Overfunded Life Insurance: A Strategy Used By The Wealthy

Jan 5, 2023

Overfunded life insurance, max-funded, or overstuffed – they’re all pointing to the same strategy of taking advantage of your life insurance policy to protect and grow your wealth.

This is a great financial strategy for high-earners who have maxed out their other retirement accounts and need an alternative retirement savings vehicle. Overfunded life insurance is also useful for those looking for more stability than a volatile market offers and can be a key part of your financial portfolio.

This is all accomplished by overfunding your life insurance—literally. Pay more into your policy and structure it in such a way that it is supercharged to grow wealth faster and accumulate more wealth over your lifetime. 

It Takes Money to Make Money

While you don’t have to be wealthy to buy life insurance or use private banking with whole life insurance, the wealthy typically use overfunded insurance policies to accomplish these goals:

Traditional role of death payout. The original purpose of insurance is a given–legacy and retirement planning. If something unexpected happens, there’s a payout.

Liquid assets in case of emergency. Money withdrawn or loaned against the policy can be used for an unexpected life event. Medical emergencies, job loss, weddings, and car problems are all bound to happen. There are no age-related penalties for accessing funds.

Asset protection. As a private contract between you and your insurer, your policy, and its cash value are protected from creditors and legal action in most states. Business owners should take note of this benefit. 

Guaranteed loan provision. You can borrow against the policy to take advantage of any purchase opportunity—including business, investment, or personal—that requires liquidity and fast action. If used correctly, many people can accelerate their wealth with this strategy.

Retirement savings. Without the contribution caps of 401(k)s or other qualified savings plans, overfunded life insurance is a safe option for retirement savings that is protected from market volatility. Most high-earners have maxed out all their retirement accounts and are looking for another avenue to save their money. Plus, with no age-related fees for withdrawal, your money is accessible for early retirement before age 59 ½ without penalty. 

Tax-advantaged Wealth For You and Your Beneficiary

Compared to other financial vehicles, life insurance can have lucrative tax benefits.

  • Beneficiaries. The payout of life insurance to a beneficiary is income tax-free. It is also estate-tax-free if the overall estate falls under a certain level.
  • Cash value. The growth of cash value is tax-deferred and can be used tax-free in some instances.
  • Policy loans. A life insurance policy loan isn’t taxable as income, as long as it doesn’t exceed the amount paid in premiums for the policy and the policy remains in effect.
  • Withdrawals. Withdrawals of cash value, called partial surrenders, are tax-free up to the basis (overall amount contributed to the policy). 

The Modified Endowment Contract (MEC)

As with most financial accounts, there are some limits. The IRS regulates how much you can contribute to an insurance policy over a certain time period and still retain the lucrative tax advantages above. Overfund your policy by too much, too quickly, and you run the risk of it becoming a modified endowment contract (MEC), which falls under less favorable tax rules. 

That’s where a well-structured policy comes in. A paid-up additions rider along with a whole life insurance policy is specifically designed to help prevent a policy from becoming a MEC. This additional rider increases your policy’s death benefit as you continue to contribute toward its cash value. In turn, this helps to maintain the minimum required ratio of the death benefit to cash value required by the IRS. Talk to your financial advisor today to learn more.

Is Overfunded Life Insurance Right For You?

Whether overfunded life insurance is right for you always depends on your unique financial situation. What are your financial goals? When do you want to retire? Do you have a sizeable income to fund the policy long-term? In any case, there are certain people for whom overfunding a life insurance policy may make more sense.

You are of high net worth. 

Policyholders who’ve maxed out their 401k contributions may want to overfund a life insurance policy as an alternative retirement savings plan. These funds aren’t subjected to annual contribution limits, so these individuals can set aside more of their money.

You started retirement savings later in life. 

Overfunded life insurance may be ideal for those who delayed retirement planning and now need to set aside as much money as possible.

Policyholders who want early access to funds. If you plan to withdraw funds for retirement or other expenses, overfunding may make sense because it increases the amount of money available from your policy.

You are looking for tax benefits. 

Because overfunded life insurance can offer account growth without necessitating income taxes on the interest, this strategy can work for investors looking for tax benefits.

Are There Drawbacks?

Some policies don’t permit overfunding, so be sure to check with a qualified Prosperity financial advisor before engaging in this type of strategy. We can also help you determine if overfunded life insurance is a smart investment for your particular situation.

Perhaps you’ve heard that whole life insurance earns low rates of return or that it takes a very long time to grow wealth inside a policy. While many whole-life insurance policies aren’t structured for optimal returns or rapid growth, if you properly structure your policy to be overfunded, you can maximize your earning potential much faster. 

Properly structured whole life insurance offers several guarantees and options not commonly found with other types of permanent policies. Plus, whole life insurance policyholders assume less risk than with other types of insurance like indexed universal life or variable universal life. Not being subject to market volatility is a huge benefit in today’s markets.

Setting Up Your Overfunded Life Insurance Policy

Provided you have a steady income, are in reasonably good health, and can commit to your long-term financial goals, overfunded life insurance may be a key part of your financial portfolio. If you’re a business owner, overfunded life insurance is nearly essential to securing the longevity of your company. Finally, if you’re currently maxing out other retirement savings options or are looking for more reliability than Wall Street, a properly structured whole life insurance policy is almost certainly the way to go. 

At Prosperity Financial Group, we can customize any strategy to fit your unique, financial fingerprint. Our expert Wealth Managers are available to answer your questions and outline an individual plan of action to help you achieve your goals. Request a free virtual consultation today below to get started. 

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We’ll spend 30 minutes getting to know you—your situation, needs, and vision—then offer a strategic plan to reach your goals.

JUST ONE CONVERSATION CAN CHANGE YOUR LIFE FOR THE BETTER

We’ll spend 30 minutes getting to know you—your situation, needs, and vision—then offer a strategic plan to reach your goals.
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