Real estate investors, more than others, perhaps, have difficulty getting comfortable with the capitalization period of a whole life insurance policy.
In this episode we break this down in detail and walk through a 30-year model of buying real estate with bank cash vs buying real estate using life insurance cash value.
You can see a full video of this analysis here:
- Hi everybody. This is John Montoya.
- And this is John Perrings.
- We're authorized Infinite Banking practitioners and hosts of 'The Fifth Edition'.
- In today's episode, we're going to dive into kind of a hot topic in the real estate world. And that's buying real estate with life insurance cash value. And more specifically, how can a real estate investor time their investments during the capitalization period of a life insurance policy? So let's jump in. I don't know about you John Montoya, but I get questions almost weekly from real estate people who learn about the infinite banking concept and they see the potential, but they wanna understand things like how to quote unquote "fund life insurance and what the process for getting money out of the life insurance policy to buy real estate is." And I'm kind of putting, little air quotes around "fund" and "getting money out". And that's because using life insurance cash value is a little bit of a different process. Well, it's a lot of bit of a different process than just putting money into a savings account. So things like funding life insurance and getting money out of life insurance are not really accurate terms. And so what we wanted to do is talk a little bit about that today. Explain why we're not really funding a policy. What we're doing is we're creating another layer and we're creating a layer of capital to make the real estate acquisition process more efficient.
- Yeah, absolutely. I liken it to a train that goes from point A to point B and they do it on rails. And so what we're establishing are the rails for this financial system that helps you get from point A to point B, but do so in the most efficient manner that allows you to accumulate wealth the safest way possible.
- So let's review whole life insurance and the death benefit and the cash value components of it. So just in a few sentences, by the way, in this first little part here, go to 'thefifthedition.com'. We have whole episodes on what cash value is, what policy loans are. So we're not gonna dive into deep detail on those, but you can get all that information by listening to previous ones you can easily search on the fifth edition.com. So now that said, whole life insurance, what is it? It's a life insurance policy that lasts your whole life. It's guaranteed to pay out a death benefit when you die, not if you die, like what you have with term insurance. And because there's that guaranteed future cash flow, we have a present value of that future value and that present value is the cash value. So since we're talking about real estate today, it's kind of like when you make payments on your house, every time you make a loan repayment, you build up equity in your house, and it's kind of working similarly. Where every time you make a premium payment in a whole life insurance policy, you're building up equity in that policy, which is really equity in that future death benefit. And that's what's called the cash value or cash surrender value. And that's the amount of cash that the insurance company will pay you if you decide to surrender the policy and that cash value is what we can use to buy other assets where we find arbitrage to buy assets. That's really what the infinite banking concept is all about is using that cash value, finding arbitrage and more efficiently using capital.
- Yeah. And the way that we wanna do it, a really quick high-level overview, we wanna speed up this process of creating equity and these whole life policies. So we do that with the use of a paid up addition writer, because the more cash value that we have, the more opportunities we're gonna be able to take advantage of. So John, why don't you talk about the break-even period? Because I know that's definitely, always top of mind for most people getting started with IBC.
- Yeah. And I would say it's even more top of mind for people who are real estate investors. And so what happens in the early years of a whole life insurance policy, when you pay premiums, the present value of that death benefit is not equal to the amount of premium that you've paid in. And so there's a slight loss of liquidity in the early years of the policy. And this is where real estate investors get a little hung up because they see they're paying a premium and they don't have all of the, what they paid in the premium and available as cash value. And let's say, $20,000, you might have $10,000 of cash value in the first year, just using round numbers. It can be higher than that, can be lower than that based on your age and your health and all that stuff. So there's usually a break-even point that happens where you have as much cash value available on the policy as what you've paid cumulatively in premium over the years. And let's just say, and this is a whole thing where people argue about this on YouTube and stuff. Let's just say that takes 8 years to accomplish. What will often happen is real estate investors will look at that kind of first year of what they've put in and they see that they have maybe half or 60, maybe 70% available in cash value. So that's kind of a big loss in liquidity in that first year. And then they'll take a look at the break-even point and they'll see it takes 8 years to break-even. And they'll just kind of in their head, they'll be like, "Man, I'm just dumping money into this thing. And I don't break-even for 8 years." They view that as a lot of lost opportunity costs where that money could be going to buying real estate. And it's sort of true, but it's also, there's more to it than that. And it's not as bad as what people think at first glance.
- From my end of the spectrum, thinking about mindset because that's always very important for me and how we think. I'll always encourage people to come into this thinking longterm, especially for real estate investors. Because for a lot of real estate investors, they're working with other people's money. When they have a project or an investment they're gonna make, they're oftentimes leveraging not their own money, but other people's money, maybe bank money in order to make that purchase. And so they're really only making a return by flipping that property. And there's really 2 ways to make money as a real estate investor. One, on the difference between what you buy and what you sell it at, but also on the financing, too. The long range view that any investor should take is to be able to profit from both sides. I think of the first home that I bought up in Sacramento and that house purchase was 276,000. And when I looked at the mortgage note and what I'd pay for that house over 30 years, what was interesting to me is that the bank financing that mortgage actually would make well more than what KB brothers did for building that house. And that was a real eureka moment for me. And I think for anybody listening, real estate investors especially, you have to think like how bankers think. And they're in it for the long run. They're in it to make money off of money. And if all you're doing is making money from flipping a property, then you're missing out. You're leaving money on the table because there's additional gains that can be made, but it happens over a longer period of time. So when you're looking at these policies that are designed to maximize cash value, even if immediately it doesn't build up quite as much cash flow as what you feel it should have, if you start to look at it from a longer timeframe, you start to see how the benefits long-term really outweigh the short amount of lack of liquidity that you might see in the early years.
- There's so much to it where if you can again, think long range. So if we go back to this idea of the break-even point, even before that break-even point, there's a liquidity break-even point, which is, maybe half that time. So maybe 3 or 4 years where, and again guys, these are all round numbers. It really does matter who the insured is in these types of conversations, but we're just trying to have a starting point for the conversation. But let's just say in 4 years, there was a point where every dollar that you pay in premium creates more than $1 of new cash value that's available for that year. There becomes a point where there's no liquidity loss in the policy. And so if we can think long range, like Nelson Nash says, 'instead of focusing on those first 4 years, what about the next 30 years, right?' Where if you can continue to make that premium payment, you have this insane liquidity engine that is the cash value. Because again, every dollar you pay in premium creates more than $1 of cash value available. There comes a point where every dollar you pay in premium, you'll have 4 new dollars of cash value. It just keeps getting better and better as the policy matures and becomes more powerful. But just quickly getting back to this break-even point where we're looking at this first 8 years. A lot of people see it and they just feel like they're dumping money into this thing, and it's just losing liquidity. But what's really happening. You could think of it almost as a static amount that is kind of going into an escrow account. Like you could sort of think of it that way. And it gets released in Year 8 and actually, slowly gets released before then, but it gets better and better. But instead of thinking about liquidity as going away, you can think of it as a static amount that you just don't have access to for the first few years of the policy. A couple other things to think about is like, yes, there's the liquidity that you need to buy real estate assets, but there's also the liquidity that you need in your operating account. If we think about the operating account, there's a certain amount that we expect to be pretty static in there, but we still need it in there just in case. Well, what if you just switched your operating account and started thinking of keeping instead of just having money sitting in a bank, or it's not earning you anything, now it's sitting in a life insurance policy, earning multiples over what it can earn in a bank and creating a death benefit that starts to create value for your future legacy planning. Those are a couple things that I think about when talking about the early years of a life insurance policy. And it usually just comes down to short term thinking. I mean, it's pretty crazy how people people are so locked in to the first few years of that policy. And they just, I mean, you're just going to miss out over the next 20, 30, 40 years of all the things that you can do when you have that permanent life insurance death benefit, it's insane how much value that brings 20, 30, 40 years down the road. A couple other things that pop up in discussions, people will say, "Well, you know, I put this money into the life insurance policy. I have this kind of capitalization period where I don't have all the money that I put in there. And, I could be putting in that into real estate and getting things like depreciation and tax benefits and all this other stuff." And it comes down to the same thing where it's like, "Well, you could still get all that. You could still get that." It's just you're changing where your money is coming from from a cash perspective. That's the only thing that's changing. You're not changing any of the tax benefits of buying real estate. And then the last discussion point before we get into a model that we've created, one thing to think about is, is all your money doing something in partaking in areas of the market that will be affected during the next market correction? And I would say most people, the answer is yes. And so when we talk about buying life insurance and adding that into your overall strategy, we're also creating something that has guarantees and that is not correlated to the market. I talk to people all the time and it's like, they completely forgot about 2008, right? And they're even doing stuff where their liquidity for their next purchase is coming through lines of credit on their existing properties. And even worse, their reserves are coming through lines of credit on their existing properties. And so like all of their liquidity. So it's like, you think you have a lack of liquidity buying life insurance. Now wait until the next market correction and all the lines of credit dry out, just like we saw a little hit that happened in COVID. That's gonna be a real lack of liquidity. So will you actually have real true liquidity that you have access to when there's blood in the streets and everything's on sale? That's when you're really going to want to have some liquidity. So those are just a couple of discussion points. I don't know if you have anything you want to add to that, John Montoya.
- I would only add, since we mentioned how IBC is the safest way you can leverage an asset because the collateral for an IBC policy is a guaranteed contract. So unlike any type of bank line of credit, which is ultimately under the control by the issuing bank. With a whole life insurance policy, you have the collateral that is backed by your life expectancy. And this contract guarantees that the underlying asset, that cash value is guaranteed to grow every single year for the rest of your life or out to age 121, whichever is longer. So you have the best form of credit that you can possibly get and all without having to verify your credit scores, what your income is, how much you have in assets. When you want a loan from your policy, the insurance company only asks you two questions. How much would you like from your available cash value and which checking account on record should we deposit that money into? That's it. We talk a lot about on the show about how having IBC is one of the most peaceful outcomes that we can possibly bring into our lives, because we don't have that risk or worry about a bank suddenly freezing our line of credit. And the reason why is because we control our liquidity, we control our capital. And I don't know if you can really put a value on that other than to say that that amount of peace of mind goes a long way, especially as a real estate investor, knowing that when you need access to capital, it's always there for you at your disposal.
- Those are such good points. And you know, another way to think about that is when you're using lines of credit on your property, yes, you're getting leverage and you're getting the use of capital, but you're still just, it's all still in that same asset. When you look at using life insurance, you're actually creating a whole new asset that you can leverage. And it's a quote unquote, "diversified asset". If you want to have true diversification, you're not really diversified using lines of credit on your property. Again, there, it's not guaranteed just like John Montoya was saying.
- Right and I think maybe the word that you're looking for is uncorrelated, right? This asset class of life insurance is completely uncorrelated to anything that's happening in the real estate market, to anything that's happening in the stock market, to anything that's happening in Congress. This is an asset class that is basically insulated from all those things, because it's basically like in a silo or in a vacuum, and whatever's happening in the outside world, completely unaffected because the cash value as mentioned will grow each and every year. And that's why you really want to look hard at making this a portion of your portfolio, especially for that portion of your portfolio that is supposed to be safe and liquid. There really, in my opinion, is no better place to park that safe money than in a contract on your life where you have full control over it. And you can start to use it as those rails that I described in the beginning to help you acquire more assets, more real estate assets with in the long run.
- That's awesome. So one thing I do want to mention when it comes to buying real estate with IBC as your collateral, this is something that you should be aware of when making a deposit using policy loans. So if you're buying real estate and you're not paying a 100% cash, you're financing it, well, you have to come up with a down payment. And so what a lot of people will do who have established IBC whole life policies is they will take a policy loan for their down payment. And one of the things that I would like all the listeners to be aware of is that when it comes to sourcing that down payment, banks are going to ask, "Well, where did that money come from?" And this is really important to understand because banks don't understand how whole life policies work and the idea for a banker, a lender, your mortgage broker, to get through their head, that you can take a policy loan, and the repayment terms are completely unscheduled, it's a foreign concept to them. So, be aware when you take a policy loan to buy real estate and that policy loan is to be used for the deposit or for the down payment, just be aware that there has to be seasoning of the funds that happens. And so you want to make sure that you are very calculating in how you go about taking your policy loans to the point where you will take a policy loan, knowing that you're gonna use it for a down payment, let it sit in your normal bank account, checking account, savings account, whatever it is for at least 90 days, because those funds have to season, otherwise your banker, lender, mortgage broker, they're going to ask you, "Well, where did the funds come from?" And you might have to explain, "Well, this is from a policy loan." And then they're going to ask you, "Well, what are the payback terms? Cause we got to build that into your debt to income ratio." And when you tell them, "Well, I don't have to pay it back each and every month", they're going to scratch your head and ask for a copy of your contract. And they're not going to find anything in there either regarding regularly scheduled loan repayments. So do yourself a favor when buying real estate and using your IBC whole life policy as the source of funds for the down payment, make sure you season those funds for at least 90 days.
- And I already know, the reaction people are gonna have to them be like, "Well, I have to, I'm gonna have to have my money out of there for 90 days just sitting there." And it's like, well, yeah, but remember in the other, the other way, your money is sitting there the whole time until you buy a property with it. So just little things that people kind of come up with that I think it's good to make clear. So we're gonna get into a little bit of a talk through not so much a walk through since it's audio. This talk, I'm about to give, I created a financial model that I compared. Just because this question came up so much, I decided to actually model it out and say, "Okay, if I start from 0 and assuming the standard arrangement of borrowing 80% from a bank and coming up with the other 20% for a down payment. What if I compared $20,000 a year of income going in, coming into my financial system, and I compare taking that 20,000 putting it in a bank and then making a down payment to buy real estate over a 30 year period versus first taking that $20,000 paying a life insurance premium, and then using policy loans to buy the same real estate. I wanted to see what that would look like, and I want it to prove it out with the math and understand what those differences are. And so the rest of this podcast, I'm gonna do my best to kind of talk through the highlights of what I came up with. And there's a video that it's about a 20 minute video that gives a detailed walkthrough and you can actually see the numbers and see some like a actual presentation that I made. And that'll be in the episode notes of this particular episode. Let me talk a little bit about the overall picture of what we're doing. So we're comparing, taking money that we saved in a bank and making a down payment to buy a real estate rental property and investment property, right? And we're gonna get income from that property. And we're just gonna keep saving and all that money just keeps getting rolled in to buy more, more and more properties or bigger and bigger properties. So by the end of this model, I actually start getting into more of the commercial space. Versus using a policy loan, so we're gonna borrow money from the life insurance company, collateralized by our cash value. We're going to take that money, buy the same property. The investment property now has two loans to pay off. So the numbers have to work out where the rental income from the investment property pays the bank loan and pays your policy loan. So the net income is going to be less during that period of time, which I'm accounting for everything in this model is net. And I'm going to show you if you watch the video, how you will come out way ahead using life insurance cash value. And so one of the things to think about is that capitalization period, what are we actually doing there? We're starting a new business. And we just talked about this in the last episode, we're starting the business of banking, right? So if you actually started your own bank, ignore having to get a charter and all that stuff, would you expect to have all your money available back to you and on day one? Of course you wouldn't, you're starting a new business, right? When we're looking at the real estate investment, what we're doing, like who is making the returns on your real estate investment? Well, number one, you're making a return on your down payment, through the value of the house and the rental income, right? The bank is making a return on the money they lend you. And so does anyone have a problem with the bank making a profit on 80% of the purchase price? And I would say that most people are probably okay with it because they understand that using other people's money to buy assets helps them as well. And if that's the case, why is anyone putting up their own cash for a down payment? Why not finance the entire thing? And that's kind of what we're getting into here. And so I am going to pull up my presentation and just kind of walkthrough this. And again, the understanding of the capitalization period is the biggest problem where we had that first year, where we have in round numbers, 50, 60, maybe 70% of the cash value to the premium that was paid in. And then we have this 8 year break-even period. And they just look at this 8 years as they're just dumping money in here and losing liquidity that could otherwise be used to buy real estate. And so the first thing to understand is the cash value will surpass the bank account prior to the break-even point, even though you haven't broken even in the policy yet, because you're getting such superior growth that you're actually going to surpass the bank account prior to breaking even in the policy. The second thing to understand is there's gonna be a liquidity break-even point probably around half that time, maybe around Year 4. Every dollar you pay in premium equals one or more dollars in cash value, even though you haven't broken even cumulatively. And so the challenge is getting over this capitalization period. And if we look at it more as like, we're gonna take, let's say out of that $20,000 a year, that we're talking about $9,000 is going to go into an escrow account. This isn't what is actually happening. I'm just kind of comparing something and making an analogy. 9,000 of that first 20 is going to go into an escrow account and you're not going to have access to that $9,000 over the next 8 years. But every time you pay a premium, every year, you pay a premium that 9,000 that's an escrow becomes a less percentage wise of the cumulative that you have in cash value. You still have access to all that liquid cash value, less that static $9,000. Okay? So it's not, money's not just going in there and being lost. If we just compared cash value to putting your money in a bank. Over 30 years, you would have 2 million more dollars in your life insurance cash value if you didn't spend any of, if you were just saving. And so you'd have 2 million more dollars compared to keeping your money in a bank. And so I'm only saying this to open your mind to, would it be beneficial for your operating expenses to sit and cash value? Your operating account could be life insurance cash value, because a lot of that's just sitting there static not being used. And then if you add a death benefit into this, we're talking about $5 million over 30 years that would add to your estate. Let's look at the first 10 years where we're going to compare what's happening between buying properties with your cash, using a down payment of cash versus using cash value, life insurance cash value as your down payment. There is a delay in the early years, and that delay happens with that first property that's purchased. We're able to make the first property acquisition in Year 4 that got delayed by one year, to Year 5 using life insurance cash value. But every year after that, we're able to buy the properties at the same time. And so what happened is we bought 5 properties over 30 years, we're able to buy the properties at the same time. And then the fourth and fifth properties were actually able to buy a year ahead of time using life insurance cash value, because think of it, remember, think of it as like a line of credit, but the collaterals guaranteed every time the rental income pays back the policy loan, we free up more cash value to use again. And that's one of the ways, that's one of the things of where the infinite banking concept comes from. Because every time we pay loans back, we free up more capital to use again. The end result of this model is a $600,000 gain just in our cash, having all the same properties. We only had one delay in the first property. And at the end of 30 years, I have 600,000 more dollars in my bank account and all the same properties that we have. And then when I add in the life insurance death benefit that we created. So if you care about legacy planning, I have two and a half million more dollars going to my heirs in the form of a tax-free life insurance death benefit for creating a larger estate value. Again, two and a half million more dollars. I have all the same properties. I have $600,000 more in cash, and I have a two and a half million dollar death benefit, or excuse me, I actually have a $4 million death benefit, but that puts me two and a half million dollars ahead of the game than I would have if I had just paid for these properties out of pocket. And so that's sort of the high level overview of this model. I know that that's a little bit hard to follow. So I just tried to keep it at the most, very broad strokes. And again, head over to 'thefifthedition.com', go to the episode notes for this particular episode. And I'll have the video in there that you can watch and get a little bit more of the details. Anything you want to add to that, John.
- There's something I'm thinking about the seasoning of money when it comes to, taking policy loans and I'll add this, what is your rate of return on equity in a real estate property? Think about it. What do you earn on equity? The answer is 0. And the reason why I bring this up is when you pay cash for a property, the money that you put down for that property, it no longer earns anything. And I know cash is earning next to nothing these days, but you are guaranteeing yourself that money you tie up into a property is now earning nothing. The appreciation is going to happen based of market values, but your actual cash, your equity in the property is earning nothing. So to tie this back to why you would want to take a policy loan to use as a down payment is because guess what happens when you take a policy loan, you still have your cash value contractually guaranteed to grow from today to the next year and so on. When you leverage your whole life policy for that down payment, you are effectively allowing your down payment to continue to appreciate in value. And it essentially turns the real estate purchase into a 100% financing, but that's okay because wouldn't you rather have your equity earning a rate of return versus 0. I would. And that's really how I've made my purchases, including the primary residence that I live in now, 20% down payment borrowed from my whole life policies. And that way I have that cash that's working for me for every single year, for the rest of my life, versus sitting in the walls of my house, earning zero.
- Those are great points. And, it gets to the idea that a lot of people are getting into real estate because they view it as they're buying an actual heart asset, which is true. They can get a rate of return, they can get a return. That's good. That's kinda what everyone's shooting for. And the main thing is everyone's being pushed into taking risk because cash in a bank doesn't earn anything, right. That's really the impetus for most people's moves today. And they see no lost opportunity cost on that cash because currently there isn't really any, when you keep your money in a bank. And so the, the question becomes, "Well, what if your cash did have value? What if it did earn something?" And that's exactly what's happening with life insurance cash value. And so you have to change your mindset a little bit to where, sorry, but some of those gurus out there are not correct that cash does have value if you know how to strategically accumulate it.
- And like we always say, you'll never be in a worse position by having access to cash, right? So.
- That's right.
- Put yourself in the best position possible.
- Would you say, becoming your own banker helps you do that.
- Well, you know my answer on that. So yes, I absolutely, that's regardless of whatever is happening in the world, in the market, just having that access to an opportunity fund so that you can go out and buy real estate or whatever you want to, whatever opportunity you want to seize upon. It just puts you in a better position with more control and peace of mind. And as I mentioned earlier, you just can't put a price on peace of mind.
- 100% as they say in the emojis these days. So this was a little bit of a longer episode. Hope you were able to stick with us. And I hope this was valuable. Again, if you have any questions on how any of this pertains to your particular situation, you can head over to our brand new website, 'thefifthedition.com'. You can also go to this episode's show notes and watch a more detailed video on everything we just went over. And you can also get access to our new course soup to nuts, whole life course, fundamentals of whole life insurance. And you can get a 50% discount right on the front page. If you'd like to, if you're one of those types of people that likes to learn online, like I am. So thanks everybody. Hope you got something out of this.
- Thank you. Take care, everyone.