[quote="marcircus"]
Dont bet home equity chasing a higher return
Popular book Missed Fortune 101 has some intriguing ideas about managing assets and tax consequences. But beware: There are four major faults in its assumptions.
By Scott Burns
It's a tough story.
Newlyweds in their early 20s buy their first home with no money down. They sell it nine months later to build a new one, also with no money down. Two years later they sell and build yet another -- all with no money down. Four years go by, and the house has doubled in value. The young couple has a magical $150,000 in equity.
Then, the economy softens.
Home sales slow just as the couple's income disappears. They sell what they can to make the mortgage payments. Then they put the house up for sale.
But it doesn't sell.
Nine months later, the house is sold at foreclosure to the mortgage lender. The couple's equity has disappeared. Their credit is shot. The $30,000 loss the lender eventually took selling the house appears on the couple's credit report for the next seven years.
Move equity from homes?
That experience, discussed in his book Missed Fortune 101" made a deep mark on Douglas R. Andrew. If he had his way, none of us would have any equity in our homes. We'd borrow every possible dime from our homes, preferably with interest-only mortgages. We'd invest the money in safe, accessible assets.
We wouldn't keep any money in 401(k) or traditional IRA accounts, either. And if we had money in those accounts, we'd figure out how to drain them without any tax consequences.
Indeed, Andrew will show us exactly how to do this through seminars advertised in major newspapers. Readers have sent me the ads: "Withdraw up to $60,000 annually from your IRA or 401(k) with no tax consequence."
Ads like this get your attention if you've got a bunch of money in tax-deferred plans, own your house outright, and have virtually no debt. Your life is a "taxable event" waiting to happen.
Andrews system
Andrew seems to offer the answer.
Here it is, in a nutshell: Liberate your trapped home equity by selling your home. Buy a new one with a large mortgage. Invest the liberated equity in a life insurance policy that is fully funded as quickly as possible. Let the interest deductions on your new mortgage offset withdrawals from your qualified plans. Finally, borrow the annual yield on your life insurance cash value, tax-free.
The book, which ranked 391 on the Amazon sales list when I checked, is one of the most interesting books on insurance I've read in years. I would love it if everyone could convert their taxable retirement savings into tax-free savings. After all, I'm the guy who has been harping on the taxation of Social Security benefits and the inevitable rise of future tax rates.
Unfortunately, those who attend the advertised seminars are likely to be very disappointed if they act on Andrew's suggestions.
Why? There is a gigantic gap between his smooth projections and what real people are likely to experience. Call it "the devil is in the details" factor. The gap is so large, many could go from having highly taxable retirement assets to having no assets at all.
Examine the arguments
The arguments in "Missed Fortune 101" have four major faults:
Sometimes ignoring the time value of money. When someone tells me, as Andrew does on page 43, that I will pay out more in taxes when I retire than I ever deferred using qualified plans while working, I worry. You can't compare dollars of taxes saved in 1970 with dollars of taxes paid in 2010. It's bad financial reasoning.
Overstating tax benefits. Every illustration in the book is based on a 33-percent state and federal tax rate. In fact, few face such tax rates. Certainly, the Prudents, the $70,000-a-year couple on page 161, don't face a 33-percent tax rate. They face a 15-percent federal tax rate plus a possible state income tax. The difference has consequences. If you pay $6,000 in deductible mortgage interest, its net cost is only $4,000 after 33-percent tax benefits. But the net cost is $4,500 at 25 percent and $5,100 at 15 percent. Big difference. The smaller the tax rate, the smaller the benefit of moving your investment to a tax-free investment.
Unlikely returns on policy cash values. Given the choice, many people would choose to have a large mortgage and money to invest rather than a smaller mortgage and no money to invest. They make that choice because they believe it is easy to earn more than the mortgage rate. In fact, with mortgage rates approaching 6 percent, it is difficult to find yields over 4 percent. Very few insurance companies are crediting more than 6 percent to policy cash values.
Zero consideration of the downside. When we take out a mortgage, we sign a contract to pay interest for up to 30 years, at whatever the rate. When we invest in an insurance contract, the insurance company guarantees a return of only 2 percent or 3 percent. The policy illustration may show a higher rate, but the guaranteed rate is 2 percent or 3 percent. As a result, your ultimate tax-free income may be far less than expected. Indeed, it may be zero. This possibility is not mentioned in the book.
http://www.moneycentral.msn.com/cont...estate/P130083
Marcircus
You sound like a decent guy, and from what you told me previously, you're an accountant or CPA. I'm surprised to hear some of the things you are saying (IRS view regarding life insurance as tax avoidance).
Hopefully, you momentrily forgot the US Supreme Court precedent which establishes every taxpayer has the right to "legally" minimize his tax obligations to the fullest extent available.
In the meantime, stop driving yourself crazy with all these "UNCREDIBLE" sources of information, and I will prove how silly they all sound
Start with D. Andrews rebuttal
"ADVICE: PERSONAL FINANCE"
Reality: Some financial advisors simply dont know what they dont know.
When something unconventional comes along thats noteworthy enough to draw attention, it often generates a mix of praise and criticism. Such is the case with Missed Fortune 101, my second book published by Warner Business Books thats been capturing national headlines.
Now Im the first to admitthe strategies outlined in the book are revolutionary. And while numerous critics, such as Jack Lott of James DicksThe Active Investor Magazine, are saying, The Missed Fortune approach helps people improve their lives, both at the financial and personal level. The views on investing are a bit contrarian
.It has given thousands of investors a priceless advantage in creating a positive moving portfolio, a few others have their doubts.
To these folks I reiterate: the Missed Fortune concepts are not for financial jellyfish. Even though the approach is novel, the concepts arent. When financial planners and CPAs truly understand the principles, they dont refute the numbers.
Some critics have the opinion that the Missed Fortune concepts dont survive testing in the Reality Lab. They probably feel threatened because the strategies are contrary to traditional approaches for retirement planning and debt management. I assure you that the Reality Lab of self-made multi-millionaires whom I work with prove my concepts are not only sound, but the very life-blood of their wealth creation.
With that in mind, lets examine some recent criticism (something Ill call myth-understandings) to better understand what Missed Fortune 101 is really recommending.
Myth-Understanding #1: One critic recently said, If [Doug Andrew] had his way, none of us would have any equity in our homes
[and] we wouldnt keep any money in 401(k) or traditional IRA accounts.
Missed Fortune Reality:
Its true, I keep as much equity separated from my house as possible and I dont own a 401(k) or IRA account. However, in my book, I dont rule out qualified plans. I explain when you should participate and when it is not wise to participate in an IRA and 401(k).
And as far as the question of what to do with equity, as I teach in my books and seminars, I separate as much equity as possible from my house to increase the liquidity, safety of principle, and rate of returnin that order of importance.
If you were one of the unfortunate victims of hurricane Katrina, would you rather have had your equity removed from your home in a position of liquidity (to access money when you needed it) or trapped in your house as the flood waters rose to the level of your rain gutters? Did you hear what the mayor of Port Arthur, Texas, said in the emotion of the moment after his house burned to the ground in the aftermath of hurricane Rita? He didnt say, Boy, Im glad we just paid off our house! Rather, he said, The sad thing is, we just paid off our house!
I prove in my book that the equity in your house has no rate of return. Regardless of whether your house is located in Newport Beach, California, Las Vegas, Nevada, or New Orleans, Louisiana, the return on equity is always the samezero! In other words, a house will appreciate or depreciateregardlesswhether it is mortgaged to the hilt or free and clear.
Personally, I keep my equity separated from my house so that: 1) I can access cash whenever I need it; 2) to maintain safety of my principle in case real estate values drop; and 3) to give it the ability to earn a rate of return. When I borrow my homes equity at, lets say 6 percent deductible interest, it only costs me a net of 4 percent after my tax deduction credits me back 2 percent. By doing what banks and credit unions do (borrow money at a lower rate to earn a little higher rate), I prove in my book that you can amass tremendous wealthseveral million dollars of extra retirement resourceswithout increasing your outlay one dime! Houses were made to house families, not store cash. The home is what is sacred, not the house!
Myth-Understanding #2: Missed Fortune concepts ignore the time value of money.
Missed Fortune Reality:
The overwhelming majority of American taxpayers I survey strongly believe that future tax rates will likely be higher. Does it really make sense to postpone tax for some perceived advantage in the future?
In the book, I prove that by having tax-favored treatment on the front end and the back end of retirement planning, I can enjoy a retirement nest egg that will generate 50 percent more than a traditional IRA or 401(k). How? Using home equity retirement planning, I get indirect tax deductions during the contribution phase of my retirement planning and I accumulate my money in instruments that are tax-free during the accumulation, distribution phase, and transfer phase of my retirement planning.
Lets say we have a nest egg of $1 million earning 10 percent (to keep the math simple). We could withdraw $100,000 per year to spend and live on without depleting our $1 million principle, right? It would last forever. But if you have to pay taxes during the harvest years of your life, most people find themselves in as high as, or higher, tax bracket in retirement as they were in during their earning years. You would need to withdraw 50 percent more ($150,000 per year) in a 33.3 percent tax bracket to net $100,000. Based on a $150,000 annual withdrawal, your $1 million nest egg would be totally depleted in less than 15 years! If my retirement fund was tax-free I could withdraw $100,000 a year to spend and never deplete my nest egg.
The strategies I recommend in Missed Fortune are actually enhanced by the time value of money.
Myth-Understanding #3: Missed Fortune overstates tax benefits.
Missed Fortune Reality:
Sometimes advisors refer to a taxpayers effective tax bracket (the percent of taxes you pay in relation to your total income) when making the argument that tax benefits are overstated in Missed Fortune. However, true savings are calculated using the marginal tax rate unless the deduction reduces taxable income below the next tax threshold. Then a pro rata calculation of the actual tax savings would need to be computed.
For this reason, I explain in the book that I use a 33 percent marginal combined federal and state tax bracket for all of the illustrations not only for simplicity, but also because most Thrivers are in this tax bracket. Even the Prudents (the $70,000-a-year couple on page 161) are in a 33 percent marginal tax bracket (a 25 percent federal tax rate plus an assumed 8.3 percent state tax rate) for every dollar they earned in excess of $58,100 in 2004 ($59,400 in 2005). Whenever a professional financial planner calculates the value of a deduction (lets say $12,000 in mortgage interest) that will reduce taxable income from, say, $70,000 down to $58,000, it results in real tax savings of $4,000 in this example (33.3 percent of $12,000).
Married couples filing a joint tax return with total income in excess of $59,400 in 2005 are in a 25 percent federal bracket plus whatever the applicable state income tax rate would be (in the book it is assumed to be 8.3 percent). Income in excess of $119,950 in 2005 for a married couple will be taxed at a 28 percent federal rate plus any applicable state tax. The principles taught in Missed Fortune remain the same regardless of changes or variables that determine precise tax brackets.
Myth-Understanding #4: Missed Fortune claims unlikely returns on policy cash values.
Missed Fortune Reality:
In Missed Fortune 101, I teach that when a life insurance contract is maximum-funded under IRS guidelines and the minimum death benefit is taken to stay in compliance, the life insurance contract can far outperform a traditional mutual fund or IRA/401(k) account particularly during the distribution phase, as I prove in Chapters 10 and 11. A properly structured and funded life insurance contract (such as an indexed universal life or fixed universal life policy) is the only investment that allows the investor to accumulate money tax-free, access the money tax-free (including the gain) and when you eventually die, the remaining amount blossoms in value and transfers tax-free.
The strategies I teach in the book allow investors to have otherwise payable income taxes pay for their life insurance. I simply show people how to let Uncle Sam pay for their life insurance.
Again using a personal example, I have received an average of 8.2 percent on my insurance portfolio during the last 25 years (including bust years). Therefore, I have netted over 7 percent, tax-free, after the cost of insurance is deducted. Some of the most conservative policies in my portfolio are currently crediting 5.5 6.0 percent (my fixed universal life policies), which, after the cost of insurance, still exceeds the net cost of borrowing the equity from my house (which funded the life insurance contract).
The value of this approach is that I dont losemy equity index universal life policies have guarantees of 1, 2, or 3 percent (depending on the contract) during years the S&P 500 index loses money. During the years that the S&P 500 makes money, I get to participate (usually 100 percent) up to a cap of 11, 12, or even 17 percent. (My money is not directly in the market, but I am able to participate in any upside potential.) Based on this model (a 1 percent guarantee minimum and a 17 percent maximum crediting rate), during the last 15 years, the gross average annual effective return would have been 9.91 percent if linked to the actual S&P 500 index performance. In fact, over the last 20- or 25-year periods, the effective return would have been over 10 percent.
If we take the last 30 years (based on the actual S&P 500 performance), the return would have been 9.61 percent, including the horrible couple of years in the market after September 11, 2001. After deducting the costs of the insurance, my net, cash on cash, internal rate of return would have been in excess of 8.5 percent. This means that I could take tax-free distributions, as explained in the book, in the amount of $8,500 per year from a $100,000 nest egg (or $85,000 per year from a $1 million nest egg), and never deplete the principal nor relinquish the life insurance benefit.
The illustrations in the book are based on an actual history of the S&P 500 index over a 15 year-year period using a conservative product with a 3 percent guaranteed rate during the years the S&P 500 loses money and a 60 percent participation rate with no cap during the years the S&P 500 resulted in a more than 5 percent return. Therefore, the 7.75 percent assumption in the book is extremely realistic, because its based on actual history.
Finally, lets talk worst-case scenario. One critic points out that if a policy performs at the guaranteed rate of 1, 2, or 3 percent, the outcome is very different. Well, certainly it would. But lets reason together. Under the rules set forth by the National Association of Insurance Commissioners, life insurance companies are required to illustrate a worst-case scenario. In that case, it is assumed that the insurance contract is crediting only the guaranteed rate from the very first day the policy is put in force and that the maximum costs of insurance allowed by law are charged to the policy. This would be a highly unlikely event, and, if it did happen, there are several exit strategies and plenty of time to liquidate the money in the insurance policy before its values are drained. The strength of the insurance contract is that it is more liquid and safe in poor economic times than other investments that would likely sustain substantial losses. In the aftermath of September 11, when so many people lost 30 percent or more of their portfolio value, my universal life contracts continued to earn between 1 percent up to 7.25 percent.
Myth-Understanding #5: Missed Fortune does not consider any downsides.
Missed Fortune Reality:
One critic contends that when we take out a mortgage, we sign a contract to pay interest for up to 30 years, at whatever the rate. He is concerned that the insurance contract only guarantees a return of 2 or 3 percent. (Actually, Im not aware of very many investments, such as mutual funds, that contain guaranteed returns at all.) Hence, he warns you that your ultimate tax-free income may be far less than expectedmaybe zero.
The very reason I recommend that prudent investors keep equity separated from the property is because even if they didnt receive a return greater than the net cost of borrowing the funds, they would rather have equity in a position of liquidity and safety in the event of an emergency rather than trapped in the house. Again, houses were made to house families, not store cash! Life insurance contracts were made to store cash.
Some advisors would have you believe that youre stuck with a losing proposition if the market goes south. The very reason I invest my serious money in maximum-funded life insurance contracts is to hedge against such situations. The flexibility of a properly-structured and funded universal life contract is its greatest feature. I have discovered that many financial advisors simply dont know how to structure an insurance contract to perform as a superior investment. But it can be done, and professionals can be taught how to do it.
One critic contends that there is a gigantic gap between my smooth projections and what real people are likely to experience. The fact is, I have helped numerous clients withdraw up to 60,000 per year out of their retirement plans with no tax consequence. Last year I helped a gentleman in his 70s transfer $1 million of equity from his home into a Single Premium Immediate Annuity as he relocated into a new home. He is now enjoying a net guaranteed lifetime income of $76,000 per year (7.6 percent of $1 million) after the cost of $1 million of life insurance and the net cost of the mortgage. As a strategic by-product, he is now able to withdraw up to $60,000 per year out of his qualified funds with no tax consequence.
The reality is, a strategic roll-out can and does work when it is structured properly by financial advisors who understand what they are doing. I have 800 advisors nationwide (and we are adding 100 per month) who are trained in how to properly structure these strategies to help Americans optimize their assets. Remember, different isnt always better, but better is always different. And I welcome the criticism, as it offers an opportunity to further explain the principles that can help so many people better prepare for and enjoy their retirement.
