Debt Free

There is a little known financial strategy out there that will enable you to self finance major purchases and grow a solid financial asset base that you can borrow from yourself. It is not commonly used but also offers tax advantages and pays dividends to you. The dividends accumulate, tax deferred, until they are used by you in the future. Instead of carrying substantial consumer debt, you can be in debt to yourself while financing major consumer purchases such as education, motor vehicles, recreational vehicles, and, most importantly, real estate. That's right, you can use this strategy to self-finance investment real estate or property improvements.

What the hell is this new financial vehicle that offers so many important benefits? Well, it's not new at all, only little used. In addition, it's not for everybody, although it's probably a good financial solution for many people that are currently unaware of it. The more you finance consumer goods, and the more consumer debt you carry, the better a proposition it is for you. What the heck is it? It's the substantially over funded whole life insurance policy.

This is not an investment, it's also not a substitute for a retirement plan, although it's been sold as such by some. For that you should max out the matching of your company's 401K and probably have a Roth IRA. That too is not the best retirement funding solution for everyone. I digress, so back to the topic at hand. Correctly set up, however, such insurance plans offer some important advantages that are unobtainable to the common person virtually anywhere else. The key is the phrase “correctly set up”. That's very important. First, some of the benefits.

1 – Dividend Payments – While not guaranteed, historically these plans virtually always pay out dividends that are added to the cash value of the policy. They tend to pay out even in years when the stock market as a whole does poorly. Even better, these dividends are paid on the benefit of the policy, not the cash value, so no matter the funding state of the policy, you'll get the maximum dividend at all times. Your policy is contractually bound to increase a certain amount each year. Dividend paying whole life companies pay dividends if their investments outperform the contractual growth rate. As stated above this is not a certainty, but is very close to one. Once the dividends are paid, they are permanently added to your asset base and cannot be taken away.

2 – Tax deferred growth and other tax advantages – This is powerful stuff. Until you withdraw more money than you've paid into the plan, you pay no taxes! Once dividends and interest on the dividends accumulate, you'll be able to do this. The dividends left in the policy to purchase more insurance are not liable for taxes. If you take out the money as a loan, and you've set up your policy correctly, you'll pay no taxes on the money, either. You do however, have to repay the money. Remember you're paying the money back to yourself, not some bank or credit card company. Unlike liquidating part of a brokerage account to make a major purchase, you'll not get hit with capital gains taxes when taking a loan against your policy to use for the same reason. You owe no taxes on the money you withdraw from your policy until you exceed the amount you've paid in. Once you reach that point, you can begin taking loans against the policy, also without taxation.

3 – Your money stays your money. You get back the money that's paid in to the policy. Unlike paying principal and interest to a financial institution when you finance a purchase, this money stays with you. You now have a financial asset base you can leverage for additional wealth generation, tax free. If you have a brokerage account and you're buying on margin, your account can be called and you must pay everything back immediately. That can't happen here.

4 – Guaranteed asset growth – Your asset base is contractually guaranteed to grow. Remember, this is not an investment, and the rate of growth should not be compared to traditional investment. You're not using this as a substitute for your retirement account (you should still regularly contribute to your IRAs, 401Ks and other retirement instruments), it's for accumulating a financial asset to be used in making purchases you would have otherwise financed with credit cards and consumer loans. In addition one of the most powerful uses of the money is leveraging it for investment growth.

5 - Receive Dividends on the Full Amount – This is so important, I mentioned it twice. When dividends are paid, you receive dividends on the full amount of the policy, even if you've borrowed a substantial amount to use for investments or other purposes.

6 – Consistent Growth at Very Low Risk- Unlike the market, you'll receive consistent growth of your asset. That's important if the primary reason you're creating it is to use as a private bank or credit reserve. With your money in the market, you may need it during a down period. That's the wrong time to withdraw your funds, no matter how badly you may need them. With the market, the high return funds tend to have higher associated risks.

7 – No Age Limitations – Maybe you'd like to retire before you reach 59-1/2. If so, you'll not be able to touch your IRA, unless you want to take a major tax penalty. You can also begin withdrawing it after 70, if you'd like to, and are in a financial position to wait.

8 – High Liquidity – The assets in the policy are easy to get to. You can tap them virtually at will when you need them.

9 – Reliability and Solidity – A correctly chosen company will provide you with incredibly reliability and solidity. They will have provided unwavering growth for many decades, in some cases more than a century. This is obviously of the utmost importance in a banking and personal financial reserve system.

It all sounds pretty damn good so far, but read on. There are some powerful arguments for using these policies as one of the financial instruments in your arsenal. You also avoid all the problems associated with borrowing against your 401K, something you should think long and hard about before you try. To effectively use an insurance policy as a financial vehicle, you must make sure the policy is correctly set up in order to maximize the advantages. Now, I'm sure there are many out there who know more than I when it comes to setting up such policies, but here are some of the key points.

1 – Use Only ”Non-Direct Recognition” Insurance Companies – Failure to do so can result in your being penalized by the insurance company for taking loans against the cash value on your policy. That goes against the reason for perusing this strategy in the first place.

2 - The death benefit is secondary. That's important. You're still here, hopefully. You're want to be using this money for purposes here and now, so you need to structure this policy so it's what's known as substantially over funded. You pay in to maximize the cash value while minimizing the death benefit.

3 – Maximize the Cash Value With a Paid Up Additions Rider This also known as a PUP or OPP, depending upon the insurance firm. What such a rider does is to give you the option to pay into the policy in order to increase the death benefit and cash value. The money paid in not only increases the cash value, but also the dividends paid to you. As with the other monies, the cash value accumulates tax deferred.

4 – Don't Surrender the Policy, or You Will Owe Taxes – You want to borrow against the policy, not cash it out. If you do so, you will owe the government their fair share (no jokes please).

5 – The Policy Must Pay Dividends – That's vital to using this type of vehicle successfully. If you're not using a dividend paying whole life insurance company, this money system won't really work. Dividend paying policies are also known as “participating”. This indicates you are participating in the overall earnings of the company and are thus entitled to dividends based in some way upon the profit. The dividend payments that come in, weather you've borrowed against the policy or not, are one of the keys to success when using this type of financial vehicle.

6 – Use an Insurance Agent With Experience in This Specific Type of Policy – Remember, this is a bit unconventional and many agents may not be all that familiar with correctly setting it up so you maximize the financial benefits.

There are, as with everything in life, some disadvantages to the system. If you do decide to go this route, the key is to minimize them and maximize the advantages. For the purposes of using the system as your own, private banking system, the disadvantages are outweighed by the advantages for most people.

1 – It's Not Completely Free – Ah, but what is in life? In most cases, you'll pay a load or fee on some of the contributions, such as the PUA. These fees vary with the policy and insurance company, so shop around.

2 – You've Got to Pay Extra - To really make the system work you've got to accelerate the cash buildup, and thus the dividend payments you'll receive. The difference between the size of your asset will be huge by adding the PUA. Not a huge disadvantage, really, you just need to make sure you include the extra cash payments in your evaluation.

3 – In the Beginning You'll Pay in But Be Able to Take Nothing Out. - It takes a few years to build enough cash value in the system to get everything off the ground. If you need the money now, or in a few years, you may find this is not the proper system for you. The advantages after the first five or six years will more than make up the difference for most people, however. Typically the program will be funded to such an extent after the initial phase that you'll be ready to completely use the system.

4 – No Guarantees of Dividends – One of the key components that make this system so effective are the dividends paid to participants. These are not a sure thing, although historically they are very, very close. Just know they are not guaranteed.

5 – Lower Return Than You'll Get In Many Investment Plans – True, in many cases far lower. However, you also get a contractually guaranteed return, so you have lower risk. Remember, you're not using this a long term retirement vehicle.

6 – Not a Universally Approved Solution – If you find one of those, be sure and let us all know about it. As with everything, some people have had great luck and swear by it, while others pan it. Much of the “luck” is due to the care which was taken setting up the plan to be sure it matched your needs. Not all insurance agents are up on the finer points of correctly setting this up. As with everything, some are more qualified for setting up this specific type of policy than others.

I'm no expert on such things, so you can get more information on this at the following places:

Here is an excellent website set up by a computer engineer who has one of these policies.

This is someone who has a great report on the subject, although they are definitely selling something, somewhere.

Here is a lively discussion in the comments to a related post over at Blueprint for Financial Prosperity.

Here is a white paper on the subjectfor you to peruse.