Building wealth isn’t free

habit-saving-moneyAll too common, I see people obsessing about fees at the wrong phases of building wealth. There are countless websites and forums where people discuss low cost index funds. The problem is, they haven’t calculated the Big fee that will hit them at retirement: taxes.

Standard IRAs and 401(K)s are designed to get you to sock away money tax free today, only to turn around and pay income level taxes at retirement. And to top it off, Uncle Sam demonstrates his hunger for that tax revenue by forcing you to start cannibalizing your savings at the age of 70 1/2. If you save up a big pile of money in something that pays a handy dividend, you can’t keep it forever. You will be forced to start taking minimum withdrawals.

To illustrate, I tracked down an online early withdrawal calculator. I plugged in $1,000,000 balance, and it told me that the age of 70 1/2, the minimum withdrawal amount was just shy of $36,500. To frame this in lingo that financial consultants use, we are all told to withdraw no more than 4% per year in retirement. 4% of that balance would be $40,000.

A subtle but little discussed point in all this is the “no more than” piece of that advice. The idea is that our retirement fund is expected to grow by more than 4%. Hence, ONLY withdrawing 4% should let our principle grow. But if we only have a 3% growth, we should ONLY withdraw 3% and hence NOT tap into the principle.

If we have a losing year, we shouldn’t draw anything at all. The hope is that our retirement funds would throw off dividends to fund ourselves. Anything else, and we are cutting into the principle and forever reducing future earnings and available cash. But these minimum withdrawals don’t grant us the ability to scale back to 3% or even skip a year of withdrawals. Instead, we are forced to cut into that principle so the government can get their piece of revenue.

It’s okay to pay taxes

TaxesIf there is any kind of lesson, it’s that taxes must be paid. The only question is when. People obsess over paying taxes today. They would rather push them off and score all the tax deductions possible. But that might not be the most efficient strategy nor the most stable one for your retirement.

The truth is, it’s better to pay the taxes now. That way, in retirement, there is no need to ship off a chunk of your retirement wealth to the government at who knows what tax rate. And if you use Roth IRAs instead of standard ones, there are no required minimum withdrawals! If there is any hint of what the IRS prefers, just checkout the fact that people making over $191,000/year can NOT contribute to a Roth IRA.

There is an old adage: would you rather pay taxes on a bag of seed or on the harvested crop? In true mathematics, if the rate at both times is identical, then you would pay the same taxes on either side. But that is rarely the case. And who knows what the tax rates will be 30 years from now?

Don’t forget about management fees

panic_buttonI’ve talked about fees many times. One really surprising article was about a couple that held dozens of mutual funds and never consolidated. They actually had a big chunk of cash. The effect was disastrous!

The couple in that linked article were paying a financial advisor 2.5% annually. Sounds small, except that they had saved up $1.3 million. Annual fees exceeded $32,000! Imagine paying $32,000 each and every year of your retirement.

The actual plan they were pursuing was to consolidates into half a dozen funds, and reduce annual costs to 1%. That is terrible! Cutting down to $13,000 in annual fees is terrible. The irony is that if they looked at the top ten stocks in each fund, they might find a lot of well recognized companies: Coca-Cola, Walmart, Apple, General Mills, Pepsi, Dr. Pepper-Snapple Group.

If they simply sold everything and bought $130,000 of each of the top 10 stocks, their annual fees would drop to nothing. There would be a one time cost of selling the funds and buying the positions, but after that, no management fees. And then they could drop the financial advisor! To top things off, they would probably rack up better dividends, dividend growth (like getting a raise in retirement), and also see asset appreciation.

Stocks aren’t the only way

Mortgage_Loan_Approved1Other options would include discounted notes. I’m in the middle of migrating my Roth IRA into a Self Direction Roth IRA. The plan is to buy warrantied, discounted notes. The noted fund I have joined sells 1st position notes at a discount. That means mortgages that were perhaps written for 5% would yield me something much higher, like 9-12%. They are also warrantied meaning that if the payee stops paying, I have the option to either foreclose and sell the property, or I can collect on the warranty and get back what I put in. Show me a stock or mutual fund that offers that.

As an example of discounted 1st position notes, imagine a note where the payee owes $100,000. Imagine it was written with a 5% interest rate. Monthly payments would be $536. The person holding the notes decides to sell it for whatever reason. Maybe they needed a quick source of capital. To move the note quickly, they are willing to accept $65,000. For $65,000, I can get that monthly stream of $536. Punch that into your calculator, and you’ll see that we are getting 9.9% yield on that investment.

To top it off, whenever the payee decides to pay it all off, I collect an extra $35,000 (remember, original balance owed was $100,000). If that happened five years out, the annualized ROI would be about 9%. Pretty good return on the money. And then I can take all this cash and buy more notes, boosting my monthly yield.

Thanks to having this inside a Self Directed Roth, there are no taxes involved. I have to pay a service fee to my note payment collectors of about $15/month. And the Self Directed Roth custodian needs a minimal fee as well. But nothing close $13,000 year! That is horrendous.

EIULs are designed to reduce costs in the future

EIULeffectThe last leg in my talk about good vs. bad management fees are EIULs. I frequently hear life insurance products criticized as being ridiculously expensive. The truth is they ARE very expensive….for the first ten years. After that, the costs drop dramatically.

Insurance companies design these products so that they collect their profits up front. That way, if you fall through on future payments, they don’t care so much. It also makes the products better guaranteed to last properly. A key ingredient, though, is to overfund as much as possible. By overfunding a policy, the cash value grows much faster. And the faster the cash value grows, the less total insurance must be bought. It’s a vicious cycle. If you slow down the growth of cash value, more of your premiums is used to fund the difference, i.e. the corridor between face value and cash value.

But when you overfund the policy, the total amount of insurance purchases through the life of the policy is greatly reduced and in the end, the annualized costs drop to somewhere like 0.5-1.5%. That’s pretty handy for getting a big chunk of cash in retirement that is completely tax free according to IRS tax code.

It’s not simple or easy to build wealth all by yourself. But delegating ALL decisions to a financial planner can be very costly when you reach retirement. The key is understanding the fundamentals of building wealth so you can hire the right experts to set up things most efficiently.

Is your wealth building plan out of alignment?

The other night I was putting together my desk. We recently move to a new house, and I had to take apart this giant desk. Putting it together was tricky, because I had to remember where all the pieces fit together. When I had finally lined everything up, I noticed that the center section of desktop was off by at least an inch.

I have one of those big, U-shaped desks. I had connected the lower part of the U shape, bridging the two sides together. This vertical piece was the main support for the desk component that would sit on top. As I placed the desk component on top, it seemed alright on the near side, but was off by more than an inch on the far side. That wouldn’t do!

So I took the top off and looked everywhere. I noticed that I had gotten the furthest bolt lined up, but had completely missed the second bolt. It was outside the support piece. This had to the reason! No wonder the cam lock never caught on to the bolt.

It seemed strange that being off by what was less than 1/4″ could have cause the opposite end to be off by such a big amount. But I went back and fix it so both bolts were properly locked on in that support piece. Then when I dropped in the desktop, it lined up perfectly. That’s when I remembered how small variations at one end become magnified the further away you get.

The same can be said about wealth building plans. Something that may seem like a small impact today can have a huge effect on your total growth in a twenty five year span. Studies have already shown that the exorbitant fees of 401K can end causing you to lose an average of 30% (or more) of your total growth.

Something small like 4% vs 1% fees in your 401K can have a detrimental effect long term. In one study, they showed that $155,000 on average was lost to high fees, which could equal an entire house in today’s dollars. With that much money, I could easily see buying another half-of-a-duplex and getting an additional $1300/month in cash flow. Think you could use that?

But who pays attention to 401K fees? Not many, I’m afraid. Most people don’t watch small stuff like that. Instead, they check if their value is growing or shrinking. When values plummet, people suddenly get interested and start moving their holdings into more conservative funds. This locks in losses, but the same fees are found in the other funds as well. This insidious issue continues unabated until its too late, when you are thinking about retiring. You want to, but discover there isn’t enough money, or at least not enough to retire completely. Instead, you need to find some other supplemental income.

That is what happens when your plan is out of alignment and not handling things like high fees, inflation, and complex rules surrounding 401K.

Throwing out old advice that didn’t build much wealth

We recently moved. My family needed a bigger house, and we looked for some time before finding the perfect place. In the process of packing for the move, I came across an old book. I had bought it just a couple years after finishing college and entering corporate America.

At the time, I was into the full blown, set aside the max 15% in your 401K deferred savings plan. In fact, I had increased it to 18% and was reaching the max annual set aside.

Advice I read years ago

I had read this book to learn all about stocks, bonds, mutual funds, futures, options, REITs, gold and real estate. As I was now sifting through all my books and deciding which ones to throw out for this up-and-coming move, I leafed through it, remembering when I had first read it.

I quickly scanned the section on investment real estate. I was shocked out of my mind! It never mentioned rental property. Instead, it covered the idea of buying real estate with the idea that it will appreciate over time, and then eventually selling it. Not one iota talked about rent, cash flow, landlording, the famous 1%-rule, 50%-rule, etc. I felt the book was really lacking. Essentially, it said that buying a piece of property and waiting for it to appreciate was risky, not very diverse, and pretty much a no-go.

They quickly moved on to REITs, which are a type of stock holding where they invest in real estate and distribute earnings to the share holders. It quickly pointed out how this was much less risky, didn’t tie up your investment capital for years, and let you avoid the expense of closing costs if you had bought the property yourself.

Costs again?

The focus on costs is nothing new. Some people drop the idea of real estate in a heartbeat simply due to the closing costs. That is sad, because real estate is one of the biggest ways that the rich become rich. Things like REITs and MLPs are regulated to pay out 90% or more of their earnings in order to maintain their tax advantaged status. That’s nice, but at the end of the day, they are just stocks. Unless you are buying on margin, you can’t get the same leverage as you can with real estate. When you consider that real estate grows at around 5%, that doesn’t seem like much. But if you purchase rental property with 25% down, then you’re cash-on-cash growth rate become more like 20%. Show me a REIT or MLP that beats that.

Another important thing to know when comparing real estate and REITs is that just because you own a REIT, doesn’t mean you escaped closing costs. You might not have to show up at a closing with a check in hand, but who do you think pays the REIT’s closing costs? They are part of the bottom line in earnings, so you are still paying for them.

By dodging the closing costs, the property really isn’t yours, and you don’t get the direct rent or cash-on-cash return of buying the property yourself. You didn’t take the risk so you don’t get the profit. Instead, you get what’s left after the REIT pays its manager, staff, promotional materials, managerial fees, and a dozen other things needed to maintain their structure. You are, as they say, at the bottom of the food chain. You receive a fragment of what’s left. If you invest $25,000 in a rental vs. $25,000 in the REIT, the outcome will be very different.

Talking about investment property without rent is incomplete

To have a section where all they talk about is appreciation is only half of a conversation. It would have been fine to mention that rent may bring in money, but there is the risk/cost of landlording. That would have been better. But that was completely left out.

I really appreciated how the book had a running theme of mentioning risk. For example, in the chapter about futures, they clearly describe how you can make money. But they are quick to point out that it’s very risky and is one of the things you really can lose your shirt. In the section on margin trading, that is also risky. It is the sort of thing where you may start with putting in $10,000, but it’s not hard to get a call from your broker indicating you have to either pony up another $30,000 or lose your original investment.

Back then, I liked learning more how those markets work, but I always appreciate that they said these more “exotic” investments were only for experts. Now, after having read “Where are the customer’s yachts?”, I have sincere doubt that there are any experts in these exotic investments. They are rare and hard to find. Ben Graham and Warren Buffett are the exception, not the norm. So whenever I read stock news, I take it ALL with a grain of salt. The only advice I read closely is from those who have made millions and billions over the decades

Time to throw it out

Since this was about packing, the question in my mind was, “Will I ever read this book again?” Seeing that this book was written for people that are worried about market risk and want to avoid exotic investments, I could tell I had outgrown it. Anyone who read it would be steered towards mutual funds and tax deferred savings plans. I wouldn’t recommend it to my dearest friends. I think reading many of the columns by Jeff Brown would be more constructive and lead to better wealth building. Hence, I threw it out instead of packing it up.

New 401K regulations will expose more fees

I have talked about this before. New regulations over the disclosure of 401k fees began coming out last year, with the last ones coming just last November. A Reuters article even bragged that there would be an “a-ha” moment when these statements came out. Have you heard it? Has anyone else started griping about their fees? I personally haven’t heard anything from my own co-workers.

Whoever is celebrating this reform in 401K regulations may be investing too much hope in the results. What is I fear is that these new regulations will only encourage those that pay attention to focus even more on fees and not actual net growth. (Those that don’t pay attention to their 401K probably won’t notice much.)

As I stated before, investing based on fees is the wrong approach. When people start looking for the cheapest option, they often throw away very viable investment options. When it comes to picking mutual funds, you may be splitting hairs when seeking the cheapest fund. That is because mutual funds have a terrible history at building wealth. So it doesn’t matter whether you spend a little or a lot in fees; you won’t build solid retirement wealth.

If you look at something like real estate, you will definitely see more fees. Closing costs, taxes, insurance, and brokerage fees are just some of the items you have to deal with. But because investing in top quality real estate can build a much sturdier portfolio that can support you in retirement, the fees are worth it. Buying an index fund may cut fees to the minimum, but their upside potential is also pretty bad.

Investing based on fees is the wrong approach

In an article published on Fidelity’s website, there is a detailed description of the new regulations written by the Department of Labor back in February. 401K custodians are going to start including much more information about fees in up-and-coming statements mailed to clients.

More of the shocking statistics that I have mentioned before are published in this article:

  • A poll showed that 71% of 401K participants don’t think they pay any fees
  • Less than 5% of employees using workplace investment plans make a concerted effort to manage their 401K plans.
More info, more profit, right?

Reading the rest of article shows a clear focus on fees. It celebrates that these new regulations will bring fees to the forefront, because active investors may realize the costs of their choices and shift to alternative funds with lower costs. But it hesitates on the subject of passive investors, since they aren’t sure about them. (I think I know how people that don’t read statements will react to more unread information.)

The article fairly indicates that of course there is no such thing as a free lunch. Fees are par for the course. But the whole thing seems be a fallacy, because it implies that mutual funds in a 401K are the way to go. The name of the game is simply picking the best returns and with the lowest fees. We just don’t have enough information to make the right choices. A little more information, and our portfolios will do better.

Crosschecking with reality

Does that sound likely to you? It doesn’t to me, and here’s why: they don’t take into consideration systemic risk. What will happen when all the funds dip with the next big market correction? As usual, people will panic and sell their positions. Then when markets rally, they will buy what’s hot. That will lock in the historical sell-low/buy-high, rinse & repeat pattern of most investors. There is strong historical data showing this to be the case in the past, so we have no reason to doubt it won’t happen in the future. You don’t have to wait for the next installment of the Dalbar Report to reiterate what we already know.
If you are picking funds based on fees, you are just following the herd, but trying to pick a fund that isn’t QUITE as bad as the others. I recently read a chapter from a book where the person argued that if you choose index funds, you only pay 0.2% while everyone else is paying 2% average fund fees, giving you a 1.8% advantage. The author crowed over this, touting it as so simple, kids can understand it. I don’t think building your retirement wealth on 1.8% arbitrage is the answer. That is fear-based and kind of like trying to outrun the person next to you as you flee from an alligator.
Of course, this all tracks right into John Bogle and his strategy that lower cost funds tend to outperform other funds. Bogle developed the idea that indexed funds are more effective overall than actively managed funds. That statement may be 100% correct, but it isn’t enough advantage to build retirement wealth.

Indeed, it may allow you to save up TWICE THE AMOUNT that an actively managed fund can after years of saving, but it doesn’t answer the right question: Will this strategy be enough to truly retire and not end up working at Walmart?

Planning with the end in mind

Don’t forget that a wealth building plan needs to be able to handle life’s rocky bumps in the road that will definitely happen. We will hit various things that will force us to scale back or stop saving money at certain times. The plan also needs to factor in things like systemic risk, our desire to sell when things go bad, taxes, and inflation. I can definitely tell you at 1.8% isn’t going to count for much even if you only consider taxes and inflation. Throw in other risks, and it only gets worse.

If there is another strategy that will build enough retirement wealth despite the hard knocks we may face, then what difference does it make what the fees are? The end result is what we need to be looking into, not the costs along the way.

New study shows excessive 401(k) fees

A new study has come out titled “The Retirement Savings Drain: The Hidden & Excessive Costs Of 401(K)S” by Robert Hiltonsmith. The results are quite shocking. Or perhaps they SHOULD be shocking. I’ve already heard about this, and so I’m not surprised. But perhaps you haven’t? Some of the big ones:

  • 65% of 401(k) account holders aren’t even aware they are paying fees
  • 5 out of every 6 investors lack basic knowledge about the fees everyone with a 401(k) pays
  • fees are taken off the top, meaning reported rates-of-return are post-fee, hiding these costs
  • administering average pension funds costs 46% less than the cost of 401(k) plans
  • new regulatory tweaks that are coming, requiring better disclosure of fees, will have little effect on reducing the fees nor fix the issues associated with market risk and longevity risk
  • the individualized nature of the 401(k) doesn’t work and must be replaced with something else
Did you catch that last one? The author of the study has concluded that much of the issues that arise in 401(k)s is because of it’s individualized nature, and that tweaks and adjustments won’t fix it. The author figures that the new disclosure rules won’t fix 401(k)s, but instead expose them for the bad investment vehicle that they are.
I said shocking right? Well, I already learned this about six months ago. I have been working on my plan to leave my 401(k) behind. I have already stopped putting money into my corporate 401(k) and rerouted that money into an EIUL. In that article, you will find mention of the high fees embedded in 401(k)s. Combine that with the onerous rules that restrict your access to the money, and that pretty much sums up my disgust with them.

The study estimates that people will lose something like $155,000 on average over their working lives to excessive fees, enough to buy a house. What could you do with $155,000 of investment capital? Buy Berkshire Hathaway, or perhaps leverage it with investment property? Both of those options has a higher historical rate-of-return. Why don’t you hear about this from your financial advisor? Aren’t they supposed to be putting you first, according to the license they hold?

Towards the end of the study is a list of bullet points for what appears to be core principles in some sort of universal retirement plan. I think either the author or the institute that funded him believe we should all receive a universal, i.e. government orchestrated pension fund. I have my doubts on how effectively the government can manage something like that, considering their track record with managing social security. I could never support something like that unless we had the freedom to opt out and choose our own path. Or, they may be saying we need something better than what the IRC affords us from section 401(k), and these are the key points that must be met to have a true success. I just don’t remember the government having a big rate of success when it comes to money.
So what is the solution to all this? Don’t be a passive investor. Take active management of your plan. And HAVE a plan. Don’t just throw money at your 401(k), pick a handful of their funds, and then assume it will all work out. At the Wealth Building Society we focus on learning how to read this information, how to understand risk, and how to understand the mechanics of investing, so you can formulate your plan. One of the top reasons so many people are failing at retirement planning is because we have been told it’s easy and we don’t need to really be active. And also that there are plenty of experts out there to handle it for us.

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Rebalancing my portfolio – Part 1

I’ve recently started a plan to rebalance my portfolio. The first leg is to stop investing in my 401k, and instead route that money into an overfunded Equity Indexed Life Insurance policy (EIUL). More on exactly what that is in a moment.

Mutual funds won’t earn you 12%

Over the past six months, I have done a LOT of reading and analysis. Did you know that over the past 20 years, investors have averaged no more than 4% return on investment when using mutual funds? Google for Dalbar report and see for yourself. To top it off, that doesn’t count taxes and inflation. Watch the video linked in here to see an example of a 401k that charges a whopping 3.6% in fees without the corporate 401k trustee even being aware of it. This is pretty bad, considering the person who originally crafted the ideas of 401k states that 1% fees should handles costs as well as provide a reasonable profit margin. With fees that high exacting year-after-year, you could lose anywhere from 40-60% of your earnings by the time you reach retirement. To add insult to injury, the trustee managing your corporate plan may only be relaying what the 401k provider is telling him, and not seriously looking after your needs. This is why only YOU can be in charge of your money, and it really is YOUR responsibility to understand everything about your retirement plans.

Tax deferred is planning to fail

Are you saving money in a 401k plan tax deferred? Did it sound good to not pay taxes today and let more of your money grow before cashing in when you retire. Guess what. When you defer taxes for 30 years it can take as little as 5 years in retirement to spend all those tax savings. And don’t expect to receive a thank-you letter from Uncle Sam. They designed it that way, so consider that works-as-designed. The truth is, it is usually better to pay taxes now and retire as tax free as possible. This takes out the risk of tax increases or bigger income as you approach retirement. If you are planning to retire in poverty and with lower taxes in the future (a big gamble), then tax deferred savings may be fine. But I prefer to call that planning to fail.

Losses will cost you more than the gains

There is something people don’t realize, and most financial advisors don’t seem to mention: losses will cost you more than your gains. For example, what if you had $100,000 in your mutual fund and had the following returns: -50% the first year, followed by three years of 20% gains. What would your average annual return be? -50% + 20% + 20% + 20% / 4 = 2.5%. So…you should have $102,500 after your years, right? Wrong. Let’s walk through this year-by-year, and find out what our REAL gain would be.

  1. After taking a big hit in the first year, your account will be worth only $50,000. That’s pretty bad.
  2. But what will a 20% gain get us the next year? Only $10,000 more, bringing us to $60,000.
  3. The third year will pull us up to $72,000.
  4. And finally at the end of the fourth year, we end up at $86,400.

So with a nice 2.5% average growth, we actually lost a total of 13.6%! That’s because when you lose money, it takes a lot more to gain it back. Let me say this again:

When you LOSE, it takes MORE to get back to where you started.

10% loss requires 11% gain, 20% loss requires 25% gain, and 50% loss requires 100% gain. Do you really expect to have three years of 20% gains like we saw up above? Has this type of gain happened for you yet? I think not. This is the sort of thing, combined with people on TV and the radio promising 12% returns as the norm, that causes a huge majority of investors to chase after the hottest funds, and in turn losing a lot more than they realize.

Tax free and no losses is worth more than you know

The key thing we seek is something that will provide you

  • tax free income
  • no losses during the negative years

Well, when it comes to tax free, the first thing you are probably thinking of is a Roth IRAs. That is because Wall Street has been marketing this stuff HEAVILY! Roth IRAs only let you save up to $5000 a year, and only if you don’t make too much money. After a certain point, you have made too much money and you can’t save a nickel that way. Throw in the fact that you can only withdraw the money after a certain age, and these are basically off the table as an effective savings tool.

Some companies have started offering Roth 401ks. They invest after tax money, but neither of the two companies I have worked for offered them until very recently, meaning there is little to put in there. But 401ks are still subject to the high fees, so I just wouldn’t go there.

(There are very particular cases where I would use a Roth IRA, but for today’s discussion, I don’t see them as a central place to save money for retirement.)

In the previous section, we discussed the importance of avoiding losses more than finding gains. What would our scenario have looked like if we could just skip the negatives? What if I found you a fund that instead of losing money in a negative year, we just took 0%? Let’s call it our “special piggy bank fund”. For giggles, we’ll even take take it on the chin and accept no more than 15% gain if the markets rise more than that. What do you think that will look like?

  1. In the first year, the stock market drops 50%, but our “piggy bank fund” doesn’t change, effectively growing/losing 0%. That means we still have our $100,000.
  2. For the second year, the market rises 20%, but we are limited to just 15% growth. This leaves us with $115,000.
  3. In the third year, the market rises another 20%, but again we only get 15%. This will move us up to $132,250.
  4. After the last year of our scenario, the market rises 20%, but we only net 15%. This leaves us with $152,087.50.
So, by taking no losses and only getting a maximum of 15%, we ended up with a little over $152,000, or a 52% increase in value. Compare that to the $86,000 we ended up with earlier. Which plan would you choose?
Looking high and low for a no tax, no loss fund
Just where can you find this type of investment? No losses? That is something your advisor is more likely to laugh at than give you a real. answer.

It turns out that our “piggy bank fund” is an overfunded cash value life insurance policy. By “overfunded,” I mean putting as much money in as IRS rules permit based on the policy’s face value. By “life insurance policy,” I mean an equity indexed universal life insurance policy that doesn’t actually put money in the stock market or buy index funds that have the risk of negative years, but instead sells index-based options. This means that in negative years, no one buys the options, and your money stays where it is, effectively a 0% growth. But in positive years, they sell options to grow at 15%, and when the growth is 20%, people buy the options to make profit through arbitrage, helping us along the way.

Is this overfunding too good to be true? Well, yes and no. The reason to overfund is to minimize the cost. Insurance companies make money on the premiums based on the face value of the policy. A $10,000 policy is much cheaper than a $300,000 one. But you can’t buy a $10,000 life insurance policy and then stuff $10 million into it. Before the 1980s, that is essentially what the rich were doing, and the IRS stepped in and put an end to that. The premiums and profits reaped by the insurance companies on such a small life insurance policy were almost non-existent, while the tax savings and guaranteed growth rates were huge and TAX FREE. The IRS doesn’t like tax free, so they put limits in place. But if you fund up to these limits you can still do quite nice. In my book, if the IRS doesn’t like it, then I DO!
“But this is life insurance! You only reap the rewards when you die!” I know this is what people usually think of with regards to insurance, but it’s incomplete. You are allowed take out loans against your policy. When you eventually die, the balance of your loans is deducted from the face value of the policy, leaving you with whatever you didn’t spend. And here is the ka-ching: the loans are considered TAX FREE money, and you actually DON’T have to pay them back!

“You should never mix life insurance and investments.” This sounds like a catch phrase with no basis in real facts. Go dig in deep and found out the differences between overfunded insurance and plain, simpleton insurance. There is a big difference. A big, tax free, no loss difference. Given all these facts, I say it’s just fine to mix the two together, because that is how this type of insurance was designed in the first place!

The bottom line
Imagine putting $500/month into an EIUL with no losses, EVER! As another factor, let’s increase our monthly savings by 4% each year to symbolize pay raises and increased cost of living. After 25 years, this would add up to around $250,000 of outlaid money, but could conservatively (8% average per year) accumulate over $1 million in savings. Now, instead of putting any more money away, you start taking out annual tax free loans. If we estimate withdrawing for the next 20 years, we may be able to get about $80,000/year. Added up, that would yield $1.6 million in tax free withdrawals.  Now go and visit your 401k and tell me what it’s going to take to save enough to withdraw $80,000/year TAX FREE. Do you remember your financial advisor mentioning never taking out more than 4% each year? To get $80,000, you would need $2 million. To handle a simple 25% income tax, it would be more like  2.6 million.
Not. Going. To. Happen.
So when I hear Dave Ramsey or Suze Orman move beyond helping people get out of the black hole of consumer debt, and start bad mouthing whole life insurance, saying to never mix investments and life insurance I just smile and instead take the advice of rich people in past generations. Most life insurance agents don’t know how to set up overfunded life insurance the proper way. Instead they seek to line their own pockets with profits, which has probably produced this backlash and  the “buy term and invest the difference” mantra. This is where YOU must lookout for YOU. An agent willing to set up an overfunded policy as mentioned above usually takes a 50-75% cut in total commissions. This makes such agents hard to find, but they are out there if you know where to look. Contact me if you want to know more.
To wrap up this first stage of Rebalancing my portfolio, I can sincerely say I’m putting my money where my mouth is. This is not a case of “tis for thee but not for me.” It is a cornerstone of my overall trajectory in saving money for retirement, but not the only part. Call me up in 20 years, and we’ll see how our financial plans are doing. I sure hope I don’t meet you as a door greeter at Walmart while my family is vacationing in Florida, seeking extra pay to make up for a lack of accumulated value and infinite trust in someone else to take responsibility for your retirement.Cross posted from

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.