What is Leveraged Life Insurance?

Leveraged Life Insurance - Bizcviral
Leveraged Life Insurance - Bizcviral

Leveraged life insurance allows policyholders to access their policy’s cash value loans while keeping the death benefit intact. It enables you to borrow against the cash value at advantageous rates for personal or business needs.

Unlike withdrawing money from your policy, loans against your cash value don’t reduce your death benefit or terminate your policy. However, unpaid loans and interest will reduce the amount your beneficiaries ultimately receive.

How Does Leveraged Life Insurance Work?

With traditional permanent life insurance policies like whole life and universal life, part of your premium goes toward building up a cash value and paying for the death benefit. This cash value accumulates over time and earns interest, providing a pool of funds you can borrow from.

You can take out loans up to a certain percentage of your cash value, often around 90-95%, and use those funds for any purpose. The loaned amount typically accrues interest at a rate the insurance company sets, such as 5-8%.

If you continue paying your policy premiums, the death benefit remains intact even with an outstanding loan balance. Upon your death, any unpaid loans and interest are deducted from the death benefit paid to your beneficiaries.

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Benefits of Leveraged Life Insurance

Leveraging the cash value in your life insurance policy offers several advantages:

Access Funds for Opportunities

Taking loans from your accumulated cash value allows you to access funds for investments, business ventures, education costs and other opportunities without liquidating assets or raising high-interest debt.

Tax-Advantaged Source of Capital

Loan interest rates on life insurance cash values are typically lower than rates for consumer loans and credit cards. The loans are also tax-free for permanent policies since you’re borrowing against your own money.

Maintain Full Death Benefit

With a policy loan, your death benefit stays the same throughout your lifetime. This ensures your beneficiaries will receive the full payout you intend for them.

Flexible Repayment Terms

Most insurers don’t require regular loan payments on a set schedule. You can pay down interest and principal on your timeline.

Risks and Downsides

While leveraged life insurance can provide liquidity in a tax-smart way, there are some risks to weigh:

  • Unpaid loan balances reduce your beneficiaries’ payout. Make sure to factor in interest when estimating their net death benefit.
  • Failing to repay loaned amounts chips away at your cash value over time. This can put your policy at risk of lapsing if the value drops too low.
  • Taking loans reduces your cash value, which may lower potential earnings. This can slow down accumulation compared to leaving funds intact.
  • With universal life policies, some insurers will terminate your coverage if the cash value can’t cover fees due to outstanding loans.

When Can I Use Life Insurance as Collateral?

In some cases, you may be able to use your life insurance policy’s cash value as collateral for a loan from a third-party lender. This allows you to access funds without paying back the insurer.

  • Certain lenders offer loans secured by your permanent life insurance policy’s cash value and death benefit. The death benefit acts as payback of the loan in the event of your death.
  • Collateral assignment loans allow you to borrow a percentage of your policy’s cash surrender value from a bank. The insurer assigns your benefits to the lender as collateral.
  • You may also be able to get a cash-out mortgage loan to tap home equity by using your policy as additional collateral.

What is Collateral Life Insurance?

Collateral life insurance refers to policies legally assigned to a lender as security on a loan. The lender claims the policy’s cash value and death benefit in the case of default.

These policies serve as collateral that guarantees loan repayment if the borrower passes away before fully paying it back. The lender gets part, or all of the death benefit to cover the outstanding principal and interest owed.

Two common types of collateral life insurance are:

  • Collateral assignment: Policyowner assigns interest in the policy cash value as collateral but retains ownership.
  • Absolute assignment: Policy is assigned directly to the lender, who becomes the beneficial owner.

How to Leverage Life Insurance to Make Money

Properly utilising the cash value growth and borrowing features of permanent life insurance allows you to put your policy to work in generating supplemental retirement income.

Here are a few strategies that take advantage of leveraged life insurance:

1. Fund Other Investments

Borrowing from your cash value provides capital that can be invested elsewhere for higher returns, like real estate or a business venture. This efficiently uses policy funds to diversify your holdings.

2. Supplement Retirement Income

Many insurers allow you to structure your policy loans as interest-only or partially interest-only. This creates income from the spread between your loan rate and the interest your cash value earns.

3. Pay Down Debts

Consolidating higher-interest credit card balances or mortgage loans into lower-rate policy loans enables you to reduce your overall debt expenses.

4. Finance Major Purchases

Tap into your cash value to fund college tuition, a home remodelling project, the down payment on a vacation property or other large upcoming expenditures.

5. Cover Emergency Costs

Unexpected medical bills, home repairs and other unplanned costs can be covered by loans from your life insurance cash value rather than racking up new debt.

What Are the Three Types of Leverage?

There are three primary ways leveraging helps amplify financial resources:

Operating Leverage

Measures how revenue growth impacts operating income. Higher revenue allows fixed costs to be spread over a larger sales volume.

Financial Leverage

Uses borrowed capital to increase ROI from investments. Interest expense is offset by higher returns than possible with only equity funds.

Combined Leverage

Multiplies return on equity by incorporating both operating and financial leverage. Leverages fixed costs and borrowed capital together.

What are the Risks of Leverage?

While magnifying returns, leverage also amplifies risk. The main hazards include:

  • Capital loss – Leveraged investments see bigger losses when asset values decline.
  • Interest costs – Debt servicing eats into returns and increases the risk of insolvency.
  • Margin calls – Heavily margined positions can trigger broker demands for more collateral.
  • Volatility – Leverage exaggerates price movements up and down.
  • Account liquidations – Accounts over-leveraged face mandatory selling of assets to cover positions.

To manage risks, use conservative leverage ratios, maintain stop-losses, and diversify holdings across asset classes.

Leveraged Life Insurance FAQ

How much can I borrow from my life insurance policy?

Most insurers let you borrow up to 90-95% of your cash value. Loan limits aim to keep policies from lapsing due to over-borrowing.

Do I have to repay policy loans?

You don’t have to make repayments at set intervals. Unpaid loan balance and accrued interest are deducted from death benefits when you pass away.

Are loans on life insurance cash value taxable?

Loans are not taxed as income for permanent life policies since you borrow against your money. However, interest isn’t tax deductible.

Can loans bankrupt my life insurance policy?

Over time, unpaid loans plus interest can drain your cash value, potentially leading to lapse. This risk can be managed by making partial payments.

Do I need life insurance to get a collateral assignment loan?

Yes, you need a permanent policy with sufficient cash value. The death benefit and cash value secure loan repayment if you default.

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Conclusion

Leveraging the cash value within a permanent life insurance policy can provide tax-advantaged access to funds needed for investments, income, emergencies and major purchases. While loans reduce cash value growth, beneficiaries’ death benefit remains intact. Manage loan repayment and policy contributions carefully to sustain leverage benefits over your lifetime. Discuss options with your life insurance agent to see if leveraging your policy aligns with your financial goals and risk tolerance.

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