Why is it important to repay your policy loans? You may have understood or heard that policy loans are unstructured, which basically means there’s no coupon booklet or payment process. You’re in control of the process, which means you determine if, when, and how quickly those loans are paid. But now the question becomes, why is it important to pay back those loans?
Oftentimes, when people are thinking about the infinite banking concept, they’ll take a policy loan and then question, “Why do I have to pay this back? It’s my money.” Well, they don’t fully understand the process.
You see, when you borrow against your cash value in a life insurance policy, you’re getting a separate loan from the insurance company’s general account. The money in your policy stays in your policy and it continues to earn uninterrupted compounding of interest. The second part is the loan that you get, which is literally a loan against the equity of your policy. The life insurance company calculates the equity and calculates how much they can loan you based on that amount of equity. So you are taking a loan from the insurance company. And the importance of paying it back is that the faster you pay it back, the less interest you pay the insurance company and the more equity that’s available for you to loan or borrow again. This is the concept of turning over your money so that the velocity of money can benefit you.
Keep this in mind. Every purchase you make is financed whether you pay cash, go through the traditional financing method, or take a life insurance policy loan. Only with traditional financing do you get a coupon book that says you need to pay this amount back at this rate. And with the traditional savings account or the life insurance policy loan, it’s a double-edged sword in that you don’t have to pay it back and you don’t have to pay it back. But keep in mind, we always say it’s not what you buy. It’s how you pay for it that matters. And when you’re in control of the banking function, you get to control the terms and conditions. But that doesn’t mean that you shouldn’t pay it back.
One of Nelson Nash’s cardinal rules, (he had four cardinal rules), number three was “Don’t Steal the Peas.” And what did he mean by that? He meant that if you borrow money against your life insurance policy, you should pay it back. Why? Because you’re going to need money again in the future. And if the money’s not back in the policy, then you’re going to have to go back to the traditional way of borrowing with a bank. And now you’re not in control.
So you may be wondering what happens if I don’t pay my policy alone? And that’s simple. Sometimes people have this policy loan, and, especially if it’s a large policy loan, the policy loan will continue to accrue interest. Meaning, that if you don’t pay back at least the loan interest, that loan interest will get tacked on as loan principal and tie up more of your policy’s equity year after year.
And that can put you in a position where it becomes so insurmountable that you have to either walk away from the policy or reduce the face amount of the policy in order to eliminate a large portion or maybe even all of the loan. But keep in mind, that can also trigger a taxable event, and that full taxable event will happen in the year of surrender, meaning anything that’s surrendered over the premiums you paid is going to be fully taxable as ordinary income. So that’s not really a position you want to put yourself in.
So the next question becomes: if I have to pay interest back to the insurance company and have the risk of a taxable gain, what is even the benefit of taking this policy loan?
Well, that’s simple. The benefit is that you’re in control. We have many clients who take loans and pay them back. We have many clients who take loans, start a repayment process, and have to suspend or reduce the amount they’re paying back because of a temporary cash flow situation. That’s the beauty of being in control of the process. You set the terms and conditions of the loans and you could pay it back, stop, reduce, whatever. Again. That’s the issue of control. But what we’re talking about also is that if there’s a long-term situation where the cash flow isn’t there to pay back a large, perhaps insurmountable loan, you do have options. And that’s where we can help you.
If you’d like to get started with a specially designed whole life insurance policy designed for cash accumulation to put this process to work for you. Or if you currently have a life insurance policy loan or are thinking about taking one, please visit our website at tier1capital.com and schedule a free strategy session today. We’d be happy to discuss the options with you.
And remember, it’s not how much money you make, it’s how much money you keep that really matters.