There are many methods of providing income for yourself that are more tax effective than working. Borrowing against your life insurance is one of them.

How it Works

With universal life insurance policies, there are two components:

1. The face value of the policy.
2. The investment pool

This face value is what you are insured for and the investment is the "extra" money you have put in. This is usually in funds or can be cash. These investments are tax sheltered, meaning, you do not pay the capital gains tax when you sell them inside the policy. If you withdraw them for your own personal use however, you will have to.

Banks will treat these investment pools as an asset however. Some banks will loan up to 75% of the value of these pools to the individual upon creating a legal contract that the debt from this loan will be paid back from your policy when you pass away. The kicker here is that when you pass away the money from your policy is now non-taxable. So you have made interest on your investments over your entire life and will not be paying the capital gains on the money since you will never withdraw it. A basic look at it would show that you are only paying the bank's interest rate on the money (because that will be the interest on their loan) which will be a lot lower than government tax if you withdraw it. A loan from a bank is not considered income, so it won't be taxed at all.

Note: I have not done this myself, but I have talked to financial advisors who know of this technique and do recommend it in certain situations depending on their clients.

This might seem like a bit of a "sneaky" trick, but it is completely legal. Banks are familiar with this method and have formulas to set up monthly loan payments that are aimed at balancing out with the investment pool value over a period of time. The bank will require you to sign legal documents as well to guarantee they are the beneficiary of that portion of your will.

I will also note that not that many people do this anyways. This is typically for high income indiduals. In my article Mortgage, RRSP, Insurance Policy ... What do I do? I discuss the priorities of where to put your money. This is third in that list. So only if you can max out the other ones should you worry about it. But, if you are young and wanting a universal policy for the rest of your life, this will give you an avenue to store money when you have the higher income in your later years.

Insurance policies restrict what you can buy as well. You can only put your money in a set list of funds. If you are buying a universal policy, make sure you ask what the investment options are. Most universal funds restrict you to their brand, but there are those out there with a larger pool to choose from.

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