There is a “financial guru” named Douglas Andrew who lives in my local area. He is a financial planner, radio host and author who advocates a rather unique approach to retirement planning. I've occasionally come across his “radio show” on Saturday evenings. It annoys me, because it is composed of several hours of sales without an ounce of real information being provided. He pushes his books, CDs, webinars and seminars which are thinly-disguised solicitations for your financial planning business. Since I couldn't get anything out of his show, and I surely wasn't going to spend an evening going to a 3.5 hour sales presentation, I decided to check out one of his books from the library. The book is called Missed Fortune 101 – A Starter Kit To Becoming A Millionaire. In big words under the title is the question, “Isn't it Time You Became Wealthy?” I said to myself, “It sure is time I became wealthy! I'm going to read this book!”
[Update 3/17: Doug Andrew is now operating under the brand “Live Abundant.” I would be surprised if the new name involves new methods, so I suspect this entire review still applies. Since most successful businesses don't change their brand/name due to the value of their reputation, it should cause the reader to consider the reasons why a change in brand would be advisable for this particular business.]
When I started writing this review, I wasn't sure how long it was going to be. It ended up being nearly 7000 words long. My only consolation to you, the reader, is that the review is much shorter than the book.
The Financial System Doug Andrew Recommends in Missed Fortune Book is Flawed
In a nutshell, here is what Douglas Andrew says you should do with your money:
- Step 1: Avoid putting money into 401Ks or IRAs.
- Step 2: Buy 1-2 homes with nothing down.
- Step 3: Use an interest-only mortgage on both properties.
- Step 4: Use all that money you saved by not putting it into 401Ks/IRAs, down payments, or mortgage principal payments and invest it into universal life insurance policies.
Does that sound insane or what? Now, it's not as bad as it initially sounds, but this plan still has plenty of holes in it big enough to drive a truck through. Here's his reasoning.
Don't put money into tax-deferred vehicles because you'll pay more tax on it later than you'll save now (half-true). In fact, if you have anything in there now you should pull it out right away even if you have to pay a lot of taxes and penalties to do so. Don't put anything down and use interest only mortgages because home equity earns a zero percent return (not true), is not liquid, and is subject to loss in the event of foreclosure. If you have home equity, pull it out as soon as possible. Then buy multiple universal life insurance policies because it's tax-free going in (not true by the way), it grows tax-free, it earns similar returns to other investments (not exactly true), it comes out tax-free, and when you die it “blossoms” into even more money thanks to the death benefit. He basically recommends you “arbitrage” your money by borrowing at a lower, tax-deductible (mortgage) rate and invest at a higher, tax-free rate (inside the life insurance policy.)
What Doug Andrew Gets Wrong in his Book Missed Fortune 101
If you don't see all the flaws in his reasoning yet, (the parenthesized comments may help) don't worry, I'll be going through them all in detail.
Safety, Liquidity, and Rate of Return
Doug spends a lot of time in his book and on the radio (and I'm sure in the seminars) talking about how good investments have safety, liquidity, and a solid rate of return. The fact is, however, that you don't necessarily need all three of these from each of your investments. For example, I don't need the money I'm planning to spend in 20-50 years to be liquid. Sorry. If it takes me 5 years to liquidate it, that's okay. There's plenty of time. But I do need that money to have a decent rate of return so I can grow the nest egg despite the effects of inflation. With regards to my emergency fund, I need it both safe and liquid. However it is a relatively small percentage of my net worth, and I can live without it having any kind of decent return. Sure, if someone wants to pay me 20% on my E-fund, I'll take it, but I certainly don't expect or need a good rate of return on that little chunk of money.
Marginal Tax Rates Vs. Effective Tax Rates
Mr. Andrew doesn't seem to get (or chooses to ignore) the concept of effective tax rates. In every example in the book, he considers 401K/IRA withdrawals to be taxed at an effective rate of 33%. The truth is that the vast majority of Americans will pay an effective tax rate on 401K withdrawals that is far less than 33%. Even most doctors and other highly-paid professionals will have a lower rate. I've explained this before on the blog, but in retirement, just like when you're working, you first subtract your exemptions and deductions from your income. So for a married couple in 2013, the first $20,000 of income is completely tax-free. Your next $17,850 is taxed at only 10% (federal) and the next $54,650 is taxed at only 15% (federal.) So your first $92,500 in income is taxed at an effective rate of only 10.8%. A required minimum distribution at age 70 is 3.6%. If 3.6% of your nest egg is $92,500, we're talking about an IRA of $2.5 Million. What kind of an income does it take to get there in 30 years or so if you're saving say 10% of your income into the IRA? About $360K per year. That means your 401K contributions would be taxed at 33% if you weren't putting them into the 401K. Contributing at 33% and pulling out at 10.8% is a winning formula.
The astute critic will note that the IRA withdrawal rate could be higher if you are getting other taxable income, such as Social Security. But even assuming that you get $30K (maximum of 85% taxable) of that $92,500 from Social Security, you're still only looking at an effective tax rate on that IRA withdrawal of 14%, far less than the 25-33% you saved while making the contribution.
This simple misunderstanding by Douglas Andrew causes him to make incorrect assumptions that lead to incorrect conclusions throughout the book.
Don't Contribute To A 401K?
Mr. Andrew isn't completely unreasonable. He does acknowledge that you should contribute to a 401K enough to get the match (well, most of the time) and that Roth IRAs are pretty cool. But aside from the fact that he doesn't understand effective tax rates on 401K withdrawals, he also glosses over several other issues when he recommends against retirement accounts. First, he gets onto this idea that “tax rates are going up!” Everyone seems to believe this (just ask around), but it isn't always true. Everyone believed it in the 1990s, then what happened in the 2000s – the Bush Tax Cuts, which were just made permanent this year for the 99.4%. Tax rates DON'T always go up. But even if they did, thanks to the fact that effective rates are not marginal rates, it still isn't a reason to avoid tax-deferred retirement accounts during your peak earning years.
Second, he places undue emphasis on the “Age 59 1/2 Rule.” Sure, there's a 10% penalty for taking money out of retirement accounts before Age 59 1/2. But how many of us retire before that age anyway? If you have a good reason to have that money, like medical issues, disability, college education, a house downpayment, or early retirement (using the SEPP rule), you can get it without that pesky 10% penalty.
Third, he makes the mistake of assuming paying less tax is the goal. Less tax isn't the goal. The goal is to end up with the biggest stash of after-tax money. If you pay the same rate upon withdrawal as you would save upon contribution, you'll end up with the same after-tax amount whether you pay the (small amount of) tax up front or whether you pay the (large amount of) tax upon withdrawal. It makes no difference whether you pay the tax on “the seed” or on “the harvest.” It's just as easy to pay $200K on $1M as $2K on $10K. The only question you have to answer is whether your marginal rate upon contribution is likely to be lower than your effective rate upon withdrawal.
Fourth, he doesn't seem to realize that Roth IRAs or 401Ks could be used for his “equity management” plan (more on that later) far better than any life insurance policy. Roth accounts allow for all the upsides of “mortgaging your retirement” with none of the downsides of using life insurance. To be fair, Roth 401Ks were not widely available when he wrote this book and Roth IRA contribution limits were quite a bit lower. But based on what I'm hearing on the radio, he's still advocating for the life insurance approach.
Fifth, he places too much emphasis on required minimum distributions as being some awful thing. We're talking about RETIREMENT money here. You're supposed to spend the money on retirement. The RMD is 3.6% at age 70, 5.3% at age 80, and 8.8% at age 90. That's hardly some huge burden. I guess maybe you shouldn't put money into a 401K that you don't want to spend in retirement. Did you need me to tell you that?
Pull Your Money Out Of Your IRA?
The author spends a chapter or two explaining how to get out of the 401K/IRA “trap” or “dilemma”, i.e. that you'll pay more tax by leaving your money in than by taking it out, paying the 10% penalty, and paying all the tax due over a year (or perhaps several.) He likes to call this “the enlightened way” or an “IRA roll-out.” This isn't some new concept. People do this all the time, especially in early retirement years prior to taking Social Security or in years when income is low. But they don't pay the 10% penalty, and they don't put the money into life insurance. They put it into something better- a Roth IRA. If you're going to pre-pay taxes on an IRA, I sure as heck wouldn't do it to buy cash-value life insurance when I could avoid the penalty and put it into a Roth IRA instead. In my opinion, this advice qualifies as financial malpractice.
Real Estate Always Goes Up?
Several chapters in the book were dedicated to developing an “equity management plan.” Basically, stripping equity out (or better yet never putting it in) of your home(s) so you can invest it into universal life policies. All the illustrations in the book are awfully favorable- home values only go up, and they do so at 5% a year (in fact at one point he brags about how his go up 7-8% a year. I'll cut him a little slack, since he wrote the book in the early 2000s prior to the real estate meltdown. He is also very good to note that you should never strip equity (or avoid putting it in) to consume it, only to “conserve” it. But when you run assumptions that don't account for home values falling up to 75% as they did in Las Vegas during the meltdown, or for the more likely long-term appreciation rate (usually inflation or inflation + 1%), you arrive at the wrong conclusions. For example, if you avoided putting $50K down on a $250K house so you could put it into a universal life policy, and then the house value went down 20% and you had to sell it a couple of years later to move to a new job, there's no way you're getting $50K back out of that policy to pay off the mortgage enabling you to sell. The interest-only mortgages (and even negative amortization mortgages) that Mr. Andrew advocates for were one of the main reasons home owners got into trouble with the real estate bubble. Leverage absolutely does work, but it works in both directions. Mr. Andrew's idea of a “401K Cabin” illustrates this idea perfectly. He figured it was going to appreciate at 7.2% a year and in 30 years his $100K cabin would be worth $800K. How's that working out for you buddy?
Home Equity Has A 0% Return?
This one really irks me. Equity doesn't have a zero percent return. That's silly to think so. The return might not be high, and you might be better off investing money instead of paying down your mortgage with it, but the expected return certainly isn't 0%. There are two easy ways to think about it that easily demonstrate this. First, when you pay extra principal toward your mortgage, what is the return on it? It's exactly the same as the interest rate on your mortgage. 8% mortgage = 8% return. If that mortgage interest is 100% deductible for you (more on this below), then you adjust the mortgage rate by your marginal tax rate to calculate your return. If your mortgage is 8% and your marginal tax rate is 25%, then your return for paying it down is 6%. That seems awfully different from 0% to me. The other way to look at home equity is to consider your home as an investment. If a $400,000 home rents for $2000 a month ($24,000 a year) and costs you $3000 in taxes, $1000 in insurance, and $2000 in maintenance and repairs, then the $400K investment yields a dividend of $18,000 a year, or 4.5%. Again, a lot different than 0%. Bad assumptions lead to wrong conclusions.
Putting Money Down Gets You A Cheaper Mortgage
Throughout the book, Douglas continually shows you illustrations where the mortgage rate is the same no matter how much you put down. That hasn't been my experience when I've been out mortgage shopping. Putting down more money gives you more options, makes it more likely for you to qualify for a mortgage at all, lowers fees, and reduces the interest rate. It also lowers your payment, since the loan is smaller, and helps keep you from overbuying, an important behavioral effect. Taking a look at the Amerisave website as I write this (January 2013) now shows the following:
- $400K home, 30 year mortgage, 20% down: 3.25%, $1280 in fees
- $400K home, 30 year mortgage, 10% down: 3.25%, $2630 + $186 per month in mortgage insurance
- $400K home, 30 year mortgage, 5% down: 3.25%, $2676 in fees + $244 per month in mortgage insurance
- 0% down loans not available from Amerisave unless you qualify for a VA or USDA loan
Now I don't want the reader to assume that these are the only loan options out there. Many doctors, for instance, qualify for a 0% down loan that's typically 1/4- 1/2% more expensive than a 20% down conventional loan. But you can see the trend. The less you put down, the more you will pay, whether you pay with a higher rate, higher fees, more points, or more in mortgage insurance. Likewise, you would see similar reductions in cost when looking at a shorter loan term compared to a 30 year mortgage. For example, Amerisave currently advertises this for a 15 year mortgage:
- $400K home, 15 year mortgage, 20% down: 2.50%, $1046 in fees.
Mr. Andrew fails to account for this factor when making his analyses. Bad assumptions = incorrect conclusions. It should be noted that we are in a time of uncharacteristically low interest rates right now. Under more typical circumstances, the additional costs of not putting money down are quite a bit higher.
Your Mortgage Interest Might Not Be Deductible
Douglas also always assumes that your mortgage interest is 100% deductible. Remember that in 2013 a married couple gets a standard deduction of $12,200. To deduct mortgage interest, you have to file schedule A and itemize your deductions. If you don't have more than $12,200 in deductions, your mortgage interest is completely non-deductible since you're going to be taking the standard deduction anyway. For your mortgage interest to be completely deductible, you need to have at least $12,200 in OTHER deductions. Most highly-paid professionals don't take the standard deduction, but 70%+ of Americans do (probably including the couple making $72,000 that Mr. Andrews keeps using as an example in his book.) How big of a mortgage do you need at today's rate to pay more than $12,200 in interest a year? $375K. I hope you're giving a lot to charity or paying a lot of state taxes if you're planning on your mortgage interest being fully deductible.
You Have To Be Foreclosed On To Lose Home Equity
Douglas seems to have this irrational fear of losing home equity in a foreclosure. He wants to keep it out of the home so he can't lose it to the bank when the bank takes the home. I understand why he has this fear, since he reveals in the book that he lost his home to foreclosure and lost $150K in equity in his early 20s. The financial professionals who read this blog tend to have very stable incomes and are rarely foreclosed on, especially if they keep a reasonable emergency fund. I'm only six years out of residency and my portfolio is already larger than my entire mortgage. This fear is highly overblown in the book. Home equity might not be an FDIC-insured bank account, but I certainly wouldn't consider it a risky investment because I could lose the house to the bank. I'm sorry you lost your house Doug, but perhaps you shouldn't have bought a 6400 square foot house at age 24 on a highly variable income.
You Still Have To Service The Debt
The book suggests you pay lots of that tax-deductible (maybe) mortgage interest because paying mortgage interest is just as good a tax deduction as contributing to a 401K. But the fact remains that you can stop making $401K contributions at any time if you run into financial trouble. You still have to make those house payments, or you'll lose the house. Perhaps Doug doesn't mind losing his houses since he doesn't have any equity in them, but there are serious consequences to a foreclosure, none of which I want to deal with. First, your credit score gets slaughtered, making it very hard to get any loan at all for 7 years. Second, you have to uproot your family out of your neighborhood, perhaps leave your church congregation, and pull the kids out of their schools. Not to mention the costs and hassles of actually moving. Third, I don't know of anyone who's been through a foreclosure who thought it was a pleasant experience. It probably isn't as bad as going through a malpractice suit, but it can't be very fun. The more debt you carry, the more you have to service. If, as Doug suggests, you have $500K in debt on your main home and another $500K in debt on your second home, that's $1M in debt you have to service every month. Even if you can get it at say 4%, you still have to come up with $3333 every month to service it. Sure, $1111 is deductible, but $2222 isn't. If you think it's a good deal to pay $3 to deduct $1, I'll let you send me $100 every month and I promise to send you $33 back.
As long as we're talking about Mr. Andrew's unfortunate incident in his 20s, why is it that all the financial gurus in Utah seem to have gone bankrupt (or gotten foreclosed on) at least once? Robert G. Allen and Carl Richards come to mind. No wonder Lending Club data shows Utah is one of the worst states to lend money in. Utah also has the fourth highest bankruptcy rate, despite one of the best economies. Don't get me wrong. I think it's great that these guys got back on their feet after being knocked down. But Mr. Andrews advocates that if you want to become a millionaire you should get advice from millionaires. I say, if you want to be a millionaire and never go bankrupt or get foreclosed on, you should get advice from millionaires who have never gone bankrupt or been foreclosed on, like the Bogleheads, rather than the Utah financial guru/seminar industry.
Paying Down A Mortgage Vs Investing
Mr. Andrew rightly points out that mathematically, there may be many times when you are better off investing than paying down your mortgage, especially a low-rate, fully-deductible one. (For instance, my after-tax rate on my mortgage this year is 1.7%, less than anticipated inflation.) But he never mentions the benefits of eliminating debt- improved cash flow, freedom to decrease income, lower fixed expenses, a feeling of financial freedom etc. Paying down the debt, of course, provides a guaranteed, albeit low, rate of return as mentioned above. That rate is really little different from the guaranteed rate available with any investment, including universal life insurance.
Criticisms Of Douglas Andrew's Book, Missed Fortune 101
Now, before we move on to my criticisms of the other part of Douglas Andrew's strategy (investing in universal life insurance contracts), let's pause for a minute to point out a few other random issues with the book, which are not uncommon with books of this type. On page 29 (where's he's busy bizarrely explaining how paying taxes is an asset) he puts out a chart that shows what happens when money doubles over 20 periods. The casual reader may make the assumption that money grows to the sky as he shows $1 becoming $1.05M over those twenty periods as the money doubles every period in a tax-free manner. What he doesn't make clear is that at typical rates of return (say 7.2%) money doubles every decade. So the chart is showing a 200 year investing horizon, four times as long as that of most investors. I can only think of one way to keep money growing for anywhere near that long in a tax-free manner (besides giving it to a charity or a university endowment), and that's to use a stretch IRA left to a great grandson upon your death. Compound interest is what it is, but it's important for investors to realize that even with a good return $1 isn't going to become $1 Million in your lifetime.
The estate tax scare is also common in financial books. “Your money might get taxed not just once, BUT TWICE!” Yea….at least the portion over $10M (married, indexed to inflation) that you don't give away prior to your death. That is such a non-concern for nearly all Americans it almost shouldn't be mentioned. The assumption that the estate tax is something you should worry about leads to the wrong conclusions- buy unnecessary permanent life insurance.
The example Andrew uses to explain how tax brackets could be higher in retirement than during working years shows a teacher who never made more than $60K would get $16K in SS income, $36K in a pension, and $30K from an IRA ($82K total) and then be shocked that she is in a higher tax bracket in retirement than during her working years. Uh….newflash….higher income means a higher tax bracket. That doesn't change the fact that most retirees live on less money throughout retirement than in their peak earnings year. How big of a portfolio would a doctor earning $400K in his best year need to generate $400K of income in retirement? $10 Million. Getting close? I didn't think so. The teacher should have used a Roth IRA, of course, knowing she was expecting such a big pension in retirement. Problem solved, without a need for life insurance.
Andrew also suggests employers should be willing to match dollars for their employees into either IRS-qualified plans (like 401Ks) or non-qualified plans (like life insurance) and that they should hold seminars to educate themselves and their employees on these options (perhaps you could call Mr. Andrew to schedule one, no?) What a bizarre world Mr. Andrew and his associates appear to live in where they see a universal life policy as not only a reasonable option for investing, but the only option anyone ever ought to use.
This idea that a $6000 mortgage interest deduction is just as good as a $6000 401K contribution is also a common one carried throughout the book. He never mentions that while they both provide the same deduction (assuming the mortgage interest is fully-deductible) that with the 401K contribution you not only get the deduction, but you also get to keep the $6K. I occasionally explain this one to my wife- “Yes, honey, I spent $10K on Roth IRAs, but we still actually have the money. If you want it, we can pull it out and spend it.” Yes, there may be taxes and penalties, but the money isn't gone like with making mortgage payments.
Mr. Andrew also uses some bizarrely high expectations of investment returns, which likely also affect his willingness to go into debt to get them. He often uses returns of 8-10% for life insurance, 12-15% for equities and 7% for real estate appreciation. All are ridiculously high, especially given today's interest rates. I understand the book was written a few years ago, but please show some appreciation for historical and expected returns on investments. Again, bad assumptions mean incorrect conclusions.
Using Universal Life As An Investment
Now, I'm 4000 words into this critique and I haven't even gotten to the biggest problem with Missed Fortune. I could forgive someone for choosing to highly leverage his house on an interest only mortgage in order to invest, as long as he realizes that adding that leverage is significantly increasing his risk. In fact, I think it probably isn't very smart, at least mathematically, to pay down a low-rate mortgage rather than investing in a tax-free account such as his Roth 401K or a Roth IRA. But, finally on page 182 (of 272) of the book, after countless mind-numbing pages of number-filled charts demonstrating the wonders of compound interest, Mr. Andrew finally reveals what this wonderful tax-free “alternative retirement account” he's been alluding to for 182 pages actually is. Insurance salesmen don't like mentioning that the product they're selling you is life insurance, probably because it causes them to lose sales because most people have learned at some point that life insurance generally makes for a poor investment when compared to alternatives. But eventually, the cat comes out of the bag, and hopefully for them, it's after they've convinced you that life insurance isn't really life insurance. They like to tell you all the ways in which insurance companies are better than banks, the government, and your mother's apple pie.
The Issue Of Life Insurance Returns
Then the typical salesmen goes through all the benefits of cash-value life insurance (and there are some very real benefits) and finally arrives at the issue of the fact that life insurance has a relatively low return as an investment. At this point, the salesman has to convince you that it doesn't matter. Mr. Andrew does it in this manner: He quotes an insurance professional who says that “Contrary to belief, rate of return is generally not the main factor in accumulating wealth.” I actually agree with that statement in that I think your income and your savings rate are probably the main factors, at least early on. However, later in life, rate of return actually IS the most significant factor. Mr. Andrew, however, thinks the most important factor is the fact that you get the money away from yourself. He even goes so far to suggest that most people would be better off burying their money in a tin can so they didn't spend it than putting it into a guaranteed 8% investment because then they'd be more likely to spend it. Well, if this investing theory is for people that dumb and undisciplined, it certainly isn't for me or my typical reader. It's bizarre that he spends the whole book talking about how liquidity of your money is so important, then he suggests that illiquidity is the main reason you should invest in life insurance.
What If You're Not Insurable
There's a very real issue with recommending life insurance universally as an investment. This investment still has to masquerade as insurance. That means you have to be insurable. If you have poor health or participate in dangerous hobbies, it's going to be a very expensive investment, if you can get it at all. Mr. Andrew's Solution?- buy the policy on your spouse or kid. Seriously. Then not only do you get all the great benefits of this investment, but you hit the jackpot when your kid gets run over.
The Costs Of Insurance
Insurance has significant expenses when compared to a more traditional investment. I mean, it's got to pay out when someone dies. Plus you have to pay the commission to the salesman and all the other costs of the insurance company. Mr. Andrews actually explains this process very well. He envisions a properly structured universal life insurance policy (basically one you pay up in 4-5 years with as low a death benefit as legally allowed to still call it insurance) as a bucket with an open spigot at the bottom. You put money in and some drains out (the expenses). In the early years, the spigot is quite widely open, then as time goes by, it gradually drains slower (not entirely true as the insurance component of a universal life contract actually gets more expensive as time goes on, but that cost is generally a lower percentage of the cash value each year). That open spigot certainly explains why a traditional universal or whole life policy has a cash value less than premiums paid for the first 10-20 years. He estimates that over the long-term, the cost of this open spigot is about 1%. I think that estimate is far too low, but it's a place to start. Since the money is growing tax-free and also was contributed “tax-free” (not true, but more on this later) and will come out tax-free, he feels that the savings on the taxes more than makes up for the costs of the insurance. Is this true? It depends on what you compare it to.
Mr. Andrews compares everything to an investment whose returns are taxed at 33% each year, which obviously favors anything compared against it. But what investments should be compared to the life insurance contract? If you compare it to money in a Roth IRA, there are no taxes. If you compare it to a traditional IRA, there are no taxes as it grows, but obviously a tax upon withdrawal, making comparison hard. A tax-efficient mutual fund in a taxable account seems a reasonable thing to compare it against (unless you made the mistake of not maxing out a retirement fund before buying investment life insurance or the even bigger mistake of withdrawing your IRA to do so). In the lower tax brackets, long-term capital gains are taxed at 0%, although recent changes with the fiscal cliff and Obamacare raise these as high as 23.8% for higher earners (still well less than the 33% used in all his examples.) Qualified dividends are also taxed at highly-favored rates. Appreciated mutual funds are passed income tax-free at death just like life insurance, so we'll just look at the ongoing tax drag.
If you have an indexed stock mutual fund with a return of 8% a year, yielding 2% a year, and we assume you're paying 20% on that yield, your tax drag is 0.4% a year, well less than the 1% (again, that's too low in my opinion) drag on the life insurance. So if the investments in the portfolio grow at 8% a year, the mutual fund grows at 7.6% and the life insurance grows at 7%. After 30 years on an investment of $100K, that 0.6% means a difference of $139K. If the life insurance costs, spread out over 30 years, were closer to 2%, the difference would be $326K less, over a 30% decrease. The lower returns available from life insurance investments are a real issue, and they are caused primarily by the costs of the insurance policy and secondarily by very conservative portfolio held by the insurance company (often 90% or more in bonds.) All of Mr. Andrew's examples assume the life insurance investments grow at the same rate as a non-insurance investment, which just isn't true. Life insurance mathematically CANNOT provide the same return as the same investments without the life insurance wrapper, because the wrapper must be paid for. The investment managers at the life insurance company simply don't have access to investment returns that you as an individual cannot get without a life insurance company. It's all the same stuff- stocks, bonds, real estate etc. In fact, insurance companies invest primarily in bonds. Given their current very low yields, life insurance dividends are likely to continue to decline as they have been doing for years. Worse, when rates go up, the insurance company will still be holding the long-term bonds it tends to invest in. At best, your returns will be locked into lower rate investments and dividends will fall and stay low for years. At worst, insurance companies will go under and all or part of your investment will be lost, depending on state-organized guarantee associations.
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 – Don't Follow the Advice in the Book Missed Fortune 101: A Starter Kit to Becoming a Millionaire
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.
