Life Insurance: Me Bank's Guide To Peace Of Mind

Life insurance is a financial product that pays out a sum of money to your beneficiaries after you die. There are different types of life insurance, including term life insurance and whole life insurance. Term life insurance provides coverage for a set period, such as 10, 15, or 20 years, while whole life insurance offers lifelong coverage and includes a cash value component, which grows over time. One concept, known as infinite banking, involves using whole life insurance as a personal line of credit, where policyholders borrow against the cash value of their policies instead of taking out traditional loans. Banks also utilise a type of life insurance called bank-owned life insurance (BOLI), where the bank is the policy beneficiary. BOLI serves as a tax shelter and a means to fund employee benefits.

Pros and cons of bank-owned life insurance

Bank-owned life insurance (BOLI) is a product where a bank purchases and owns an insurance policy on an executive's life and is the beneficiary. While BOLI offers several advantages to banks, there are also some drawbacks to consider. Here are the pros and cons of bank-owned life insurance:

Pros:

• Tax-Advantaged Investment: BOLI provides banks with a tax-efficient method to offset employee benefit costs. The cash value growth is not subject to annual taxation, allowing banks to accumulate funds faster than with traditional taxable investments.
• Source of Non-Interest Income: BOLI generates a steady stream of non-interest income for banks, contributing to their bottom line.
• Employee Benefits: BOLI enables banks to offer valuable benefits to key employees, such as executive bonuses, supplemental retirement income, or funding for employee benefit plans. It also helps with risk management by offsetting the financial impact of losing a key employee.
• Cash Value Growth: The cash value of BOLI policies grows over time, creating a valuable asset for banks that can be accessed when needed, providing additional liquidity.
• Diversification of Investment Portfolio: BOLI offers banks an alternative asset class that is not directly tied to market fluctuations, thus diversifying their investment portfolio.

Cons:

• Regulatory Risks: BOLI is subject to regulatory requirements, and banks must ensure compliance with applicable laws and reporting standards, adding complexity to their operations.
• Interest Rate Sensitivity: BOLI returns are sensitive to interest rates. Prolonged periods of low-interest rates may result in lower cash value growth than expected.
• Costly Surrender Charges: Surrendering a BOLI policy prematurely can result in significant surrender charges, potentially eroding the cash value.
• Alternative Investment Opportunities: By allocating too much of their assets to BOLI, banks may miss out on other potentially more lucrative investment opportunities.
• Policyholder Risks: If the insured employee lives longer than expected, the bank may need to pay premiums for an extended period, impacting the overall returns on the policy.

How bank-owned life insurance works

Bank-owned life insurance (BOLI) is a type of insurance coverage purchased by banks to insure the lives of their key employees, executives, or board members. BOLI is a permanent life insurance policy that acts as a tax shelter for financial institutions and helps them fund employee benefits.

While BOLI is owned by the bank and the bank is named as the beneficiary, it is important to note that it is not available to individual investors. The bank benefits from the tax-free nature of the policy and its proceeds. The money earned from the death benefit or cash surrender value is used to pay for employee benefits.

Here's how it works: the bank sets up a contract and makes payments into a specialised fund—the insurance trust. The policy is purchased for a specific employee, and the bank pays the premiums. All employee benefits covered under the plan are then paid out from this fund. The premiums paid into the fund and any capital appreciation are tax-free for the bank, allowing them to fund employee benefits without paying taxes.

BOLI offers several advantages to banks. Firstly, it provides a tax-favourable way to generate earnings that can offset the costs associated with employee benefits programs. Secondly, even if an insured employee leaves or is terminated, the policy remains in place, allowing the bank to continue funding employee benefits. Additionally, the cash value grows tax-free if held until the death of the insured, providing a tax-efficient method of financing employee benefit and compensation plans.

However, there are also downsides to BOLI. If a bank surrenders a policy due to an inability to keep up with premiums, the policy will be taxed, and there is a 10% penalty on any gains. Additionally, the credit quality of the BOLI insurance carrier's credit rating is crucial. A poor credit rating can expose the bank to risk, especially if the policy is not purchased as a single-premium policy.

Types of BOLI accounts

Bank-Owned Life Insurance (BOLI) is a strategic financial tool used by banks to fund employee benefits and gain tax advantages. There are three primary types of BOLI accounts: General Account BOLI, Separate Account BOLI, and Hybrid Account BOLI. Each type offers distinct features, investment strategies, credit ratings, and levels of protection against creditors.

General Account BOLI is the most traditional and commonly chosen option. Banks typically invest their BOLI funds in conservative assets, such as bonds and real estate. The insurance carrier maintains a credit rating, which can fluctuate. This type of BOLI is simple and provides a broad overview of investments but lacks detailed insights and creditor protection.

Separate Account BOLI offers more transparency and control over investments. The insurance provider separates the general account holdings into investments managed by dedicated fund managers, who provide specific details about the portfolio's composition and performance. While this type offers enhanced protection against creditors, banks assume more investment risk.

Hybrid Account BOLI combines elements of both General and Separate Account BOLI, offering a middle ground. Banks receive a guaranteed credit rating and detailed information about investment holdings. This type balances the simplicity of General Account BOLI with the transparency and creditor protection of Separate Account BOLI.

The choice of BOLI account depends on the bank's goals, risk tolerance, and need for transparency. General Account BOLI offers simplicity, while Separate Account BOLI provides detailed insights and robust creditor protection. Hybrid Account BOLI seeks to strike a balance between these factors. Understanding these nuances helps banks make informed decisions, aligning their investment strategies with their financial stability and benefit programs.

Tax benefits of permanent life insurance

Permanent life insurance, also known as whole life insurance, offers several tax benefits to policyholders. Here are some of the key tax advantages:

Tax-Free Death Benefit

The death benefit provided by permanent life insurance is generally paid out to beneficiaries free of federal income tax. This means that your loved ones will receive the full sum assured without having to pay taxes on it. This can be especially beneficial in maintaining the standard of living, paying off debts, or fulfilling education plans for children.

Tax-Deferred Cash Value Growth

Permanent life insurance policies offer a cash value component that grows over time. The growth of this cash value is tax-deferred, meaning you don't have to pay taxes on it until you make a withdrawal. This allows your savings to accumulate faster as the interest is applied to a higher amount. The cash value can be a significant source of funds during your lifetime.

Tax-Advantaged Withdrawals

You can access the cash value of your permanent life insurance policy through loans or withdrawals without immediate tax consequences. This flexibility allows you to use the funds for various purposes, such as supplementing retirement income, paying for medical expenses, or funding education. However, it's important to note that loans and withdrawals will reduce the death benefit and may require additional premiums.

Dividends from the Insurance Company

Whole life insurance policies may receive dividends from the insurance company, which are generally not taxable. These dividends contribute to the growth of the cash value and are not guaranteed but are often paid out annually by mutual life insurance companies.

Estate Planning Considerations

Life insurance payouts are typically received by beneficiaries much quicker than property or other physical assets, which may be tied up in probate processes. This timely payout can provide financial relief to your loved ones when they need it most.

While permanent life insurance offers these tax benefits, it's important to consult with a financial professional and a tax advisor to navigate the complexities of tax regulations and make informed decisions regarding your specific situation.

Whole life insurance as an investment

Whole life insurance is a type of permanent life insurance that provides coverage for your whole life as long as you continue to pay your premiums. It is an investment tool and savings account that can be tapped into while the policyholder is still alive. The premium amount remains the same for the life of the policy, regardless of age or health.

Whole life insurance can be a good investment option for those who want a stable life insurance option with guaranteed returns and no increase in premiums over time. It is also a good option for those who want to leave a guaranteed death benefit to their loved ones and generate cash value to fund their own future expenses. However, it is important to note that whole life insurance is more expensive than term policies due to the built-in cash value and has less flexibility when it comes to modifying coverage and choosing how to invest the cash value.

There are several ways to use whole life insurance as an investment:

• Withdrawing or taking a loan on the cash value: Policyholders can tap into the cash value to pay for major expenses, such as college, a down payment on a house, an emergency fund, or retirement income.
• Creating generational wealth: Whole life insurance can help heirs navigate the federal estate tax, which can reduce inheritance by up to 40%. By creating an irrevocable life insurance trust (ILIT), death benefit proceeds from a whole life insurance policy can pass to heirs outside of the taxable estate.
• Collecting dividends: Some whole life insurance contracts offer dividends, which can be used to reduce out-of-pocket payments, pay the policyholder directly, earn interest, or purchase paid-up additional insurance to increase the contract's cash value and death benefit.
• Surrendering the policy: If the policy is no longer needed, it can be surrendered, and the accumulated cash value can be collected, minus any fees and outstanding loan balances. However, this may create a taxable event, and it is important to consider the consequences of giving up the death benefit.

While whole life insurance can be a good investment for some, it may not be suitable for everyone. The premiums tend to be expensive, and the cash value can be slow to grow. Additionally, the rate of return can be low compared to other investments, and policyholders cannot control their portfolio as the insurance company chooses where to invest the cash value.

Frequently asked questions