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(posted on June 29, 2007)
By Lew Nason, President and Marketing Coach
Insurance Pro Shop
The goal is to convert the life insurance policy into
what is called investment-grade life insurance.
The over-funded life
insurance policy can then be used as
- a college funding vehicle,
- a
non-regulated retirement plan or
- a family bank — the infinite banking
concept — while providing families the valuable protection they need.
People have several major questions about this concept.
Does
it really work?
Is it truly in your best interest?
Is it just a scam to
sell cash-value life insurance and make higher commissions?
What
happens when the mortgage interest rates rise?
Does equity harvesting really work?
Does harvesting home equity to over-fund a life insurance
policy up to the MEC guidelines really work?
There are two major
aspects of this question:
1. Does removing the built-up equity in a home and then investing it make sense?
The simple answer is yes, it makes sense, as long as you can
make more on the money than it’s costing you.
For example, if you can
borrow the equity at 6 percent, invest it and earn more than 6 percent,
then you are making money. And, we are not even considering any of the
other very valid reasons that Missed Fortune and other books give for not leaving built-up equity in your home.
Important Note: Contrary to what most of the books written on
this subject tell you, in many situations you will not be able to
deduct the mortgage interest on the equity you borrow.
According to IRC
Section 264a(3)
“mortgage interest is not deductible on any amounts of
equity you put into life insurance, where the plan is to take out
tax-free withdrawals.”
IRS Publication 550 states that you cannot
deduct interest “on money you borrow to buy or carry single premium
life insurance, an endowment, or an annuity policy.”
IRS Publication
936 includes a phase-out of the mortgage interest deduction depending
on your income and other limits to what you can deduct.
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2. Does it make sense to invest that money into an investment-grade life insurance policy?
Again, the simple answer is yes; if you need the life insurance
protection for your family. You are going to pay for the life insurance
protection one way or another, so the best way to get the protection
you need is with a permanent life insurance plan.
The actual cost of
the life insurance protection inside of a cash-value life insurance
policy is much cheaper than buying a separate term insurance policy.
We
haven’t even taken into account the numerous tax advantages, the
flexibility and the safety of cash-value life insurance.
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Is equity harvesting truly in your best interest?
While there are many pros and cons — and some debatable
mathematics — with this strategy, the undeniable truth is that when
left to their own resources, most people are not consistently saving
for their future.
In many cases, people use their home equity as a
revolving charge account.
By taking the equity out of the home and
putting that money to work for you today, you are forming the habit of
saving.
By tying the payments to your mortgage, you are ensuring that
you will continue to make the payments in the future.
Plus, you are
creating a liquid safety net or emergency fund. When you have money
working for you, you will feel better and more secure about your
current situation and your financial future.
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Is equity harvesting just a scam to make higher commissions?
There are many people, both in and out of the financial
services industry, who believe in the philosophy of “buy term and
invest the difference” instead of purchasing a cash-value policy.
There
are two major problems with that philosophy:
1. The first problem is that it assumes people will buy the
term life insurance they need and then invest the difference.
When we
consider that there was a negative saving rate in the United States for
2005 and 2006, it becomes obvious that most people are not investing
the difference.
2. The second problem with this philosophy is that it supposes
that an investment that invests the difference will out-perform the
investment inside the life insurance policy.
Numerous studies over the
years, performed by many independent consumer research firms, clearly
show that the average stock market investor is only making a
two-percent to four-percent return on their investments after fees and
taxes, whereas the average internal rate of return for most cash-value
life insurance policies is above 5 percent.
And this isn’t even
considering the advantages of tax-deferred growth of life insurance and
the ability to take tax-free withdrawals.
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What happens when the mortgage interest rates rise?
If you decide to use an adjustable-rate mortgage, there are two primary concerns with regard to rising mortgage interest rates:
1. The first concern is whether it’s possible to make more on
the amount borrowed than the loan originally cost. Consider that
mortgage interest rates are a function of the financial economy and do
not rise independently.
As mortgage interest rates rise, so does the
internal rate of return of cash-value life insurance.
Mortgage interest rates are generally tied to an index and have yearly
caps as to the amount of mortgage interest that can be charged, so they
tend to rise slowly.
Over time, the spread between the mortgage rates
and the internal rate of return of cash-value life insurance may be
less and, in a few cases, may even go negative for a time.
However, the
considerable tax advantages that cash-value life insurance provides
will generally allow you to keep a net positive spread — even as
interest rates rise.
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2. The second concern is that your current income can support
increasing mortgage payments.
One of the many advantages of using
cash-value life insurance is that it’s liquid. Unlike most other
investments, you can access your money — tax free — and without federal
early withdrawal penalties.
So, if you need additional money for the
increasing mortgage payments, the cash value in the life insurance is
available to use.
Summary
-
Harvesting home equity and investing it into an investment vehicle
isn’t a new concept.
- It’s a time-tested, proven concept that the
wealthy have used for generations to keep their money liquid, so they
can take advantage of investment opportunities as they come along.
- It
has enabled the wealthy to accumulate vast fortunes even during the
stock market crashes, recessions and the Great Depression.
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The key to making equity harvesting work for you is selecting the right
type of home mortgage for your situation and comfort zone.
- You want a
mortgage with the lowest interest rates and fees you can find and are
comfortable with.
- Then, focus on selecting a competitive cash-value
life insurance policy.
- Don’t choose a life insurance policy based
solely on current company illustrations.
- Instead, find a company that
has a solid financial rating and a documented long-term history of
above-average product performance.
- When done properly, equity harvesting is an invaluable
financial concept when it comes to accumulating wealth.
- However, it
doesn’t stop there. It can also help use your home equity to reduce and
eliminate debt.
- You’ll free up your current income, so you are able to
put even more money away, and you’ll be on the way to securing the
financial future you have always dreamed of for you and your family.
I’ve been using this concept personally for more than 25 years, and I know it works.
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