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Interesting post (#847) over on the Life Insurance Board regarding the statement "withdrawals from a VUL policy are tax-free." For convenience, it appears below.

Dear JAFO: You are a great FOOL, loans are tax free (not interest free). You may take cash surrenders, which are tax-free up to the cost basis point. Once you exceed the cost basis however; you owe the IRS for what you get. As a result, you are NOT missing something. Now please allow me two asides...

1. Please consider getting that agent to put his statement in writing on his business letterhead. Then make two copies; send one to the State Insurance Commissioner (in Austin), and the other to the State Securities Commissioner (also Austin). Since VUL is bundled with investments, The State Securities Board has some oversight.

2. I have enjoyed Patty's and Mark's messages. I believe that they focus their practice on client needs (as do I). Let me address term vs cash value from my own perspective (and hope they both agree with me). There is no real battle. By that I mean there is no way a person can say that one is always better than the other in all cases on earth. It really depends on the nature of the NEED (INSURANCE SHOULD BE NEED BASED) a consumer is trying to protect.

Anyhow, I invite you to share that rogue's statement with my friends in Austin.
Carpe diem!!

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Good article on the subject of "tax-free withdrawals" from life insurance policies from the Los Angeles Times.


Ae age 80, Opal M. is facing a financial disaster of her own making. Unfortunately, when the seeds of this disaster were sown more than a decade ago, she was assured that what she was doing was financially savvy and would give her tax-free access to cash that otherwise would be locked up for years. No one told the Central Valley resident about the unpleasant--often devastating--long-term repercussions that will cause her to either pay thousands of dollars annually for a virtually worthless product, or face taxes on $70,000 of phantom income.

What did she do to create this disaster? She borrowed against her life insurance policy. Thousands of other people do the same thing each year. Often, like Opal, these policyholders have no inkling of the costly consequences. Indeed, many agents tout the ability to borrow policy principal as one of the important benefits of investing in cash-value life insurance. At the end of 1997--the most recent year for which statistics are available--consumers had borrowed $104.5 billion from their policies, up $2.7 billion from the previous year. "You can get in deep trouble with a life insurance policy when you start borrowing," says Joseph M. Belth, publisher of the Insurance Forum, an Ellettsville, Ind.-based newsletter, and author of "Life Insurance: A Consumer's Handbook" (Indiana University Press, 1985)

The reason income taxes so often come into play has to do with the complex nature of the product. Life insurance, which is designed to protect dependents from
financial ruin in the event the family breadwinner dies, gets special tax treatment. Death-benefit proceeds--the payment a beneficiary receives if the insured person dies--are exempt from federal income tax. In addition, any investment income earned within a life insurance policy is tax-deferred, meaning you do not have to pay tax as the cash value of your whole life policy increases. You can also borrow against your whole life policy without facing income tax on the loan
amount. But if you cash the policy in, cancel it or "annuitize" it by asking the insurer to pay you the cash value over time, you pay tax on the profit built up in the account at your ordinary income tax rates. Worse yet, if you happen to have borrowed from your account,that taxable profit could amount to nothing more than a paper entry.

That's exactly what happened to Opal. Back in 1985, she bought a single-premium whole life policy for $55,000. However, two years later, at the urging of her insurance agent, she borrowed $50,000 from it. The agent assured her that the balance of her money--the $5,000 plus two years' interest that her
account had already earned--would pay the necessary premiums to
keep the policy going. She could delay paying interest on the loan
indefinitely, he said. And that's how it worked for 11 years.
It's important to note that when you borrow from a life insurance
policy, you are not actually borrowing your own money. Instead, you
are borrowing from your insurer. The cash value in your life
insurance policy is simply used as collateral for the loan. Why is that
On paper, Opal's $55,000 remained with the insurer and
continued to grow. At the end of 1998, the cash value of her account
totaled $123,363. But her loan balance was growing at the same
time--at a slightly faster rate. At the end of 1998, she owed
Insurers will allow you to borrow an amount equivalent to 100% of
the cash value in your account. However, they will not allow your loan
balance to exceed your cash value. So Opal got a bill for the
More ominous was the note at the end of the bill: "Failure to pay
the required loan repayment may have adverse tax consequences to
you. We will report to the IRS as taxable income the excess of your
cash surrender value including the outstanding loan amount
overyour remaining cost basis at the point of default or termination of
your coverage." Translation: If she didn't pay, she'd have to report
roughly $70,000 in taxable income on her next tax return.
Why? Technically, her account grew to $123,363, a $68,363 gain
over her principal investment of $55,000. Although Opal will not get
any cash out of the policy--it will be used to pay off the policy
loan--she still has to pay income taxes on the phantom gain.
Her only alternative is to keep the policy in force by paying the
loan balance as required. Unfortunately, because her policy value
and her loan value will continue to grow every year that she does
this, the annual interest cost will rise too. Next year, her required
payment is likely to be in the neighborhood of $2,600; the following
year--assuming interest rates remain constant--it will rise to about
"The only way you can win with this is to die," Opal says ruefully.
She's right. If she dies while the policy is in force, the tax-exempt
death benefit--which is always a few thousand dollars more than the
cash value on the account--pays off her loan, with no adverse tax
"These guys who encouraged people to borrow money out of
policies were not looking down the road. They were not looking at an
80-year-old with a huge tax bill," says Ben Baldwin, president of
Northbrook, Ill.-based Baldwin Financial Services and author of
several books on insurance. Policy loans "are like flypaper. They're
very difficult to get off your hands."
At this stage, there is little anyone can do to make Opal's situation
easier. Whether she chooses to keep her policy or cancel it, she's
sure to end up thousands of dollars poorer.
Other policyholders should take note, Baldwin says. If you have
an outstanding policy loan, take a look at what's happening to your
loan and cash balances to determine whether you are likely to face
problems. Meanwhile, if someone encourages you to borrow against
a policy, understand the eventual consequences.
"The bottom line is you should not borrow against a life insurance
policy because somebody thinks it's some cute deal," Baldwin says.
"Only borrow against a life insurance policy when you need the
money very badly. It's a last resort."
* * *
Times staff writer Kathy M. Kristof welcomes your comments and
suggestions for columns but cannot respond individually to letters or
phone calls. Write to Personal Finance, Business Section, Los
Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or

* * *

Insurance Loans: Myths and Realities
Planning to borrow from an insurance policy? You'd better
beware. If you buy into some widely held misconceptions, it could
cost you a small fortune. What are the myths and realities?
Myth: You never have to pay the loan back.
Reality: Eventually, the loan must be repaid. However, as long as
your loan balance is less than the cash balance in your account,
most insurers will not require repayment. They will require payments
the moment your loan balance rises above the cash value in your
account. If that doesn't happen in your lifetime, your estate pays the
loan back when you die.
Myth: Policy loans are tax-wise because you don't pay tax on the
loan proceeds.
Reality: Taxes are not due on the proceeds of a policy loan--just
as you don't pay tax on the proceeds from a home equity loan. But,
while the interest you pay on a home equity loan is tax-deductible,
you get no tax deductions when you repay a policy loan. Worse yet,
policy loans only remain tax-free as long as your policy remains in
force. If your life insurance policy is terminated or lapses, the excess
of your cash surrender value--including the outstanding loan
amount--over your principal is a taxable gain.
Myth: Borrowing against my policy will not affect the death benefit
payable to my heirs.
Reality: Technically, the death benefit on the policy remains the
same. However, if you die, the insurer will take the amount you
borrowed before passing the remainder to your heirs. In other words,
if you have a $100,000 death benefit and a $40,000 policy loan, the
insurer will give your heirs just $60,000 if you die while this loan is
outstanding. If your heirs need that entire $100,000 death benefit,
you need to buy more insurance to cover the gap.
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And the point of the article with respect to VUL is...??????

Alan McKnight, CFP
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FoolWAM wrote,

And the point of the article with respect to VUL is...??????

Alan McKnight, CFP


The point of the article with respect to VUL is that if your "tax-free" loan amount exceeds the value of the policy you either have to pay more money into the policy or suffer the tax consequences.

I noticed from one of your posts on TMF Life Insurance Board that you admit you haven't read TMF's excellent expose' on the subject of life insurance. I heartily recommend it. It may explain why many FOOLs are a tough sell when it comes to life insurance as an investment/retirement vehicle. See link:
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intercst: Very interesting article you cited... I liked it! It reaffirms my own attitude that discourages clients from borrowing from life insurance policies (as well as 401k & 403b account) unless absolutely necessary; and only for a short period of time, with the intention of repaying the loan.

I don't have a problem with a person withdrawing accumulated dividends from a whole life policy, or withdrawing gain from a VUL (both allowed up to the "basis" amount without tax consequences), but to turn to loans as a means of avoiding taxes can result in the situation Opal M. had in the Times article.

The plan to borrow from policy value to provide income beyond the extraction of the policy's "basis" should be done very carefully! I don't think FoolWAM would recommend it for many... Regards, PP
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I just happen to read the Fool's section on insurance yesterday. The biggest beef I have with it is the opening philosophy of not being an estate planning tool or and investment. The rest of the article brought up some good points. Insurance is certainly a viable tool in estate planning. I don't think that any financial advisor worth his or her salt would disagree with that. Insurance can be an alternate investment vehicle if set up properly. I would certainly never offer it to a client as a primary investment vehicle.

I'm sorry that the lady in that insurance article got the shaft, but there are many variables at play here. She obviously did not understand what she had purchased, and either the agent was totally incompetent or was a crook. An agent or planner that understands policy structure, would never give advice such as what was given her.

You will see stories like that everywhere, but that doesn't make the tool a bad tool. It was totally misused.

I can show you many clients of mine who were totally screwed by their stock broker, but does that make investing in stocks bad???

I appreciate your input!

Alan Mcknight, CFP
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What are you doing up so early on a Sunday morning?

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It's actually about 8AM. Did you ot remember to set your clock ahead?? :-)

I do need to quit playing on the computer and get my little girl ready for church. I guess I better go wake her up.
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