Episode 27: HOW TO UPGRADE TO FIRST CLASS

Description:

The rich invest differently than the middle class and poor. In this episode, Tom speaks with Patrick Donohoe about advanced techniques of investing in life insurance that offer opportunities to expand wealth and reduce taxes.

SHOW NOTES:

03:32 – What Is The “99%-1% Rule?”

06:14 – How Can You Spend Your Money & Still Leave A Legacy?

10:22 – What Are The Benefits Of An ILIT?

13:51 – How Can Life Insurance Protect Against Bad Partners?

18:07 – How Can Life Insurance Protect Against Unexpected Business Obstacles?


Learn more about Patrick Donohoe at https://paradigmlife.net/about/patrick-donohoe/

Transcript
Announcer: This is The WealthAbility™ Show with Tom Wheelwright. Way more money, way less taxes.

Tom Wheelwright: Welcome to The WealthAbility™ Show, where we’re always learning how to make way more money and pay way less taxes. Hi, this is Tom Wheelwright your host, founder and CEO WealthAbility™. Right off the bat, I want to warn everyone, this show is not for everyone. This is only for people who want to be elite investors, who want to do what the rich do on a regular basis. This is not for those … Let me put it this way. It’s not for those who want to sit in coach, and they’re content to do so. This is for those who want to live life in first class, and want their children and their family to live life in first class. Now everyone can do this. The reality is most people will not do this.

Tom Wheelwright: Today I’ve got a very special guest who can explain what we’re talking about better than anybody I’ve ever worked with on explanation, and Patrick Donahoe, who is the founder, president of Paradigm Life, I’m going to let Patrick introduce himself in a second, but I just want to give a little bit of background. Patrick’s, in full disclosure, Patrick’s one of my very best friends. We do things together. We do things together as couples. And Patrick has a knack for explaining how to use life insurance of all things, life insurance to really create a legacy and allow you to really spend your life in first class. And then we’ll also talk a little bit about, all right, what do you do to protect your business from unwanted partners? So Patrick, welcome to the show and thanks for being here.

Patrick Donahoe: Tom, it’s an honor to be here, and I’m so excited for your podcast. I mean, I would, I would echo everything back to you. I mean, you have taught me more about a wealth building and about financial philosophy than anyone. I love our conversations, and it’s one of those things whenever I get to see you, I’m just itching to dive right into the deep end.

Tom Wheelwright: Well we do dive into the deep end. We’re gonna dive in the deep end a little bit today. So that’s kind of fun. I try to keep … I want this show very accessible to everyone, and that’s why I want you to explain this stuff because you make it accessible. At the same time, this is stuff that really, not everybody does, and it’s not like mainstream stuff. So really want to talk about that. And we talked about some of the basics of life insurance with Kim Butler, and I know she’s your mentor. And she did a terrific job on our podcast a few months ago talking about the basics of life insurance. I don’t want to talk about the basics today, except for one thing. The one thing that you taught me, Patrick, and that’s the 97%, 1% rule. So just remind everybody what that is.

Patrick Donahoe: Well, I would say first it’s 99 and 1% is, has to do with the type of insurance that’s out there. The 1% statistic has to do with the insurance that most people purchase, which is term insurance. Typically, when somebody is purchasing insurance, they want the most amount of coverage for the least amount of price. That’s why term insurance is so attractive. But yet none of it ever pays out. And that’s why it’s so low in price. But yeah, if you look at permanent insurance, which is what most wealthy dynasty families purchase, big business owners purchase, that always pays out. I know that that was one of those initial conversations that we had when a light bulb went off.

Tom Wheelwright: Yeah, for sure. I mean, you know, when you start saying … Well here’s what you’re talking about. You’re talking about the difference between an expense and an asset.

Patrick Donahoe: Exactly.

Tom Wheelwright: Because if you’re looking at term insurance, this is an expense. So you want to keep the cost down as much as possible, because you’re never going to collect on that. Less than 1%, I mean, when you told me less than 1% of term insurance collected I’m going, “Wow.” Okay. And then when you told me that more than 97% of whole life insurance is collected, I’m going, “Okay, well that’s just expense versus asset.” So the question is, what do you have? Do you have an expensive or an asset?

Tom Wheelwright: Now I’m at that age, now you’re a lot younger than me, and so you’re not thinking about this yet, but I’m at that age where it starts getting a little tougher to get life insurance in the first place. This whole idea of permanent life insurance is … It actually becomes … It’s not as attractive when you’re young, but young’s when you have to do it. Because when you get older it gets pretty … It gets a lot more expensive.

Patrick Donahoe: Yeah, you’re … And that is, it’s a common perception. And I look at insurance companies and they have it together. They have equations, they have knowledge about a person’s medical situation, height and weight and other statistics that … It does, it’s when you get older, you’re closer to passing away, and they understand the different parameters there. So they’re very, very protective of who they approve and who they don’t just for that very reason.

Tom Wheelwright: Right. And it’s a time, value, money. I mean, let’s face it, I’m a lot closer to payout than you are.

Patrick Donahoe: Yeah.

Tom Wheelwright: So let’s talk about, just conceptually about not the basics of life insurance, not just having some money set aside et cetera, but we use life insurance a lot when we’re doing estate planning. And what I love is, is the idea that if I have life insurance, maybe I can leave a legacy and still spend all my money. You and I have talked about that. Can you just go into that a little bit?

Patrick Donahoe: Sure. I mean, we break down the different stages of when life insurance is purchased by three main stages. The first is the growth stage, second is the income stage, and then the legacy stage. In growth stage, that’s where, when you do start it younger, there’s ways in which you can set it up so that you have really high amounts of available cash, liquid money to be able to use for various purposes.

Patrick Donahoe: And then you get into the income stage is where this is, it’s an asset, it’s used a little bit differently. First off, you can take withdrawals tax-free, and you can also use that as kind of like a balance between the other assets that you have. So if you have some taxable assets, some tax deferred assets, and then now you have tax-free assets, it really helps you to navigate the tax efficiency that will exist when you are using that money to live off of, when you’re actually financially free and you’re taking some of the assets and cash flow that you’ve established during the growth phase.

Patrick Donahoe: And then the legacy phase. I look at legacy is, it’s both when you’re young and when you’re older, because I’ve … It doesn’t happen that often, but I’ve seen young families lose the bread winner or lose the stay at home parent. And I get to see that. And even though there is a very low probability of that happening, establishing something right out of the gate where you have a permanent asset that will transfer to someone, it helps alleviate anxiety and alleviate some emotions that are … They exist when you do investment, when you take on debt, when you take on business partners, when you take on liabilities, the debt is there, and it really, if something were to happen prematurely, knowing that something is going to pay out helps alleviate that anxiety and makes you a better producer as a result.

Tom Wheelwright: That’s exactly right. And then when you get to my age and you’re going, “Okay,” so now you’re looking at spending what you’ve accumulated, and I’m going, “Okay, now if I … I want to take care of my kids. I want to make sure that if something happens, I take care of my wife. I want to do that.” I’m really thinking about, okay, from a legacy standpoint, I want to make sure that my kids, because I have one child with some special needs, and I want to make sure … And you never know when somebody’s going to have special needs. You never know when somebody gets in an accident or has health issues. But I’m going, I want to make sure that they’re taken care of. But at the same time, I want to spend my assets. I mean, I want to enjoy life. My mother, she had a plan. Her goal in life was to break even. So she didn’t want to leave us with any debt, but she really didn’t want to leave us with any assets because she wanted to spend the money. She goes, “I taught you guys well, I got you established on your own. Now that’s up to you. I’m going to spend what your father and I have built together. We’re going to spend it together, and we’re going to enjoy life in our later years here.” And that came actually pretty close to a break even.

Tom Wheelwright: Other people want to leave a legacy, but you can leave a legacy and still spend it. That’s one thing that I think the wealthy really understand that the average person doesn’t is that having a policy that’s actually substantial, A, first of all, life insurance proceeds are not taxable. Okay? They’re not subject to income tax. So that’s the first thing. But second of all, it’s not that hard to set it up so they’re not even subject to estate tax. All right. We have what we call … Patrick, you use it all the time is an irrevocable life insurance trust, what we call an ILET. And basically the kids own the life insurance. You fund it, the kids own it, and it’s out of your estate. So it’s not subject to income tax or estate tax. And really there’s not a lot that you can say that about. I mean, life insurance is one of those odd animals where you get estate tax and income tax, and fairly easily.

Patrick Donahoe: Yeah. We look at it as that’s like the … It’s your legacy asset once it’s set up, and you hit on some amazing points, Tom, which is people accumulate wealth, they accumulate their assets over the course of time to live off of those at some point in the future. But yet it’s interesting just to see the psychology where they’ve accumulated for so long, it’s become like a habit. And then at the end it’s very difficult for them to take distributions from it. But what the insurance does is it acting as a legacy asset now opens up so many possibilities with spending down assets, using the reverse mortgage on a primary residence, selling business interests, selling real estate interests, because you’ve delegated this insurance policy as the transfer asset. The asset is going to pass on.

Patrick Donahoe: But it also could be the asset that’s used last. If you spend down and extinguish all the rest of your assets. This is the last asset that you can use there.

Tom Wheelwright: Well that’s the other nice thing. As opposed to a qualified plan, like an IRA or a 401(k), which everybody knows how I feel about those generally, as opposed to that which you have to take down and you have to pay tax on when you get older, you turn 70 and a half, you have to be taking that money out. With life insurance you don’t, okay, but if you want to, you can. And when you do take it out, it’s tax-free. So this is like, to me it’s a bit of nirvana from a tax standpoint, because you can have it be the legacy, but if you choose, you can actually use it up tax-free before you die. Right?

Patrick Donahoe: Yep. Absolutely. And then, we haven’t even discussed the loan provision side of it, which was instrumental during that growth period of time. But that’s the benefit of this very versatile type of asset where it has multiple uses depending on the stage of life that you’re in.

Tom Wheelwright: It does. So let’s talk about a use that very few people ever talk about, and that is the use of life insurance to protect yourself from unwanted partners. Now I’ve had a lot of partners over my career, and I’ve had some really good ones and I’ve had some really bad ones. But at least I chose my partners. I can’t think of anything worse than having a partner thrust upon you. Okay. I want everybody to picture this in your mind. All our listeners, picture this. You have this business, and this is your baby. I mean, I know. I mean I sold a business just a year ago or so, and it was hard. It was hard because that was my baby. I mean, I had worked at that, I devoted so many hours to that. And even though I sold it, and I did so voluntarily, it’s still my baby.

Tom Wheelwright: Can you imagine, you’ve got this business that you’ve built up, you’ve put your heart and soul into it, okay? I mean, sometimes 80 hours a week, heart and soul into it, not taking distributions for months. And then your partner, who is a terrific partner, has an accident, has cancer, or just dies. And then all of a sudden your partner’s spouse, or ex-spouse, or children become your partner, because guess what? You have no provision to buy them out. And in fact, there may even be a buyout provision, but you have no weight to execute that buyout provision. And Patrick, I think that’s where you come in, right?

Patrick Donahoe: Yeah. You’ve probably seen way more nightmare stories than I have. But this essential … Every business starts out with the best picture of the future. Things are going to go great, we’re going to make a ton of money, we’re going to live forever. But rarely does that ever work out. And obviously with somebody passing away, that’s one thing. But even, I heard one of this guy going really delusional and gave the interest of the business to his religious leader, and the religious leader became the partner.

Tom Wheelwright: Oh my goodness.

Patrick Donahoe: It totally took the business out. So it’s one of those things where it’s an instrumental document, and the most popular way, and I would say the most lucrative way to fund it is through insurance, where you have the insurance essentially funding whatever the buyout clause is.

Tom Wheelwright: Right. So let’s walk people through this, because I always want to make sure that people have something tangible to take away when they’re listening to The WealthAbility™ Show. So let’s say that you’ve got a partner, and you’ve got a limited liability company. So you’re going to have an operating agreement. And that operating agreement is going to say in the operating agreement, what happens when somebody retires or dies or goes bankrupt. Okay? Those are the three big ones. There’s also what happens if you have a dispute. But let’s talk about the what if they die. Okay, because if they retire, you’re going to pay them out over some period of time and you’re going to … That’s what you’re going to do. If you have a dispute, you’re going to do the same thing. If they go bankrupt, hopefully that just means you’re going to take it over. But let’s say they die.

Tom Wheelwright: Now, what are you going to do? Now you could put in there a similar provision like the retirement. Now the goal of an operating agreement is twofold. One is it tells you how you’re going to operate. But the other is, is it’s really the goal of an operating agreement should be to protect the business. Okay? It’s not to protect the members or the owners, it is to protect the business. And I hope everybody will write this down. The goal of an operating agreement is to protect the business.

Tom Wheelwright: What we want to do in that buy-sell agreement when we have a death potential is first of all, we need to come up with what’s the value going to be, and then how are we going to fund that? Now, the reality is, is that when you have a death, you actually have two issues going on, all right? The first is you have an estate, so whoever the heirs are of that partner, they’re now your partners. Okay? So you have to find a way to, how are we going to buy them out? But there’s something else that’s happening too. And that is that you have a funding need because presumably your partner wasn’t just sitting around twiddling their thumbs. Presumably they’re actually working in the business.

Tom Wheelwright: I think about my partner Ann, and she’s brilliant, okay? I mean, she’s, fortunately, she’s young, she’s healthy, et cetera. She’s a lot more worried about me dying than I am about her dying. But at the same time, let’s say that … I mean, if she were to die, the business would be in a world of hurt. Let’s face it. Because we would have to replace her, and that is not an easy task. She is literally the smartest person I’ve ever met in my entire life. And to replace somebody like that who handles all the systems, all the back office stuff, is not an easy task, and it’s going to take time and it’s going to take money. And where do you get the money to do that?

Tom Wheelwright: Having that life insurance policy on … We have life insurance policies on each other. That life insurance policy, part of that money, yes, part of that money is to go to buy out her heirs, presumably her husband, but it’s to buy out her heirs, buy that partnership interests. But the rest of it is actually to be used in the business to protect the business while it keeps going. So Patrick, there have got to be even other … I mean, are there even other uses that you can see for those funds that are so important?

Patrick Donahoe: No, absolutely. I mean, you hit on the primary ones. These are fundamental business agreements that I would say are rarely set up, especially with smaller businesses. But yeah, you’re hitting on the one that I see the most, which is a partner that passes away or becomes disabled or their cognitive ability is no longer there. So insurance can you essentially buy that out, whether it’s a disability policy or there’s a different rider for insurances to essentially fund disability. But then you also have the cash side of things, where you can fund these type of policies and build cash value, which can then be used for the business in a variety of capacities, typically through a loan.

Patrick Donahoe: But also one thing that, as far as Ann is concerned or any primary key person in the business is, you have to replace them. And that might take hiring a headhunter, it might take months, it might take years. And so essentially the capital that comes from insurance will essentially bridge that gap that’s clearly going to result in a financial loss. And that’s why the insurance company, that’s why there are provisions in the tax code that allow for a lot of tax benefits associated with this, so that business, as you said, operating agreement protects the business so the business isn’t disrupted.

Tom Wheelwright: You know-

Patrick Donahoe: Or at least it mitigates the disruption.

Tom Wheelwright: You make a really good point, Patrick, with the cash value of the life insurance, which I really hadn’t keyed on. Let’s say that they are disabled, so they can’t continue to operate. Now you have really two issues. One is you really need to get them and their family some money so that they can pay for whatever their care is. But the other is, is that you need to be able to replace them et cetera. Even though you’re not using the life insurance proceeds, rather you’re using the cash surrender value of the life insurance. So this is a bit of a cash reserve, really in your business. And there actually was a nice court case, I don’t know if you saw this the other day, Patrick, but you can use … If you use a split dollar, and this is the type of thing that, by the way, the wealthy use all the time, split dollar, and you can talk to Patrick more about it offline. But if you use split dollar, you have the cash reserve in the company, and the term, part of it, is actually considered a distribution. It’s not even considered income to the partner who’s on that policy, who might get some of the benefits of that policy.

Patrick Donahoe: Yeah. Well the biggest case that’s ever been done with using split dollar is Jim Harbaugh. So it was … Who is coach of Michigan, highest paid coach in history I think. A lot of his compensation came through insurance. It covers multiple things. It’s obviously to cover the replacement of him, but it’s also to fund some retirement benefits for him. But the university keeps a lot of the ownership of the insurance up to a certain level, which ultimately helps to replace the money that they paid out to him as a coach.

Tom Wheelwright: Oh, interesting.

Patrick Donahoe: So it’s one of those things where it covers multiple aspects of the contract and the financial commitments they made to him.

Tom Wheelwright: Well that’s fascinating. I hope you all have just gotten a little bit of a taste of … We think, unfortunately we think about life insurance as, first of all, we typically think of it as an expense as opposed to thinking of it as an asset. And then we start thinking about it, okay, we can use that, we can use it for investing and stuff like that. But we rarely think about it for things like how do we protect our business? How do we protect ourselves from unwanted partners? How do we protect ourselves even from a downturn in the economy so that we have, that legacy stays in place and we can spend all our assets. I mean, there’s all these other uses of life insurance. So I love it as a, really a hugely, a tax-free, should be tax-free, a really a tax-free way to do a lot of things that you’re going to want to do in your life.

Tom Wheelwright: Patrick, thank you for being on. Would you give everybody, how can people contact you?

Patrick Donahoe: Probably through our website is the best way to learn more. It’s paradigmlife.net. And then our phone number’s there, our email addresses are there, but we also have a lot of video resources that explain a lot of what you guys have been hearing today.

Tom Wheelwright: Oh, awesome. This is something I know about Patrick, and I really encourage you to go to, it’s paradigmlife.net, because Patrick does a lot of education of his clients. And that education is available. So Patrick, I want to thank you for all of the financial education that you provide to myself and to the rest of the world. Thank you so much for being on the show. It’s absolutely been great having you.

Patrick Donahoe: It’s been awesome, Tom. I’d have a conversation with you every single day if I could. Honestly talking about this, it’s the business that has really helped. My life, because I see so many applications too, and I get to create value in a number of capacities. It’s one of those things where it’s a very misunderstood asset. It’s not even really looked at as an asset by most people. But it really comes down to your and I’s perspective of finance and wealth is that it’s not done the typical way if you want to be successful, and thinking outside the box is paramount.

Tom Wheelwright: That’s right. Thanks Patrick. Remember, this is the stuff that the wealthy use. I mean, wealthy the people always do this. I mean this is not even a second thought. I work a lot personally with pretty wealthy individuals, and they’re always using life insurance in some capacity. Okay? So this is something, this has advanced. I get it that, you know what? This is again, not for those of you who want to sit in coach, but if you really want to live life in first class, if you want to live life to the fullest and have the assets that you really want to be able to do what you want, not what you need, like financial planners would tell you, but what do you want? Then this is just one of those strategies. And when you do a strategy like this, you’re always going to end up paying way less taxes and making way less money. That’s way more money. Way less taxes. See you next time.

Announcer: You’ve been listening to The WealthAbility™ Show with Tom Wheelwright. Way more money, way less taxes. To learn more, go to wealthability.com.

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