Accelerating Retirement Savings With Leverage

It's a common tale. A small business owner has devoted his life to building his company. He's put every dollar he has into it and, in return, he's done an excellent job of providing a nice living for his family and his employees. But then retirement appears on his horizon, and he realizes that he's saved too little to retire comfortably or leave something for his heirs.

Usually, the only real course of action is to make the most of the existing assets. It can mean taking on more risk than is prudent to eke out slightly higher rates of return. Or worse, it can require harvesting cash out of the business in ways that leave it weak and reduce its sale value.

Cash flow as an asset

Another set of tools has emerged that let financial advisors and their business-owner clients get back onto plan 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 a 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 retirement savings and, through the might of compounding interest, have a much better chance of reaching his goals without undermining the health of his business. It's also a cost effective and tax-efficient way to move money out of the business and into the owner's control.

Consider the case of the restaurant owner. For the last 15 years, this businesswoman has successfully built a restaurant franchise group with multiple locations across the city. But while she paid close attention to the demands of the business, she ignored her retirement planning. Her current retirement savings were significantly behind her ultimate needs.

To supplement her retirement savings, the franchise owner and her financial advisor allow the business to take out a simple, interest-only loan for the benefit of the business owner. The owner, in turn, fully funds an annuity with a face value of $1 million.

While the annuity enjoys compounding growth, the business makes level interest payments for the length of the loan. The loan is secured by an assignment of the fully collateralized policy and perhaps a general UCC1 filing. Some groups may also use the business's accounts receivables or the owner's personal guarantees as collateral.

In some (but not all) cases these payments may be considered a tax-deductable business expense. This deal takes only 27 days to complete.

When the loan comes due, the client will still be able to sell her healthy restaurants, retire the note from a side fund or arrange other means to pay it off. Meanwhile, the annuity will provide the supplemental retirement income the owner needs.

Three keys to a successful program

Leveraging assets to meet personal financial goals isn't for every client. But given the right circumstances, this strategy can be very effective. There are three 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.

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

Second, it takes the right vehicles. The economics must make sense. To get the widest spread between loan interest and investment growth, it's important to start with a long-term, simple, interest-only loan of 10, 15 or 20 years--whatever the retirement horizon. Over time, products that enjoy compound interest will outpace simple interest products, even when the interest rates are the same or similar.

While the proceeds of this loan can be used to fund almost any retirement vehicle allowed by the U.S. tax code, only a few products actually meet the criteria. For the owner to gain the most, however, the program needs to be selective-it should only benefit the owner, for instance-as well as offer low costs and tax efficiency. Purchasing universal life policies and annuities offers a combination of low costs, tax efficiency, stability and principal protection. The last item--principal protection--is important to eliminate the risk of principal loss in a down economy. Clients benefit from the highest possible degree of security and potential for higher returns.

Tapping an established leader

Finally, 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 investment successful.

Using leverage to fund a retirement plan is a frequently overlooked solution to the common problem of starting too late on retirement planning. In fact, it really can be a smart solution to 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 same kind of returns a conservative client would expect to receive.

Alan M. Harrington, JD, is the president of Global Financial Distributors, Duluth, Ga. You can e-mail him at aharrington@globalfd.com.

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