Don’t Interrupt Your Compounding


Journal & Topics Media Group | Serving Chicago’s Great Northwest Suburbs

January 2020


by Chris Everett

Let’s take a look at the cost of interrupting the compounding in your investments.

  1. Borrowing from your 401k is a no-no!  So many believe that borrowing from their 401k is borrowing from yourself?  Not true.

Figure 1 is a chart of Tom’s retirement plan.

He’s been saving $500 per month for the last 20 years.  He ends up borrowing from his plan every five years or so.  Each time he does, he has the next five years to pay it back plus interest.  The interest goes to the lender, not him.  The result: he literally starts over every five years.

If we assume Tom makes a 6% rate of return on his account, he would have had $220,714.  But, because he continues to interrupt the compounding in the plan by borrowing, after 20 years he only has $33,823.

All that borrowing cost him $186,891!  That’s a huge loan cost no one ever explained to him.

If he only put half as much into his plan and didn’t borrow against it, he would have $110,357.  It’s not enough, for sure, but it’s 33% better than his previous strategy.

He is better off saving the other $250 outside of his plan in an emergency account.  He should also hire a fiduciary financial planner to learn other ways to plug all leaks he’s created.

  • A 529 Investment Plan (Figure 2) is more costly than you were ever told.   You should save for college, just not in a 529 plan. When you contribute to age-based 529 investment plans, the investment mix starts out more aggressive and over time become more conservative.  That’s why it’s not uncommon for those plans to average about 4% long term. 

If you invest $500 a month in a 529 Investment Plan and agree to increase your contribution each year by 3%, in 18 years, you’d have $184,113.  Not bad if you only have one child to educate.  They can withdraw $39,000 with a 3% annual increase for four years.  Looks like a successful plan, right?  And there’s an extra $35,504 left over if your student attends for an extra year – which happens all too often.  The plan is interrupted at the very time it was about to really take off and grow.  They would have $387,898 at retirement. Of course, they couldn’t do that.  #3 below offers a better way.

  • Use a Properly Structured Cash Value Life Insurance instead. To make it properly structured, sacrifice death benefit for maximum cash value.  Most agents won’t show this to clients because it lowers their commission. But it’s how to get more for your money. 

My client Nancy, a 32-year-old new mom in excellent health, will put $500 a month into her cash value policy for only 17 years and will have a death benefit for life. Her policy has a death benefit of $816,585! 

When it’s time to pay for college and to protect the compounding in her policy, she will take a policy loan. This places a lien against the cash value but does not interrupt the compounding.  She borrows the same amount as the 529 strategy but will have $189,478 of cash still in her policy. After college, she will repay the loan back at $1,500 per month so it’s repaid before she retires. If she needs to stop or restructure the payment she can. At retirement, she will have $24,000 a year in tax-free retirement income with an annual 3% cost of living adjustment.  She and her family are much better off with the life insurance strategy.

Plus, she will have a permanent death benefit. After paying for college and taking years of increasing tax-free retirement income, if she lives to age 100, her death benefit is over $1.6m.

By the way, if she needs to access the death benefit during her lifetime for long term care expenses, she can.

Many people find this hard to believe.  I think it’s because they are used to outdated designs.  If structured properly, all this is possible.  Hire a fiduciary who is really on your side to make this work for you, not the insurance agent.

Bottom Line:  Stop Interrupting Your Compounding. I have happy clients . . . and I continue to love my job.

Stop Kowtowing To Your Banker

The Daily Herald Business Ledger

BANKING AND FINANCE: published July 19, 2019

by Chris Everett

Last week while listening to a client complain about the hoops his banker makes him jump through for an equipment loan, I asked him why he doesn’t do his own financing?

“I don’t have $125,000 laying around,” he said.

But he DID have it. He just forgot.

He forgot about the $300,000 growing in his cash value life insurance policy.

“But that’s for my retirement!” he said. “I’m going to get a tax-free pension out of that when I retire!”

I told him it was possible to have those insurance dollars do more than one job simultaneously. In fact, every dollar he was contributing to his cash value life insurance policy was already doing more than one job: It was creating a growing tax-free death benefit for his beneficiaries.

A lion’s share of the death benefit was available to him for long term care expenses. If he became disabled, the premium would be paid by the insurance company. If he needed a cash withdrawal or loan, he could get it in about 5 days. This safety cash was earning at least 4% plus a dividend tax free. Banks are not paying that. And when interest rates rise, the rate on this cash-stash would rise as well.

But for the immediate issue at hand, his need to borrow $125,000, I reminded him that a loan against his life insurance cash value is not a loan of that cash value. It’s a lien. Therefore, his cash value would continue to enjoy uninterrupted compounding. That’s “breaking news” right there. But I digress.

He smiled when I reminded him that the borrowing cost in his insurance policy was lower than the bank rate.

And while a lower interest rate may be enough motivation, the beauty of this strategy goes further than that.

Most obvious — You don’t have to kowtow to a bank any more to get the money you need. If the money’s there, the insurance company doesn’t care why you want to borrow. They don’t even care if you ever pay the loan back. The loan is collateralized by your cash value. Of course, it’s in your best interest to pay the loan back. Especially, in his case, since he wants to access his cash values in retirement as tax-free income.

Retirement Advantage — What if he ends up not needing to or wanting to take tax-free retirement income from the policy as planned? Those cash values give him another advantage.

What if he set up regular withdrawals from his market-based retirement account and the market corrects? He can call us to stop the regular withdrawal and instead, take the cash from his life insurance policy … tax free. Because it’s tax free, he can take less than what he needed to take from his Taxable Retirement Account.

Now he can wait for his retirement account balance to recover before he takes another withdrawal.

Most attractive — You can design the payback any way you want. For example, you might decide on a five, 10 or 15-year payback structure or even longer. You can even amend the payback structure any time you want — a great business advantage if or when you experience a cash flow challenge.

If you die during the loan, the insurance company would simply deduct the remaining debt from the death benefit.

Tax deduction — You can still deduct the cost of the loan as a business expense in the same way you would if you borrowed from the bank.

Interest Rate Changes: The policy loan rate remains constant, at least in his case. There are policies with variable rates, therefore understand your policy.

My client thanked me and walked out of the office with a bit of a pep in his step. I love what I do!