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If you have ever purchased a home with a mortgage, you understand the concept of equity. Every month when you make your mortgage payment, a portion goes toward paying down the principal balance. Over time, you own more and more of your home. That ownership is your equity.
Whole life insurance works in a similar way, but most people don’t understand this aspect of how these policies function. When you understand equity in whole life insurance, you’ll begin to see why this type of policy is different from term insurance or universal life insurance products.
Equity implies ownership. Equity is the value of an asset minus the liabilities associated with that asset. When you own equity in something, you have control over it. You can use it. You can borrow against it. It is yours.
With whole life insurance, you build equity in your policy as you pay premiums. This equity grows over the lifetime of the policy until the contract matures. At maturity, you own 100 percent of the death benefit.
This is a unique feature that sets whole life insurance apart from other insurance products. Other types of insurance products provide a death benefit if the insured dies. In addition to this, whole life insurance provides a way for the policy owner to own the death benefit. This provision is guaranteed by a legally binding contract so the value of the policy does not get eroded by low interest rates and the ever-increasing cost of insurance that term and universal life insurance contracts face.
Whole life insurance policies were developed because life insurance policy owners weren’t satisfied with purchasing life insurance on a month-by-month or year-by-year basis without accruing equity. Policy owners wanted the opportunity to develop ownership. Because with ownership comes control.
If you rent an apartment for 20 years, you have nothing to show for all those rental payments. You had shelter, but you built no equity. If you purchase a home and pay a mortgage for 20 years, you have built substantial equity.
Early insurance customers recognized this. They wanted more than just temporary protection. They wanted to build equity at the same time. When whole life insurance is paid up, the policyholder owns the death benefit.
The portion of the death benefit that becomes your equity is called paid-up insurance. As the policy owner, you can take policy loans by using your equity as collateral. You can also ‘sell’ your equity via withdrawals from the policy.
The sooner paid-up insurance is established in a policy, the faster the cash value will accrue. This is why properly designed whole life policies should focus on building paid-up insurance as quickly as possible within IRS guidelines. When a policy is designed well, it will begin to show guaranteed cash value that exceeds premiums paid within eight to 15 years.
The cash value of a whole life insurance policy represents the value of the paid-up insurance in the policy. This is your equity. The cash value can be accessed at any time through a policy loan or a withdrawal.
This is different from how cash value works in universal life insurance products. In universal life insurance, cash value is essentially a side account. It reflects extra premiums that were paid plus any interest earned on those premiums after expenses. It is not equity. It is just money sitting in an account.
With whole life insurance, the cash value represents actual ownership of a portion of the death benefit. The insurance company is no longer at risk for that portion. They recognize that you own it. This is why they are willing to make policy loans against this value from their reserves.
When you pay premiums into a whole life insurance policy, those dollars work to build your equity. The insurance company assumes the risk of managing those premium dollars in exchange for providing a legally binding contract that guarantees a death benefit.
Whole life insurance premiums are fixed level premiums that do not increase during the lifetime of the insured. Premiums can be reduced or stopped in the future.
As you pay premiums, more and more of your death benefit coverage is converted into paid-up insurance so you are steadily buying your death benefit with every premium payment. Until eventually you own the entire death benefit. This takes place when the policy matures.
All whole life policies mature, usually at age 100 or 121. At maturity, you will own the entire death benefit which means your cash value will be equal to the death benefit.
One of the greatest benefits of building equity in a whole life insurance policy is that you can use it while you are alive. The equity you build is accessible through policy loans.
When you take a policy loan, you are borrowing from the insurance company using your equity as collateral. The insurance company makes the loan from their reserves which means you can use your money without removing it from the policy. You maintain the growth and compounding effect while also having access to capital for other purposes.
When a death benefit is paid from a whole life insurance policy, any outstanding policy loan is paid off with the Death Benefit, and the remaining benefit is paid to the beneficiary.
This is different from universal life insurance Option B policies, where beneficiaries receive both the cash value and the death benefit. That sounds better on the surface, but it is a misleading comparison. In those policies, the cash value and death benefit are separate components because the cash value is not equity in the death benefit. It is just a side account. Perhaps a more accurate way to think of it would be a refund of extra premiums and death benefit.
In whole life insurance, the death benefit already includes the cash value because the cash value represents your equity in that death benefit.
Understanding equity in whole life insurance changes how you think about insurance. It moves insurance from being an expense to being a tool for building wealth.
When you rent term insurance, you get protection, but you build nothing. With whole life insurance you are building something of value, if the policy is designed right. You are establishing equity that grows over time and that you control.
This equity is protected by guarantees in the contract. It is overseen by state insurance commissioners. Your equity grows with guarantees. It is not subject to stock market crashes or real estate downturns. The historical track record speaks for itself. Participating whole life insurance has survived nearly two centuries of economic challenges.
Equity in whole life insurance comes down to ownership. You own part of your death benefit. That ownership gives you control, options, and flexibility.
You can use your equity to fund purchases without going to a bank. You can use it to supplement retirement income. You can use it to help your children or grandchildren. You can use it however you see fit because it is yours.
This is what early insurance customers wanted when they demanded whole life insurance. They wanted ownership. They understood that with ownership comes liberty and freedom to make your own financial decisions.
When you understand equity in whole life insurance, you understand why billionaire Andrew Carnegie believed life insurance to be a responsible and practical way to provide for one’s family. You understand why banking corporations own billions of dollars of life insurance. They recognize the value of ownership and understand equity.
The question is not whether building equity in a whole life insurance policy makes sense. The question is what size of policy should you get. At mcFie Insurance there are two criteria we use when working with clients to determine policy size: Affordability and Comfortability. If it’s not affordable, you can’t do it. If it’s not comfortable, you won’t do it.
Q: How long does it take to build meaningful equity in a whole life insurance policy?
A: With a properly designed policy, you can expect guaranteed cash value that exceeds premiums paid within eight to 15 years. However, equity begins building from day one.
Q: Can I lose the equity I build in a whole life insurance policy?
A: Your equity is protected by guarantees in the contract. The cash value can only decrease if you withdraw money or have an outstanding policy loan and stop paying interest. As long as you pay your premiums and manage loans responsibly, your equity will continue to grow.
Q: Is the equity in my whole life insurance policy taxable?
A: The growth of cash value is tax-deferred. When structured properly, you can access your cash value through policy loans without creating a taxable event.
Q: How is equity in whole life insurance different from equity in my home?
A: The concept is similar but with key differences. With home equity, you typically need to sell the home or refinance to access it. With whole life insurance equity, you can access it anytime through a simple policy loan without selling your policy or going through an approval process.
Q: What happens to my equity if I stop paying premiums?
A: If you stop paying premiums, your policy may lapse depending on how much equity you have built. Some policies have provisions that use your cash value to keep the policy in force. This is why it is important to design the policy to be affordable from the start.
Q: Does building equity in whole life insurance make sense for everyone?
A: Building equity through whole life insurance makes sense for people who want guarantees, who value having access to their money, and who want to build something they own over time. The best way to find out if it makes sense for you is to schedule a strategy session where we can look at your situation.
by Anna McFie
With so much important information to learn and understand about managing money, it's helpful to have content that is clear and straightforward to understand. Whether it’s video, article or print resources, designing information in a way that’s clear and straightforward for you to understand is my goal so you can have great success with managing your money well.
This free binder has the information to build your own Infinite Banking system.
