Have you ever wondered what it would be like to have your own family bank? This would not only build wealth for yourself but also for your whole family and future generations. You could borrow from your own bank anytime you want. It would help you to reach many of your goals in a more tax-efficient manner and provide a great deal of flexibility.
How can you create your own bank?
You may be able to create your own bank by purchasing a Participating Whole Life (WL) Insurance policy where you use the dividends paid to purchase Paid-Up Additions which are increasing the face amount and cash value of the life insurance policy you own. If you want to make it into a family bank, you will purchase policies for your children and even your grandchildren, ideally investing in the policies shortly after they are born. This article will explain how.
Books on the subject
This approach was first written about by R. Nelson Nash in his book called “Becoming Your Own Banker” which outlines how to do this in the USA. The rules are different with regard to what can be done with life insurance policies in Canada but you can still achieve similar benefits. If you want to go in more depth on this subject within Canada, you may want to read “Live Your Life Insurance Canadian Edition” written by Butler, Rempp, and Guest. If you would like to discuss this or get more information on how you may be able to implement our own bank, contact me at [email protected] and I would be happy to meet with you to determine the right plan for you to meet your goals. That plan may include Term Life Insurance in the case of temporary insurance needs, Whole Life Insurance, Universal Life, various living benefits insurance or a combination of these and more.
Borrowing against your policy
The cash value in your participating whole life insurance policy grows tax-free for as long as you keep it in the policy. You can borrow against the cash value in the policy to purchase a house, pay for a child’s education (see Alternative to RESP below), make an investment in your own business or some other investment, and even provide a tax-free flow of money in retirement (see Retirement Strategy below).
I mention borrowing by using the policy as collateral on the loan instead of borrowing from the policy directly on purpose. In Canada, when you borrow from the policy directly, it is considered a partial disposition which would likely cause some income tax to become payable. Once the money is withdrawn from your policy, it can’t be replaced, and it will lower the amount of the face value of the policy by more than the amount taken out.
Policy on another’s life
Even if you find out that you are not eligible for life insurance because of your current health, you can still execute this strategy with a whole life insurance policy on a loved one’s life. This could be a spouse, a child, a grandchild, or someone else that you can show you have an “insurable interest” in. This insurable interest means that if this other person died, you would experience some financial loss or other hardship. It could also mean a business partner or a key employee in your business.
What about buying Term Insurance and investing the difference?
You may have heard of the term – “Buy Term Life Insurance and invest the difference.” In my younger years, I believed in this philosophy, but I learned that generally this does not work because life happens, and it is very easy to spend what you would have invested into things you want and can’t wait for. Term Insurance is much less expensive than Whole Life Insurance, especially in the early years of the policy. In fact, a thirty old will likely spend more on a Term Life Insurance policy to the age of 85 than the premium on an equivalent Participating Whole Life Policy and the term policy may not last for the policyholder’s entire life since a term policy usually ends at age 85.
In the early years, there is a large difference between the cost of premiums between Term and Whole Life Insurance. The idea is then to take this difference and put it into an investment that has a potentially higher rate of return than what the Whole Life Insurance policy would theoretically provide. Term insurance can only be renewed up to a certain age because it is only meant to provide coverage for temporary requirements like mortgages and when children are young. There is no problem with having Term Insurance in addition to a Whole Life policy to meet these temporary needs and make it more affordable. Depending on what you invest in, you may not get the guarantees that Whole Life Insurance provides because your Whole Life policy will never go down in value.
Whole Life Insurance doesn’t have the same restrictions with regard to the amounts that can be invested in registered accounts (e.g. RRSP, Pensions, TFSA). You will also not receive the wild swings in the market valuations like you do when investing in equities, either directly through stocks or indirectly through equity mutual funds.
Creating your own “Family Bank”
To make this a “Family Bank”, it requires that the eldest generation buy policies for the youngest generation and then pass it on to their child who would ultimately pass it on to the grandchild. This passing on of the policy from one generation to another is all done tax-free and probate free. When this is done for all members of the family and continues for future generations, it creates enormous benefits and flexibility for the whole family.
The advantages of implementing this “Family Bank” are:
- It guarantees that each generation is insurable since policies are taken out on children shortly after they are born and most likely to pass medicals.
- Make collateral available for all members of the family that can be used to borrow against for many different purposes that may not be available otherwise.
- Cash Values in the policies are guaranteed to grow tax-free over the lifetime of all family members and with participating policies, grow faster than non-participating policies. (see below for an explanation of participating policies)
Alternative to RESP
Instead of investing in Registered Education Savings Plans (RESP), you could invest in a Participating Whole Life Insurance with your child as the life insured on the policy, starting when the child is very young. In this way, if the child doesn’t end up getting a post-secondary education, you won’t be restricted in what you do with the earnings to avoid tax. When your child or grandchild becomes the age of majority, you can transfer the policy to them with no tax implications. If they end up going to college or university, they could borrow using the policy as collateral while the cash value in the policy continues to grow. This would also contribute to their financial independence. They could later use the policy to borrow against it for the down payment on their first house and other key life goals. It can also be used for all the unknown things that come up.
Retirement strategy
You can even fund your retirement using Participating Whole Life Insurance. After building up the cash value of the policy in the years before retirement, you can borrow money from your policy using it as collateral on the loan. The money you receive will not be taxed because it is a loan and the investments inside the policy continue to grow. You can even capitalize the interest on this loan, so it isn’t paid while you are living. When you pass away, the face amount of the policy is used to pay off the loan including the interest, and the remainder goes to your beneficiaries. Since the payments you receive don’t count as income, you are more likely to be eligible for Old Age Security (OAS) and maybe even Guaranteed Income Supplement (GIS), depending on the income you have from other sources. You are also more likely to afford to wait till age 70 to receive Canada Pension Plan (CPP) and OAS so that you can maximize the amounts you receive from these programs. You can increase OAS monthly benefit by 36% and CPP by 42% by waiting that long to begin payments.
This is similar to but better than a reverse mortgage. With a reverse mortgage, you are borrowing against the value of your house with the possibility of decreasing property values and needing to sell the house to move somewhere else that better meets your needs. When you borrow against your Life Insurance policy, the value is guaranteed to increase. It is important to not take out too much each year relative to the size of the cash value so you don’t outlive the funds and can’t take out any more in your later years.
Other benefits of this strategy
Unlike savings kept in a bank, your policy can also be creditor-proof when you name your spouse, parent, child, or grandchild as a beneficiary (in Quebec, grandchildren aren’t included in this list). You can also name anyone else as an irrevocable beneficiary to creditor proof the policy but know that when you do that, there are few changes you can make to the policy without the beneficiary’s permission.
What is meant by “Participating”
Life insurance companies determine the amount of premium that needs to be paid based on assumptions for mortality costs, expenses incurred by the insurance company, and investment returns. These assumptions are very conservative so it lowers the risk to the insurance company for using the wrong assumptions. The company’s actual experience may be better than these assumptions because fewer people died than expected, investment returns were higher than expected and administration expenses were lower than expected. When this happens, the insurance company retains some of this surplus to increase its policy reserves in case they experience a shortfall in revenue in the future. (Note that participating policyholders do not assume any risk for shortfalls) Some of this surplus may be shared with participating policies in the form of dividends. There are some options on how you could receive these dividends, but for your “Family Bank”, I highly recommend that you put these dividends into Paid-Up Additions (PUA). Here, the policy dividend is used as a single premium to buy additional whole life insurance coverage that is fully paid for. This additional coverage has its own death benefit and the cash surrender value, thus providing more potential room to borrow against. With this addition, no new medical evidence of insurability is required.
Additional note on Term Insurance
This article focuses mainly on Participating Whole Life Insurance policies but there are advantages to other types of insurance, including Term Life Insurance. It is important to have your needs assessed by a Life Insurance Agent to provide you with the insurance and investments that best meet your needs. Some of the advantages of Term Insurance are that it has a low initial cost in the early years of the policy, the premiums are guaranteed over the term, there are renewable and convertible provisions available that can be used to extend coverage and the term of coverage can be customized to meet a specific need. The disadvantages of term insurance are that premiums and coverages are not guaranteed beyond the term or renewal period, premiums increase as the life insured age, coverage is usually not available past a certain age, and the policy is worthless at the end of the term.
Conclusion
Would you like to find out if creating your own “Family Bank” is right for you? Whether it is or isn’t, there are many paths to wealth and freedom. Contact Kevin Ballantyne at [email protected] to set up a time to chat about your goals and financial needs.
Written by Kevin Ballantyne, BBA, CBEC, CPA, CA
Financial Associate
Experior Financial Group Inc.