The Access Tax: The Cost of Money You Can't Touch
An often-discussed benefit of the life insurance contract is the ability to access your capital without underwriting. As with all decisions on where to allocate resources, we must evaluate in comparison to other comparable options. This exercise uncovers stringent restrictions on accessibility and usage. The goal of this post is to get you to think like a banker; in the same way that we call inflation a ‘hidden tax,’ we must think of the ‘access tax’ as the penalty we pay for lack of access to our capital. This is a tax that can most accurately be quantified by estimating the lost opportunity cost inherent in tying up capital for future use. The hypothetical nature of an estimated counterfactual does not lend itself to being input as a specific value that one can plug into a spreadsheet, but it is an important consideration nonetheless. Fortunately, we are able to input this variable of estimated lost opportunity cost in the software we use with clients, so we can more thoroughly gauge the future impact of decisions made now.
Compared to What?
As always, we ask, ‘compared to what?’ When first considering a change of financial paradigm to foundational whole life insurance, the first inclination is to compare the growth of cash value to the rate of return of various investment products. It takes understanding of what we are trying to do in order to see the error in this comparison and appropriately categorize insurance as a savings vehicle to be held up against products such as high yield savings or money market accounts. These vehicles offer liquidity and guarantees (to the degree one trusts banks and FDIC insurance), but they suffer from the same flaw as every other (non-whole life insurance) vehicle, which is the single-use nature of the capital. When the money is withdrawn and deployed for its intended purpose, it leaves your personal economy in a direct exchange for the product or service for which it was withdrawn. You have a vehicle, for instance, but no longer have the money used to acquire it. This restriction aside, they do not suffer from the access tax problem which is our focus here.
There are, however, some savings vehicles which do impart the access tax. Vehicles such as certificates of deposit (CDs) restrict liquidity by imposing penalties for early access. The problem of the access tax fully takes its form when capital is placed in qualified plans, which is where most adherents to the conventional financial planning models begin their economic order of operations. You are to max out your tax-advantaged buckets first, then put the remaining ‘savings’ into a taxable brokerage account, the growth-only focused planner advises. In full servitude to ‘the market,’ which we depend on to perform as we hope it might, we set up recurring contributions and that money is diverted into its decades-long prison before we even get a chance to miss it.
If one has no other use for that money in the meantime, and no desire to learn about the process of banking, cash flow, and the control thereof, this plan might work fine. Of course, its success depends entirely on forces outside one’s control; but if there is no intention of asking how capital might be better utilized, it is perhaps the best someone can do. Given the abysmal savings rate in America, forced ‘savings’ might be the highest value usage of that capital for the disinterested. (Savings is in quotes because money exposed to the market is of course not savings, but investing, and often mere speculation).
Optimizing the Financial Order of Operations
Our clients, and those who strive to understand their capital and their role in its proper stewardship, ought to recoil at the idea of forfeiting control, access, liquidity, and guarantees in such a manner. As with all our content, we are assuming a measure of genuine interest in optimizing the financial order of operations. As such, this way of thinking may be too much for some in your life who think outsourcing their finances to experts is the best they can do. To each their own.
But let’s attempt to put a number on the access tax in such a plan. I will use numbers from my own whole life policy to find this cost of capital, which will serve as a guideline for you to determine your own criteria for making this decision in the future. The first move I made using the contractual right to access my cash value was to invest in a real estate syndicate operated by another IBC practitioner. The terms were 10% annual return for five years, followed by return of principal and a proportional equity stake in the property acquired with the funds raised. The policy loan was granted to me, without underwriting and with no questions asked, at an interest rate of 5%. My spread on this was 5%, but my actual rate of return on every dollar paid in interest to the company was 100%. The loan was for $30,000 which meant my first-year interest came to $1,500; my first year return on the investment, however, was $3,000. So, for every dollar paid in interest, I netted two from the syndicate, thus the 100% return. By putting the entire $3,000 return towards the policy loan, I paid down the balance and reduced the interest accumulated the following year. With the return holding constant to a diminishing interest charge, the percentage return on this investment increases each year. (For more on this, see my How to Use a Policy Loan article, where I walk through this in great detail in an effort to explain the mechanics of a policy loan).
Whole life insurance is not an investment vehicle, but it can make your investments more efficient by leveraging the rights inherent in the contract. So while I was saving efficiently (and protecting my family), I did not restrict my access to that same capital, which was growing uninterrupted as I collateralized it to invest elsewhere. Knowing that any dollars I have in, for example, a high-yield savings account, could be in that real estate syndicate yielding two dollars for every one spent, I consider that the floor to my lost opportunity cost on dollars tied up in qualified or otherwise inaccessible accounts.
I have since acquired two rental properties using my right to access cash value. After paying off the first loan and adding two additional loans, my current total loan balance stands at $60,000 which generates $3,000 per year in interest. The rental properties are cash flowing to the tune of $500 per month, meaning that between the three investments generated by my cash value, I am netting around $15,000 per year on the back of the $3,000 paid in interest. The return on these interest dollars is 500%. I still maintain the 100% target as my cost of capital, as the 500% is cumulative of several investments made over time.
Think Beyond the Spreadsheet
The analysis above makes the decision of where dollars should start when they entire my personal economy a no brainer. Given what they could be doing for me in my system of whole life policies, that they might skip my control entirely and find themselves automatically moved into a qualified plan is unthinkable. That does not mean I might not decide to put them there myself, but it certainly will not be my first bucket to fill.
Retaining contractual rights to access my cash value without the restrictions, penalties, and underwriting that are present in any other financial vehicle or lending mechanism means I can optimally save, diligently protect, and safely grow my capital. I maintain liquidity without concern for what the market may be doing. The cost associated with lack of access to capital is not a definable number, but is most certainly a form of tax that must be considered when making decisions as to financial order of operations. When you set up auto-draft to the qualified plan, have you thought through the lost opportunity cost inherent in that decision? If you think of long-term financial decisions through the lens of assessing an access tax to the strategy, you will be more comprehensive in your analysis. This is not to say which buckets you need to fill first, or what your order of operations must be, but to ignore costs that don’t lend themselves to easy quantification is short-sighted and can lead to significant wealth erosion. When you work with Remnant Finance, we look holistically at your current situation and strategy to ensure that these hidden taxes are not working against you. Money is not math, and math is not money, but getting the math right sure helps!
