The question is “how can we take money out of our life insurance tax free?” Is it possible to take money out of your life insurance policy and have it feel like a distribution from your Roth IRA?

Every life insurance policy allows you to take out tax-free distributions, but not all of them allow you to take out tax-free and cost-free distributions.

With a traditional life insurance policy, anyone can take out whatever they’ve put in. This is referred to as your basis. The trick comes in taking out money above and beyond your basis, and the solution is by way of a loan.

The first type of loan is the standard/preferred loan. A standard loan is typically for the first six ten years of your policy and is usually done in less than optimal circumstances. You should exhaust your other sources of emergency income first before doing this.

A preferred loan typically starts in the first six to ten years of your policy but you are not taking a loan from your own policy. You’re not taking a distribution from your policy either. You’re taking a loan directly from the life insurance company.

They will charge you a real rate of interest on the loan, and at the same time will take an equivalent amount of money from your growth account and assign it to a loan collateral account with an assigned rate of interest. If your collateral account is being credited at the same rate as the loan you received, all you know is you received the money from your account and didn’t have to report it as income.

If the life insurance company has guaranteed the rate of interest remains the same on the loan and your loan collateral account, it doesn’t matter how big the loan gets. The rate at which they are crediting you and the rate at which they are charging you is the same.

There are some possible issues with this strategy. Some companies will guarantee that rates won’t change but not under every circumstance. When it comes to loan provisions, the devil is in the details.

If you have a spread on the interest rates between the loan and the credit, you will eventually run out of money. If you run out of money and you’re not dead yet, all the of those tax free distributions become taxable to you.

Over the course of your life, a spread loan can crater your distributions. [

The additional interest you owe on your loan will come out of your cash value. This leads to geometric growth of the interest you own on the loan interest and it starts to take a toll. This can bankrupt your policy. [

You don’t buy a life insurance retirement plan simply because the guy across the table tells you it’s a good idea. That’s like getting married after the first date. [

You should have a list of things you want to have in your ideal life insurance retirement plan. A divorce from a wife can be painful, but a divorce from a life insurance plan can be likewise as painful. [

Having the wrong loan provision can really sink your ship. [

There is a second loan type called a Participating Loan that relates to a plan called Index Universal Life. It works similarly to a standard or preferred loan except the interest on your loan may be slightly higher and the interest on your loan collateral account is tied to the index within your universal life plan. The insurance company will give you the growth of that index up to a certain cap and in the event of a down year, they simply credit you a zero. [

Historically, the indexes grow at 7% to 7.5%. If you can get 7.5% growth without taking an more risk than you are used to taking, that’s a pretty safe and productive way to grow your assets. [

The way to look at this kind of loan is: will you have more positive arbitrage or more negative arbitrage over a period of time? The Monte Carlo simulations bear out the usefulness. [

You have to find a company that will guarantee that the rates will never go up over a certain number. [

The preferred loan is the conservative way to go. You don’t have arbitrage working for you but you won’t have the risks associated with it as well.