Hopefully, you have thought of some ways to improve the banking performance of the logger’s situation. Here’s another one – look at the cash value at his age 65 on page 62 — $3,518,411. Suppose that he sells his logging business to a young man that we will call John. About the only value that such a business has is the residual value of the equipment. But he says to John, “You are a young man, John, just starting out in the logging business. I logged all my life and, let me give you a word of advice. That equipment is going to wear out and you are going to have to replace it at regular intervals. Let me finance it for you. I’ll give you a half-point under the market. Of course, I will make you buy C&C insurance to protect me against loss. I can even handle that, too, and give you a better deal that you can get elsewhere.”
In fact, if he wishes, our man can get into the business of financing anything that might come to his mind. Just use your imagination. Suppose that he finds a very good deal on a piece of real estate. With the cash resources that he has he can negotiate a very good price. All he has to do to get the cash is call his “gopher” at the insurance company and direct him to send whatever is needed.
You may have noticed that all the illustrations in the book are using dividend withdrawals to make the purchases of cars, etc. except this series on Equipment Financing. To understand all this, turn to page 55 and study the circle with all the arrows again. Notice there are two ways to introduce money into the pool of money – one is by paying premiums and the other is by making loans and repaying greater interest than the policy calls for. Pay very close attention at this point because it is extremely important – it doesn’t make all that much difference which method you use to get money into the pool. In fact, it is slightly more efficient to make dividend withdrawals for the major purchases, like cars, and pay premiums that are equal to, or larger than you would have to pay some finance company or bank.
Then, why is the logger using policy loans to buy the equipment and making loan repayments to the policy? Because he wants to own the bank (the policy) personally. Then he can buy the equipment, personally, and lease the equipment to his “C” corporation, which is a “captive customer” just like the example of the grocery store in Part I of this course. This strategy gives him an interest deduction for the policy loans because he made the loan for business purposes. He can depreciate the equipment over a fairly short period of time and recover his cost in it. Lastly, he can lease to his captive company and charge it more than normal price for the equipment needed in that business.
If he were to make dividend withdrawals to purchase the equipment, he could, indeed, depreciate the cost of it, and have the captive customer advantage – but he would not have an interest deduction for income tax purposes. This factor makes it more profitable to use the loan and repayment method in such a case as this.
This won’t work if he has an “S” corporation. That is not a different tax entity from him. If this presents a problem to you in your understanding of corporations then I suggest you read all of Robert Kiyosaki’s books where he stresses the value of “C” corporations.
The withdrawal of dividend credits method is much easier to explain and easier to understand. Therefore, all the illustrations in the balance of the book will use this method.
Finally, look at the income stream of $92,000 per year on page 54. That income is not taxable until he withdraws more than his cost basis of $160,000. Now, go to page 62 and look at that stream of income — $225,000. When does this become taxable? Same answer – when his income total exceeds his cost basis. Next, look at his Cumulative Net Outlay at age 65. It is $946,184. Now, subtract his original premiums for the first four years ($160,000) from that number and you have isolated the “interest” (it is really additional premium) that he paid his policy to finance his equipment. This figure becomes part of his cost basis and he gets it all back tax-free at retirement time.
By now, I hope that you realize the figures you see as to yield in cash values, death benefits, and dividends are not “set in concrete.” They will vary with the economic conditions of the times. But the largest factor is how the policy owner understands what is going on and how he utilizes the resource. If he will adopt all the suggestions to improve the performance that we have outlined in the last two lessons, then the figures you see on this illustration should be much larger. When you think all this through, I think that the figures should double!
This completes Part IV. We start Part V in the next lesson,