As we continue to live through COVID-19, much of the US economy is hurting. However, a few opportunities have emerged, such as interest rates that—ultimately controlled by the Federal Reserve—are now at an all-time low. This government policy is intended to stimulate the economy and give businesses and individuals easier access to capital, and government officials have indicated that the policy will continue for the foreseeable future.
A near-0% interest loan policy benefits big banks, which can borrow at close to 0% and lend profitably, even at low rates. It also benefits big businesses, which can expand their operations with a near-0% cost of capital.
And ultra-low rates can significantly benefit ophthalmologists and their families. Here, we outline three ways they can take advantage of this situation, starting with the most obvious and popular, then moving to the more complex.
1. Refinance Debt
As mortgage rates have now reached all-time lows, most homeowners have already refinanced their home mortgage or are considering doing so. A simple financial model can calculate the long-term benefit of refinancing. Many websites have easy-to-understand mortgage comparison calculators, or a mortgage broker can provide this analysis.
The essence of this analysis is to compare an existing mortgage with a new mortgage at a lower interest rate. A thorough knowledge of the current loan terms (eg, prepayment penalties) and potential closing costs to secure the new mortgage is essential. The goal is to calculate the break-even point—the length of time at which paying the new lower-interest mortgage makes up for the one-time additional costs of changing the mortgage. Bottom line: If the loan terms are the same and you intend to remain in the home well past the break-even point, refinancing may be a good idea.
The same concept of refinancing can be applied to loans as varied as practice real estate mortgages, rental property mortgages, practice lines of credit, practice equipment financing, and even student loans.
Knowledge of your current loan terms, closing costs, and an accurate financial model are required to make these important financial decisions.
2. Use Premium-Financed Life Insurance
In our books and previous articles, we have explored the relative strengths and weaknesses of term and permanent life insurance (whole life, universal life, equity-indexed life, etc.). Bottom line: Significant tax, retirement, and estate benefits are offered by permanent life insurance.
Nonetheless, to build up large permanent policies that generate six-figure annual tax-free retirement income, ophthalmologists generally need to make significant investments into these policies for at least a few years while they work. Many physicians would like the tax-free retirement income but are averse to paying large insurance premiums.
This is where premium financing comes in. One can finance these policies during the funding phase, only paying a few percentage points in interest, rather than the entire premium. Then, typically 10 to 15 years into the plan, when cash values have grown, the cash value can be used to pay off the loan principal. What remains is a large debt-free permanent policy that can be used to generate tax-free income throughout the physician’s retirement.
Although this brief description glosses over a complex and significant transaction with a number of risks and success factors, the essence of it remains arbitrage; that is, growing the policy cash values at rates generally around 5% to 7% annually, which is higher than typical premium financing interest rates.
Today, those rates have plummeted, and some banks are offering rates below 3%, often with long-term lock options. As such, there has never been a better time to engage in this transaction since it became mainstream more than 25 years ago.
3. Leverage Intra-Family Loans for Gift and Estate Planning
Often, a core element of sophisticated estate and gift tax planning is making loans between family members. Unlike loans between unrelated parties, intra-family loans must charge a minimum interest rate specified by the US Internal Revenue Service (IRS) to make the loan legitimate. This applicable federal rate (AFR) is issued by the IRS each month so that taxpayers and their advisors can know exactly how much interest must be charged in these scenarios. In fact, the IRS issues three specific AFRs: a short-term rate (maturities of 3 years or less), medium-term rate (3 to 9 years), and long-term rate (maturities greater than 9 years). In January, these rates were 0.14%, 0.52%, and 1.35%, respectively.1
Although the specifics go beyond the scope of this article, there are myriad ways physicians can transfer wealth tax efficiently among family members, trusts, and partnerships when the interest rate on long-term loans is so low.
Such loans can provide tremendous flexibility for physicians who want to transfer wealth to younger family members (or to trusts for their benefit) but want a safety valve to bring the funds back to them in case they need it. A loan to the individual or trust can provide that flexibility. If the physician eventually decides that he or she does not need a portion of the loaned assets back, he or she can forgive the loan using gift or estate tax exemptions. If the physician does want the assets back, the loan can be kept in force. Either way, by making a loan while interest rates are so low, the family has built flexibility into its plans at the cost of a tiny interest rate dictated by the IRS.
Conclusion
All retina specialists should determine how they can best capitalize on today’s historically low interest rates. For many, one or more of these tactics may be beneficial. As always, when implementing any of these options, be sure to work with a trusted and experienced professional advisor.
1. Internal Revenue Service. Section 1274. Determination of Issue Price in the Case of Certain Debt Instruments Issued for Property. www.irs.gov/pub/irs-drop/rr-21-01.pdf. Accessed February 11, 2021.
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This article contains general information that is not suitable for everyone. Information obtained from third party sources are believed to be reliable but not guaranteed. OJM makes no representation regarding the accuracy or completeness of information provided herein. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice. The information contained herein should not be construed as personalized legal or tax advice. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently, accordingly information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.
