Where loans can be accessed with interest rates less than 1%
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With the rapid rise of interest rates in the last year, many physicians might be interested and surprised to learn where extremely low rates still exist.
In this article, we will discuss why a physician might want to access a loan and at least one path that can offer locked-in interest rates below 1% annually.
Why a loan might make sense
There are many reasons why physicians may want to access a substantial loan. They may want to take advantage of a timely investment opportunity and do not want to sell assets that will generate capital gains to come up with the cash. We see this often in the form of deals involving surgery centers, med spas, real estate, startups and private business opportunities.
Beyond investments, loans can be helpful to physicians experiencing a large expense that was not properly planned for, including tax payments, medical expenses, tuitions or uninsured property loss. For these reasons and others, physicians often have a need for a large cash infusion.
One cardinal rule for investors wanting to generate cash is to avoid incurring a tax in the process, if at all possible. If they choose to sell assets to generate cash, between federal capital gains taxes, state taxes and Affordable Care Act taxes, a physician might lose up to 35% or more of built-in gains. Even in today’s volatile markets, many long-term assets have significant built-in gains from the asset price increase during the last 10 or more years.
Popular strategy
The practice of borrowing against an asset to generate cash for either expenses or investments is common. As discussed in previous articles, the wealthy often use a strategy called “Buy, Borrow, Die” to borrow against their assets to access cash and then have their heirs pay off the debt after inheriting the asset. This allows them to permanently avoid any capital gains taxes on a sale.
Even more commonly, real estate investors often build up equity in a piece of real estate, then borrow against it to buy the next piece of real estate and so on and so on. This is a popular way such investors fund and finance growth – by borrowing against existing assets.
Many physicians have implemented a version of this strategy by using home equity line of credits (HELOCs) and portfolio loans to access cash without having to sell the home or any part of the portfolio. It is the same concept.
Higher rates
This strategy has worked well for the last decade because interest rates have been low. That changed in mid-2022 when the Federal Reserve Board began raising the rates at which they lend money to banks as a tactic to reduce inflation. In the past 9 months, those rates have continued to rise causing common loan rates, including mortgages, HELOCs, portfolio loans and credit card interest, to escalate drastically as well.
Obviously, the strategy of borrowing against assets to generate cash becomes less attractive when HELOC, portfolio and mortgage loan rates have gone from 2% or 3% to 6% or 7%, which is exactly what has occurred in less than a year. In many circumstances, it makes the strategy financially unwise.
Taxes
What works now for this strategy? In other words, where can one access cash for extremely low interest rates, perhaps even below 1%?
A potential answer to that is permanent (cash value) life insurance policies. Under certain circumstances and with the right permanent insurance contracts, the policies themselves can be a source of tax-free cash when you need it. Let’s examine a simple case study.
Doctor Adam invested in a permanent insurance policy, putting in $100,000 annually for the past 4 years. The death benefit of the policy is now close to $2 million, and the cash value is in the mid-six figures. If Adam wants to access $100,000 in order to invest in a private equity deal he has been presented, he can borrow against that cash value. When choosing the insurance carrier and policy type with his insurance agent 4 years ago, Adam and his agent discussed the potential power of accessing cash values and, therefore, selected a policy that had a favorable policy loan rate. In Adam’s policy, he has a contractually guaranteed loan rate of 0.5% when he borrows against policy cash values – and that rate is fixed for the life of the contract. Adam can now borrow the $100,000 for 0.5% annual interest and can be wired those funds in 1 or 2 days.
Will Adam pay back the principal of $100,000? He certainly has the option to, at any time. However, if he does not pay the principal back, the insurance carrier will simply take it out of the death benefit paid to his beneficiaries when he passes away, as long as the policy stays in force. In this way, Adam has accessed part of the “death benefit” of the policy during his life.
In the short-term, physicians like Adam, who already have cash value life policies in place, might use their extremely low policy loan rates to access cash to pay down their variable loans, where rates have surged in the last year. This strategy can help borrowers significantly reduce the total amount of interest paid on HELOCs, portfolio loans, variable rate mortgages and more.
In the long term, these physicians know they have at least one asset on their balance sheet that can be an ongoing source of capital when they need it.
Expertise needed
While the strategy described in Adam’s case is simple, it is not easy. Professional expertise is needed to vet available policies from top carriers and, even more importantly, to design and manage a specific policy over time. Not all cash value policies work or perform the same. In fact, the opposite is usually true.
As an example, one large life insurance carrier whose products are popular among physicians has extremely high policy loan interest rates. This insurance company, which is well known and highly rated, typically has loan rates of 6%, 7% or even 8% in their policies, more than eight times higher than loan rates from similarly sized carriers. Often, physicians who own such policies have no idea about this discrepancy until they are years into paying premiums and look at taking a policy loan for the first time.
The good news is that, as long as your health is still good, you can make a tax-free exchange from a policy that has nonoptimal interest rates to one that has extremely low interest rates, without incurring any tax. This is called a 1035 tax-free exchange.
Conclusion
For the past decade or more, physicians and other high-net-worth investors have used the savvy technique of borrowing against assets to generate cash while avoiding taxes. Now that interest rates have risen so dramatically, this technique has become unattractive, unless one has a properly designed permanent life insurance policy. In this case, cash can still be accessed tax-free through policy loans, which are often at rates below 1% per year.
It is essential to work with an insurance advisor who is well-versed in the types and features of permanent life insurance policies so that you can have the option of low-interest policy loans as part of your long-term financial plan.
- Reference:
- Wealth Planning for the Modern Physician and Wealth Management Made Simple are available free in print or by ebook download by texting HEALIO to 844-418-1212 or at www.ojmbookstore.com. Enter code HEALIO at checkout.
- For more information:
- Sanjeev Bhatia, MD, is an Orthopaedic Sports Medicine Surgeon practicing at Northwestern Medicine in Warrenville, IL. He can be reached at sanjeevbhatia1@gmail.com or @DrBhatiaOrtho.
- David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm OJM Group, where Jason O’Dell, MS, CWM is a partner and financial advisor. They can be reached at 877-656-4362 or mandell@ojmgroup.com.
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