Using Leverage To Solve The Retirement Challenge

Consider this case: A husband and wife team has spent the last 15 years building a multi-million dollar real estate business. Through hard work, smart thinking and overcoming a few setbacks along the way, they built and manage a couple dozen medical office buildings around a Southeastern U.S. metropolis. 

While the rents provided a solid revenue stream, at every decision point the couple elected to reinvest in their business rather than set something aside for retirement. Capturing immediate opportunities today always outweighed the long-term planning required to meet future financial needs. 

When the couple finally sat down with a financial advisor, they determined that they would like at least $150,000 per year of income during their retirement years—or for at least 25 years. 

The husband and wife decided their best course was to allow their business to borrow $1 million to fund an equity indexed annuity that they would use to jump start their retirement savings. Over a two-year period, from early 2008 to early 2010, the couple’s company paid $78,640 in interest on the commercial loan. During the same period, the policy credited $241,989. In the two years following the program’s inception, the positive balance from interest crediting to the policy versus the loan interest paid by their firm provided the couple with a 200 percent return. At a time when the markets were barely paying 5 percent, this was clearly an extraordinary result. 

This story is on its way to a happy ending, but that doesn’t always happen for entrepreneurs. Almost by definition, business owners are “doers” who focus all their time and energy on building their businesses and meeting the needs of their employees. It can be an awesome responsibility—one that successful small business owners take seriously. 

But the sad truth is that in all of the “doing,” too many small business owners fail to plan for their own future needs. It’s not uncommon to find entrepreneurs who, despite their business success, have no plan with which to meet their future financial needs. By investing in their business, they have left all of their economic eggs in just one basket. 

There are several retirement programs available to business owners. Each has its own unique benefits and drawbacks that need to be carefully assessed. Selecting the right plan is often far simpler than funding it. 

The most obvious—and most common—financing choice is, in many cases, the least attractive (and in some cases impossible). Harvesting cash from the business can deliver the monies necessary to fund retirement plans, but it may leave the business weak and reduce its sales value—assuming the cash even exists. 

Another alternative, however, has emerged that lets financial advisors and their business-owner clients get on track by unlocking value that is stored in the business. Most companies don’t realize that cash flow—income from the sale of products and services as well as lease or rental income—is an asset that can be leveraged for any legitimate business purpose, including funding the owner’s retirement. 

By allowing the business to borrow money to fund an annuity or universal life policy, the business owner can “front-load” his savings plan and, through compounding interest, have a much better chance of reaching his goals without undermining the health of his business. It also may be a cost-effective and tax-efficient way to move money out of the business and into the owner’s control. 

While the cash value of an annuity or life policy enjoys compounding growth, the business makes level simple-interest payments for the length of the loan. The loan is secured by an assignment of the fully collateralized policy and perhaps a general Uniform Commercial Code Form 1 filing notice. Some lenders may also require the business’ accounts receivables or the owner’s personal guarantees as collateral. In some—but not all—cases interest payments made by the business may even be considered a tax-deductible business expense. 

And when the loan comes due—in as many as 20 years—the client will still be able to sell all or part of a healthy business, retire the note from a side fund or from the growth within the product, or arrange other means to pay it off. Meanwhile, the cash value from inside the policy will provide supplemental retirement income to meet the owner’s needs. 

Leveraging assets to meet personal financial goals isn’t for every client; however, given the right set of circumstances, it can be a very effective tool. There are four keys to making this program work successfully. 


First, it takes the right client. 


The client needs to have a solid business with a steady stream of income in excess of what the company needs to pay its bills or grow. Other firm assets that are not already pledged as collateral elsewhere are frequently considered as well. 

In addition to lease or rental income, other types of assets could include inventories, holdbacks at auto dealerships, medical receivables including Medicare and Medicaid, and pre-need contracts at funeral homes. 


Second, the client must be comfortable with leverage. 


Most business owners are accustomed to using debt to cover start-up costs or acquire the equipment and workspace that helps their business grow. Unlike equipment, which depreciates over time, financial products are appreciating assets that will become more valuable as the years go by, making this an even more attractive option.


Third, it takes the right vehicles. 


The economics must make sense. To get the widest spread between loan interest and interest crediting within the insurance product, it’s important to start with a long term, simple, interest-only loan of 10, 15 or 20 years whatever the retirement horizon may be. Over time, products that enjoy compound interest will outpace simple interest products, even when the interest rates are at the same or similar levels. 

Purchasing universal life insurance policies or annuities offers a combination of low cost, tax efficiency, stability and principal protection. That last item—principal protection—is important to consider when principal loss is a concern, especially with retirement planning. As a result, clients benefit from the highest possible degree of security and potential for higher returns. 


Fourth, it takes the right partner. 


Look for a partner that is an established leader in this space or has established relationships with banks to provide the financing; relationships with legal and tax services to ensure each transaction provides maximum value to the client; and relationships with highly rated carriers to provide the carefully selected insurance and annuity products. It’s also important to work with a partner that has the experience to pull the deal together quickly and can make this program successful. 

Using leverage to fund a retirement plan is a frequently overlooked solution to the very common problem of starting too late on retirement planning. In fact, it really can be a smart solution for shifting dormant, non-productive assets into a more useful position for the benefit of the business owner. This approach keeps risk in check while still offering the potential for the same kind of returns any conservative client would expect to receive. 


Published by Broker World magazine's April, 2011 edition