Navigating Life Insurance Choices: Investing, Variable Policies, and Financial Growth
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Follow us whatever you get your podcast and if you like what you hear, leave us a of you and tell your friends we're back and answering you a real world money questions to help you make smarter financial decisions. This episode tion comes from James, who sent us an email here. IT is hello nerds.

I got contacted about setting up life insurance as a way of borrowing against myself foreign investments to grow my money. Besides giving them ten to twenty thousand dollars to fund the insurance, what's the scamp I would be borrowing against my own money and paying myself back interest. Is there a downside besides the cash being locked up and the insurance company collecting interest and fees? James.

to help us answering James this question on this episode, the podcast, we are joined by nerd wallet insurance pro. Lisa Green, welcome back to smart money. Lisa.

thank you, sir john, for having me insurance .

can be a complicated and kind of intimidating topic to those who are newer to IT. So lisa, let's start by setting some foundations. Our listener, James, is interested in life insurance. And broadly, there are two categories of life insurance, term life insurance and permanent life insurance. Can you please start by explaining what each of these is and how they fit into life insurance broadly super?

First of all, all life insurance policies have one thing in common. They are designed to pay out a sum of money to survivors when the injured person that term is the simplest form. At last, a specific number of years.

If you don't die during those years, the coverage ends and no one gets to pay out. You can think of this is similar to having an auto insurance policy for a year. If you don't crash your car, the policy doesn't pay out.

Permanent life insurance, on the other hand, is designed less your entire life. These policies often mature at an advanced age like ninety five or one hundred and twenty. The primary reason to have life insurance is to replace your income if you die.

I feel like me. Your family relies on your paycheck to pay the bills. If that paycheck were suddenly gone and you still want your family to have food to e close to wear, the home to live in, you'll probably want them to have a payout from your life into its policy.

So a lot of people have a hard time deciding between term and permanent. Life insurance is one generally Better for most people than the other.

Yes, actually, for most families, term life insurance maybe all that you need. Let's say you buy a thirty year term life insurance policy when you're Young and starting a family, it's designed to cover you during the working years when you're the primary breadwinner. Perhaps by the time that policy is your pet family may not be relying on your paycheck anymore. Your mortgage is paid off, your kids are grown and out on their own, you have some money in the bank. You just don't need life insurance anymore.

And when might permanent life insurance be a Better idea?

In some cases, people do need permanent life insurance. For example, let's say you have a child with a disability who will need financial support even after you're gone. You might want to use life insurance to fund a special needs trust for them, and you might want permanent life insurance for this so that the coverage does not expire in two or thirty years. Here's another example. If paying for your funeral will cause financial hardship for your loved ones, you could consider a small permanent life insurance policy that would cover your final expenses.

And there are a number of different types of permanent life insurance, and this is where life insurance can get especially confusing. Lisa, can you give us a really brief overview of some of the different kinds out there?

sure. Whole life insurance is the most common types of permanent life insurance, and you may also have heard of some other types like indexed, universal or variable life insurance. These have differences in how the policies are funded and how the cash value grows, but they are all permanent life insurance.

They're designed to last unto you are very, very old. Some of these policies can become very complex. And mcquaid, careful monitoring.

I also wanted note that not everyone even needs life insurance. The point to keep in mind is that you need life insurance. If someone depends on you financially.

that's a really good point, he said. And in general, when IT comes to insurance products, they are typically best deployed to help you cover a potential risk that is unlikely to happen like an untimely death but could be financially catastrophic to you or your ones. So one of the big differences between term and permanent life insurance is the cost, with permanent life insurance causing a heck of a lot more than term. How much more are we talking here with permanent?

Yes, people might be surprised at the Price difference. Permanent life insurance can be much more expensive than term. For example, let's look at a forty year old applicant for a new life trance policy.

Let's say that this person is an excEllent health, and they want to, about twenty year term life insurance policy for five hundred thousand dollars, pay up. That policy might cost him about three hundred dollars a year. Now let's say this same person wants to buy a whole i've insurance policy that might be six thousand dollars a year that's twenty times more expensive than term life.

But turn versus permanent is not the only factor. For example, if that person above is a smoker for that same term policy, the smoker might pay thirteen hundred dollars a year compared to the three hundred dollars for the non smoker. So that's already more than four times the rate of the person whose in excEllent health and doesn't smoke.

If you've been smoking and thinking about quitting, let this be one more reason to do so, right of one of many. So going back to insurance, of course, what goes into these rates and how can people uses information to compare policies and shop around .

lots of factors go into setting life insurance rates. Here's just a few examples. First of all, your age, and this makes sense, somebody whose seventy years old is quite a bit more likely to that in the next twenty years than someone whose thirty years old so that seven year old is going to pay high r rates than the third year old.

Your sex is another issue. Women tend to pay less than men because meant to da sooner, your health can be a big issue if you have a preexisting condition or even uh, family health condition that runs in your family, that could cause you to have to pay higher rates. And your lifestyle habits can also be an issue.

We mentioned smoking a moment ago. Uh other habits could be a risky hobby like skydiving or even having a dangerous job. Those could raise your rates as well.

So it's sometimes tough to compare the cost of term versus permanent life insurance because some types of permanent life insurance have flexible premiums where you get to decide within limits how much you want to pay in. But overall, permanent life insurance is more expensive than term for several reasons. First of all, IT lasts longer. That means it's more likely to pay out the insurance company is more likely to have to pay money on you and also IT may build cash value. Part of the premium that you pay can go into building a cash value that you couldn't into future perhaps consider barring against.

Now that brings me back to James this question because they seem interested in a form of life insurance that lets you borough against the amount that you pay into IT. And this could be something like a regular whole life insurance product or even a universal whole life insurance product.

And these forms of life insurance can get a little complicated since there is the regular life insurance component that we just discuss and people are generally familiar with, but then you can also use IT as a savings or maybe even also an investment account of sorts. And there's was known as the cash value component. So leader, can you describe how this cash value component works?

absolutely. When you buy a term life insurance policy, what you pay in premiums is to cover the cost of ensuring your life. sure. There are some administrative costs because the people who work for the insurance company have to be paid, but for the most part, you're paying for pure insurance coverage.

Term life insurance would not work for what James has in mind because IT doesn't build up in the cash value to borrow against permanent life insurance is different. IT has higher premium and part of the premium pace for the cost of insuring your lie. The other part of the premium goes into building cash value.

You can think of cash value as being similar to a savings account. Every time you pay your premium, some of the said your cash value grows slowly over time from the money you pay in and also from the amount that that money can earn. There's different types of permanent life insurance because there are different ways to earn money on that cash value. Some policies like whole life insurance pay a guaranteed rate of interest. Other policies may pay based on the performance of specific investment options that you chew, and then when the cash value has grown enough, you can borrow against IT, but keep a man IT can take ten, fifteen years or even longer to build up enough cash value to borrow against.

So I think we are starting to see now why life insurance products can be a little confusing for people. Can you give us an example of what one of these policies might look like in practice?

I have a personal example I can share of putting extra money into cash value. I have a small permanent life insurance policy that my parents bought on me. When I was a child, interest strates were higher back in. And so this policy was guaranteed to pay interest of at least four percent.

Now you probably remember a few years ago when interest strates were so low that if you put your money in the bank, you could only get like zero point zero zero, zero zero, zero, zero zero one percent interest on IT. Okay, it's a little bit of an exaggeration, but youth were very low. So I put some money into the cash value of my life insurance policy, where IT would earn four percent.

Recently, I took a look at how that policy had performed over the past couple of years. Here's what I found. I did earn four percent interest on my cash value one year.

I also got a small refund. But remember, the cost of insurance over those couple of years, several hundred dollars went to pay for the cost of ensuring my life. That money is not in the cash value anymore. So after removing that from the equation, I was left with the return of about two and half percent a year on the money that I put into the policy.

So now in the end, you think he was actually a good return on .

your investment kind of depends on what you compare IT to. It's Better than that T V, tiny returns that I would have gotten by letting the money in a bank account. Course, interest strates have risen since then.

In right now, I could go get a five sn certificate of deposit local bank. So the life insurance policy is not as good of a deal now as I was back then. So what if I had put the money into a mutual find instead? Let's say, S, N, P.

Five hundred index turned. I ran those numbers, and I saw that I really would have come out ahead most sleep because of not paying the cost of insurance. The expense ratios on an index band are typically a lot lower than the cost of life insurance. But I also would have risked losing money if if the market declined, which I did for part of that time.

What will be back in just a moment?

Stay with us.

So lisa, some consumers can get a little bit excited when they hear about these new and sort of novel types of life insurance policies because they can seem like a secret way to stash cash or invest through do a life insurance policy. But these products are not simple and they are not great for everyone. I would maybe even say most people so think might be a good candidate for something like this.

Variable life insurance is one way that some people use to achieve their investment goals. IT is permanent insurance that combined an investment and an insurance policy. You can allocate its cash value to different investments through serb account that are similar to mutual fund.

You can choose subway accounts from the options that are presented to you by your insure. Depending on how those investments perform, your cash value can gain value or you can lose value. So this type of policy can be very risky. In fact, the federal government requires people who sell variable life insurance policies to be registered to sell security, such as stocks as well as life insurance. That's a signal that variable insurance is more complex than a standard policy.

So IT seems like James might be eluting to this concept, something infinite banking. Could you explain what that is? Because that sounds .

completely made up. absolutely. The infinite banking idea has been around since the nineteen eighties. And recently, IT has just really gone viral on tiktok.

IT involves treating the cash value of a permanent life insurance policy as if I were your own personal bank. Here's how IT typically works. You buy a whole life insurance policy and you put as much money as you can into its cash value.

You keep doing this for several years. IT typically takes ten years or more to build up enough cash value to borrow again. Then you can borrow money against the cash value and repay IT so that the cash value continues to grow.

You may have heard this described as borrowing from yourself and paying yourself interest. That isn't exactly what's happening. You're borrowing from the insurance company using your cash value as collateral for the loan, and you're repaying the loan with interest to the insurance company.

Your policy does continue to acute interest during this time according to the terms of your contract, but probably at a lower right than what you're paying on the loom. Now there is an advantage to borrowing against the value of your life insurance. You don't have to like qualify for the loan in the same way that you do for traditional loans.

So you don't have to go through an extensive application process to prove your credit. Worthing is you can simply request alone against your cash value and get IT regardless of your credit score or other factors. You won't have access to all of your cash value though, if you look at all that out, IT would crash your policy and IT in. And you also have a lot of flexibility in repaying the loan, which you is another advantage for some people.

But people should keep in mind that the death benefit, which again is a sensibly the whole point of having life insurance maybe reduced by the low amount left out outstanding if you pass away before you pay off alone.

yes. So this begs the question, who might be a good candidate for a product like this?

For infinite banking, the right candidate would be a person who is very disciplined and willing to put a lot of money into the cash value of their policies year after year. This is not a casual endeavor. You would need to pay a lot of attention to your policies and really make this a lifestyle.

I want to share a direct quote from the creator of the infinite banking concept. He was an insurance agent named Nelson nash. And in his book becoming your own banker, he said, he is going to take years to get started. And IT needs to be a lifetime commitment that doesn't ounds .

like something an insurance sales person would .

say where somebody involves in a multi level.

Yeah, this gets me to one of my main grapes with life insurance products like this is that people think that they found some secret way to invest or become their own banker. Very intuned. What I see on tiktok a lot, but for most people, there are much simpler and less expensive ways to invest your money or access your own cash, like maybe a four one k or just a higher giving this account, you can access your own money that way without having to wait ten years to be able to really have enough in there, most likely. And if someone is helping up one of these insurance products listened, I would say, ask yourself why they might be doing that, because I might just be an insurance sales person looking to make a buck.

So James, with all that we're getting to the core of your question, which is what's the scamp? That's a great question. You should ask that basically every day when every receiving emails just asked yourself, what's the scm here?

Even if it's from like especially if it's about .

like your own sibling, just ask what the scams. So IT sounds like they have about ten or twenty thousand dollars to put into one of these products. What kinds of fees or other expenses might they face and what other downsides should they be aware of?

All, there are definitely downsides to change the suggestion of buying life insurance in order to borrow against IT. First of all, permanent life insurance is expensive. IT can easily cost ten or twenty times as much as the same amount of term life insurance, and that is basically the minimum payment.

People who advocate life insurance as a source to borrow against will encourage you to put in more than the minimum, quite premium or as much as the policy will allow for infinite banking. It's typical to put ten percent or more of your take home pay into your life insurance policy on a continuing basis. That's a big commitment that many people may not want to make or be able to make.

Second, IT takes a long time to build up enough cash value to borrow again, often fifteen or twenty years. Third, the cost of insurance access a drag on the financial performance of a permanent life insurance policy. Part of your premium is used to pay the insure for the risk that you'll die and we'll to pay out of death benefit and forth.

This requires a really high level of financial discipline that can be tough to maintain. Your premium can be very large. And if you fall behind on paying them, your policy could lap. And all this assumes that you can get reasonably Price life insurance in the first place.

I really appreciate you sharing all of that, lisa. So i'd like to hear what would be maybe your bottom line for James or anyone else who's maybe still at this point considering a product like this?

Yes, James has ten or twenty thousand dollars to invest. That's great. So James need life insurance.

The first question to ask is whether James is death would have financial repercussions on the people in their life. If the answer is yes, then James should look into life insurance. For that reason, term life insurance may be the most cost efficient way to do that. Then James may want to consider other financial priorities for that ten or twenty thousand dollars, other student loans or credit cards that need to be paid off.

Does James have an emergency savings span enough to cover several months of living expenses? And is James setting assad money for retirement? IT may make sense to direct in percent or more of income into a tax advantage retirement account like a four one k or a rough I R A, before expLoring something like infinite banking. If James has this money available to invest, then James is in a position to make some smart financial decisions for the future, and I wish him all the best.

Well, this Green, thank you so much for coming on smart money and talking with us about this. Thank you for having me. And that's all we have for this episode. Remember, listener, that we are here for you and you are money question. So send them our way.

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