The Cash Flow Banking Process is simple, but it takes time. Here’s how it works:
You plan an annual savings amount, and purchase a Participating Whole Life policy to maximize cash value at a time when you think you will next need the money. It could be next month, or in 10 years.
When you need to spend the money on things like cars, vacations, or RRSP contributions, you borrow from your insurance policy as a policy loan, and make a plan to repay the loan. In the meantime, the cash value in your policy is still growing tax-deferred at an attractive rate.
Once the cash value of the policy exceeds approximately $25,000, you can elect to borrow from a bank using a secured line of credit, rather than from the insurance company directly.
When the cash value of the policy is small, you will borrow from the insurance company at approximately 7% (in 2016) when you need to finance something. Once the cash value exceeds about $25,000, you can usually borrow from a bank using the policy as collateral, for about prime + 1.5%. When the cash value exceeds $100,000 you should be able to borrow at prime+0.75%. Obviously, this is not too good to be true but it is attractive.
The long term internal rate of return on your premiums is expected to be 3.5%-5% depending on the age at which you take the policy out. Not stellar, but keep in mind that the growth on cash value is 100% tax deferred. Compared with today's savings account rates of 1%, .3.5% tax deferred looks pretty attractive.
|If you borrow:||And your expected Internal Rate of Return of Cash Value from premiums is:||Your net cost of borrowing is approximately:|
|From the insurance company at 7%||3.5%||4.5% Your policy is growing around 3.5% and you are paying 7%|
|From a bank at 3% with a collateral loan||3.5%||-0.5% Your policies cash value is expected to grow faster than the loan interest rate.|
If you have a better source of financing than those options, such as a Manulife One line of credit, of course you will use that instead of a policy loan.
Case Study – Young Professional
A young professional Candace has just started her career as a computer programmer. She anticipates spending about $5000 a year in vacations and thinks she will buy a used electric car in about 5 years for around $20,000. Candace also thinks she should make RRSP contributions, but isn’t concerned about maximizing them. Including RRSP contributions, she thinks she can save around $20,000 a year.
Candace elects for a participating whole life policy that maximizes cash value now. She decides to commit $10,000 a year to the Cash Flow Banking Strategy by purchasing a participating whole life policy, and $10,000 contribution a year to her RRSP.
Each year, when Candace goes on vacation, she pays for everything on her credit cards. When her credit card bill comes in, she immediately borrows the funds from her insurance policy, and makes a plan to repay that loan over the next 6 months.
Based on projections, she anticipates she will have enough money to pay for the car purchase. In year 10 she can borrow close to $90,000 for a down payment on a home.
Case Study – Building a Cash Flow Solution for a Grandchild
A grandparent decides they would like to create a small legacy for a 10 year old grandson. The child’s parents are already taking care of RESP contributions. The grandparent instead decides to allocate a $20,000 lump sum to build a cash flow solution for the grandchild. No more contributions to the strategy are required. They elect for a solution that has lower cash values in the early years , with higher cash values year 20 and beyond.
When the child becomes an adult and needs to finance tuition, vacations, or a down payment on a property, they can borrow against the policy, and repay their loan. In the meantime, the policy cash value is growing each year without attracting tax or requiring any premiums. The policy cash value is expected to grow faster than the collateral loan (based on 2016 interest rates and dividend scales).
When the child finally retires, they can borrow against the policy as a source of tax-free cash flow to fund their retirement.
|Grandchild's Age||Projected Cash Value||Internal Rate of Return on Cash Value|
(Based on Equitable Life Estate Builder with premiums due for 20 years, current dividend scale, $1150 annual premium, in Sept 2016. ).
© 2016 Doug Ransom - Insurance Advisor