Policy Loan Interest Explained

When an individual practices the Infinite Banking Concept, they are using their whole life policy as a financing tool. This concept allows you to recapture lost opportunity cost in your life, opportunity cost you probably don’t even realize you’re losing.

In an earlier blog, How Do I Access the Money in My Policy, we explained 3 ways of accessing the money in your policy. They included a sad way, a dumb way, and a smart way. The smart way involves taking policy loans, and we will explain in depth how these work here.

To start off, the term policy loan is confusing.

This makes one think that when you use your whole life policy cash value to take a loan that the money is leaving your policy. That is not true. When you take a policy loan, the cash value in your policy is not touched. It remains in your policy earning the guaranteed rate + dividends (you want to be sure to use a company that pays dividends when you have outstanding policy loans).

What really happens when you request your policy loan is that the insurance company sends you funds out of their own general account.

You get to use the money for whatever you choose, there are no qualifications that need to be met (aside from having enough cash value to collateralize the policy loan).

The company will charge you interest, and the interest accrued will be paid to the insurance company, NOT YOU. The loan could have a fixed or variable interest rate, depending on your choice of policy and company selection. If you have a variable loan, the interest rate can change at yearly policy anniversaries. Interest will accrue on this loan at annual simple interest, and be paid back to the insurance company, NOT YOU.

A numerical example.

Say you take a $10,000 policy loan and you have a 5% interest rate. $10,000 * 5% = $500. It will cost you $500 to use the $10,000 out of the insurance company’s general fund for 365 days (1 year). The interest is going to accrue daily on this loan. To find that number you take $500/365 days = $1.37 per day approximately. If you don’t want to pay this loan interest out of your own pocket at the end of the year, assuming you have enough cash value, it can be added to the $10,000 original loan, for a total of $10,500. If you elected to not pay the interest, you would have compounding loan interest now in the second year. You do the same calculation to find your yearly interest cost with the new number, $10,500 * 5% = $525. $525/365 days = $1.44 approximately. The extra $25 was the compounding effect of the interest accrued in the first year of your loan. If you pay off the $10,000 loan after 6 months, you would only pay $250 of interest BACK TO THE INSURANCE COMPANY.

Why do insurance companies allow policy loans?

Okay, we covered the fact that when you take a policy loan, your money stays in your policy earning the guaranteed rate + dividends, and you receive funds from the general account of the insurance company. The insurance company charges you annual simple interest and the interest owed on the loan goes back to the insurance company. Now you’re probably wondering why the insurance company would let you do this. Let’s take a deep dive and see why this makes perfect sense.

A life insurance company does not own your policy, you do and they are just the administrator. The insurance company hires actuaries to design products to be sold, and agents to distribute or sell the product. Once an agent sells a whole life policy, the insurance company has to collect premiums, and then make loans or investments to grow the money, to deliver on the death claims promised.

Here is a quick example showing a simple way to think of why they must lend money.

You are 25 years old and purchase a whole life policy with a death benefit of $1,000,000 and an annual premium of $5,000. You pay premiums for 40 years and at this point your policy is considered paid up, meaning no more premiums are due but you own the rights to the $1,000,000 death benefit forever.

You have only paid in $200,000 in premium, so where does the $800,000 difference come from?

Right, the insurance company made loans and investments to make up this difference and deliver on its promise to pay you a $1,000,000 death benefit. They can put this money to work in a number of places. You rank first though in the hierarchy, and this gives you TOTAL CONTROL!

Repayment terms of policy loans.

What about the repayment terms?

Let’s look at the cash value and death benefit first. Your cash surrender value, what I commonly refer to as cash value, is what you can borrow against. It is like a line of credit with a credit card that you have the ability to use, but don’t have to. This functions as the collateral to policy loans. If you die with a policy loan outstanding, the insurance company simply deducts the loan amount from your death benefit and pays the net death benefit (what’s left after your policy loan has been paid off) to your beneficiary.

Alright, we’re ready for another example.

Let’s pretend you have $300,000 of cash value and $1,000,000 of death benefit with your whole life policy. It will vary between companies, but you will have the right to borrow between 90-99% of your cash value in your policy. Again, this just varies between insurance companies.

Now, you take out a $200,000 policy loan, what happens?

Your $300,000 stays in your policy earning guaranteed interest + dividends. You now have access to just $100,000 more, because of your $200,000 loan you just received. Your death benefit will have an exact dollar for dollar reduction to your loan amount, in this case $200,000 principal + interest as it accrues (functionally the death benefit never really did reduce on the policy, the life insurance company is just showing you the net death benefit). The insurance company owes you the death benefit already when you pass away as long as you pay premiums, and they must put the cash value to work already to deliver on this promise, so this is truly the perfect collateral.

With this loan, you now can:

1. Pay it back on terms of scheduled payments
2. Let it continue to roll over year after year in your policy and make sporadic payments
3. Never pay it back, assuming your cash value accumulation outpaces the growing loan amount (growing because the insurance company is charging you interest).

You could also just pay the interest every year or make payments toward the principal, the control is yours. You have this flexibility in payment terms because the company has the perfect collateral. They already promised you the death benefit and must put the cash value to work to deliver on this promise, so if you would pass away, they would simply keep the amount of death benefit it takes to pay off your policy loan, and pay the remaining amount to your beneficiary. It is a perfect arrangement between the borrower and the lender.

*IT IS IN YOUR BEST INTEREST TO PAY BACK POLICY LOANS.

Policy loans and IBC go hand in hand.

You will be using policy loans quite often once you have a firm grasp on the IBC. We have clients that currently are only utilizing their policies as a high yield savings asset. Others are implementing the strategy, using the policy as a financing tool, and creating more wealth while having total financial control. Below you will see a small demonstration I have put together demonstrating a policy loan with software from an insurance company.

This is an example of 2 identical policies, the only difference is the top example does not have a loan, and the bottom example does.

What I want you to focus on are the fundamentals we wrote about. The $30,000 loan was taken at age 33 and no repayment was made. The loan + interest after 1 year is $31,500. I have highlighted the death benefit at age 33 on both examples. You can see there is an exact dollar for dollar reduction in the death benefit on the bottom example with the loan outstanding, from the top example with no loan ($733,869-$702,369=$31,500). You can also see how much cash value you still have access to on the bottom example with the loan outstanding. The loan is repaid over the next 8 years. I have age 41 highlighted so you can see that after the loan is paid back, the death benefits match again. This was an example of paying back $5,000 yearly until the final payment of $1,578. I made this structured for the ease of illustration. I say this just to point out this is only one strategy to pay back a loan, and you should remember the control is in your hands; you decide when and how much to pay back on the loan.

This piece was technical and may require more than one reading, but I hope it provided you with clarity. If you have questions, please reach out to us.

When you’re ready to discuss the IBC with Infinite Banking experts, Book Your IBC Discovery Call with Cash Value Solutions.