Opportunity cost is what you lose when you let dollars go unnecessarily to a financial institution (possibly in the form of fees), the government (possibly in the form of income taxes), or any third party (possibly in the form of having money locked-in or simply being spent), and are missing a better investment opportunity. Paraphrasing Heymann and Bloom in Opportunity Cost in Finance and Accounting, “the value of a resource is determined by its use in the best alternative given up.”
If you read the book Live Your Life Insurance, we cover a story about Mark & Mary’s and their desire to set aside money for their children’s education. If they had used an RESP (Registered Education Savings Plan), they would have had that money locked-in until their kids went to university and then that money would have gone to the college and it would have been gone – causing themselves a large opportunity cost, as that money and all its future growth that could have benefited the family for many future years, was now at the college instead of in their own account.
Money has its present day value but also provides an opportunity to produce a regular income off of it for many years. A zero account balance, after paying all the money to the college, can no longer provide any future income or growth towards future retirement goals.
By borrowing against their life insurance cash value to pay for their children’s education, Mark and Mary can educate their children, while at the same time keeping their own family assets growing. Once university costs were paid back, the policy still had its full value and all of its growth, as if they had never taken the loan in the first place. If they had paid for college with their RESP, all of that money would have been gone, and they would now need to restart a savings plan for future goals.