N.B. This concept is not original. It is adapted from an article written by the late Benjamin N. Woodson, CEO of American General Life Insurance Company.
Imagine walking into your bank with the following proposal.
Ms. Banker, I am interested in buying a vacant lot in town. I believe that considering the town’s current development philosophy, it has tremendous appreciation potential.
The reason why I prefer a vacant lot to a rental property is because any appreciation of the lot will not be taxed until I decide to sell it, whereas income from a rental property would increase my current taxable income.
At a purchase price is $275,000, I believe the property to be an excellent bargain, but I would like your bank to provide a written guarantee to financially protect me and to provide me with peace of mind.
First, I want the bank to finance this transaction, so that instead of paying the $275,000 in a lump-sum, I will make annual payments of $16,000, which equates to about a 6% interest rate.
Next, although I believe the property will be worth several million dollars in 30 years, I want the bank to guarantee that it will purchase it from me for $500,000, should it not be worth more and should I choose to sell.
I am prepared to accept a reasonable shrinkage in its immediate value should I choose to sell in the very early years, but I want a written guarantee that the land will have a market value proportionate to the guaranteed value of $500,000 that it will be worth in 30 years, and that the bank will buy it from me at that value any time in the interim, should I choose to sell.
Not wanting to burden my heirs with a transaction they are not familiar with, I would like the bank to guarantee that, if I die before 30 years, it will pay them not only the $500,000 it is guaranteed to be worth, but another $500,000 (a total of $1,000,000) in anticipated appreciation. Additionally, I would like the million dollars to be paid net of any taxes and/or transaction costs.
Finally, if I should die during the 30 year pay-in period, the bank will 1) cancel all remaining payments due on the loan, and 2) pay my heirs the fair market value of the property, but no less than $1,000,000.
Ms. Banker, if you will agree to these terms, I am prepared to move ahead with the transaction.
There is no banker in the world who would agree to such a preposterous proposition, but, as I’m sure you’ve surmised, all I’ve done is describe a whole life paid-up at age 65 life insurance policy.
So how is it an amazing deal if it is for a vacant lot but a lousy deal if it is for a life insurance policy?