As technology continues to improve and people live longer, creative financial planners are finding alternative methods to help their clients live more financially comfortable lives.
One of those methods is accounts receivable financing, a strategy that allows an insured retiree to make cash withdrawals against a death benefit policy while still alive. The program is especially popular with physicians, as it includes a provision that protects assets against frivolous and nonmerited lawsuits.
“This is very exciting, and it’s going to apply to so many people,” says Rick Appel, CPA and senior vice president for Advanced Strategies Group. “It’s a tremendous way to accomplish many goals from current asset protection to providing future retirement income on a tax-preferential basis that has no equal.”
Smart Business talked to Appel about what makes accounts receivable financing work for physicians and business owners alike.
How does the program work?
A bank makes a noncallable note basis loan to the business, which could be an individual or professional corporation, a regular C corporation, a sub-chapter S corporation, a partnership or a limited liability company. The business would transfer the funds to the employee or physician, who would in turn remit it to a premium deposit account for the purpose of paying life insurance premiums. This would occur over a period of five years to fund the life insurance policy. The best type of policy is a global-indexed universal life policy.
The loan amount would be made on the basis of the accounts receivable of the physician’s practice or the business. A UCC-1 form is filed that provides protection from creditors on these assets, assets that normally aren’t productive and are usually converted to cash. We basically take that money and put it into the life insurance policy. Within five years, you will have a fully funded global indexed universal life policy. When the insured reaches retirement age, the policy will allow tax-free withdrawals that can be used to fund his or her retirement.
Each and every year, from the time of inception of the program until retirement, the cost to the individual would only be the annual interest payments on the loan. The benefits are tremendous because the interest rate is LIBOR a common benchmark interest rate index that’s used to adjust adjustable-rate mortgages plus 1.75 percent.
How are the life insurance policy’s crediting rates determined?
Three components make up the rate the policy earns and its cash value. One is Standard & Poor’s 500 Composite Price Index, which represents about 70 percent of the market cap of U.S.-traded companies. The second is the Dow Jones Eurostoxx 50, which are the leading companies in the Euro zone. And the third is the Hang Seng Index, which has the 33 largest Asian companies and is representative of the majority market cap for that area.
Each five-year interval has a five-year look-back period calculating the performance of each index. The highest performing index is weighted at 75 percent, the second-highest is 25 percent and the lowest is thrown out. The result produces higher interest crediting rates than other interest crediting methodologies by overweighing the best performing index. The difference between the interest paid on the loan and the crediting rate on the policy’s account value produces an arbitrage that has tremendous leverage.
Can you give an example of the program in action?
A physician is 42 years old and his practice’s average accounts receivable is $820,000 a year. He borrows that amount and purchases a $3.5 million death benefit policy. Over a five-year period, he puts $820,000 into the policy and each year pays $59,000 to carry the loan.
Assuming age 65 is retirement age, he starts pulling out more than $366,000 a year of the policy cash value on a loan basis, which is nontaxable, and he does this from age 65 to 85, which would yield a total of $7.69 million in nontaxable retirement benefits. The compounding is tremendous in a tax-free build-up inside the life insurance policy.
At the same time, he had a large death benefit that increased from the original $3.5 million to the time when he started making withdrawals. Over the years the policy was funded, he would have paid $830,000 in interest while pocketing more than $7.6 million in tax-free money.
He had the option of paying off the loan when he started retirement from the policy values or he could have paid it from other sources or waited for the death benefit to pay it off.
RICK APPEL is a CPA and senior vice president for Advanced Strategies Group. Reach him at (248) 359-2480 or RAappel@AdvancedStrategiesGroup.com.