The problem with the typical retirement plan is that it focuses on long term savings. This approach emphasizes getting high returns on investments, and cutting back on expenses to create a bigger pool of savings. Instead, the key to creating sustainable income is to use current income to create more money today and in the future.
Of course, market and interest rate risks are still a consideration. But the following concepts are about cash flow, not growth. So investment returns are minimal, and the overall concepts are less volatile. Flexibility and access to cash is the objective.
1. Leverage existing assets. If you can borrow money at a rate that’s slightly less than what you can earn on an income producing investment, then you create a cash flowing investment. This can be used to build an income producing asset. The spread between borrowing and investing can be as little as 1%. The key is that the investments are not invested for growth. They’re strictly for cash flow. If you do get a bit of growth, that’s a bonus.
Aim for long term returns in the range of 5%. So if the cost of your investment loan is $100 per month on interest only, and you can earn $125 to $140 per month from income, then the extra $25 can be applied towards the principal on the loan or towards reducing non-deductible debt.
Read: Get out of debt without going broke
A client recently used this strategy. He had home equity but minimal cash, so he set up a line of credit for 50% of the value of his home and then invested 75% of that into an income producing segregated fund. This income covered the interest, plus some principal, on the line of credit. The client had access to cash to fund his lifestyle, and the line of credit paid for itself in 15 years with minimal tax implications.
2. Use savings to reinvest. A 60-year-old single, self-employed entrepreneur had $60,000 inside an RRSP. There was no way she could save enough to provide her with the $40,000 she currently needed for her lifestyle expenses. But, she could do this:
- Withdraw from her RRSP over five years for a net, after-tax monthly income of $792;
- Direct $500 per month of the net RRSP income towards an investment loan at 3.5%, and invest the $170,000 proceeds at 5% into a segregated fund; and then
- The net after-tax income on the investment is $500 per month, leaving a total monthly income of $792 per month. Finally, she can use these funds for lifestyle expenses, and to develop a product for her business so she can create additional income.
Her alternative to accumulate savings to provide $792 in passive income is to direct $1,589 per month at 5% towards her RRSP for five years. She’d end up with $170,000 that could be withdrawn over 45 years and would be fully taxable. But she’d have to sacrifice income today, and would not be able to invest in her business.
3. Insured retirement. This concept is one I learned over 20 years ago. It’s not relevant for everyone, but it can provide a cash flow solution. The concept is to direct the money a client is currently spending on life insurance towards a whole life or universal life policy. For example, if the insurance cost was $100 per month for $100,000 of life insurance, the cash value inside the policy over a 25-year period could amount to $50,000, or more.
This is the amortization many people have for their mortgages. So include the insurance/savings discussion when you’re talking to your client about a mortgage. Suggest buying term insurance, and investing the difference. Or create a complete package that builds an asset inside a policy, which can be used as collateral for a loan. This would provide your client tax-free income from the loan, as well as death benefits that would pay off any outstanding balance during the life of the mortgage.
4. Bank on yourself. This is another insurance concept involving whole life insurance. Funds are directed into the insurance policy for a short period of time. Then they’re used as collateral for a loan that doesn’t require conventional bank credit qualifications, and has flexibility on how and when it’s paid back, as well as what it’s used for. Plus, the money that remains inside the policy continues to grow.
Remember, this is a cash flow strategy. Say your client creates an asset inside the policy for $10,000. Then that asset can provide borrowing power for, perhaps, a car, an education or a holiday.
These are just a few approaches that reduce the emphasis on growth, and decrease expenses to plan for financial independence.