The Pros and Cons of Overfunding Life Insurance

Curious about the pros and cons of overfunding life insurance policies? We’ve got you covered. Learn more here!

When most people think of life insurance, they are only thinking of the peace of mind it can bring to their loved ones, knowing they are taken care of after they’re gone. However, life insurance can actually be much more than what you might think. With a little savvy and know-how, a life insurance policy can be a smart and convenient way to accumulate and use your wealth, even while you’re alive. 

There are numerous ways you can take advantage of a policy like this. But one of the most common is to overfund the life insurance policy itself. This strategy is not always in an investor’s best interest, as it does come with some downsides. However, for certain people this can be a good way to use a life insurance policy for maximum benefit. 

What is “Overfunding”?

Just like how it sounds, overfunding simply means paying more into a policy than you have to. Most term life insurance policies operate on a simple principle. This is what you put into it is, more or less, what you get out of it. 

Policies are set up to pay out a predetermined amount, and you pay into it on a monthly basis. Those payments are calculated based on your current age and health, as well as how much the policy will pay out at the end. 

As long as you keep making your monthly payments, you are considered in good standing with the company. When you pass, your beneficiaries get the payout amount as long as you’re still in your term. 

Overfunding means that you pay more into the policy than is required. Because the money you pay goes straight into your policy, and because many companies allow you to withdraw funds from your policy, it becomes a sort of savings account that you can add into and draw from at will.

This doesn’t work for all life insurance policies, it should be noted (in particular, term policies). However, most cash-value insurance policies provide some sort of overfunding option.

The Pros of Overfunding a Life Insurance Policy

As you can probably tell, there are some advantages one might get from overfunding their life insurance policy. Here are some of the most important ones:

Tax-free growth

One of the great things about whole life insurance policies is that, as they grow, the accumulated funds are growing tax-free. Because of this, these are considered almost like a shelter of sorts where you can invest in long-term growth without having to worry about taxes now and, very possibly,  later.

Early payoff of your policy

One of the more convenient benefits to overfunding a policy is the fact that you may no longer have to contribute once it’s been overfunded enough. So, regardless of what may happen in the future, paying off the policy early means that it is always in good standing, and can not be defaulted or denied by the company later on. Your beneficiaries will never have to worry.


Whole life insurance policies often offer annual dividend payments, where policyholders are actually able to get back a portion of the growth the policy has experienced over the last year. These payments can be used for basically anything you want, but many actually choose to put them right back into the policy, which allows both the cash value and the potential death benefit to grow even faster

Protection from a volatile market

Although life insurance policies grow as the market and financial indicators change, they are not reliant on the market. This is because the funds are not actually invested in the market. This has the effect of protecting your insurance for the long-term. Should a bear market, or even a crash, threaten to wipe out your other investments, you can rest assured. This is because your whole life insurance policy will most likely not lose value due to these downturns.

The Pros and Cons of Overfunding Life Insurance

Tax-free payouts

Most money in a life insurance policy is paid out tax-free at the time of your death. This goes for both the “standard” amount of the policy as well as any extra funds paid into it. This means that if you are planning on leaving a legacy to your family after you’re gone, an overfunded life insurance policy is a great option. This is to make sure that they receive more of what is coming to them, rather than watching it all go to taxes.

Few contribution limits

With only a handful of exceptions, overfunding a life insurance policy comes with no contribution limits. This is unlike 401ks and other investment plans. You can add as much extra to it as you would like, however and whenever you see fit.

We did say there are a few exceptions to this one, and it is important to take note of it. Most policies have safeguards in place to prevent holders from contributing too much in any seven-year period. This is because exceeding this limit in this time frame can turn the insurance policy into a MEC (Modified Endowment Contract). This changes its tax-favored status. Make sure you understand these limits before overfunding!

No age-based limits

Unlike investment plans such as 401ks and IRAs, there are no age-based limits for these life insurance policies. This means you can withdraw funds from the cash value before a specific age without facing government-mandated penalties.  

Protection from credit and creditors

Unlike other types of investments, life insurance funds are protected from creditors. These do not even show up on things like credit checks. This means that your life insurance policy is a protected haven that you can rely on. That way you can make sure your beneficiaries are protected, no matter what. These protections do vary from state to state, so it’s important to know the laws for where you live.

The Cons of Overfunding a Life Insurance Policy

As great as this list sounds, you should also be aware that it does come with some risks, as well. Knowing these drawbacks is the only way to be sure that you’re making the best decision for your financial future. Here are the cons as we see them:

Extra fees

We mentioned before that overfunding a life insurance policy is often a good decision because of the tax-deferred growth. However, there are definitely fees and expenses that must get paid to the insurance company.

Every company is different, so we can’t give you a definitive list here of all of them. It should suffice to say, though, that doing your research is important. And talking with your insurance is the only way to know whether or not you are okay with facing those possible fees down the road. That is if you decide to invest in this way.

Policy lapse

When playing around with a policy like this, sometimes it can be hard to keep track of where it stands. Is it still fully funded? Have you paid enough extra that you can comfortably withdraw some funds without having to worry? Have you taken out too much? 

One of the most common mistakes we see from investors is addressed in that last question. Which is taking out too much money to the point where the policy is no longer funded. Without paying the money back in, you can risk the policy lapsing and being terminated.

MEC risks

One final note: as mentioned above, many policies have rules in place about how much you can contribute over any seven-year period. If you contribute more than this amount, the policy can automatically turn into a Modified Endowment Contract with no possibility of it ever changing back. This alters the tax-free withdrawal status on the policy and can cause you to lose a lot of money in the long run. Always be aware of these limits!

As you can see, overfunding a life insurance policy can be a smart financial move. That is provided you plan ahead and know what you’re doing. If you would like to speak to someone about how you can get started with a policy like this, please don’t hesitate to contact us today!