Introduction
The Double Play is putting your money to work in two places at one time by leveraging the cash value of a Maximum Over-funded Life Insurance policy to invest in real estate. That may sound like a mouthful, but words matter. Many people searching the internet are simply looking for information about investing in Real Estate With Life Insurance. It’s important for you to understand not all policies will work for The Double Play. There is much more to it than simply getting a policy and using that loan to invest in real estate. You need to learn the key success factors for investing in Real Estate with Life Insurance!
The purpose of this article is not to show you “How” to do it, the purpose is to show you “How to best do it“. I want you to understand what a Properly-designed Life Insurance Policy looks like. And as you take this information, and effectively implement it in your own life, you should find that your own results greatly exceed your expectations.
Anybody can get a Life Insurance Policy and borrow against the Policy’s Cash Value. But would you be better off doing that or just investing directly in Real Estate with your own money? It’s important to realize that The Double Play will result in superior wealth accumulation. But many poor policy designs will not result in greater wealth accumulation. Be careful! It would be extremely frustrating to look back later in life and realize that you had been leaving money on the table.
The Key Success Factors for Investing in Real Estate with Life Insurance
So what are The Key Success Factors for investing in Real Estate with Life Insurance aka The Double Play?
- Policy design – Maximum Over-funded,
- Tax-advantaged access to the cash value, and
- Policy type: Whole Life or Indexed Universal Life
Maximum Over-funded Policy Design
The most important success factor for investing in Real Estate With Life Insurance is a Maximum Over-funded Life Insurance policy. I want to first show you how to know if your policy is designed properly and show you why it is so important. So let’s start by asking a question: “how do you know your policy is designed properly?”
Is My Policy Is Designed Right?
It’s important to understand that in a Properly-designed policy the ratio of Cash Value to premium should be about 85%. I think it’s fair to state that everyone understands that a Life Insurance policy has fees and expenses. Not every dollar of your premium is going to the Cash Value, right? The insurance deducts the cost of insurance and other fees from the Premium and the rest goes to the “Cash Value”. You want the fees and charges to be as small as possible. The way you do that is to minimize the Death Benefit. The Death Benefit drives the fees and charges in a Policy.
It is helpful to point out that you can easily check this on your illustration. Just look at the very first year. Compare the Cash Value to the Premium. Just divide the cash value by the premium to arrive at the ratio of cash value to Premium. It’s important to not however, that the ending cash value includes the dividends for the first year. So obviously, if you were leveraging the cash value from the beginning of that year, you would not have earned that dividend yet. So that dividend should also be backed out. That is especially true when 2 illustrations use different growth rates.
How Does A Poorly-designed Policy Impact The Double Play?
A numerical example will help illustrate why a poorly-designed policy is going to hurt your cash accumulation.
What we’re looking at here is a side-by side comparison of properly-designed Life Insurance and a poor Policy design. This is a very simple business model showing only the very first premium payment into a Maximum Over-funded Life Insurance policy. This is the basic Double Play model right here. The only thing we’re missing is subsequent premium in the years to follow. We’re just looking at that one year in isolation.
Assumptions
Let’s cover some of the basics for this scenario. We are assuming that the policy owner has $100,000 per year for Real Estate Investing. They have a choice of investing directly into real estate or investing in real estate with Life Insurance. The Table shows the results of that $100,000 going into a properly-designed policy and a sub-optimal policy. In Both examples the Investor is putting their $100,000 a year into a life insurance policy where the Cash Value is leveraged to invest in real estate. We need to know which is better.
Let’s assume that the Cash Value is earning a dividend of 6% and that the policy owner can get a Cash Value line of credit at 5%. The investor is going to pay 40% on taxes and they are making a hypothetical investment that returns 10%. So how is our hypothetical investor going to fare with a Poorly-designed policy?
Results
Let’s look first at the example of the poorly-designed policy. I’ve labeled this as the sub-optimal policy design. It has a Cash Value to Premium ratio of 65%.
It’s crucial to understand that nearly $35,000 is lost to the fees and expenses. That means less Cash Value available to leverage and less dividend crediting. So not only is there the initial $35,000 lost to fees, but the ongoing growth will be poor. In this example, the $65,000 earns a 6% dividend which is a dividend credit of $3,900. So that’s the Life Insurance on its own.
The investor uses their Cash Value line of credit to get a $65,000 loan. It’s important to understand that a loan against the Cash Value is use for investing in Real Estate with Life Insurance. If the investment made 10%, the investor will finish the year with gross income of $6,500. The loan interest is tax-deductible as a business expense so we subtract $3,250 interest expense from the income. The result is taxable net income of $3,250. In the 40% tax bracket they’ll be writing a check to the IRS for $1,300.
After all of that, there is $1,300 of profit left over. And since our Cash Value earned $3,900 during the same time period, our total gain was $5,850.
Infinite Banking, Bank on Yourself, etc.
It’s very important to consider that many of the trusted names in the business use these poorly-designed policies. To their credit, these policies aren’t really intended for investing in real estate. They are purposely left under-funded so that extra premium can be added later under the false pretense of “paying yourself interest”. It’s important to realize that these “interest” payments are really just excess premium. In a properly-designed policy, that extra would have been built into the policy Design.
Before we get too excited about our combined return, we need to consider what we would have made if we invested directly in Real Estate.
Are We Better Off Than If We Had Invested Directly In Real Estate?
So before we look at the properly-designed policy, let’s see what the results would look like if the investor invested directly in Real Estate instead. This will test if investing in real estate with Life Insurance truly makes sense, right?
In this example, the $100,000 will generate income of $10,000. Presuming the same 40% tax rate, the investor would have been left with $6,000.
This is more than the the combined gain of the Poorly-designed policy. It definitely was not worth all the trouble to set up the Policy, fund it, and leverage the Cash Value! Don’t give up hope yet thought! We haven’t looked at the Properly-designed policy yet.
The Business Case With A Properly-Designed Policy
What do the results look like if we utilize a properly-designed maximum over-funded life insurance policy?
It’s important to realize that we have much more Cash Value working in a Properly-designed policy. As the Table shows, we have access to an $85,000 policy loan instead of only $65,000. Again, remember that this extra $20,000 is exposed to Dividends as well as the outside investment.
Dividend Income
If we assume that the $85,000 earns a 6% dividend, we will finish the year with dividend credit of $5,100. So that’s the life insurance on its own.
Investment Income
Presuming the same 10% return we used in the other examples, the investor will finish the year with gross income of $8,500 instead of only $6,500. Since we borrowed more, we have a higher interest expense at $4,250. That leaves taxable net income of $4,250. In the 40% tax bracket they’ll be writing a check to the IRS for $1,700.
The Double Play!
Now when we add up the Dividend and Investment Income we get $7,650. Do I need to point out the obvious? I want to emphasize that is a higher return than the investor would have received from investing directly.
This simple graph shows the advantage of starting with 85% of your money. It is looking at just the first year premium over time.You can see that the investor achieves payback in one-third the time. The poorly-designed policy takes over 6 years to break even. The Properly-designed policy does it in just over 2 years. You can also see that the overall wealth accumulation is greater.
Give it time!
You may have noticed that even though we earned more, we aren’t back to $100,000 yet. You just have to have faith in the power of compounding interest.
It is important to understand that The Double Play results in a higher overall growth rate. You need to realize that the $7,650 Double Play income is 27.5% GREATER than the return achieved by investing directly in Real Estate. That means that over time, the combined growth will quickly and inevitably catch up to and surpass results from investing direct.
We catch up to where our money would have been had we done the alternative!
The Double Play is an exercise in patience and the power of compounding interest. You have to be able to answer a simple question: would you rather have $85,000 growing at 7.6% or $100,000 growing at 6%?
Long Term Results
This graph shows why the Policy Design is such an important success factor for investing in Real Estate with Life Insurance. The graph is comparing each of the three scenarios over time. You can see in the first 10 years that the real estate-only option slightly outperforms. But as the graph makes obvious, you can see that the properly-designed policy significantly outperforms the alternatives over a longer horizon. It’s absolutely clear that powerful impact of compounding interest in the later years leads to greater wealth accumulation.
In this example, I had assumed that the interest was tax-deductible. This brings us to our key success factor number two: accessing the Cash Value in a tax advantaged manner.
Use a Cash Value Line of Credit
The next most important success factor for investing in Real Estate with Life Insurance is the Cash Value Line of Credit. It is crucially important to access your Cash Value in a tax-advantaged manner. In the previous example, I simply assumed that the interest was tax-deductible. But it’s important to realize that policy loan interest is not tax-deductible.
Policy loan are personal loans, not business loans. Because the entire investment gain could be taxable, you can see that we need to have the business interest deduction. Let’s look at the numbers again…
You can see how high the taxes are without the interest deduction lowering the taxable income (Sub-optimal). It’s important to realize that the business tax deduction is imperative for The Double Play. Without it, there is no point in using Life Insurance in your Real Estate Investing. You can see that after the loan interest and the taxes, the net gain after paying the taxes and paying the interest would be only $850. I want to make it clear that the interest deduction results in 3X the income. Compare the tables!
So how do we solve this problem? It’s important to know that some banks offer a Cash Value Line of Credit (CVLOC). The CVLOC is the way we get deductible interest. The interest is deductible because the loan is a commercial loan for business purpose. The bank uses an assignment of collateral against the policy for security. The assignment just means that the bank essentially holds co-owner status with the Policy Owner. The Policy Owner will need permission from the bank to make any changes to the policy.
Alright, so you’ve seen why you need to have a properly-designed policy and be able to deduct the interest. The last key success factor for investing in Real Estate with Life Insurance is the choice of policy type.
Use an Indexed Universal Life.
The final Key Success Factor is to use an Indexed Universal Life.
I try to be as unbiased as I possibly can. While The Double Play is certainly possible with either Whole Life or Indexed Universal Life (IUL), if you want to get the best results, I recommend the IUL. It’s important to realize that the IUL gives you the best opportunity for long term wealth accumulation.
The Cash Value of the Indexed Universal Life will almost certainly outperform the Cash Value of a identically designed Whole Life. The reason is that the Cash Value in an IUL has a better opportunity to outperform the Cash Value of a Whole Life. To understand why, we need to understand the internal mechanics of an IUL.
How IUL Works
The main thing you need to realize is that Insurance Companies DO NOT invest the Cash Value of an IUL in the stock market. It’s important to realize that up to the point where the Dividends are credited, both Whole Life and IUL function exactly the same.
You also need to understand that the Insurance Company’s reserves are invested in Bonds, Treasuries, Mortgage-backed securities, Preferred Stock, and some Private Investments. This is true for ALL Life Insurance companies. In previous blog posts, I showed the balance sheets from the insurance company annual reports. The Annual Reports show that they are all investing in the same types of debt investments.
It’s also important to understand that the Dividend Crediting is an allocation of the net gains on the Company’s reserves to each policy. That means that the Cash Value is essentially the Policy owner’s share of the Company’s reserves.
IUL and Whole Life differ only in the way that the Net Gains on the reserves are credited to each Policy.
is that the gains that would have been credited as a Dividend are instead used for hedging on Market Indices. The goal of this hedging is to capture as much movement in the market index as possible. It’s hugely important to understand that only the “Dividend” is at Risk. All of the Cash Value remains unchanged.
Caps and Floors
You may have noticed that IUL policy’s have a cap and a floor. The Cap and Floor are the upside and downside limits on the Interest Crediting. The Cap represents the maximum upside limit. The Floor is the downside limit. The insurance companies use options on market indices to capture as much movement as possible. The Cap and Floor are determined by the option pricing and availability.
The gains on their reserves determine the budget for options. When interest rates are down, dividends are lower and vice versa. Caps and Floors are highly correlated with the gains on the reserves. Caps will be lower when interest rates are down.
The main takeaway is that if the market goes down, then the options expire worthless. When this happens, the only loss is the income that you would have otherwise received as a dividend. While this may result in variable returns from year to year, long term performance is superior.
IUL Crediting Rates vs Whole Life
It’s important to understand that the goal of an IUL is not to match the market index performance. Instead, the goal of an IUL is to simply earn a premium over what the company would have credited as a Dividend.
Conclusion
If you want to leverage your Cash Value for Investing in Real Estate, It’s important to remember the 3 key success factors for investing in Real Estate with Life Insurance. It’s important to remember that for The Double Play to make financial sense, we need:
- A policy with the highest possible Cash Value per dollar of Premium.
- The Policy needs the best possible growth rate.
- The Policy needs the lowest possible expenses.
- Tax-deductible interest to lower the taxable income.
The way we meet all these needs is to make sure that we are:
- Using a Properly-designed, Maximum Over-funded Policy. This will maximize Cash Value and Minimize Expenses.
- Use an Indexed Universal Life for best possible growth.
- Use a Cash Value Line of Credit instead of Policy Loans.
[1] Note: this graph is based on a different set of assumptions where the poorly-designed policy is capable of still generating some positive growth.
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No Rendering of Advice: The financial content in this document is provided for your personal education. It is not intended for trading purposes, and cannot substitute for professional financial advice. Always seek the advice of a competent financial advisor with any questions you may have regarding a financial matter. Information in this document is not appropriate for the purposes of making a decision to carry out a transaction or trade nor does it provide any form of advice (investment, tax, or legal) amounting to investment advice, or make any recommendations regarding particular financial instruments, investments, or products.
The sole purpose of life insurance is for the death benefit protection. Any other benefit is ancillary.
