based, and easily accessible. That sounds like life insurance to me.

In my own personal situation, I’ve got money in a money market account, but my real emergency fund is the cash value of my life insurance policies, which is in excess of 50 percent of my income. All this while I’m getting a competitive rate of return. But, again, this strategy might not be right for everyone.

5. Use Debt Wisely

Our ultimate objective is to put someone in a better position financially on a holistic basis than where they are today. As part of that, we need to look at how people are using debt. There’s good debt, and there’s bad debt. Good debt is the type you can deduct on your taxes, like your mortgage or home equity lines; good debt gives you leverage to acquire assets. Bad debt is pretty much everything else. Unfortunately, Americans have gotten themselves into a position where a high percentage of their cash flow goes to debt service. In the planning work that we do, we want our clients to be debt-free. Few people have the ability to do that right away, so if people can’t be debt-free, our number one objective is to turn bad debt into good debt.

If a person has equity in their home, there’s really no return on that equity. You can’t pull a brick out of your house, go down to the supermarket and buy groceries with it. One strategy is to convert some of your non-deductible debt into deductible debt just by refinancing, leveraging some of the equity to pay off some of the bad debt. This would create a tax deduction that you did not have before, and you might create more cash flow for yourself.

By restructuring your debt, you can free up cash flow which could, in turn, be used to fund insurance or accomplish other financial goals. Note: you’re not borrowing money to fund insurance. You’re using debt more wisely and using the improved cash flow to fund the insurance.

The key to all these approaches is to take a holistic view of someone’s financial situation and understand the role that life insurance can play in producing a significantly better result. That allows people to reposition the pieces and use existing cash flows in a way that enables them to achieve their goals.

I hope I’ve given you some food for thought. Of course, everyone’s life and financial situation is unique. You should talk with your financial advisor to determine if these or other strategies might work for you.

If you are interested in learning more details on any of what I’ve discussed, I encourage you to get a copy of my book, “Playing the Wealth Building Game.” It’s not a “how-to” book, but it will give you some additional insight on different ways to think about money.

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