Universal Life Insurance with a Bank Loan

This is a sequel to the author's article Universal Life - Does it Really Work? Please read it first unless you are quite familiar with the concepts involved with Universal Life.

In the Universal Life policy we have accumulated a large amount of cash because we are using it as a means to transfer wealth from one generation to another. In this case we have been depositing $100,000 annually for twenty years, starting at age 45. The policy is actually a joint life, last-to-die, on a non-smoking male and his non-smoking spouse, aged 40. This means the policy insures both spouses and the death benefit is paid only on the second of the spouses to die. The initial death benefit is $15,000,000, increasing with the increasing value of the fund in the policy.

We are allowing a 7.5% rate of return through investment of the fund and, by the male's age 65, it has grown to $3,500,000 and the death benefit, therefore, to $18,500,000. The clients wish to leave as much as possible to their heirs but also to reduce the amount of income tax payable during their lifetime. If they withdrew funds from the tax-sheltered universal life policy they would pay income tax on virtually all of the withdrawals. Much better than no income but it is rather expensive to make withdrawals.

So, by pledging the policy as collateral for an accumulating bank loan, or series of accumulating bank loans, they can use the loan proceeds as income each year and pay no income tax. Starting at the male's age 65, a $250,000 annual loan accumulating at 10% would accumulate to $5,100,000 by age 75; but the policy would have almost $7,900,000 in it making the death benefit almost $23,000,000. By age 85 the loan would have accumulated to $17,600,000 but the tax-sheltered policy would have $18,250,000 in cash and a death benefit of $33,000,000. At about the male's age 88 (female age 83) the accumulating loan amount more or less equals the cash value of the policy but there is still another $15,000,000 of death benefit.

What is the purpose? $2,000,000 is deposited over 20 years to the policy with no income tax write-offs. Starting at year 21, over the following 24 years, $6,000,000 is borrowed from the bank plus the capitalization of interest, with no income tax consequences whatsoever. On the death of the second spouse, assumed to be at the female's age 83, $38,600,000 is paid in tax-free death benefit. As the policy is assigned to the bank, the loan is repaid from the proceeds and the remaining $15,000,000 is paid out to the named beneficiaries.

If the numbers seem a little rich, try the same thing but lowering all amounts to ten percent: $10,000 paid in for twenty years and $25,000 withdrawn for twenty-odd years and a death benefit surplus of $1,500,000. It does work.