Make sure you have read about Savings vs. Investments and 50x Bank Interest Rates - Part 1 as these two posts provide the foundation for what I am about to discuss.
What's interesting about these whole life insurance accounts is that large corporations - and especially large BANKS - have billions of dollars in these policies. Last I looked, Wells Fargo had as much in these policies (about $18 BILLION) as they had in all of their buildings and equipment. Think they might know something you don't?
So why don't you know about them? Well, the banks aren't going to tell you about them as they can't sell them. Most financial advisers do not sell insurance, so they won't mention them either. That leaves insurance agents, the vast majority of whom do not know about these specific techniques and - even if they do - they are not likely to promote them as they do not pay very well. Oh yes, and the government dramatically restricts advertising of life insurance policies (e.g. insurers cannot advertise the policies as "alternative savings accounts").
How It Works
Insurance companies take the premiums they receive and invest them in bonds, loans, and maybe even stocks. Unlike banks, they don't have nearly the overhead expenses in the form of branches, tellers, loan officers, etc. This allows the mutual insurers to return most of their "profits" to the policyholders.
Whole life policies earn dividends, which would otherwise be profits but for mutual companies are treated as a return of a portion of your premiums. As a result, these dividends are not taxable (this is how your returns compound tax deferred).
Normal policies earn returns in the 2-3% range over decades - not particularly good, but remember what savings accounts are paying right now? BUT, you can cram additional money into the insurance policy (technically buying additional insurance) which also earns dividends and boosts your returns up to 4-5% right now (typically). Unfortunately, the IRS puts a limit on how much additional funding you can put in before they say it is an investment and not insurance, and you would therefore lose your tax benefits, which we don't want to do!
I also promised you can get to your money at any time. This is true, but a little tricky. The way you get "your money" is actually by taking a loan from the insurance company. Insurance companies are legally obligated to loan against your cash value (I will call this your "account value"). With the best companies, the interest rate varies, and is close to what you are earning in dividends - sometimes a little more, sometimes a little less. So say you have $100,000 in cash value - you can take a loan at 5% from the insurance company while at the same time your $100,000 is still in the "account" earning 5%. While it sounds weird, the net result is the same as taking your money out of the bank - the 5% you are earning offsets the 5% you have to pay on the loan.
Advantages
1. Return - 4-5% is much better than other savings vehicles. Remember to compare this to other savings vehicles and not investments - though if you do the math, the tax deferral and lack of fees does compare favorably to many investments.2. Grows tax deferred
3. Access to your money (unlike 401ks, IRAs, etc) - again, not as easily as banks, though
Disadvantages
1. Setting up an account takes time - it takes 1-2 months usually, and involves medical history, medical exam, etc.2. Access to money is not as convenient (which can also be a plus if you tend to spend too much, as I have sometimes been wont to do)
3. Long-term commitment - takes 5-10 years to break even on policy & get to point where policy can pay for itself
Next time we will walk through an example to give you a better idea how this works. In the meantime, if you have questions (which is likely after a very brief explanation from someone who is not particularly good at explanations), then please comment below. Thanks!
