All Forum Posts by: Thomas Rutkowski

@Lalit R.

The subject has been well-covered on this thread...

https://www.biggerpockets.com/forums/519/topics/24...

The strategy absolutely works. If you can put your money into an asset growing a x% and you can get a line of credit against that asset, then anything you do with the loan proceeds by investing it is a bonus on top of the return on the cash value.

Its much more powerful than simply buying term and investing the difference.

@Paul Beets

You shouldn't be using a policy loan to do this. Your LLC should get a line of credit from a bank with an assignment of collateral against the policy as your personal guarantee. You can get a LOC at Prime. This will make the interest tax deductible.

What you are doing is going to end up in a wash. Your loan to the LLC is an expense to the LLC but the interest you earn is income to you.

This is bad. You need to get that loan paid off and eat the tax loss. Do it right going forward and you'll see just how powerful this strategy is. 

 Yes. There are many banks that will give you a line of credit secured by an assignment of collateral against a life insurance policy. I can give you some names if you need them. Rates are usually at Prime because the collateral is very safe and the loan is 100% secured.

You've come up with a lot of good applications for the loans. The opportunities are endless. The beauty of this strategy lies in the fact that you can keep your cash in an asset that is earning higher long term returns and is liquid. Generally, you have to sacrifice returns in exchange for liquidity. 

If you can keep the money working and earning, why pay it back at all? If you can get money at 5% and you have an opportunity to make 8%, then you borrow as much as you can get (taking risk into account, of course). I wouldn't pay it back until the opportunity is no longer there.

 A properly-designed UL/IUL will show Year 1 cash value at about 90% of the premium that is paid. That gives a broad picture of the fees. Keep in mind that the interest crediting is done at the end of the year, so to find the CV at inception, you have to back out the assumed growth rate. So when I state 85%, I am making a ball park estimate of the cash value at inception. Age, tobacco usage, and health impact this a little bit.

You really have to look at the policy fees and expenses report to see the itemization of all of the internal costs. There are 3 main categories of expenses: Premium Charge, Policy Charge, and the actual Cost of Insurance. The premium charge varies by company and is assessed on each dollar of premium put into the policy. So if you design a policy for a 5-year funding, there are no more premium charges after you are done paying premium. The Policy Charge is tied to the Death Benefit. It is assessed over the surrender charge period of the policy. In percentage terms, it is going to be about 9% of the premium IF THE POLICY WAS DESIGNED RIGHT. If the DB is too high, this charge increases. Finally, there is the annual cost of insurance. This is relatively tiny. 

So in a 5-pay design, you'll still need to worry about covering the policy charge for years 6-10. But by year 5 the policy has so much cash that it doesn't take much growth to cover it. After Year 10, the cost of insurance will be about 0.25% of the CV for the rest of your life. That is the only remaining policy expense at that time.

As you can see, this is nowhere near 100% of the first year premium that the naysayers would have you believe. That's for a plain WL, not an overfunded one. 

The cash value IS liquid right away.

 The growth on the cash value inside the policy will likely cover the interest on the loan, but the problem is that the cash value is inside the policy. Its one thing to know that the cash value is growing by more than enough to offset the loan interest, but its quite another to have the physical cash to make the interest payments. The cash is there, but its in another pocket.

The cash value of the policy could be leveraged to generate additional income. If you do that, though, it won't be liquid for other opportunities that come up. You could just do that alternative with the loan proceeds anyway and skip the insurance. 

 You may not like paying "the stupid sales commissions that whole life involves" but you would do better in the end. 

First, a permanent life insurance policy for this purpose is designed for minimum death benefit and maximum cash value, so the commissions are minimized. They're not nearly as high as you might think.

Second, even after the fees and costs are subtracted, you can still get a higher credit line. So you have access to a higher credit line. In a properly designed policy, the cash value will be about 85% of the premium for the first few years of the policy and much less later.

From a security perspective, the cash value of a whole life will have a lower risk profile than Municipal Bonds. And you also have the benefit of the death benefit.

I have clients doing just this. I certainly don't advocate strategies like this, but as you show, this is a "Triple Play": Home/REI, Cash Value, REI

 I don't think of this as a hedge against future interest rates. It is simply a way to preserve the equity in your home. A market crash could wipe out any homeowner's equity. If you've captured it and put it into a principal-protected asset, then you still have the equity even after a market crash. 

Home equity is not a good investment anyway. Every dollar of principal paid down on a mortgage is a dollar you will never see again until you sell the house. It earns no return whatsoever. This strategy puts the equity to work and the cash value built up in the policy can be a source of tax-free retirement income. Equity in a house does not pay bills.

 Permanent Life Insurance is a great place to safeguard the equity in your home(s). An IUL is even better. Its an asset that is principal protected and offers a great rate of growth.

Think of it this way: if you can get money at 5% and safely invest it at 6%, how much would you want? All of it! right?

I personally don't worry about the interest rates. This is the primary risk factor when financing premium. However, you have to keep in mind that you are paying simple interest (that you are paying on the HELOC) and earning compounding interest. So even if your loan was at 6% and your cash value grew at only 5%, the accumulation value would overtake the interest expense.

I've got plenty of clients who are either leveraging their cash values to invest in real estate, or borrowing to finance the life insurance, or a combination of both (the Triple Play). 

Just be very careful and make sure that your policy is properly designed. A properly designed policy should show about 85% cash value relative to Premium at the end of year 1. If its any less than that, its not properly designed. You also need to make sure that the policy includes the Early Cash Value rider to eliminate the surrender charges. You need to be able to access the cash value immediately in case something happens and you need to access the cash value. Only a few carriers have this rider. 

You also want to use a 5 year funding process. You can't simply dump all your premium in one year and one lump sum. 5 years gets your cash into the policy and working without paying for too much death benefit.

You may want to check out some of my blog posts on this...

https://www.biggerpockets.com/blogs/7595-make-your-money-work-harder

 The answer to your first question is no. The answer to the second question is that you NEVER surrender the policy. 

Explanation. 

The cash value of a policy is quite literally you saving up your own death benefit. So as long as the cash never leaves the policy, it continues to grow, and over the course of your natural lifetime, you should save up more than enough to cover your own death benefit. The real risk to the insurance company is when you die early. So all they need to do is tack on the cost of a 1-year term policy each year to cover the gap between your cash value and the death benefit. But this gap shrinks each year as your cash value accumulates.

If you call up an agent and ask for a policy quote for a $1-Million death benefit, you are going to get a MINIMALLY FUNDED policy. That is, the premium will be no more than the minimum amount necessary to save up $1-Million over your remaining life expectancy and with the insurance company's worst case interest rate scenario (the "Guaranteed Rate"). When you are using a policy for wealth building, retirement income, or for personal banking, then you want an OVER FUNDED life insurance policy. This is the maximum that you can pay for the $1-Million death benefit. Its all about the cash value.

The insurance company is doing the "buy term and invest the difference" for you. The advantage is in the tax savings.

If you've read through this entire thread, the main point is that you do not ever WITHDRAW the cash. You take a policy loan or get a line of credit with your cash value as collateral. Loans are not taxable.

So if you get that $1M death benefit policy when you are young and you have kids, future college expenses, and a mortgage to worry about, by the time the kids are grown up, out of college and the house is paid off, you may not need that $1M death benefit any more. At this point you can leverage the cash value to generate tax-free retirement income. 

This is how it works...

Let's say you have enough cash value to generate about $50K in loans annually for the rest of your life. The insurance company loans you $50K of their money, not yours. Yours is the collateral securing their loan to you. Understand? This is important. At the end of the year, you have accrued interest on the loan and owe the insurance company. But your collateral has also earned interest during that year. 

Each year, the insurance company will loan you enough to pay themselves the interest on the loan. Your collateral that is securing the loan has grown by enough to cover the interest on the loan, so its a wash. It ends up looking just like a tax-free distribution from the policies cash values.

The key is that it is very important that you find a policy that has this wash loan provision. Many of the big, well-known companies, have punitive interest rates that cost you more than the dividends/interest that your policy is earning. In this case, you move slowly backward, eroding your cash value. However, policies like Indexed Universal Life, allow the cash value to capture a portion of the equity premium. Whole life and Universal Life are tied to the debt markets, so their their interest earning is likely to be relatively equal to the interest expense on the policy loan.

When you die, the loans are paid off from the death benefit. Your beneficiaries receive whatever is left. Thus, you have an opportunity to spend your kid's inheritance.

You cannot borrow from or against an IRA. The previous discussion specifically mentioned 401(k).