fbpx
Image for cash value line of credit blog

Cash Value Line of Credit: The Ultimate Hack for The Double Play

The purpose of this article is to discuss when you should use a policy loan for The Double Play and when you should use a Cash Value Line of Credit.  When interest rates were much lower, this was a no-brainer: Cash Value Line of Credit (CVLOC) rates were much lower than policy loan rates AND the interest can be tax-deductible. But now that rates are higher, it often makes more sense to do your investing with a traditional policy loan.

Nonetheless, keep this information in your mind. The decision to get a life insurance policy is a lifetime commitment. Interest rates will be up and down during that time. Sooner or later, you’ll need this information.

Background 

It’s important to realize that policy loans are considered personal loans. This means that the interest cannot typically be deducted as a business expense. If a policy is held in your personal name, then you are the borrower. However, it is your business that is doing the investing. The money or loan proceeds need to get into the business.

A CVLOC is a loan taken from a 3d party bank by your business. Since your business is the borrower, the interest is a business expense. Your business is the borrower and you are giving the bank an assignment of collateral against the policy (personal guarantee). This means that the bank can surrender the policy if your business defaults on the loan.

I’ve seen some articles from CPAs and Accountants showing that as long as the interest on a policy loan is used for business purpose, that you can legitimately deduct the interest. I’m not exactly sure of the mechanics of that since your personal taxes and your partnership/corporate taxes are separate. But I’m also not providing tax advice either. Using the CVLOC with your business as the borrower is the simplest and cleanest way to make the interest a business expense.

In the rest of this article, I’d like to share with you the reason why you would want to use a CVLOC and also explain when it makes sense to use a policy loan.

Comparing the Business Models

Using a Policy Loan 

The Table below shows a hypothetical investment when the interest IS NOT tax-deductible. The investment is for $100,000 with a 10% return ($10,000) in a 40% tax bracket. With no interest to deduct, the entire $10,000 is taxable. After paying $4,000 in taxes we have $6,000 left. If we presume a 5% policy loan interest rate, we owe the insurance company $5,000. This leaves only $1,000.

If we further presume that the life insurance policy was paying a 6% dividend, our hypothetical investor made a combined total of $7,000.

Using a Cash Value Line of Credit 

The table below highlights the difference when the interest IS expensed. The investment parameters are all the same as the previous example. The big change in this scenario is that this time our interest expense of $5,000 reduces our $10,000 gross income to $5,000 of taxable income. Now we only owe the IRS $2,000 for taxes instead of $4,000. Our hypothetical investor walks away with $3,000 instead of only $1,000. After factoring the dividend, the investor made a total of $9,000.

$7,000 or $9,000? Which would you rather have?

You should also keep in mind that if you had used your own money (no life insurance leverage), you would have been left with only $6,000 after making the same investment. The Double Play results in more total income in either of the scenarios. That is the power of The Double Play!

What Do We Do With This Information in 2024? 

The problem in 2024 is that interest rates have skyrocketed. Interest rates were at historic lows just a few years ago. Up until 2022 it absolutely made sense to use a CVLOC since rates were much lower than policy loan rates. But since then, policy loan rates have stayed roughly the same while CVLOC rates have shot up. Rates are so high that even with the tax advantage, it still makes more sense to use the policy loan and skip the deduction.

That said, keep the CVLOC in mind, because interest rates will certainly be changing over time.

When Should You Use a Policy Loan? 

Right now! The difference in policy loan and CVLOC rates is so great that it makes more sense to do The Double Play with a policy loan. Just remember that this is (Hopefully!) just a temporary situation.

The other time that it makes more sense to use a policy loan is when you are using bank financing. The reason  is that your bank is unlikely to loan you money to purchase a property if you are using a loan to make the down payment. They want to see you have some skin in the game. Luckily, Life Insurance policy loans are a valid source of funds for the down payment.

The really great thing about combining a policy loan with bank financing is that it results in an Infinite Rate of Return. You will have no money in the deal. The Policy Loan will provide the down payment and the bank will provide the rest of the financing. That is 100% Other People’s Money (OPM). This is the holy grail of Real Estate Investing. While the policy loan interest may not be deductible, the primary mortgage interest certainly is.

Conclusion 

While most of the time it makes sense to use a CV-LOC to get the tax deduction, there is a time and a place for other loan options. It’s good to have options.

As with any real estate investing strategy, make sure you consult qualified tax, legal and financial professionals. But don’t overlook the power of a cash value life insurance policy as a unique source of investment capital and returns.

Leave a comment

Your email address will not be published. Required fields are marked *