tons of great info and I appreciate everyone's chiming in. It's funny a development deal just popped up on my radar today that has me very intrigued and it is close to home. There is opportunity everywhere if you keep your eyes and ears open. I still like the idea of selling a few properties here and experimenting in another market.
One more question, what interest rate would I be earning on the 42.5k cash value if I borrow that full amount to use for something else?
That depends on the insurer. If your contract says "non-direct recognition," or something similar like "net 0% cost loan," or "wash loan," then you are earning the rate you were earning prior to the loan on your cash value. In some cases, you can get a positive spread on the loan, meaning the net cost of the loan is negative.
These are usually set up as variable rate loans (they have to be for this to work).
If you take a fixed-rate loan option, or your contract says "direct recognition," then you usually get paid a lower interest rate on your borrowed cash value. Some whole life insurers actually raise the dividend on direct recognition policies or pay an alternate dividend scale that doesn't result in a net cost.
Okay so on a common policy, here is the scenario
my cash value is $50,000
I borrow $50,000 from the cash value for a house.
What kind of interest rate would the cash value be making when I have borrowed all of it to buy a house?
OK. I'm not sure how else to put this to you other than how I've already explained it.
Do you have an insurance policy? If so, what kind? And, what does it say in your contract (they are typically written in plain English so you should see loan provisions in there somewhere).
The problem I am seeing is there bits of information shared for certain scenarios. The answer and the policy changes depending on the question being asked, but I have yet to see what the basic terms would be for an entire policy.
I think most people on here would want to be able to use their money right away. So the agents piped in with the $50,000 a year option with $42,500 cash available once that contribution is made. So using that particular policy, what would the death benefit be? Someone said $1,500,000 could be the death benefit, but then in another post they said the death benefit would be really low in the $50k example. 1.5 mil is a high death benefit so that makes me think that number is not accurate. Here are some simple questions that would be awesome for someone to answer.
Using a policy that allows the most cash value the soonest. For example $50k contributions made every year for five years.
1. how much cash would be available to first year and the fifth year?
2. What would the death benefit be?
3. Once someone died would the death benefit be $1.5 mil (or whatever the answer is to 2) or would it be 1.5 mil plus part or all of the cash value. If it would be part of the cash value, how is that figured?
4. If I had $500,000 borrowed against the cash value when I died, would that $500,000 be deducted from the death Benefit so the heirs would only get 1 mil (or whatever the answer to 2 is minus the loan) or would it be something different?
5. Would I have to keep paying premiums until I died? Would they decrease over time?
6. What would the interest rate be that was paid on the cash value when it was not being borrowed and what would it be when it was being borrowed.
I am not looking for specific amounts that you will be held accountable to, but just ideas of what these costs would be on a particular policy.
I live and own investments in the San Francisco Bay Area. I also believe that it will continue to grow long-term particularly because it's the center of technology. I also believe that, in order to generate stronger returns (including cash-flow) savvy investors have always invested in Emerging Markets. For me, I consider Austin in 2007, Dallas, Houston, San Antonio, Charlotte, Atlanta, etc. the great cities of the future, and...emerging markets. Though San Francisco is likely to remain the main tech center, Seattle, Austin, and other markets will continue to compete with it for talent. I have first hand experience because in the last 3 years all of my properties have turned over with the new tenants being engineers!
One reason I like Florida is because of the low taxes and the population increase they are seeing as well.
Btw for the readers, Mark is pretty much your Ace in the hole for this Denverish area just in case you want to hop on that cash flow with some appreciation train. It is not SF appreciation obviously but way better than most of the stuff and locations I see BPers pushing...not that he is pushing jack nor needs to.
IMO it is not a matter of hoping for appreciation, nor is it cash flow vs appreciation. These both are location specific fundamentals that exist before you invest. Most markets do not appreciate historically in reality. If one is buying 3/2s for 80k in 2016 it is unlikely that market has conditions in place that appreciate in significant massive long term ways. There are many possible exceptions still.
From Amit:
I appreciate that.
Let's see if I understand the given scenario above.
1. Spend $50k a year to get $42,500 a year death benefit you can borrow against. Aren't I losing 15 percent of my money off the bat? Insurance is not that expensive.
2. After spending that $250,000 the first five years what death benefit are my heirs getting? Because from what I understand that $250,000 cash value or $218,000 cash value is gone when I die.
You said it was a low death benefit so how low?
Hi Mark - The $50,000 is just the "premium". A healthy 45 year old putting $50K per year of premium into a policy should be a death benefit of ~$1.5M. I know it seems like you are taking a significant loss. The key, though is that you now have available collateral up to the amount of the cash value. $50K of Premium turns into $85K of assets going to work for you ($42.5K cash value and $42.5K loan proceeds). As my business model shows, those two combined will generate more total income than $50,000 invested in the exact same asset class.
I hope this makes sense. Once people realize that they are not borrowing from the policy but are borrowing against the policy, the lightbulb goes on and they realize their money is working in two places at the same time.
Okay, here is the problem I have:
Insurance sales talk and the language of business, accounting!
"50k turns premiums turns into 85K of assets" loan proceeds are not assets, it's borrowed money.
Then you say you have collateral up to 50K, that allows 42.5 cash value and 42.5 available to borrow as loan proceeds. What you have is 42.5 in an asset, CV and then you have 42.5 of borrowed funds which is a use of cash, not an asset if you are obligated to repay the loan proceeds. If you do not repay the loan proceeds, there will be an offset, funds will be taken from the CV or death benefit to repay the loan, the loan was collateralized by the policy.
You mentioned earlier, immediately available. I take that to mean after you pay 50K, 42.5 becomes available.
Where does the other 7.5 grand go?
You're suggesting I can pay 50K in, the next day take a loan out at what rate of interest?
Then the following day I can withdraw my CV of 42.5K?
If that is actually true, where is the collateral for my 42.5 loan?
What happens to mt death benefit after taking out the loan.....after taking out the CV and, if I could, taking out both with the insurance company only holding 7.5K?
Speaking as if 50K turns into an 85K asset is incorrect, misleading as you at least have a contingent liability.
To compute a rate of return, we would expense the cost of insurance, then look at the rate paid by the insurance company on the CV accruing interest and divide that by our total outlay of cash, less the cost of insurance. Since we can't get all our CV back, it is a cost of allowing funds to sit idle in order to obtain the interest amount on the actively earning side of our CV, an opportunity cost.
Then we have funds available as loan proceeds, any interest charged on the loan? We can use that money to leverage other investment opportunities. Loan interest expense reduces our profit from that opportunity. If the policy is owned by a business, such as a key man policy, this interest is deducible, but you still have an after tax interest expense. If the policy is owned by an individual, interest may not be deducible on a personal tax return. It MAY be possible to show the loan for a business enterprise by an individual. That also brings into question is our real estate operator in business or is this an investment. There are other reasons you may not want to be considered as being in the business of real estate.
So, we aren't really looking at 170% return, we are looking at the net income after taxes of our use of funds, not our assets. RE folks here call it cash on cash.
Said another way, you give me 50K, I'll loan you 42.5K take out 2.5K for the cost of insurance and your loan cost you 5 K. You still owe me 42.5K. If you don't repay it, I'll collect from your death benefit or your cash value.
Sounds like you're suggesting that if I give you 50K, you'll provide me with 85K, no obligation, I can drop my policy, I'll do that all day!
We have had a few PMs outside this thread, for other's FYI, I understand this policy is a 5 year pay, put in 50K for 5 years, when the funds are vested to be taken out clearly makes a difference, as well as to the reserves still held by the insurance company.
We can have funny banking, but the bottom line is, the insurance company isn't going to advance more than you put in and give you free insurance. There will always be a cost of the insurance. Admin costs must be paid, including the agen't commissions.
Nothing at all personal Thomas, or David or Albert who gave a great post, BTW, but financial sales folks are taught to serve fruit salad, mixing apples and oranges, let's talk in business terms of credits and debits, assets and liabilities, percentage of available funds for use and clean up the magic checking account, turns into and your two bags of money. Insurance sales jiberish isn't meant to be understood, so let's talk in accounting and finance terms.
Then, what is your business model? Since no two real estate investments are the same because we deal in a liquid asset market, let's use T-Bills as the alternative investment, a hundred grand at a time. If you're saying 50K a year for 5 years, that's 2 T-Bills and 50K for insurance. I can borrow against my T-Bills and my insurance at my bank.
If you can, explain your business model, how it is statistically valid, in what market, the cost of management, any interest rate fluctuations, any debt obligation, use of funds, etc.
I certainly don't hate life insurance, it's a great tool when applied properly for the right reasons, it's just that.....just because someone can afford it doesn't mean they need it or should use it as there are always other alternatives. :)
This is exactly what I was trying to get at, but simple questions aren't being answered. They are deflected into something else.
Here is my take.
I give insurance company $50,000
insurance premium is $2,500
Insurance company takes $5,000 right off the bat.
I can now borrow $42,500 of the $47,500 I paid.
Theoretically I am also earning interest on the $42,500 that I paid in, but no one is giving any solid numbers on what that interest rate is. Let's assume it is 7 percent, which from what I have read is never going to happen. That would be $2,975 I am earning on my $42,500, while I am borrowing that money from myself. Awesome....;..
Except I paid $5,000 to earn $2,975, In real life I am guessing that number would actually be much lower, like $1,000 if anything.
Then when I die all that cash I paid the insurance company goes away and the insurance company gets it to pay the "cost of insurance". But, then why was I paying $2,500 a year out of my insurance policy for the cost of insurance to begin with?
One more question, what interest rate would I be earning on the 42.5k cash value if I borrow that full amount to use for something else?
That depends on the insurer. If your contract says "non-direct recognition," or something similar like "net 0% cost loan," or "wash loan," then you are earning the rate you were earning prior to the loan on your cash value. In some cases, you can get a positive spread on the loan, meaning the net cost of the loan is negative.
These are usually set up as variable rate loans (they have to be for this to work).
If you take a fixed-rate loan option, or your contract says "direct recognition," then you usually get paid a lower interest rate on your borrowed cash value. Some whole life insurers actually raise the dividend on direct recognition policies or pay an alternate dividend scale that doesn't result in a net cost.
Okay so on a common policy, here is the scenario
my cash value is $50,000
I borrow $50,000 from the cash value for a house.
What kind of interest rate would the cash value be making when I have borrowed all of it to buy a house?
Let's see if I understand the given scenario above.
1. Spend $50k a year to get $42,500 a year death benefit you can borrow against. Aren't I losing 15 percent of my money off the bat? Insurance is not that expensive.
2. After spending that $250,000 the first five years what death benefit are my heirs getting? Because from what I understand that $250,000 cash value or $218,000 cash value is gone when I die.
You said it was a low death benefit so how low?
Hi Mark - The $50,000 is just the "premium". A healthy 45 year old putting $50K per year of premium into a policy should be a death benefit of ~$1.5M. I know it seems like you are taking a significant loss. The key, though is that you now have available collateral up to the amount of the cash value. $50K of Premium turns into $85K of assets going to work for you ($42.5K cash value and $42.5K loan proceeds). As my business model shows, those two combined will generate more total income than $50,000 invested in the exact same asset class.
I hope this makes sense. Once people realize that they are not borrowing from the policy but are borrowing against the policy, the lightbulb goes on and they realize their money is working in two places at the same time.
But is the cash value gone when you die in this scenario?
Also after putting 50k in for five years what would the cash value be?
I can't speak for Thomas's policy design, but if you are talking about a participating whole life product, then the cash value is not gone. I few posts back I explained that the cash value is a reserve against the death benefit. People often think that, when you die, the insurer takes your CV and you "only get the death benefit." This is an unnecessarily confusing way to explain it and carries a certain connotation with it that's absolutely not true.
The cash value is the actual reserve used to pay for part of the death benefit (you are going through the process of self-insuring in a whole life policy). So, with every premium dollar you pay during your life, the insurer sets a significant portion of that aside (cash value), adds interest to it, and then when you die, your family gets whatever the stated death benefit is (which consists partially of cash value and partially of pure insurance).
In universal life insurance, this can be true if you set it up as a level death benefit option. ULs also have an increasing death benefit option where cash value is stacked "on top of" the death benefit. In this case, you get the death benefit in addition to the cash value (which *sounds* like a better deal but isn't necessarily -- all other things being equal, you'd end up with the same death benefit as whole life.).
Lets make this simple.
If my death benefit is $1,500,000 and my cash value when I die is $500,000. When I die how much do my heirs get?
Let's see if I understand the given scenario above.
1. Spend $50k a year to get $42,500 a year death benefit you can borrow against. Aren't I losing 15 percent of my money off the bat? Insurance is not that expensive.
2. After spending that $250,000 the first five years what death benefit are my heirs getting? Because from what I understand that $250,000 cash value or $218,000 cash value is gone when I die.
You said it was a low death benefit so how low?
Hi Mark - The $50,000 is just the "premium". A healthy 45 year old putting $50K per year of premium into a policy should be a death benefit of ~$1.5M. I know it seems like you are taking a significant loss. The key, though is that you now have available collateral up to the amount of the cash value. $50K of Premium turns into $85K of assets going to work for you ($42.5K cash value and $42.5K loan proceeds). As my business model shows, those two combined will generate more total income than $50,000 invested in the exact same asset class.
I hope this makes sense. Once people realize that they are not borrowing from the policy but are borrowing against the policy, the lightbulb goes on and they realize their money is working in two places at the same time.
One more question, what interest rate would I be earning on the 42.5k cash value if I borrow that full amount to use for something else?
Let's see if I understand the given scenario above.
1. Spend $50k a year to get $42,500 a year death benefit you can borrow against. Aren't I losing 15 percent of my money off the bat? Insurance is not that expensive.
2. After spending that $250,000 the first five years what death benefit are my heirs getting? Because from what I understand that $250,000 cash value or $218,000 cash value is gone when I die.
You said it was a low death benefit so how low?
Hi Mark - The $50,000 is just the "premium". A healthy 45 year old putting $50K per year of premium into a policy should be a death benefit of ~$1.5M. I know it seems like you are taking a significant loss. The key, though is that you now have available collateral up to the amount of the cash value. $50K of Premium turns into $85K of assets going to work for you ($42.5K cash value and $42.5K loan proceeds). As my business model shows, those two combined will generate more total income than $50,000 invested in the exact same asset class.
I hope this makes sense. Once people realize that they are not borrowing from the policy but are borrowing against the policy, the lightbulb goes on and they realize their money is working in two places at the same time.
But is the cash value gone when you die in this scenario?
Also after putting 50k in for five years what would the cash value be?
5 pages of this so I apologize if this has already been stated - This can be a good way to leverage the cash value of an insurance product - what you need to know and what many do not state when selling the policy is that Cash Value builds slowly - Very slowly. Before purchasing one, ask for a hypothetical from your agent/advisor.
Louis, the point of all of my posts have been that you can design a policy with cash value immediately. Any investor putting any of their own cash into a deal, can make more money by putting the money into life insurance premium first.
If you go to an agent and you tell him you want a $250,000 whole life policy, then you are correct. It will take forever to build cash value. BUT if you have $250,000 that you are using for your real estate investing, we can work backwards to design a policy with the smallest death benefit possible for the premium. This might look like 5 annual premiums of $50,000 for a policy that is paid up for life. The initial cash value could be as high as $42,500 before 1 cent of dividends are paid. In 5 years all of your working cash will be in your "magic checking account".
This client would have roughly $42.5K of cash value PLUS $42.5K of loans available for real estate investment (plus the remaining $200K of cash the first year.) Both will be generating gains. Your money is literally working in two places at one time. The life insurance cash value is not replacing the real estate as an investment, it is enhancing the returns on the real estate.
Whenever I try to understand whole life I feel like random numbers and terms I don't understand are being thrown out everywhere to confuse me. Reminds me of that time I fell for the meat salesman and free freezer that ended up costing $2,000 plus a bunch of other costs that weren't discussed.
I'm not saying this is a bad investment, but when I don't understand it well and the concepts can't be me simple I stay away.
Let's see if I understand the given scenario above.
1. Spend $50k a year to get $42,500 a year death benefit you can borrow against. Aren't I losing 15 percent of my money off the bat? Insurance is not that expensive.
2. After spending that $250,000 the first five years what death benefit are my heirs getting? Because from what I understand that $250,000 cash value or $218,000 cash value is gone when I die.
You said it was a low death benefit so how low?
This is still the closest I have seen to real.numbers being posted. I would love to see.
The death benefit for this example of putting 50k in every year and being able to borrow 85 percent.
The estimated amount you can borrow for the first five years
The return you get on your money if it is being borrowed for other investments.
If this cash value is gone when you die.