[Editor’s Note: This is Part 5/5 of a critique of Missed Fortune 101, a book by Douglas Andrew. If you’re not coming here from part 4, better go back and read parts 1-4 first.]
Insurance Is Not Triple Tax-Free
There is an investment account that gives you a tax deduction when you contribute, grows tax-free, and then comes out tax-free. It isn’t a universal life insurance policy. It’s a health savings account. Mr. Andrew likes to pretend that contributions to a UL policy are tax-free. It takes a huge mental leap to buy into his logic. He suggests that because you can deduct your home equity interest, taking out a bigger home equity loan to put the money into a UL policy is like putting tax-free money into the policy. That’s like saying I can buy a boat tax-free if I borrow from my home to do so. That’s like saying if I borrowed money from my home to put into a Roth IRA it’s a tax-free contribution. It’s silly logic, but that’s how it works to him. In reality, you buy life insurance contracts with after-tax money, just like boats and Roth IRAs. It does grow tax-free and upon withdrawal, your basis is tax free. You can borrow from the policy tax-free, and the death benefit is income tax-free. But the contributions ARE NOT tax-free, no matter how much Mr. Andrew wishes they were. This further demonstrates why it’s almost surely an awful idea to pull money out of your 401K (paying penalties and taxes) in order to put it into an account whose tax benefits are really no better and whose costs are likely much higher.
The Early Years Of A Life Insurance Policy
Structuring a life insurance policy as an investment isn’t that complicated. You’re basically trying to get the benefits of life insurance (tax-free growth, tax-free loans, tax-free death benefit) without the downsides of life insurance (primarily high costs but also ongoing required premium payments.) You overfund the policy, basically paying for the whole policy as soon as you can without it becoming a modified endowment contract (because then the loans you’re planning to use for retirement income aren’t tax-free). You choose as low a death benefit as possible in order to maximize the cash value. But even with doing these things, you still have a few years at the beginning of the policy when your returns absolutely suck. To make matters worse, if you want out, you’ll likely be paying a significant surrender charge. It’s hilarious to me that Mr. Andrew preaches liquidity, then advocates for this as an investment. I suppose you could consider it liquid later on when the cash value has grown (if by liquid you mean you can get your money within a few business days). But it sure isn’t liquid in any sense of the word in the first few years. I agree with Mr. Andrew that an investment is best judged over the time period it is intended for, and over very long time periods a well-structured life insurance contract bought at today’s rates is likely to have low, but positive returns (2-5%). But it seems an awfully big sacrifice to have such crappy early returns just to get okay returns later. It would be one thing if it would provide 15% returns if you held on long enough, but that just isn’t the way it works.
Bank On Yourself – esque
This strategy isn’t all that different from the Bank On Yourself concept I’ve discussed before. The BOY folks seem to prefer using whole life policies whereas the Missed Fortune folks like Universal life. A UL policy can be funded a little faster, but UL policies don’t offer non-direct recognition on loans from the policy, an essential part of the BOY concept. The main concept is the same – earn tax-free returns similar to fixed income investments and take out tax-free loans as needed, whether to buy a car or pay for golf as retiree.
Borrowing from your life insurance policy cash value is tax-free, but it isn’t interest free. In fact, you usually pay interest of 4-8% when borrowing from your own money. It isn’t a huge deal with a non-direct recognition policy, since the dividend rate is usually pretty similar to the loan rate, but with a universal life policy or a direct recognition WL policy, borrowing from your policy may really cost you.
Current Expected Returns On Universal Life
I asked an insurance agent, Larry Keller, to provide me a quote for a UL contract for a 30 year old male. Since Mr. Andrew always makes the assumption that the UL “side-fund” is going to grow at 7.75%, I was curious to see what I could really expect it to grow at given today’s low interest rate environment. Looking at the illustration was disappointing to say the least. There are actually two illustrations, one with the guaranteed scale and one using the current dividend scale.
The Guaranteed Scale
The policy shows you put in $25K a year for four years for this policy with a $1 Million death benefit. The guaranteed minimum dividend (not your return) is 2.5% per year. After one year, you have $17,530 if you surrender it. After four years, you have $88,036 (remember you’ve put in $100K at this point.) In fact, the surrender value never actually gets to $100K, and due to the increasing costs of the insurance you must pay each year, the policy lapses at year 43 (unless you add cash to it.) So, in fact, there is no guaranteed permanent death benefit with this policy and it never actually guarantees you a positive return, no matter how long you hold it. Not much of a guarantee, is it?
The Non-Guaranteed Scale
Let’s look at the scale using their current projections (which are almost surely to fall given our current interest rate environment.) Again, you put in $25K a year for four years for this $1M policy. Assuming the current dividend rate of 4.95% AND the current insurance charges, your net surrender value after one year is $18,074. After four years it is $93,824. After 10 years it would be $119,265, a return of 2.09%. After 20 years, it would be $175,531, an annualized return of 3.08%. After 30 years it would be $258,457 for a return of 3.38%. After a full 40 years (you’re now 70 years old), this $100K you invested would now be worth $369,021, giving you an annualized return over 4 decades of 3.45%. At least on the non-guaranteed scale you get to keep your $1 Million in life insurance, instead of losing it at Age 73. In fact, starting about age 72 it actually starts increasing, and if you die at your age expectancy of 83, and never borrowed from the policy, your heirs would get $1.587M. The return on that would be 5.51%.
There are four things you can learn from this exercise. First, if you’re trying to arbitrage between your mortgage rate and the return on these policies, you’d better have a very cheap mortgage. Even using my 2.75% mortgage (1.7% or so after-tax), you’re only making 0.39% a year on this arbitrage, for the first ten years, and that’s assuming it performs no worse than illustrated, which it is almost surely going to do. Second, that 2.09-3.45% number looks an awful lot like inflation. The real, after-inflation, return is going to pretty darn close to zero. I don’t know how you feel about inflation, but I’m not really into locking my money up for decades and then not actually making any money on it. Third, that 2.09-3.45% number is very different from the dividend rate of 4.95%. WITH PERMANENT LIFE INSURANCE THE DIVIDEND RATE IS NOT YOUR RATE OF RETURN. Last the return on the death benefit is higher than the return on the cash surrender value. That’s why life insurance is much better used for money you plan to leave behind than for money you plan to spend in retirement. Surprise, surprise, life insurance is actually life insurance, not an “alternative retirement plan.”
Conclusion
I’m not the first to criticize Douglas Andrews “Missed Fortune” ideas. You can find other critiques here, here, and here. It isn’t that the whole philosophy is flat-out wrong. But there are a lot of bad assumptions and half-truths so that when you add them all up, “this dog don’t hunt.” Avoiding retirement plans causes most people to have less after-tax money in the end. Withdrawing from them early is also generally a mistake, especially if you’re paying significant taxes and penalties. Buying real estate with nothing down is a mistake that not only increases the risk of foreclosure, but also raises the costs of your mortgage. Universal life policies as an investment are likely to have long-term returns of no more than 2-3.5% going forward, and quite possibly may have negative returns, especially for shorter time periods. Arbitraging a low mortgage rate for a possibly slightly higher return on a universal life policy not only increases your financial risks, but is unlikely to make any kind of a significant positive difference in your personal finances. In summary, if you follow Douglas Andrew’s ill-conceived financial plan, the only people likely to end up wealthy due to your efforts are your lender and your life insurance agent.
What do you think? Have you read the book? Are you a Missed Fortune believer? Do you like keeping zero equity in your home or buying universal life policies as an investment? Fire off below in the comments section! As always, keep the discussion focused on ideas, rather than individuals.
Reading this blog I have come to realize that WCI is a voracious reader. I however can not understand how he managed to get all the way through this book. I wanted to comment from day 1. Horrible financial advice. I am very thankful to have found this blog not only for its content but its links to further content.
whole life insurance is never an investment for yourself. It could, at a high cost usually, be an investment for your children’s retirement. I for one don’t work hard every day to fund my kids retirement.
I confess I skimmed the last chapter or two. 🙂
THANK YOU! 💕
“Buying real estate with nothing down is a mistake that not only increases the risk of foreclosure, but also raises the costs of your mortgage” – WCI
I would agree with this in most but not all cases. If it is your principle mortgage and you have access to preferred lending (VA loan, Doctor loan) and a job with very little career unemployment (like physicians) than I see no problem with a zero down mortgage as long as the home is within your means (which I define as mortgage + taxes + homeowners > 25% of after tax pay)
I do see a problem with a zero down mortgage. You not only get a more expensive loan, but you also have some additional risks. That said, they aren’t necessarily bad risks to take.
One thing to consider is that if the housing market tanks you may not be able to refinance the mortgage and you may not be able to sell the house readily as you’re much more likely to be underwater. It might not be a big risk to you personally, but to pretend it doesn’t exist at all is folly.
Not true with a VA loan, Dr. The 100% LTV loan has no extra costs and has the lowest 30-year fixed rate in the US. Also, it offers a no-qualifying [no income, appraisal, credit] refinance if rates drop, the IRRRL.
Assuming the current interest rate of 4-4.5%, isn’t it better to put the minimum amount of money possible as down-payment an instead use it to invest in anything that provides a return higher that 4.5%?
Did you miss the risk part of investing? What risk-free investments do you have available to you right now paying >4.5%? I don’t have any. Maybe if you have a 7% student loan you could pay off or something.
Great article. I think the big failure in missed fortune is the failure to address inflation if it skyrockets. That is where this could faireally badly.
My question. Can I open up a heath savings account myself in a place with low fees, or does my employer have to offer it? My employer does not offer a health savigns account, but it seems like a great way to invest money in a tax free manner, it seems to work out like a roth.
Actually, inflation would help someone who has their real estate highly leveraged. You could pay back the loans with depreciated dollars. The “investment” returns would obviously get killed though.
If you have an HDHP you can open up an HSA anywhere. If you don’t have an HDHP, you can’t open one anywhere.
Radio Financial Guru Sued for $427,000
http://www.courthousenews.com/2012/08/09/49145.htm
Interesting. Surprised I didn’t catch it in the local news. Not surprising however.
This lawsuit doesn’t prove he has no money. I took his class and he says by putting your money in his life insurance policies , your money is secured and you can’t be sued, so it works great for him or people who are in the business that they could possibly have lawsuits and be sued.
The State of Utah has a horrible reputation dating back many many years. The classic ponzzi scheme has been the investment scam of choice because of the trust factor associated with the culture. Now we have another version clothed in financial language that the vast majority of people don’t understand. Talk fast, show graphs and gloss over. I found your comments interesting and not surprising. Why hasn’t someone called this guy out long ago. I hope those that are suing will prevail. I am amazed that people listen to this crap. All you have to do is listen to that inner voice, “if it’s too good to be true it probably is.”
Also shows the value of bbb rating.
There is a lot to criticize here, but i find these kinds of discussions interesting. The criticism you offer is generally reasonable, but i would point out that if you want to be very successful (the intent here is to become wealthy) you cant always take the strait path. Think differently.
I would take a good look at 401ks. The benefits are far less than they are made out to be. You always pay income tax rates (lower 15% rates were made permanant recently on taxable investment earnings).
So, the main benefit is deferral. You give up control of the money and limit your investment options (to understand the first point consider that the account is not in your estate – the same as if it were a trust) .
I’m not sure what you mean when you say “benefits are far less than they are made out to be.” I’m not sure what they’re made out to be. I expect to save money in my 401K at about 38% and withdraw it at a rate between 10 and 20%. That’s a pretty good benefit. It also grows without taxes on distributions. Investment choices in my 401K are limited….to anything you can buy through a Charles Schwab Brokerage account. My other 401K, the TSP, also had limited, although extremely low cost funds.
I’m not sure what you’re talking about with the capital gains rates. We were talking about 401Ks which obviously have nothing to do with capital gains rates. The recent changes to the capital gains rates includes an INCREASE in rates to 18.8% for those with a taxable income over $200K ($250K married) and 23.8% for those over $400K ($450K married). You are correct that the 15% rate for those with taxable income between $36,250 ($72,850 married)and $400K was made permanent (as was the 0% rate for those under $36,250 ($72,850 married)).
I’m not sure why you think having a 401K outside your estate is such a bad thing. That’s usually the goal of estate planning. The 401K doesn’t have to go through probate since it has named beneficiaries. I don’t see that as “giving up control of the money.” I could cash out both of my 401Ks tomorrow if I wanted to. That’s hardly a loss of control.
It is simply not true that one pays a minimum of 15% on 401K withdrawals. It is taxed as ordinary income (and is included in MAGA).
With my social security benefit, I will have approximately $20,000 of 0% tax bracket (MFJ) so the first $20,000 I withdraw each year is withdrawn with no tax due. So if I meet my living expenses with the combination of SS, $20,000 from tIRA (rolled over from 401K) and the remainder from Roth, I pay no taxes on my 401K money.
Most physicians will be paying lower tax rates later on period. He has shown this several times. Deferral is a benefit as you mentioned but it isnt the only benefit.
you only give up some control in the 401k and the investment options only need to include a few common vanguard index funds. There is no rule that the 401k has to include bad funds.
even taxable investing would be superior to the approach by missed fortune
I can’t believe you read the whole book. From the first day of your review it was pretty easy to see that this guy sells snake oil. The fact that the guy can’t even pay his debts is icing on the cake.
Thanks for reviewing his ‘literature’ for us.
What advice would you give to someone that has made the mistake of starting to fund one of these life insurance policies? I’ve had some “financial gurus” of my own who have very generously given me investing advice for the past two or so years. Thus far, they’ve had me move my Roth IRA from Vanguard to some company they work with and they’ve had me buy a life insurance policy which I am overpaying as a “foolproof” way to save for retirement. From your blog, it seems like backing out now may be foolish because of the high surrender charges. So am I committed to see this through?
PS, Wish I’d started reading WCI years ago!
Cash value life insurance policies are one of those things that, strangely enough, can be good to hold on to if you’ve already had them for decades. If you’ve only had it a year or two, and you now realize you don’t want it, you’re almost surely better off getting rid of it ASAP despite surrender charges. The reason why is that you’ll have to throw away MORE money waiting for the surrender charges to go away than to just pay them now. Why not order a new illustration from the life insurance company and go to a fee-only adviser for a second opinion before deciding what to do? You can also pay a small fee and have a guy like this:
http://www.evaluatelifeinsurance.org/
take a look at it.
An adviser suggesting you move money away from Vanguard is almost surely not good for you. Don’t get me wrong, I’ve occasionally moved money away from Vanguard to take advantage of other opportunities, but I would guess your adviser moved you from low-cost index funds to high-cost loaded mutual funds (or worse annuities or cash-value life insurance), no?
Consider this, in the words of Dave Ramsey, your “stupid tax.” We’ve all paid it at one time or another. Better to pay it when you’re young and learn from it than to get to age 60 and realize your “stupid tax” bill is millions of dollars. You might try getting some of your money back from the adviser by threatening a suit, but I would guess you wouldn’t be very successful…all those forms you signed and all.
WCI,
Thanks for the thoughtful response. This certainly would qualify as my stupid tax. The light bulb only went off when i saw how much higher my fees were for the Roth this year than any of the previous 5 years (and how much of that fee was going to my adviser!). I will check out the sources you pointed out and figure out the best way forward. Your 5-part series on insurance as an investment vehicle was a great read. Thanks again!
I was lucky my light bulb went off when I was a PGY2. 🙂 Glad you enjoyed the series.
Enjoyed your thorough critique of Mr. Andrews. As an advisor I have found that perhaps the most tax efficient way to dispose of unwanted life insurance is through a 1035 exchange to a low-cost variable annuity (such as Vanguard). Your basis in the life insurance contract carries over to the new annuity leaving you “unused” gains. Keep the annuity until the gains are exhausted and then surrender the contract w/o tax or penalty.
I find that solution is far less useful than it should be. Most people disposing of unwanted life insurance don’t have any gains at all, and can just surrender the policy and take the cash tax-free. Most people who have significant gains (and thus have been in it 20+ years) are often-times better off keeping the policy, especially a typical whole life policy. Perhaps not a universal policy as discussed in this post. That leaves a pretty small segment of folks who don’t want their policy, should get rid of it, AND have a taxable gain.
Allow me to clarify the strategy… The fact that most who surrender insurance policies early on don’t have a gain is exactly why the 1035 works. For example, suppose I paid in $25,000 over two years but the cash value is now $15k (not unusal at all in the early years of a policy). By transferring the $15k cash value in the life insurance to a variable annuity I get $10k in “free” gains until I recoup my $25k basis. This saves capital gains tax on that $10k earned down the road compared to simply cashing out and investing in a brokerage account. Additionally, some CPAs argue that losses incurred on the surrender of a variable annuity contract may be deducted as a miscellaneous itemized deduction subject to the 2% floor (as long as there is a profit motive). Either way it’s win.
That makes sense. The additional benefit of future untaxed gains may be worth the additional annuity expenses, especially to someone in a relatively high tax bracket.
And you can buy an annuity from TIAA-CREF without commission or from Income Solutions for a 1% commission. Again a fee-only advisor like Jim Hunt or Scott Witt can help
I have paid 50,000 k total and cash value of 30,000 but AVIVA is charging Surrender fees:45,000$:so I have no cash I can get out( Cash balance – surrender value).I can just cancel the policy( loosing 50 k vs keeping the policy and keep bleeding 25 K every year for the rest of the policy).
Any ideas?
Sounds like a great investment. Another $50K loss for cash value life insurance. The agents who post comments on this blog somehow never run into people like you. They all think these things are awesome. Since you’ve spent so much on this, I’d probably pay some money to get it professionally evaluated. Try this guy: evaluatelifeinsurance.org and perhaps get a second opinion from a life insurance agent.
you should have bought ul from northwestern mutual. Commission is only 3% of premiums paid in all years
While Missed Fortune is flawed in its logic and mathematics, the use of UL has its place. First of all if I were to fund a cash value policy as a retirement accumulation vehicle, I would use well designed indexed universal life (IUL) that is similar to an indexed annuity (protection of principle with upside potential linked to a stock index and subject to a cap of 11-15% depending on the carrier used). I would over fund up to the MEC limit for 5 years with the minimum death benefit allowed and then let it grow for many years. One should understand that this is a long term plan and the growth in the policy will not start to accelerate until 10-12 years into the policy. While the Roth IRA and 401K are ok, one must realize that you are limited in the amount you can put into these plans vs the unlimited amount you can fund an IUL and that there is no downside protection if the market crashes as in 2002 or 2008. What happens to my 401k if the market goes down 40% in the year I retire and start taking distributions? Yes, there is a cost of insurance but over 30 years it will approach 1-2% of the cash value in the policy. Most people are today are very concerned about the loss of principal and are willing to make a reasonable rate of return in exchange for that peace of mind that their principal is safe.
I agree that it is worth giving up some return in exchange for safe principal. Unfortunately, 1-2% over a long period of time is an awful lot of money. Consider a return of 8% vs a return of 10% for instance. If you’re saving $100K a year over 30 years, the difference between 8% and 10% is $11.3M vs $16.4M. $5.1M may not be much to you….
At any rate, I’ve written before about a similar product, equity-indexed annuities, and they’ve definitely got their issues. Mixing investing and insurance is generally a mistake. Buy life insurance for the death benefit. Use retirement accounts for retirement. Yes, there are limits to retirement accounts, but they’re usually much higher than most assume. Between my profit-sharing plan, two backdoor Roths, an HSA (stealth IRA), and a defined benefit plan I’m looking at over $83K this year in tax-advantaged, asset-protected accounts. At any rate, investing in a tax-efficient manner inside a taxable account is a reasonable alternative. The tax costs can be kept lower in many cases than the costs of insurance especially when you add in the cost of the guarantees with an indexed insurance product.
https://www.whitecoatinvestor.com/pros-and-cons-of-equity-indexed-annuities/
Funny how he proponents of IUL always use scare tactics of losing money the year of retirement. You’re completely ignoring the fact that a well-constructed portfolio would have a proper risk-based asset allocation such that the riskier assets would decrease in the overall make-up of the portfolio as someone nears retirement age. You’re implying that a portfolio for a retiree is 100% stocks for a 40% drawdown to occur when in reality, it is realistically 30-50/70-50 stock/bonds.
There is no such thing as a well constructed IUL contract. The commission are well constructed to benefit the agent however. You can buy UL from NML for a 3% commission if you can find an agent willing to sell that design. Otherwise go direct to TIAA CREF-0% commission. In all cases buy minimum DB non MEC design if you are trying to maximize cash value
I am curious to know what types of investments are held in your various retirement plans and do you understand the fees that are being charged. There are plenty of hidden fees in 401Ks, 403b type accounts. These videos from 60 minutes and a recent retirement program on PBS shed some light on the inherent problems
http://www.youtube.com/watch?v=nAHgr9dY9BU
http://video.pbs.org/video/2365000843/
I understand that many people are not aware of the fees in their retirement plans, but I assure you I am quite aware.
My overall portfolio expense ratio is 0.16% per year. My cheapest investment is the TSP at about 2.5 basis points. My most expensive is Bridgeway’s Ultra Small Market Fund at 0.87%. My 401K charges $200 a year from the 401K provider (something like 15 basis points in my case) plus fees that total around 5 basis points for “recordkeeping” by Schwab. The ETFs in that account have ERs that average less than 10 basis points. My defined benefit plan has a 0.6% fee plus the fees from the mutual funds held in it, which average around 0.4-0.5%, but which I hope to help decrease by replacing the actively managed funds with index funds when I meet with the 401K committee next month.
Thanks for the links to these recent programs. I agree that retirement plan fees are a big issue, just like insurance company fees and expenses are.
I’ve discussed the holdings in my portfolio elsewhere:
https://www.whitecoatinvestor.com/how-i-currently-implement-my-asset-allocation/
It’s not quite up to date, but it hasn’t changed much (and doesn’t change often.)
Have you thought about any strategies to employ if the market takes a downturn? Do you go to cash if any of your funds go down by a certain percentage or are you strictly a buy and hold investor? As you get older will you change your allocation for less risk?
Yes. I rebalance. No, I am a buy and hold investor. It’s the worst way to invest except all the other ways that have been tried. Yes, I will decrease risk as I get older.
What do you plan to do?
“It annoys me, because it is composed of several hours of sales without an ounce of real information being provided.”
In all the discussions, both Andrew’s and yours there is no mention of state income taxes which can range from 0 in Nevada to over 9% in California. Of course one cannot do an analysis for every state, but there has to be some notice that whenever you do an analysis, one has to factor in the appropriate state tax.
Perhaps it is eliminated from discussions just to simplify the discussion. Obviously you have to take your own individual tax situation into account when doing financial calculations.
Andrews pushes indeed universal life and claims he has earned 10%+ over the last decade. That rate is before the imposition of company operating expenses and mortality charges. He likely sells full commission policies. Northwestern Mutual allows savvy buyers to pay a commission of only 3% of the premium on UL and 20% or less on blended whole life. These policies can be designed to minimize insurance and maximize cash surrender values. Read more in the book Insider Trading in the Life Insurance Market
Jamie – I know t’s fairly recent but can you say how its worked out for you so far? I hope you’re not on the hook for the fees that some here have posted. It’s irresponsible for KABC and other stations not to do their DD and find out that this guy is not the savvy investor he portrays himself to be. What a lack of integrity on his and their part to allow him to entice others to invest in lose/win ventures.
Bottom line, I would never buy Universal life insurance, only term insurance. My axiom is don’t mix investing with life insurance, a bad idea!
Does anyone know if the “Missed Fortune” seminar is now titled “Live Abundant”? I signed up for a FREE seminar for Live Abundant and now, after reading everything online about Missed Fortune, I will not be going.
Yup. Looks like he changed his name. I guess I’ll have to update this series.
You know, most companies with a good reputation don’t change their brand/name because it is worth something. That should tell you a lot.
WCI, excellent critique. I am a 35-year tax attorney, who has criticized DA’s misrepresentations for years. You gloss over his biggest flaw, which is that his strategy will often cause policies to MEC, eliminating the tax- [not fee-] free withdrawals. There are ways to avoid MEC, but DA does not even alert folks to the danger.
The Roth IRA still seems to offer the best combination of tax-free growth and withdrawal. As you note, most of DA’s objections are irrelevant. He also fails to consider that regular IRAs can sometimes be converted at no tax cost [a silver lining of recessions].
I was going to attend one of his workshops to see if he had cleaned up his act. But your critique makes it clear it is the same old scam. What is sad is that Missed Fortune did have a solid starting point – using real estate equity when better returns are available with comparable risk.
It is also disappointing to see yet another scam with Utah roots. Based on a comment in his radio show, I suspected a UT connection, which I confirmed quickly via Google. I would think that UT would be getting tired of hosting so many scams. But I guess there may be overrriding concerns.
Thanks for an excellent job revealing the multitude of flaws in his claims.
I would like to sign up for your news letter.
Here’s where you can do it:
https://www.whitecoatinvestor.com/free-monthly-newsletter/
Your example is only half the story. First off, a DR should not only fund a policy like this for 4 years. They fund this till retirement like any other retirement strategy. Secondly, strategies like this may not keep up with cash to cash examples. Thats not even a point. So the comparison you make is just not accurate and lacks actual facts.
Your example does not deduct the term cost of a million dollar policy through all those years, your also not deducting income taxes, your also not mentioning the access to the money, not mentioning that life insurance cash value can be exempt from lawsuits for malpractice etc.
Within a SEP IRA a dr will in all likely hood be taxed at the highest income bracket. So in a qualified plan he will lose 35-40% to taxes through retirement. Not only that, but once he hits 70 1/2 RMD age and passes at age 85 or so, his spouse will be taxed and all subsequent heirs will be taxed after on that money. IRA and 401k is a 40% permanent tax lien by the government. Anyway, once you calculate the tax free income he could receive throughout retirement which should be 3 to 4 times what the Dr contributed it can be much better than the alternatives.
You don’t get taxed within a SEP-IRA and upon withdrawal most docs (and most Americans) will pay an effective rate that is much lower than the marginal rate at which they put the money in. Misunderstanding of this important concept leads many to make bad financial choices like those advocated by Missed Fortune.
It’s a “tax lien” you say, but you ignore the fact that there was a 40% tax subsidy up front. But hey, you want to miss out on all the great tax breaks investing in retirement accounts give you, that’s your choice. But if you want to argue it’s a good idea….don’t be surprised when those who actually know how they work disagree with you.
Ok so this strategy is not for “most Americans.” So aside from that, to take D A’s farmer line ” would you rather be taxed on the seed or be taxed on the harvest.” So you can be taxed on the 750,000 going in (the seed) while your in a lower bracket, house, kids, etc or be taxed into perpetuity (the harvest) on the $2 – $3 million coming out with no deductions? Not only that but that 40% tax rate can change, could be 30%, could be 50% solely at the discretion of our government and their funding needs and that tax is FOREVER to every single heir of that DR. That doesnt sound like a good deal to me at all. Aside from all the other points I made above.
I’m sorry you don’t understand this concept. I’m not sure how I can better explain it. I’ll try one more time then leave you to do what you want with your money.
Assume you have the same tax bracket now as later. We’ll say 25% for ease of use. Do you choose to use a tax-deferred account or a tax-free account?
You make $10K. You invest it and leave it there for 30 years. Then you pull it all out and pay any taxes that are due.
In the tax-deferred account, you invest $10K and it grows at 8% over 3 years to $100K. You pull the money out, pay $25K in taxes and you’re left with $75K.
In the tax-free account, you pay your $2500 in taxes now and invest $7500. Over 30 years at 8% it grows to $75K.
Either way, you end up with the same $75K, even though you paid 10 times as much in taxes if you used the tax-deferred account instead of the tax-free account.
Hope that helps.
Now, if you are like most people, and end up paying a lower effective tax rate on withdrawals than your marginal rate at contribution, it’s easy to see that you’ll come out way ahead for using the tax-deferred account despite paying much more in taxes. The only way you come out behind using a tax-deferred account is if you end up paying a higher effective tax rate at withdrawal than your marginal tax rate at contribution. It is possible for that to happen for a super saver, but it’s pretty unusual with regards to contributions made during your peak earnings years.
Now you know why I think talking people in to taking money out of their tax-deferred accounts during their peak earnings years, paying the taxes and penalties on it, and then investing it in a low return investment like life insurance should be criminal.
Ok that example is way too simplistic for this. I am under the impression we are talking about doctors and those earning $200,000 + a year and contributing to a SEP IRA vs an Indexed ul or whole life. I am not talking about having a 100k and cashing out an IRA at 55 and going into Life insurance…. I am saying the SEP IRA should not even be started in the first place for reasons already stated above. Again this is not for every american, only high income earners 150-200k plus and if your wife is a doctor making the same that is 300k – 400k. I may be at the wrong place for this discussion.
So when I retire as a doctor I want to maintain my same lifestyle. I will not have a mortgage, my kids will be grown, my practice sold. So what deductions do I have? 0….. My tax rate now is the lowest it ever will be. I will be much higher in retirement and if i am not i did something very wrong. So I can be in a 20-25% bracket now making 200k but if i make 200k in retirement without the aforementioned deductions I would be paying 39%. Also 20-30 years of working 200k @ 30 wont be 200k at age 70. So to tell a doctor he will be in a lower tax bracket at retirement is wishful thinking.
First of all, a doc contributing to a SEP-IRA is probably making a mistake. Far better to use an individual 401(k).
Second, anyone using IUL or WL INSTEAD of a retirement account like an individual 401(k) is a fool. The tax benefits of insurance are dramatically less than those available in any type of a retirement account. Plus the investment characteristics of insurance are dramatically. Your best chance of comparing cash value insurance is against a taxable account, and preferably with lower returning tax-inefficient assets like bonds.
If you’re only making $400K a year, the chances that a cash value insurance policy is right for you are very low. Let’s talk about your specific situation if you think your tax rate is the lowest it’ll ever be. In fact, I bet it’s lower next year than it is this year. But you’re still not getting it. We’re not comparing your maximal marginal rate this year to your maximal marginal rate in retirement. We’re comparing your marginal rate now to your effective rate in retirement. You’ve got to fill the brackets. So under current tax law, married with standard deduction, your first $20K is tax free, next $18K comes out at 10%, next $50K at 15%, next $75K at 25% etc. So the effective tax rate on $150K of retirement account withdrawals is less than 15%. That’s way better than the 28-40% you’re saving when you put the money in.
I have no idea why you think you’ll be at 39.6% on a mere $200K of income in retirement. Why do you think that? Have you never looked at the tax brackets? At the most your marginal rate at that level of income will be 28%, and your effective rate down around 15%.
Seriously, do you sell this stuff or are you honestly a doctor only making $400K and planning to live on $200K who is convinced this is a good move? Because nobody who actually understands the tax code and is looking at your situation would think investing in life insurance instead of a tax-deferred retirement account would be a good idea.
Here’s a link to the current tax brackets. I suggest you take a look at them and then read up on how they work:
https://taxfoundation.org/2017-tax-brackets/
Table 2. Married Filing Joint Taxable Income Tax Brackets and Rates, 2017
Rate Taxable Income Bracket Tax Owed
10% $0 to $18,650 10% of taxable income
15% $18,650 to $75,900 $1,865 plus 15% of the excess over $18,650
25% $75,900 to $153,100 $10,452.50 plus 25% of the excess over $75,900
28% $153,100 to $233,350 $29,752.50 plus 28% of the excess over $153,100
33% $233,350 to $416,700 $52,222.50 plus 33% of the excess over $233,350
35% $416,700 to $470,700 $112,728 plus 35% of the excess over $416,700
39.60% $470,700+ $131,628 plus 39.6% of the excess over $470,700
But hey, as I said before, if you love whole life or IUL or whatever, feel free to buy as much as you like. But if you’re a doctor and wondering if you did a good thing buying it, the answer is probably no. Doesn’t mean you should sell a policy you’ve had a long time, of course, as the crap returns are heavily front-loaded.