One of the most compelling benefits of the cash value of whole life insurance provides is ongoing, immediate access to your money. Unlike other investments and accounts, you don’t have to forfeit the use of your cash value to make this strategy work for you. Today, host, Patrick Donohoe, explores the benefits, structure, and most common uses of the loan provision. He also tackles the things you need to consider as you look at using your own policy to finance major purchases and investments.
Key Takeaway Timeline
1:39 – How the loan provision came to be
2:46 – What source of funds does the policy loan come from?
3:38 – Benefits and protections of whole life policy loans
7:06 – Common uses of policy loans
10:30 – Criteria to consider as you evaluate policy loans vs. other financing options
12:43 – The built-in investment accountability policy loans offer
14:04 – Remaining diligent with policy loans taken for personal purchases
16:35 – Policy strategies for retirement and legacy planning
18:20 – The value of liquidity in times of uncertainty
18:58 – Common misconceptions of policy loan interest
Ongoing immediate access to your money, which is often referred to as liquidity, is one of the most compelling benefits of the Wealth Maximization Account, which is the foundational financial vehicle of The Perpetual Wealth Strategy. Unlike other types of investments and investment products, you don’t have to forfeit the use of your cash to make this strategy work for you. For some clients, regularly leveraging cash value is the backbone of the strategy that they’ve adopted to grow their wealth. We’re going to talk about a common misunderstanding of how this benefit works as well as some of the wise and unwise uses of the loan provision. Let’s get started.
A policy loan is one of the unique features of the Wealth Maximization Account. Looking at the benefits that I have talked about in previous episodes like the certainty of it all, the tax efficiency of it all, the growth of it all, the interest and dividends. There are lots of benefits. We’re going to get into asset protection in a future episode. The loan provision is by far one of the best. If it didn’t exist, it would still be a viable vehicle and a great long-term savings plan. People used it as such and that is where the loan provision came from. One of the original groups of people that were using these types of strategies and financial products were farmers.
As you can imagine, farming is not a month to month paycheck or a bi-weekly pay period. They have one pay period, which is harvest. There’s money needed in between, whether it’s for the planting, nurturing, and then ultimately harvest is when you get paid. Farmers were using insurance as their family savings vehicle. They’ve influenced the insurance companies to give them a loan against those values for things that they needed during the year. Finally, when harvest season came around, the farmers were able to pay back that loan. It became a common practice and eventually, all insurance companies adopted it. Now, it is a guaranteed provision of these types of policies that are built into the contract.
Looking at what it means, the insurance company will loan you their other money against your policies. The policy continues to grow and continues to earn interest. They will lend you their other money and you essentially put your policy as collateral. Many banks will do the same thing. They may not offer the same characteristics or terms of the loan, but they will give you a business or personal loan in large amounts against the actual policy. The policy is the collateral. The policy stays intact. It earns interest and dividends. It continues to grow in that respect, yet you can put it up as collateral for a bank loan.
I’m going to talk mostly about the policy loan. It is a loan that comes from the insurance company. It is a private loan and it doesn’t appear on your credit report. When you take a loan, they are not going to report your payments. They’re not going to report amounts. They’re not going to report the frequency of use. They don’t report anything. It’s a private loan between you, a private person and the insurance company, a private company. Looking at the other reasons I would assume, it’s because of how flexible the terms are. The terms are there is no application. You don’t have to tell the insurance company what you’re using the money for. You essentially request it and they give it to you. It’s a very quick process and most of it is done online now.
When you receive the money, they will bill you interest every year and then they’ll also allow you to defer that interest. They don’t expect any payments. That’s a default. We’ll get into making payments. This is where when people avoid debt, oftentimes, it’s because of the fear of not being able to pay the debt, losing their home, losing their car. There’s this fear of loss associated with it. With the policy, you’re not going to lose your policy because you don’t make loans payment. That is something that’s interesting and attractive to the loan provision and the interest rate is very low.
If you look at another loan that you didn’t have to qualify for, it gave you flexible terms like the ones I mentioned. You would assume that the interest rates would probably be higher than credit card interest rates. The loan interest that the insurance companies charge is typically off of the Moody’s Aaa Investment Grade Corporate Bond Index. It’s low-interest rates, especially now. The idea is it’s a benefit for anyone. If you’re using this to magnify your potential retirement income in the future or you’re using it for growing your assets as your foundational base or you’re using it for the loan provision. The loan provision applies to anyone because of the liquidity factor.
You know that your money continues to grow. You know that it is going to compound and it is going to earn tax-efficient interest. You have access to that money. That state of mind is very healthy when it comes to your other activities, whether it’s your professional pursuits, your business pursuits, your investment pursuits, etc. You know that the money is going to be there when you need it. Looking at the advancements that insurance companies have made regarding loans, many people are still not using this benefit. They have insurance for traditional reasons. They’re not necessarily using these liquidity provisions. The insurance companies nonetheless have made some advancements as far as the time in which they’re processing it. When I first started out and created Paradigm, they were still doing paper checks. It has changed significantly since then. All insurance companies are doing electronic transfers as well as payments. Some even have modern online portals. It’s great to see that. It makes it even better.
Common Uses Of Cash Value
Let me get into the common uses of cash value. First and foremost, the policies are one of the primary saving vehicles within The Perpetual Wealth Strategy. It’s the foundation. The hierarchy of wealth, which is discussed in a couple of chapters of the book. It illustrates that we can keep it as our foundational assets similar to how banks and corporations keep it as theirs. Looking at the use, once you have established that foundation, whether it’s a reserve or an emergency fund of a certain number of months of your expenses, you start to exceed that or when you start to make more money and are opening up multiple policies. The idea is to treat the money above and beyond your emergency under your safety capital as an opportunity fund where you’re now looking for opportunities to use the loan provision.
These opportunities are all over the place. I’ll use personal purchases first. I think the loan provision allows you to have a comparative tool. What I mean by that is the policy loan, in essence, a great rule of thumb, it’s to be used in place of another bank loan, both with being at better terms or better interest rates. I say this because when somebody goes into a bank to buy a car or buy a home or otherwise, a business loan, etc., you don’t know if you’re getting the best terms. You’re not sure if you’re getting the best deal.
I came across this a lot, a few years ago when banks, specifically the banks associated with car loans, would give you these manufacturer deals of low-interest rates. Some as low as 0%, 0.9%, 1.9%, 2.9%. They were doing it with a sleight of hand. They would offer these low-interest rates and people were buying cars in droves. If you looked at the fine print of the purchase contract, what these manufacturers were doing is if you did use the incentive interest rates, 0%, 0.9% or whatever, they would not give you a rebate. If you went in and purchased the car in cash, you would get as a specific rebate, which would give you a purchase price of the car at a certain amount.
If you went and use their incentive financing, they do not give you this manufacturer’s rebate. Therefore, the purchase price of the car was higher. What this loan provision does is when you go in with the ability to take a policy loan, you can go into that type of transaction and ask better questions. What is the purchase price if I use this way? You can start to see if you’re getting a good deal or not. I’ve done that. I’ve used policy loans for multiple cars. I’ve used it also for many real estate deals, personal purchases and tons of business purchases.
When you go in and you determine whether or not you’re going to use a policy loan, first off, the rule of thumb as I mentioned, is a purchase that you would otherwise have used a bank for. The second is for a business opportunity or an investment opportunity. I also think that the policy loan plays a similar role as it did in the example I gave of the car. As you go into an investment and you have a cash value that’s earning 5% tax-free, net of fees, net of everything. That comparatively speaking depending on your tax bracket could be 8%. It’s as far as what you would have to earn after-tax or before-tax somewhere else. That gives you a benchmark as to, “What type of deal am I getting into? What’s the interest rate? What are the terms? What’s the risk level?”
With the policy being as tier-one status, meaning it’s safe, it has a high degree of certainty and you’re earning what the equivalent investment or yield would be that 8% or so. If it’s 10%, is it worth taking on that risk for just maybe a net 2% more? Maybe not. This allows you to weigh those options. When it does make sense, now you can use the principle of arbitrage, which is using the loan provision, which gives you a loan at 4.75%, 5%, 6% and then now invest in something like real estate or business opportunity at 15%. Now you have that degree of arbitrage, which is paying 6% and earning 15% and leverage. I’m not going to get into all that but it’s a powerful concept. It allows your money in the policy to continue to grow, yet capitalize on these opportunities.
That’s why we often call it the “and” asset. You’re not choosing between policy in a real estate deal or a policy in a business opportunity. You’re able to do both. Another thing too that is interesting is there’s this built-in accountability. Most people want to do the right thing financially, but there isn’t a whole lot of accountability associated with what they do. I ultimately look at my financial statement as my scorecard. It’s what tells me if I’m making progress or not. When it comes to using the policy, the policy first and foremost, is my systematic savings accounts. It’s my emergency fund and I keep my opportunity on there.
When I do take advantage of real estate deals or business opportunities, I document it as such and use a loan to essentially capitalize those deals. The cashflow associated with those deals and the return associated with those deals in the future, will payback first all of the basis into paying off the policy loan before I consider the money above and beyond profit. If I invested $50,000 in a deal and it’s cashflowing every month $200, $300, $500, I am not going to consider that deal profitable until I either sell it, pay back the loan and then consider that profit or get cashflow to the point where it pays back that principal amount. I then would consider it profit. It keeps you accountable from an investment standpoint or a business standpoint.
From a personal standpoint, this is where things can get tricky because the loan provision in and of itself doesn’t hold you accountable because you don’t have to make any payments and you can defer the interest. That’s why we recommend, if you use it to purchase a car or do something else from a business standpoint or something personal, then creating your own amortization schedule and setting up systematic payments until the loan is paid off is a healthy thing to do. It will keep you accountable for using the strategy the way it was intended to be used.
I’m going to address those who are using this tool and their goal isn’t necessarily retirement income. The main discipline is the idea of treating your financial life as a business. I find this very beneficial to me especially. You look at where your income is coming from and where your expenses are. That’s where you have your profit and loss. You have a balance sheet, which is assets and liabilities and hopefully, having equity or positive net worth is the goal. That’s your scorecard. That’s your financial statement. Looking at the accountability associated with if you have money that’s in cash value, but you can also borrow against it. You have an asset but once you borrow, now you have a liability and it’s ensuring that you have the cashflow sufficient to pay back those liabilities.
The Retirement Question
I think the accountability factor is huge because the big benefit associated with policies is that it is that “and” asset. The 401(k)s are not that way and other types of long-term savings accounts are not that way. It plays one role. It has one purpose. This can have a multitude of purposes. The first purpose is systematic savings. The second purpose is it could be your line of credit or your bank in a sense. It’s going to be your short-term savings just as much as it’s going to be your long-term savings. I’ll transition now into the discipline associated with those or planning on either partially retiring or fully retiring.
Looking at the retirement question, there are a couple of strategies that I talked about in the book. One was the covered asset and the other was the volatility buffer. These are two strategies where you can make massive improvements to the amount of income that’s available to assets that you have already accumulated. There are these models out there that are known as Monte Carlo models. These Monte Carlo models are essentially mathematical in nature and give you an idea of what you can take from a given portfolio or a given asset on an ongoing basis without running out of money. There are some other factors in there. We’re looking at using insurance as the foundational assets, the legacy asset or asset that’s going to be passed on. It allows you to capitalize on the other assets that you have.
We try to teach clients and get to the point where you have a one-to-one ratio of your permanent death benefit to your other assets. That one-to-one ratio allows you to maximize any possible income associated with those other assets and delegate your policy as your legacy assets. That’s what’s going to get transferred. Now it opens the door to using a reverse mortgage for tax-free income on your primary residence. It allows you, not deferred annuities, but annuitize your mutual funds, your brokerage accounts, your retirement accounts and not have to worry about market volatility necessarily. That’s the idea associated with the policy for those that are planning on using it for retirement income. At the same time, life always throws curve balls at us. It always gives us some challenges that we weren’t able to anticipate, even if that’s your purpose.
Knowing that the policy has this loan provision or this liquidity allows you peace of mind. If there’s a medical emergency or if something is needed within your family and you need access to money, this is a way in which you can access that without necessarily interrupting the potential future use of the policy. Of course, these loans have to be paid back. This is the last thing I’ll talk about. These loans, there’s interest associated with them. That interest goes to the insurance company. That’s a common misconception out there with other groups that advocate what we do and I’ve written books about it. It’s somehow magically by using a loan, you’re going to have even more interest. That’s not the case. If you look at the loans associated with insurance policies, these loans are coming from the insurance company.
These loans are from their other assets, from other accounts. If they didn’t charge interest on it and they didn’t count or book that interest in their accounting as revenue, then it would impact the pricing of the other types of insurance policies. It would impact the pricing of these insurance policies. It would impact the dividends as well. When a loan is taken and interest is charged, that interest is a revenue source for the insurance company. It goes to them because they understand the opportunity costs more than most other financial institutions. If they were to give a loan with no interest, it’s money that they would not have been able to invest and earn interest. Therefore, they charge interest in the range of what they would have earned in investment had they not given a loan to me or you or to other policy owners.
That’s all we’re going to talk about as far as policy loans are concerned. If you have questions or some follow-up, go to ParadigmLife.net. There is a Perpetual Wealth Strategy Podcast page as well as other resources to help you understand the powerful nature of policy loans. Thanks for joining me and taking the time to learn more about these powerful benefits that The Perpetual Wealth Strategy is giving you, now that you’ve implemented the strategy. I can’t stress enough how important it is to maintain an active role in regard to financial education. I’m grateful that you’re dedicating time to learning. This information is not going to be in a commercial at the Super Bowl. It’s information that is talked about in books.
With all of the stuff and all the noise that’s out there, continuing to educate and understand how this applies to you is important so that you understand what your options are when you have financial decisions to make. It’s been a pleasure to be here. Thank you so much for your support. I love doing this. In the next episode, we’re going to talk about another benefit to a policy, which is asset protection. How having one of these Wealth Maximization Accounts is going to secure your assets from potential future legal issues. Join us then. Thanks, guys and we’ll see you next time.
About Patrick Donohoe
Patrick is the President and CEO and started Paradigm Life in 2007 after learning from his mentor Kim Butler about financial strategies outside of Wall Street. With a background in economics and marketing, Patrick immediately realized the opportunity to teach investors, business owners, professionals and families on a large scale using modern digital media and communication technology. Since 2007 Paradigm Life has worked with thousands of individuals in all 50 states. Patrick has shared the stage with financial experts such as Robert Kiyosaki, Peter Schiff, G Edward Griffin, Tom Hopkins, Blair Singer, and more. Patrick co-created the Cash Flow Wealth Summit (www.cashflowwealthsummit.com) with his friends Tom Wheelwright, CPA of Provision Wealth and Andy Tanner, the author of 401kaos and Stock market cash flow (have links to their websites and books). Patrick hosts The Wealth Standard Radio – a popular financial podcast every Wednesday morning at 9am MST on the Tune In Radio Network. The Wealth Standard Radio has been on the air since 2007. Patrick grew up in West Hartford, Connecticut and moved to Salt Lake City in 2003 to attend the University of Utah and graduated with a BA in Economics. His yearly highlights are a family trip to his parents home in Cape Cod, Massachusetts and to Hermosillo, Sonora Mexico where his wife Synthia’s family resides. He enjoys playing ice hockey and is an avid participant in CrossFit. Patrick currently resides in Salt Lake City, Utah, with his wife Synthia and their three children Hannah, Meghan and Jack.
A Wealth Maximization Account is the backbone of The Perpetual Wealth Strategy™