The Beneﬁts of Leveraged Life Insurance For Real Estate Investors
Inﬁnite Banking Concept, Immediate Financing Arrangement, it goes by many names depending on who you ask.
I simply refer to it as “leveraged life insurance”
It can be structured in many ways, using different types of insurance products, but it almost always follows the same basic principals…
- Purchase a life insurance product with cash value
- Use the cash value as collateral for a loan
- Redeploy the borrowed money into another investment vehicle
What you end up with is (hopefully) a smart, tax-efﬁcient, and ampliﬁed rate of return, and a larger life insurance policy than you would normally be able to afford on its own.
The structure can be based on a single life, a joint life, a whole life policy, a universal life policy, a corporate owner, or a personal owner. The devil is in the details.
These are some of the most complex, but possibly most lucrative tax and investment structures available to Canadians. Generally reserved for sophisticated investors who understand the power (and risks) of leveraged investments.
AKA, your typical real estate investor.
Interested? Then keep reading.
Kim and Jake are a 45-year-old couple with two kids aged 15 and 12. They are seasoned veterans of the real estate game and have built a strong portfolio of rental properties over the course of the last 10 years. In addition to the rental properties, they have rather large deﬁned contribution pension plans, full beneﬁts, maxed out TFSAs, and a large pool of RESP assets for their children’s education fund.
Both Kim and Jake are high income earners paying tax at the top marginal rate.
They recently sold an under-performing property and received a modest inheritance from Jake’s uncle are ﬂush with excess cash.
Not interested in directly purchasing and managing any more properties themselves, they developed an interest in entering joint-venture projects with less experienced investors and high-yield second mortgages. They were conﬁdent that they could generate a long term 8.5% return on investment on such a strategy.
They had a budget of $50,000 per year for the remainder of their working lives for this strategy which they could easily meet as they had excess discretionary income every year and access to a pool of unused cash from the sale of their rental property.
Jake’s uncle recently passed away and Jake’s father was the estate trustee. Jake’s uncle was a successful real estate investor in his own right.
What Jake witnessed though was a bit unsettling.
Jake’s uncle did not plan his estate transfer very well. He had a will, but it hadn’t been updated in over a decade. He also had several extremely high value properties scattered around the GTA, some of which he had purchased in the 1980’s.
Jake’s uncle’s estate ran into the following issues:
- Tax issues: since Jake’s aunt passed away many years ago, Jake’s uncle was not able to achieve a horizontal transfer of assets to a spouse and his beneﬁciaries and estate trustee were SHOCKED by the amount of tax due upon ﬁling his ﬁnal tax return.
- Liquidity issues: Jake’s uncle had 3 children whom he wanted to provide for equally. 2 of his children were real estate investors themselves, the third had zero interest in real estate and preferred a cash inheritance.
This complicated the situation because the estate was ASSET rich but CASH poor, leaving very little to pay the massive tax bill and nothing to equalize the assets among the children.
The result was:
- Prolonged ﬁghting among the beneﬁciaries
- Signiﬁcant legal fees to rectify the situation
- The “ﬂash” sales of several high-quality properties to fund the tax bill and other ﬁnancial obligations of the estate
Kim and Jake were not interested in having history repeat itself with their estates.
TAXES, TAXES, AND MORE TAXES
Kim and Jake wanted to ensure their estate transfer was as smooth as possible. Their children were young, and it was hard to tell if both would be interested in managing properties down the road. However, they wanted to set their estate up in a manner that allowed for the creation of inter-generational wealth.
We sat down with them and prepared an estate tax projection…
The results had them absolutely ﬂoored!
We projected a modest 4% growth rate on their properties leading to a tax bill of just over $6 million.
HOW LEVERAGED LIFE INSURANCE HELPED
Lucky for Kim and Jake they were both young, healthy, and non-smokers. This allowed them to obtain a well-priced Whole Life Insurance Policy and implement an Immediate Financing Arrangement (“IFA” for short).
An IFA (sometimes called “Inﬁnite Banking”) is a strategy for families who:
- Have a need for a permanent life insurance policy to fund a significant cash need at death
- Have excellent cash ﬂow and/or a sizable pot of taxable investments
- Have access to investment opportunities such as business expansion, real estate, stocks, or other asset classes
The Immediate Finance Arrangement strategy offers advantages that may assist with cash accessibility while maintaining ﬁnancial interests and providing valuable life insurance protection.
Kim and Jake purchased a permanent tax-exempt life insurance policy. They made payments into the policy to create cash values and then collaterally assign the policy in exchange for a loan. The loan proceeds were to be reinvested to produce income from a business or property.
If the loan proceeds are reinvested, the interest paid on the loan and all or a portion of the policy premiums may be tax deductible. Kim and Jake, along with their advisors ensured the loan and the collateral assignment of the life insurance policy met all requirements for deductibility under the Income Tax Act.
The resulting structure looked like this:
$50,000 per year contributed to the policy over a 20-year period
A high cash-value, whole life insurance policy was chosen to maximize borrowing capacity
Upon the second annual payment Kim and Jake obtained a line of credit secured against the policy’s cash value
Kim and Jake immediately borrowed back the prior year policy premium and re-invested the cash into joint-venture investments, equities, and 2nd mortgage investments
Kim and Jake paid the monthly interest on the loan from their own cash-ﬂow, took a tax deduction for the interest payments along with a collateral insurance deduction, then borrowed back the after-tax cost of interest
The strategy provided the following beneﬁts:
- Allows for attractive 6%+ ROI on the CSV TAX-FREE
- Borrowing up to 90% LTV is smooth
- LOC not reported to credit bureaus in Canada
- Multiple tax deductions including:
- Interest deduction on personal taxes
- Collateral insurance deduction on personal taxes
- Flexibility to build diverse second portfolio including:
- Real-estate or JVs
- Second mortgages
- Any other taxable investment
In fact, the couple was projected to maintain excellent cash ﬂow and would only be out of pocket in year 1.
THE PROJECTED RESULTS
Based on the projections, the couple was able to simultaneously build:
- An attractive, tax-deferred, whole life policy
- A large and diversiﬁed investment portfolio
- Continued real-estate investment through joint ventures
The combined results were projected to be significantly better than either the insurance policy or the portfolio alone.
Are you frustrated with the level of tax you’re paying? Do you feel like tax advisors and ﬁnancial advisors aren’t speaking the same language? Are you often left wondering if you are leaving money on the table due to a lack of integrated planning?
Fabio and his team have been helping clients plan their tax, retirement, and estate matters since 2002.
If you’re interested in taking control of your ﬁnancial matters, then don’t hesitate to contact us directly for an initial conversation.
No cost, no obligations.