How to create a “Family Bank” without using Whole Life Insurance?

Question

I live in New York, and have family in PA, NJ, and FL.

I have a family of about 25 members who would like to pool their savings into one account, and each member would like to have the option of putting their savings into another account for investing as well (real estate, small business, solely for loans).

We are deciding on issues like, if a family member needs some of the savings, that they would be allowed to take it out as a loan only and any profits made, part would be given to member and part would stay in the company.

Any interest from any loans or profit from any investment made would stay inside the company (LLC or Corp) so to not trigger the need to pay taxes until the money is taken out of the company.

The questions here cover Legal, Taxes, and Accounting.

Please note the savings account element is more to have a sort of forced savings within the family and the investing account is a way to pool our funds for worthy investments instead of taking out a bank loan in full or in part.

I’ve heard of Family Banks using Whole Life Insurance policies but we would like to have more direct control of our funds as a family, would also hate for an Insurance company to go under and this way we make our own rules.

Would LLC or Corp be best?

If its an LLC with one account for savings and another for investing be ideal, or are more accounts needed?

Can members or shareholders take out a loan if needed?

If member can take out loans, is there a limit to how much they can take out or how much interest we can legally charge that member?

If interest is made, this is income to the LLC, can tax be pushed to a year when/if this income was taken out of the LLC as a distribution?

If there is any interest made or profit made in LLC, and it stays in the LLC account, doing the LLC still have to pay taxes on that money or will it only be taxed if there is a distribution made to a member that year?

Can anyone suggest any accounting system to handle many personal loans at various rates and investments? that would be great too.

I was looking into banking software, microfinance software, non-bank banking software, etc.

Thank You

Lingo Lin · Answer

@John Perrings will do, i’ll PM you tomorrow AM, we’ll chat. Thank you.

My mind is only set on what makes sense at the moment, but we as a family still have to run it by RE Attorney and CPA to see if its even possible.

Noi K. · Answer

@Thomas Rutkowski @Lingo Lin

Thank you both for very interesting discussion!

Thomas, I just have a question about this part -

"You deduct your cost of money as a business expense, so you have taxable income of $4,462.50. You will pay $1,785 in taxes leaving you with $2677.50."

Isn't $4,462.50 deductible interest payment? ($8500 x 5.25%)

That makes the taxable income $4037.50. Tax due is $1615, leaving $2422.50 after tax.

ROI then is 7.86% (instead of 8.12%).

Am I reading it right? Please let me know if I missed anything.

Assuming 7.86% vs 6.0%, it looks like this after 1/10/20/30 years -

Example:

-

Leveraged

Simple

Initial Fund

-

100,000.00

Put into WLI

-

(100,000.00)

-

Cash Value

85%

85,000.00

-

Dividend on Cash Value

6.40%

5,440.00

-

Take out LOC

-

85,000.00

-

Interest on LOC

5.25%

(4,462.50)

-

Investment Income

10%

8,500.00

10,000.00

Taxable Income

-

4,037.50

10,000.00

Tax

40%

(1,615.00)

(4,000.00)

Income after Tax

-

2,422.50

6,000.00

Total Income

-

7,862.50

6,000.00

ROI

-

7.86%

6.00%

Fund after Year 1

-

92,862.50

106,000.00

After years

10

183,516

179,085

-

20

391,183

320,714

-

30

833,843

574,349

Lingo Lin · Answer

@Thomas Rutkowski great point, thank you for the breakdown, very helpful.

Thomas Rutkowski · Answer

Thanks!

Talk to your CPA/Tax Advisors abut the structure. That said, an investment club model might work for your group.

You are partially right. Their "amount at risk" is only $250K and that is covered by them essentially purchasing a $250K term inside the policy. But follow the money. The insurance company does not keep the cash value. The cash value of the policy is literally you saving up your own death benefit. The insurance company is only responsible for the gap between the death benefit and your cash value. BTW, this provides an incentive for the insurance company to earn the highest/safest return possible. The faster the cash grows, the quicker their risk is eliminated.

Example 1: If you have a $1M death benefit policy with $500K of cash value, your beneficiary will receive $1M. $500K comes from the insurance company (their portion of the risk) and the other $500K comes from the cash value.

Example 2: Same policy and cash value, but this time you have a policy loan of $500K secured by the cash value. If you die, the insurance company takes the cash value because it is the collateral securing the loan you took. Your beneficiary still gets the remaining $500K.

Don't lose focus on the big picture. Here's an example looking at one year in isolation...

Assumptions: Let's say you can make 10% doing private lending. The fees are what they are. We are looking at the cash value, not the premium. The cash value to premium ratio will be about 85% for year one. Mass Mutual's current dividend rate is 6.4% (that's the return on the cash value, not the premium). You can get a line of credit against the policy's cash value at 5.25%. That's my current rate from my bank. Let's also assume that your marginal tax rate is 40%. $100,000 annual premium for 5 years. Paid at issue.Let's look at the just the first year's premium in isolation. (The fees actually get better in later years.) Status Quo:If you DON"T do this, then you simply earn 10% on the full $100K. That $10K will be taxed at 40% and you will walk away with $6000 after tax. Your net after tax return is 6%. You will begin Year 2 with $106,000 from your lending activities, plus another $100,000 you are committing. Leveraging Cash Value: Your $100K premium turns into about $85K of cash value that can be leveraged using a 3d party line of credit. With a 6.4% dividend, the cash value return will be $5,440 ($85K x 6.4%). You will start Year 2 with $90,440 of cash value plus another $85K from the next premium. You borrow $85K at a cost of 5.25%. You earn 10% on the private lending you do with that money. At tax time, the numbers look like this...You have revenue of $8,500 (10% return). You deduct your cost of money as a business expense, so you have taxable income of $4,462.50. You will pay $1,785 in taxes leaving you with $2677.50. When we look at the combined efforts, we made $5,440 on the cash value and $2,677.50 on the "side fund". That is a combined total of $8,117.50 after tax. Your net after tax return on the $100,000 investment is 8.12%. The problem, of course, is that between the two accounts, you only have $93,117.50, right? This is where you have to think long term. Would you rather have $100,000 growing at 6% (net of tax), or $85,000 growing at 8.12%?

• Let's say you can make 10% doing private lending.
• The fees are what they are. We are looking at the cash value, not the premium. The cash value to premium ratio will be about 85% for year one.
• Mass Mutual's current dividend rate is 6.4% (that's the return on the cash value, not the premium).
• You can get a line of credit against the policy's cash value at 5.25%. That's my current rate from my bank.
• Let's also assume that your marginal tax rate is 40%.
• $100,000 annual premium for 5 years. Paid at issue.

Let's look at the just the first year's premium in isolation. (The fees actually get better in later years.)

Status Quo:If you DON"T do this, then you simply earn 10% on the full $100K. That $10K will be taxed at 40% and you will walk away with $6000 after tax. Your net after tax return is 6%. You will begin Year 2 with $106,000 from your lending activities, plus another $100,000 you are committing. Leveraging Cash Value: Your $100K premium turns into about $85K of cash value that can be leveraged using a 3d party line of credit. With a 6.4% dividend, the cash value return will be $5,440 ($85K x 6.4%). You will start Year 2 with $90,440 of cash value plus another $85K from the next premium. You borrow $85K at a cost of 5.25%. You earn 10% on the private lending you do with that money. At tax time, the numbers look like this...You have revenue of $8,500 (10% return). You deduct your cost of money as a business expense, so you have taxable income of $4,462.50. You will pay $1,785 in taxes leaving you with $2677.50. When we look at the combined efforts, we made $5,440 on the cash value and $2,677.50 on the "side fund". That is a combined total of $8,117.50 after tax. Your net after tax return on the $100,000 investment is 8.12%. The problem, of course, is that between the two accounts, you only have $93,117.50, right? This is where you have to think long term. Would you rather have $100,000 growing at 6% (net of tax), or $85,000 growing at 8.12%?

If you DON"T do this, then you simply earn 10% on the full $100K. That $10K will be taxed at 40% and you will walk away with $6000 after tax. Your net after tax return is 6%. You will begin Year 2 with $106,000 from your lending activities, plus another $100,000 you are committing.

Leveraging Cash Value: Your $100K premium turns into about $85K of cash value that can be leveraged using a 3d party line of credit. With a 6.4% dividend, the cash value return will be $5,440 ($85K x 6.4%). You will start Year 2 with $90,440 of cash value plus another $85K from the next premium. You borrow $85K at a cost of 5.25%. You earn 10% on the private lending you do with that money. At tax time, the numbers look like this...You have revenue of $8,500 (10% return). You deduct your cost of money as a business expense, so you have taxable income of $4,462.50. You will pay $1,785 in taxes leaving you with $2677.50. When we look at the combined efforts, we made $5,440 on the cash value and $2,677.50 on the "side fund". That is a combined total of $8,117.50 after tax. Your net after tax return on the $100,000 investment is 8.12%. The problem, of course, is that between the two accounts, you only have $93,117.50, right? This is where you have to think long term. Would you rather have $100,000 growing at 6% (net of tax), or $85,000 growing at 8.12%?

Your $100K premium turns into about $85K of cash value that can be leveraged using a 3d party line of credit. With a 6.4% dividend, the cash value return will be $5,440 ($85K x 6.4%). You will start Year 2 with $90,440 of cash value plus another $85K from the next premium.

You borrow $85K at a cost of 5.25%. You earn 10% on the private lending you do with that money. At tax time, the numbers look like this...You have revenue of $8,500 (10% return). You deduct your cost of money as a business expense, so you have taxable income of $4,462.50. You will pay $1,785 in taxes leaving you with $2677.50. When we look at the combined efforts, we made $5,440 on the cash value and $2,677.50 on the "side fund". That is a combined total of $8,117.50 after tax. Your net after tax return on the $100,000 investment is 8.12%. The problem, of course, is that between the two accounts, you only have $93,117.50, right? This is where you have to think long term. Would you rather have $100,000 growing at 6% (net of tax), or $85,000 growing at 8.12%?

You borrow $85K at a cost of 5.25%. You earn 10% on the private lending you do with that money. At tax time, the numbers look like this...

You have revenue of $8,500 (10% return). You deduct your cost of money as a business expense, so you have taxable income of $4,462.50. You will pay $1,785 in taxes leaving you with $2677.50. When we look at the combined efforts, we made $5,440 on the cash value and $2,677.50 on the "side fund". That is a combined total of $8,117.50 after tax. Your net after tax return on the $100,000 investment is 8.12%. The problem, of course, is that between the two accounts, you only have $93,117.50, right? This is where you have to think long term. Would you rather have $100,000 growing at 6% (net of tax), or $85,000 growing at 8.12%?

When we look at the combined efforts, we made $5,440 on the cash value and $2,677.50 on the "side fund". That is a combined total of $8,117.50 after tax. Your net after tax return on the $100,000 investment is 8.12%. The problem, of course, is that between the two accounts, you only have $93,117.50, right? This is where you have to think long term. Would you rather have $100,000 growing at 6% (net of tax), or $85,000 growing at 8.12%?

The problem, of course, is that between the two accounts, you only have $93,117.50, right? This is where you have to think long term. Would you rather have $100,000 growing at 6% (net of tax), or $85,000 growing at 8.12%?

This is where you have to think long term. Would you rather have $100,000 growing at 6% (net of tax), or $85,000 growing at 8.12%?

Would you rather have $100,000 growing at 6% (net of tax), or $85,000 growing at 8.12%?

$85,000 growing at 8.12%?

Lingo Lin · Answer

@Thomas Rutkowski , what an eye opener thank you. I’ll PM you for more details. I read the 101 and the thread where it was chopped to pieces, especially enjoyed the active real estate investor and how he used the vehicle...not the insurance ;), its sinking in.

Your statement made in that thread is the golden nugget;

——start quote——

“A properly designed policy for leverage like this should have about 85% cash value to premium in a 5-pay or 7-pay design. The infinite banking guys underfund their policies to allow you to "pay interest to yourself". This "interest to yourself" is really just excess premium that you should have paid into the policy up front. Underfunding is great for the agent (higher commissions) but bad for the client (less cash value to leverage).

Remember, policy loans are loans from the insurance company. They are loaning you their money with your cash value as the collateral. The more cash value to premium, then the bigger the loan you can take. The bigger the loan, the more money that is working in two places at one time.

Strategically, and this is for everyone following, you should get a commercial loan with your cash value as collateral/personal guarantee. This will allow you to get a better rate and more importantly, deduct the interest as a business expense (assuming you are doing business in a business entity.

So not only do you get the advantage of tax-free growth on the cash value, but you can also reduce the taxable income on your real estate investments.”

——end quote—-

That statement is absolutely great and thank you for that Thomas.

Venturing forward a bit...crossing the line, maybe unchartered territory?

You mentioned deducting the interest if using a business entity, I get that, basically a business tax write-off, my original “vision” for my family a group of 25+ may require a different approach given that many of them may not even qualify for a WL plan as many don’t have stable income or may simply not make enough at their current jobs to afford the monthly premium payments.

My proposed solution is working with an RE CPA and Attorney to create an entity that would allow the family to pool funds in a checking account (use accounting tools to keep track and abide by all legal and IRS guidelines) funds that if needed will be available to take out as a loan (not borrow against the funds) the interest paid on that loan will go 100% back into the borrowers account, this interest will help offset the lower interest paid by the checking account itself (example Goldman Sachs has online savings with 2.25% interest) if the loans taken have a 1% per month interest on them, thats 12% a year on just the portion of what was taken out as a loan. Many family members may never need to take out a loan in a given year so they would have the option to transfer all or part of their funds to another checking account specifically for providing small loans to other family members at say 2% per month interest (1% going to the member who put funds in the loan account and 1% going to the person who took out the loan) Risk would be minimized as they are small loans under $2500 and can increase as each successful loan is paid (like building credit worthiness) within the family, no colateral, more of a trust as we meet religiously on a monthly basis it’s like Thanksgiving every month with my family.

We’d like to brainstorm different investment projects (cross checking each with a RE Attorney and CPA as well as a respected Pro in that field) it can be real estate, small business, etc.

Its a vision that has a lot of moving parts but it puts the interest rate paid to the insurance company back into family hands where it can be used to buy other assets and as for insurance a 35 year term policy would give any family member a 35 year window to generate more funds using assets, specifically real estate, which can very likely exceed the death benefit offered in a WL policy.

I read somewhere that upon death in a WL policy, the cash value is absorbed by the insurance company and then the death benefit is paid out to the beneficiary, so if a death benefit is say 1 million and the cash value is at $750k, it’s equivalent to having a $250k term policy even if you had to renew a 35 year term policy at an older age, there is life insurance for seniors.

The part of the WL premium that covers other costs including the life insurance portion, if its 15% of the value to premium, thats a big chunk if monthly premium payments are say $750-$1000 (I don’t know the numbers just an example) thats $125+/month for life insurance, same coverage may be had in a 35 year term for half that.

Just would like more understanding from a Financial Planner point of view.

What are your thoughts on this? have you seen this done or something similar for a large group.

Thomas Rutkowski · Answer

The subject of using life insurance as a bank has been beat to death on this thread...

https://www.biggerpockets.com/forums/519/topics/245380-paradigm-life-infinite-banking-whole-life-insurance?page=3

1. The way you access the cash value of a policy is by a loan. That loan can be from the insurance company or from a 3d party bank. In either case, the lender gets an assignment of collateral against your cash value to secure the loan. So no, the interest does not go back into your account. The gimmick that these different "family banking" advocates use is that they get you to think that you are borrowing from yourself and paying yourself back with interest. That interest you are paying yourself is in the form of Paid-up Additions (read: More Premium) into the policy.

If you are trying to build a family bank, wouldn't you want to put as much money as possible into it up front? You would want to keep the fees and expenses to a minimum and stuff the bank as full as possible so that you could draw the biggest loan against it as possible.

If that is the objective, why would you want to put premium into the policy later? Its self-defeating and inefficient.

Bottom line: The interest is paid to the insurance company or the bank who loaned you the money. if you borrow from a bank, the interest expense may reduce your taxable income because of the interest deduction.

2. In regards to your last paragraph, the cash value of the life insurance is not your primary investment. When you borrow against the cash value, you literally have two assets working for you at the same time. And the combination of the cash value and the real estate investments will be greater than the same amount of money invested directly in real estate. I have numerous mathematical examples of this in the thread that I referenced above.

3. This is a good Life Insurance 101 that explains the basic mechanics of a permanent life insurance policy...

https://www.biggerpockets.com/member-blogs/7595/77981-whole-life-vs-indexed-universal-life-life-insurance-101

John Perrings · Answer

Not quite how it works. I can tell you’ve made up your mind but if you’re ever open to learning more, a discussion would probably be better. PM me if you’d like!

Lingo Lin · Answer

@Eamonn McElroy I agree, if everyone actually applied what they learned we as a family would be in a very good place financially. But when a large part of the family does not apply what they learn and they need help from the rest of the family to get bailed out financially, something needs to change. This is what the family wants to see done as a group, we’re just trying to figure out what others have done. I will look into a family trust fund, thank you for the advise. We are seeking. RE Attorney and CPA, so at the moment we are just brainstorming and putting it all on a whiteboard before we go to the pros with a clear picture of what we want to do.

Lingo Lin · Answer

@Brian Gerlach Thank you Brian, 100% agreed, we are interviewing Attorneys and CPA’s with Real Estate focus. Since real estate investments would be the largest ticket items we as a group would buy, anything below that like a small business that same Attorney and CPA would be comfortable handling that too. Thank you for taking the time to respond.

Eamonn McElroy · Answer

You may want to look into trusts based on what you're describing.

Either way, I think personal improvement and working on financial literacy and responsibility will elicit faster and longer lasting change in a person than an external force requiring saving and doling out punishment if the rules are violated.

How to create a “Family Bank” without using Whole Life Insurance?

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