You keep hearing people say “no lost opportunity cost” and “recapture interest” while you research the Infinite Banking Concept. A feeling of what is going on, I don’t understand how this works keeps rolling through your mind. I’d venture to guess this lack of clarity is holding you back, keeping you from taking action and implementing the IBC; Becoming Your Own Banker.
Let’s answer your questions!
What is lost opportunity cost?
Here is a quote from Nelson Nash, “You finance everything you buy. You either pay interest to someone else or you give up interest you could have earned. There are NO EXCEPTIONS.” Lost opportunity cost is the interest you pay to a third party to use their money, or the interest you give up earning on your money because you paid cash.
Lost opportunity cost and taxes are the 2 biggest destroyers of your wealth. Lost opportunity cost looks like this in a chart when you pay cash.
Lost opportunity cost is often something you don’t even know is happening. You don’t directly feel it affecting you like interest you’re paying to a third party. The indirect feeling is that you can’t get ahead financially.
What is meant by “recapture” interest?
When the term recapture interest is used, financial professionals are referring to using a system that allows your money to stay at work for you even while you use it. This allows you to keep from interrupting compound interest, which only works with time.
Every time a withdrawal is taken without a system that keeps your money at work causes you to start over with compound interest, which is depicted with the label financial expense in the above graph.
High cash value dividend paying whole life insurance with a mutual company is the ideal tool to create a system in which you can recapture interest (lost opportunity cost).
How does dividend paying whole life allow me to recapture interest?
When you start a dividend paying whole life insurance policy, you should realize it has 2 distinct characteristics:
- Death Benefit
- This is what the company will pay you if you pass away.
- Cash Surrender Value
- As you pay premium to a whole life policy, it builds cash surrender value. The cash value is always less than the death benefit until age 121, when the contract endows (at this point the 2 are equal). The cash value is a living benefit. You can collateralize or withdraw this money and use it for whatever you choose. Cash value is equity which serves as collateral when you use policy loans.
The “smart way” to use the cash value is through collateralization. When you do this your cash value continues earning interest and dividends if declared by the company, even though the policy is collateralized, allowing you to recapture interest. You keep earning interest and dividends because the cash value hasn’t left your whole life insurance policy. You are using the insurance company’s money from their general account, AND paying them interest to use their money. You can borrow as much money from their general account as you have cash value in your policy (or close to it; 90-99% depending on the company).
Why do insurance company’s pay me interest when my cash value is collateralized?
When you purchase a whole life policy, the insurance company has a minimum GUARANTEED death benefit they are on the hook for now to pay you. To make this happen they have to collect premiums and put them to work. Here is a short example of why.
You are 30 years old and have purchased a $100,000 whole life policy. You will pay $1,200 yearly in premium for 30 years to keep this policy in force, and after this time no more premium is due, but the death benefit is still yours. This means you paid in $36,000 in premium. The insurance company must lend the premiums out to earn money, so they can afford to pay you the death benefit, because you haven’t paid in $100,000. They can buy bonds, real estate, and businesses to earn money. The person with first rights to the capital though is YOU. If you borrow money from the insurance company, it is still at work, and growing so they can deliver on the GUARANTEED death benefit.
Now for the reason why you have first rights to the capital.
Mutual insurance companies are owned by their policyholders. Because they have no stockholders to please, the best interests of the company are the best interests of the owners, i.e. the policyholders. The company is naturally conservative because of this, and makes long term, safe investments to deliver on its promises (death benefits).
No matter what they invest in though there is some amount of risk, all be it small in their investments. The safest place to invest money, which also requires the least expertise from the hired help at the insurance company, is with you.
This is due to the fact that because there is a minimum guaranteed death benefit, the insurance company knows what your collateral (cash surrender value), will be worth every step of the way. They have to meet at age 121 remember. There is no other place where they know the future value of their collateral.
One example of this would be that they can buy real estate, but they cannot guarantee the value of the real estate in 30 years’ time from today.
By having the cash surrender value as collateral to your loan, it is the safest possible place to put money to work. If you pass away with a loan outstanding against your policy, the company simply deducts the loan amount from your death benefit, and pays you the net death benefit. (Take note that there is a minimum guaranteed death benefit. Dividends are not included in this, but if a dividend is declared by a company it now becomes apart of the guarantees, increasing your minimum guaranteed death benefit.)
Seeing is believing!
Since this blog is about a topic most people have trouble understanding, I want to leave you with an example you can see. It depicts a policy being funded for 8 years, and then a loan being taken in the following year. I stopped the funding to make it easier to isolate what is going on with policy cash value growth, and loan interest being paid on the $100,000 loan.
This is the same policy depicted, only the top illustration shows a loan being taken and repaid, while the bottom is just to show the same policy in a growth illustration.
When you compare the 2 illustrations, you can see that the insurance company continued to pay interest and dividends even though a loan was outstanding. I highlighted the cash value growth from the time the loan was taken to when it was paid back in green, $55,354. The loan interest paid to the INSURANCE COMPANY is $17,971 (the cumulative value of the column Loan Interest Charged Yearly). This is a difference of $37,383. Because your policy was still earning interest and dividends while collateralized with the loan, you have access to all $55,354 (you recaptured the $17,971 in interest you paid, because you were still earning interest and dividends).
You contributed to the insurance company growing your cash value to meet your death benefit at age 121 in this example AND benefited by recapturing what would have otherwise been lost opportunity cost.
Dividend paying whole life insurance with a mutual company is the ideal place to warehouse and accumulate wealth, maintain access, and build your path to financial independence. The reason this isn’t widely practiced is because of the narrow view people have of what life insurance can do.
If you want to learn more Book Your IBC Discovery Call today.