Protect Your Home Equity
Your home may well be your greatest asset, and one of the most important ones to protect from creditors. If you happen to live in states like Texas or Florida, which have unlimited homestead exemptions, the entire value of your home will be protected.
If you live in another state, though, where homestead exemptions are very limited, they will be of little help to you if you have more than $5,000 or $10,000 of equity in your home.
There are, however, a few options you have to protect your home equity.
The less desirable among those are Tenants by the Entirety (TE), Qualified Personal Residence Trust (QPRT), LLPs and FLPs. All of those options have major flaws that either can ultimately cost you your home or greatly increase your tax liability, sometimes both. You can find more information about each of those options in The Doctor’s Wealth Preservation Guide.
By far the best option is the Debt Shield, also known as Equity Stripping. Debt Shields and Equity Stripping may sound fancy or exotic, but the terms simply stand for taking out a large amount of debt on an important asset that otherwise does not have much if any debt.
The theory behind debt shields is simple: if an asset is riddled with debt, a creditor will not want it. If a creditor does want it, he/she will have to stand behind the first creditor holding the loan against the valuable asset. Therefore, debt shields offer excellent protection for your asset.
How does Equity Stripping work?
Before recent internal revenue code changes, clients could simply borrow as much money as a lender would give them via a re-finance of their home, and write off the entire interest payment as an itemized deduction on a personal tax return. Then they could take that borrowed money and invest it in specific ways to create supplemental retirement savings.
Unfortunately, the IRS has since limited the amount of refinance debt that can be deducted to $100,000. However, you can get around that limit by buying a new home, and then borrowing the entire purchase amount while stashing the equity from your old home in eligible forms of retirement savings.
In fact, with the equity harvesting program, the money from the loan is typically used to purchase a low expense cash-building life insurance policy where the death benefit is at the minimum rate allowed so the client can take “tax free” loans from the life policy, in retirement. More information on tax-free loans from a life policy can be found in the Life Insurance section of The Doctor’s Wealth Preservation Guide.
The home loan itself is typically set up as interest-only and tied to the lowest interest rate possible — Libor, for example. The reason the loan is interest-only is due to the fact that the whole point of the loan is to keep it on a valuable asset so the asset is not attractive to a creditor; and even if a creditor makes a claim against the asset, the creditor is second in line behind the lender.
Is Equity Harvesting financially viable?
The IRS thought it was so financially viable that it acted to limit the interest deduction on home equity loans and refinancing of homes. As a general statement, if the cash value life insurance policies perform as they have for the last 20+ years, and if interest rates remain anywhere near what they have for the last 20 years, then Equity Harvesting will work very well for you financially. You can find an entire chapter on Equity Harvesting in The Doctor’s Wealth Preservation Guide.
As a bonus, you will find that you may be able to get rid of any other life insurance policy for which you are paying now. Why? Because with the equity harvesting concept, you are buying a life policy with a sizable death benefit.
While there is no perfect solution, Equity Harvesting allows you to create a situation where no creditor would want to make a claim against the house. In addition, it is also very likely to work out as a nice wealth building strategy for you, assuming, of course, that your advisor uses the correct type of life policy — one that is specifically designed for equity harvesting.
