Sunday, March 04, 2018

Stacking My Investing Cash In Life Insurance

I didn't blog yesterday because of two things, the first being going to weekly coffee with my mom, and the other being that I spent the afternoon refreshing my memory on the benefits of a particular financial vehicle I own, a cash value life insurance policy.

Let's get this out of the way first: I don't give a damn what Dave Ramsey thinks on this topic. Period, end of discussion.

A few days ago I wrote about how legendary investor, Warren Buffett, is letting Berkshire Hathaway's cash position swell because he and Charlie Munger can't find any good deals they want to invest in. In 2017, they made just one acquisition and accumulated a cash position of $116 billion USD. That's unusual for Berkshire.

In that post I asked the question that others are asking, too: "If Buffett isn't buying, why should I?"

It's a good question, especially right now. The U.S. stock market is at all-time highs, interest rate hikes and inflation brought on by low unemployment and wage growth is probably on the way, and tens of thousands of workers of the Baby Boom generation are retiring, possibly prompting them to rotate out of equities.

I don't think this should be looked at as a recipe for disaster, like some do (right before a pop-up ad appears on their site offering gold, freeze dried foods, and heirloom seeds for sale). Rather, it's just going to be part of a cycle, maybe even something to be expected that goes hand-in-hand with demographic trends the world over. In any case, it makes the argument that perhaps the best thing to do for now is prepare for big opportunities.

As such, I've recently stopped making any asset purchases and have begun stacking cash instead. Basically, I want fast access to capital; I want liquidity.

I also want a decent return, at all times. "Cash under the mattress" doesn't generate a return. In fact, thanks to inflation, it actually loses purchasing power whenever it is not put to work somehow.

That's where my cash value life insurance plan comes in.

I've had this thing for six years now. Basically, I purchased it with a vague plan to use it for an "Infinite Banking" strategy. Also known as "Bank On Yourself," this is an approach to saving and investing some use where the particular features of a cash value life policy allow them to act as their own banker to themselves.

The quick version: cash value life insurance can be borrowed against. You can request a loan from the insurance company, which will lend to you at contractually guaranteed rates (it's part of the insurance contract) using the cash value in the policy as collateral. Because the loan is collateralized, the insurance company won't ask what it's for, there is no underwriting process, and they won't say, "no." The loan also does not appear on your credit report. You then use the loan proceeds to buy whatever, then you "pay yourself back" by not only paying down the loan principal, but adding additional funds to your policy by also paying into it the interest you would have otherwise paid to a bank. In that way, you are your own bank, your total borrowing cost can be the same as if you had borrowed the money from someone else, but you keep the profits from the loan instead of that someone else getting them.

Now, the key thing going on here is that the cash value inside of my policy is always there, no matter how much of it I borrow. That's because policy loans are borrowed against the cash value, not from it. This means that during the entire time I have a loan out, my policy's cash value continues to earn interest, just like it was before I took a loan.

Think about it. While I have loan proceeds plugged into something that's generating cash flow (or maybe my next car), and while I'm paying myself interest on the loan that would have gone to some bank otherwise, the full amount of my principal is continuing to compound. Had I saved up my cash in a checking or savings account, a retirement plan like an IRA, a certificate of deposit, etc., any borrowings from those kinds of accounts take my capital out and halt its compounding. Depending on the type of account and the nature of the loan taken from it, there can also be penalties and interest owed to the IRS; not so with mine.

These interest earnings I'm receiving daily within my policy (that's right, mine credits interest every single day) are also accumulating tax free. Right now with annual bonuses, my policy's interest rate is effectively 4.69% with a guaranteed minimum of 3%. Because this is tax-free accumulation, however, in my 2018 tax bracket of 22%, this is a taxable-equivalent yield of just over 6%.

Does anyone reading this know of a stable savings vehicle earning a 6% pre-tax yield that will continue to compound interest while it's leveraged into another investment?

Finally, in my later years, I can actually use this policy as a source of tax-free retirement funds, also by borrowing from the accumulated cash value. Life insurance policy loans do not necessarily need to be paid back. If you don't pay the interest on the loan each year, the insurance company simply adds it to the balance of the loan. If the balance of your loans ever equals the cash value of the policy, the insurance company simply closes the policy and pays off the loans with the cash value. If however there is still cash value left in the policy at the time of your death, then the loans evaporate and your beneficiaries receive the benefit payout, or in the case of the manner in which my policy is structured, they get the specified benefit plus the net amount of accumulated cash value. It's just a matter of timing the loans versus life expectancy and sizing them correctly, which because they are loans are not taxable as income. I can also do this any time I want to, not only after a certain age that the government decrees.

You can get close to this with a Roth IRA, but unless you liquidate everything in it and keep it in idle cash, you could face wild swings in the value of it during your retirement years, and unlike the capital in my life policy, yours would not be continuing to compound by any significant amount.

There's a few more benefits to this approach that I'm familiarizing myself with again, such as being able to structure the loans from my policy to a business endeavor in such a way that the interest paid to my insurance company and to myself are fully deductible by the business. Suffice to say, there are a lot of benefits to be had here. There are some costs, too, the chief one being the cost of the insurance itself. And that's where a lot of the critics of this method focus, by chanting the platitude that "insurance is for insurance, not for investing" and then comparing the cost of cash value life versus term life insurance. Without going too far into why they're wrong, I'll just say this: the kind of insurance I have should be called "life insurance," because I can use it during my lifetime, whereas the kind of insurance the critics prefer should be called "death insurance," because you can't do anything with it during your lifetime, only pay for it, and it only provides a benefit to someone else after you've died (assuming you don't outlive the term of the policy, in which case all of your money is just gone...).

Why haven't I been more aggressive with this asset of mine in the past? Well, basically it's because I haven't been thinking in terms of building up a war chest ahead of anticipated big opportunities. I do fund my policy monthly, but nowhere near the maximum amount that I can each year. I think from here on out, good markets or otherwise, I'm going to make it my default investment every time I allocate cash. After all, I'm not getting 6% with stable value and rapid, tax advantaged access to my cash from anything else that I have at my disposal...


For more info on this topic, you can Google "infinite banking" or, "bank on yourself." YouTube searches for this topic will turn up tons of materials, too.

Also, if this sounds intriguing to you, find an insurance agent who is familiar with these topics and work with them. Remember: the younger you start, the cheaper the costs and the more time your money has to compound.

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