Are you using a “Magic Checking Account”?
I had an epiphany very early in my “life insurance” career. As a sales manager was explaining policy loans to a potential client I brought to the office, my ears piqued on his use of the words: “take policy loans against the cash value”.
Against?
This was intriguing! My real estate investors mind started running away with the possibilities: “Ok". I thought to myself, “let me get this straight, my cash value can earn 7-8% tax-free. Let's call that 12% on a taxable equivalent basis in a product that can't lose value. Wow! AND I can get a loan secured by that cash value at the then current rate of 4.4%. So any investment I could make with that loan amount that earns more than 4.4% will add value ON TOP OF the tax-free return on the cash value! I can literally put my money to work in two places at one time. Holy crap!”
This is like a having a “Magic Checking Account” where your bank account balance continues to grow and earn interest even after you write a check. In essence, it's like having a credit line equal to the amount of money you keep in the bank. It works because the interest credited to the cash value securing the loan is the same or more than the interest on the loan. Try that with a real bank!
I had talked to life insurance agents earlier in my life. Nobody ever told me that I could do this with life insurance. This was the most powerful financial strategy I had ever come across in my entire life and it's not taught in business schools or even remotely well-known. Instead, we have financial lightweights like Dave Ramsey and Suze Orman telling people that they shouldn't buy permanent life insurance! These "gurus" understand personal branding and marketing themselves much more than they understand finance.
I’m sure that this makes sense to you. It's easy math. But I know some people are visual. They need to see the numbers. Let's take a look at two examples. Let’s call the first: Putting your money to work in ONE place at ONE time:
$100,000 invested in a note bearing 10% will generate $7,200 after tax. Not bad. But let’s see what it looks like when we put our money to work in TWO places at ONE time:
That’s a 32% greater return by making your money work HARDER. That 2% may not seem like much now, but never forget the power of compounding and the Rule of 72. If you can keep up that growth rate, 30 years from now, you would have about TWICE the savings.
Comments (21)
Hi Thomas, thanks for the informative post.
I currently have a whole life insurance plan with 182,000 death benefit through Guardian. I pay about 1800 a year, and 200 or so of that is riders that increase death benefit. My cash value is only $7500 after 7 years, but death benefit has increased by 12K, and the cash value increases by $120 at this point. Loans are 8%
I'm now structuring everything around being a real estate investor with wholesaling and rentals being my bread and butter. What would your recommendation be to do with this policy? I'm ok with cutting my losses and cashing it in unless there are better options. I have term insurance through work and don't have a need for the insurance.
John W., over 6 years ago
@Kent Martin @Noelle Saingarm @Keith Gifford
Thomas, great article. Can you tell me what the downsides or criticism are that some have that you think might be valid for some people? I know that's a hard question for a proponent to answer, but would appreciate a balanced view if possible!
Ian
Ian Saingarm, over 7 years ago
Hi Ian - Most of the criticism you've seen in this thread is incorrect. I've picked apart the faulty assumptions people have used to try and debunk this strategy.
It can be hard to implement this strategy because you cannot put all of your cash into life insurance at one time. The ideal design for someone with money would be a 5-pay (5 annual premiums and then the policy is paid up for life). That means you have to keep your money working, but liquid enough to make the annual premiums. Its not impossible, but it is a challenge.
If you are an investor with a long-term planning horizon, there is no downside. You will grow your money faster than if you invested it directly in real estate. You are protecting your family with the death benefit. You are protecting yourself from creditors because they cannot go after the cash value of your life insurance.
Thomas Rutkowski, over 7 years ago
Good article. I bought my first house with a loan off of my dad's WL policy and refinanced through conventional financing when I moved overseas and turned it into a rental to help with cash flow.
Bought my second house when I moved back to Houston and used a loan from my own policy to cover finishing out a garage apartment that I'm now renting.
Starting later this year I'm going to start investing in duplexes or four-plexes and plan on using a similar strategy as my first house to simplify the underwriting process (no underwriting is as simple as it gets)
I'm sure there'll be some tweaks as I live and learn but my basic plan is:
1) Take loan from WL and purchase property
2) Refinance from bank and pay off WL loan
3) Repeat
Hoping to snowball this process and build my own little empire. :)
Jieh Larson, over 7 years ago
That's great! Thanks for sharing.
Thomas Rutkowski, over 7 years ago
Thanks for this post. I just found it as I was looking at options for financing. This is the perfect short-term option for me!
Ruth Lyons, over 7 years ago
Very interesting article. Thank you for taking the time to share this information with us.
Dean Weltman, about 8 years ago
Thomas, thank you for this post. I love how you've explained this and although it may not be right for every situation, I can certainly see how this is another valuable tool for investors who want access to capital. No matter what kind of investor you are (wholesaler, cash flow investor, rehabber, etc.) access to capital is one of the fundamental hurdles we face... and those of us who can access more capital can do more deals. Thanks for the info!
Kent Clothier, over 8 years ago
Thanks for the feedback Kent. This strategy is simply a way to show any investor using any of their own cash in a deal, how they can build a little more wealth without substantially changing their business. Its certainly not a short term play. But even 1-2% extra compounded out over your working life, can add tremendously to your wealth.
Thomas Rutkowski, over 8 years ago
Thomas, how are the dividend taxed?
Steve Kordish, over 8 years ago
Dividends are only taxable to the extent that you take a "Withdrawal" from your cash value or do a partial surrender. And even then, your premiums define your basis for computing gains. Once you understand the wonderful tax treatment of life insurance, you would NEVER surrender it.
The insurance industry regulators require insurance companies to offer loans against the cash value of permanent life insurance policies. This creates tax-free access to your cash value and all gains on the cash value. Since the cash value is "collateral", it remains in the policy and continues to earn dividends/interest even after the policy holder takes a loan. So when you hear a financial guru say something like: "Why should I have to pay interest to access my own money", that's complete BS. The interest earned and the interest owed cancel each other out.
Policy loans are a beautiful mechanism that allow tax-free access to your savings at any time. To a certain extent, permanent life insurance is like a "Roth" savings vehicle. You pay your premiums with after tax dollars and the cash value will grow tax-free and you can "access" it tax-free. But, of course, there is a death benefit to protect your family and you can use the cash value at ANY time. You don't HAVE to wait until you retire. And the death benefit ultimately pays off the outstanding policy loans at death.
Thomas Rutkowski, over 8 years ago
Thank you Thomas! A great read!
Matt
Matt Santos, over 8 years ago
My favorite whole life carrier is paying a 7.1% dividend right now. Their loan rate is 5%. Most other whole life policies are right around 6% dividend rate with 6% loan rate (wash loan).
IUL average interest crediting rate is 8.2% with a loan rate currently at 4.2%.
Client would make 1% more on the cash value and would save almost 1% on the loan interest rate with an IUL.
Message me privately and I'll share the worksheet from above so you can test the impact of rate changes. Not that you couldn't recreate it in 5 min ;)
Thomas Rutkowski, over 8 years ago
Thomas, you're leaving out a very important point.. If you die, your beneficiaries will only receive the face value of the policy, less any outstanding loans. They don't receive any of the cash value.
So for example, if you have a $300,000 life insurance policy, and you've been paying the expensive premiums of a whole life policy (which can be at least 5 times as expensive each month compared to a term policy) for years and years to accrue cash value, but then you die, your heirs only receive the $300,000 and the insurance company keeps the cash value you've built up. So all the extra money you've paid over the years in excess of what you would have spent on a term policy has gone to waste. You'd have been better off to put that extra money under your mattress each month, because then at least something goes to your heirs. And what's worse if if you borrowed $50,000 against your cash value and then die, your heirs would only get $250,000 in this scenario.
What if a banker was trying to get you to open a savings account, and explained it like this: "You'll put in several hundred dollars a month... but if you die, we keep it all, and none goes to your estate." ... Would you open that account?
Note: I was previously licensed to sell life insurance, securities, and annuities, but left that industry a few years ago to write mortgages.
Michael Smith, over 8 years ago
Michael, you make that sound like a negative. That's the whole point of life insurance. I don't see it as a negative at all. Anyone who uses life insurance like I describe is primarily doing it to create the "Magic Checking Account". Once my clients understand that they can make more money using this strategy than investing directly in real estate, they tell me how much they want to pay in premium. In an over-funded 5-pay policy,roughly 85% of the premium is going to go straight to the cash value.
The cash value of a policy is essentially the "seed" that is going to grow and eventually equal the death benefit if you live to your normal life expectancy. The policy holder essentially saves up their own death benefit. The life insurer covers the risk if the policy holder dies early. This cash value is never "lost" as you state. It is an integral part of the death benefit.
1. An IUL will outperform most mutual funds over a long term. I've got research to back this assertion.
2. Dollar for dollar, life insurance will generate 2-3 times the after tax retirement income of a typical brokerage account. (because of the leverage). Even if the CV didn't grow as fast as alternatives, it will provide more income.
When the client dies, their beneficiary gets the remaining death benefit after loans are satisfied. The cash value is the functional equivalent of their life savings. Its not lost! Its seamlessly transferred to the beneficiary. And they spent it while they were alive.
Someone who didn't have life insurance would have no death benefit and their remaining life savings would go into probate.
How is that any better? My client had all the income they needed during their lifetime and the remainder went to their beneficiary.
Thomas Rutkowski, over 8 years ago
Hi Thomas,
Can you explain what you mean by "The long term returns are greater and the loan interest rates are lower for IUL"?
Thanks,
Gautam
Gautam Venkatesan, over 8 years ago
What kind of permanent life product is this? Is the 7% guaranteed?
Gautam Venkatesan, over 8 years ago
This works with any permanent life insurance product: Whole Life and Universal Life. All carriers must offer loans against the policy's cash values.
Both types of policies offer guaranteed rates, but not necessarily at the current dividend rate. One of the WL carriers I use is currently paying a 7.1% dividend. The "Guaranteed" rate is only 4%. An Indexed UL credits interest based on the performance of an underlying index, like the S&P 500. There is no "Guarantee", but the mechanism for calculating the interest is known. These have a track record of ~8%+ for the 5, 10, 15, 20, 25 year periods and your principal is protected against market declines.
I use an IUL for my own "magic checking account". The long term returns are greater and the loan interest rates are lower.
Thomas Rutkowski, over 8 years ago
Thomas Rutkowski, over 8 years ago
Where does the $85,000 come from?
Dawn Anastasi, over 8 years ago
The $85,000 is an approximation of the cash value at policy inception. I know it looks like a big hit to take, but when you use this strategy, you have to keep in mind that you really have $170,000 of assets going to work instead of just $100,000.
Thomas Rutkowski, over 8 years ago