Looking for some Good Ideas for your Emergency Fund? Part 1: Cash Value Life Insurance?

In the spirit of the Holiday Season, which just wound down for the most part (hurray I can drive by major commercial locations again!), I figured I'd make today's piece a sort of “holiday gift ideas with cash value life insurance that kick ass” type post.  For years I've been advocating what I'm about to roll out here, and I've got clients who have accomplished some seriously nice cash positions that are crushing what others are traditionally taught to do with their emergency fund money on a rate of return playing field.

If there's one thing Dave Ramsey, Suze Orman, most financial pro's and I can all agree on, it would be the importance of having an emergency fund that could pay your bills for 6-12 months (some have much smaller goals and shoot for something like 3-4 months, but I'm a big believer in setting your targets high since missing them doesn't put you in a position of being completely screwed).  This sort of money needs to sit somewhere safe and as such savings accounts are typically the weapon of choice–some people use money market mutual funds, which can be a significant increase in rate of return, but this typically isn't suggested to you unless you're working with some sort of financial professional (I've always found it odd that Suze and Dave tend to be mum on this).

Obviously, due to the serious need for security, mutual funds, stocks, bonds (and bond funds) and other even higher risk assets are an absolute no no (though I've run into plenty of people who had “safety” money in mutual funds (bad).   But the depressing uphill battle one fights with a rainy day fund's sitting in something like their bank account is the fact that, on average, their buying power faces a nasty attrition effect year-over-year thanks to our wonderful friend inflation.  The average rate of inflation for the past several decades has been around 3%, this means that if you've got $100,000 sitting in the bank growing at practically nothing you loose roughly 3% of that money's value (this is what we call buying power in economics and finance) each year–if you suck at math $100,000 today is worth roughly $97,000 next year because that's all it's going to buy worth of goods given inflation.  So, in order to keep on top of things, you need to combat inflation's degrading effect by adding more money (and God help you if your expenses go up, that'll “synergize” the problem).

So What about Cash Value Life Insurance?

First, let's keep in mind that there's a right and wrong way to do everything, and one could easily screw the pooch on this one.  So while this is an excellent idea,  care needs to be taken in putting a plan into action on this one.  And an excellent  idea indeed.  Life insurance is a true tier one asset (meaning it's quality from a reliability stand point).  We know banks love it for this very purpose.

I'm going to approach this by detailing the aspects that would make this a good idea (i.e. the key features you need to ensure this will help, and not hurt, you).  I'm also going to approach it from two different fact patterns (namely younger people and older people–the older folks can take advantage of something that's a little tricky for younger people to really find a benefit).

The Younger Folks

We'll define the younger crowd as those under age 59.5 (if you're lazy–or have a thing for discrete variables–and a fan of sig figs feel free to round to 60).   If you fall into this category  you'll need to look at blended high early cash value products.  You're looking to put as many PUA's into this plan as possible without turning the contract into a Modified Endowment Contract (MEC).  You also want a contract that allows policy loans immediately (which would be stipulated as: as soon as the policy has cash surrender value, that's the sort of language you want to see in the contract–or sales material, again if your lazy and that's all you have the brain powder to read).

A cash rich policy like this would be completely accessible by the owner of the policy whenever he/she wanted and would usually yield a return several times better than a money market mutual fund (which is much MUCH better than your bank account).  Avoiding MEC status is important.  If the contract is a Modified Endowment Contract, taking policy loans would be taxable for money taken out beyond your basis, which would have to come out first (LIFO) under a MEC.  Not to get too worried as just about every insurance company out there performs very frequent MEC testing for in force policies (it's would be hard to throw a rock and not hit one).

For the Older Crowd

For the more…”experienced” (in life) individual, you could follow the advice above (and you'd be in good shape if you did).  However, if you buy into the idea that you shouldn't buy green bananas because you don't have that much time on your hands, a MEC isn't necessarily a terrible thing for you.  Since you've broken the age for non-penalty taxes withdrawals, a MEC is pretty much a fixed annuity with a death benefit in your world.  Single Premium Whole Life (SPWL) insurance is a wonderful product for this application (especially if you're looking to move non-qualified money from one place to another).   For even better bang for the buck, look for SPWL that allows you to purchase PUA's (a little unique, but it's definitely out there).  The approach is a low initial death benefit with a lot of extra PUA's (this will work wonders for cash value).

What about Universal Life Insurance?

Because I've been getting a lot of questions about it lately, Universal Life Insurance (UL) might work, but its use of surrender charges tends to make it a much less attractive option on this idea.  Unless you can find a really short surrender period policy (they do exist) I'd stay in the participating whole life arena.

But what's so Excellent about this?

What's so great?  Let us count the ways:

  1. Increased rate of return
  2. Tax deferral
  3. Potentially tax free withdrawal
  4. Death benefit
  5. Private and non-probate asset
  6. Fewer fees (in most cases)
  7.  Recaptured opportunity
  8. Systematic savings

I've decided more recently that more is better, so instead of trying to tackle this all in one post (and in a attempt to keep posts as close to a thousand words or less) I'm going to be addressing these points in a new post coming in a day or two.  Stay tuned for how to use cash value life insurance as a safe money play.

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