Scott Burns wrote for the Star Tribune a few weeks ago, asking:
Is insurance the answer to pension-taxes dilemma?
This idea, described in detail in Douglas Andrew's Missed Fortune 101, “doesn't survive testing in the Reality Lab,” according to Burns.
Burns actually runs some numbers. Among other things, he cites:
- the high commissions charged for life insurance,
- the high cost of life insurance;
- the rather optimistic assumptions in Andrew's predicted returns on the life insurance
- the big shortfalls if the life insurance only returns the guaranteed rate (about 2%)
To this end, he mentions that “high taxes sound pretty good,” which is a point that Andrew uses to argue against most other retirement plans.
The last sentence of the article, though, captures it best:
“The only certainty is that most people will be disappointed, perhaps disastrously, with the consequences of exchanging home equity or tax-deferred retirement accounts for life insurance.”
Despite what Mr. Andrew suggests, I want all of those “lazy, idle dollars” that are “trapped” in my house staying right where they are, thank you very much. I like them there just fine — lazy, idle, and trapped. They may not be earning me any interest, but I'm sure not keen on “putting them to work” by paying the lion's share of my “returns” to two different for-profit industries — the lending industry and the life insurance industry. Regardless of whether I make money on the arbitrage or lose my shirt, they both still take their cut!
Not gonna do it. Wouldn't be prudent!
By the way, if you do a Technorati search for “Missed Fortune 101” (in quotes) now (late September 2005) you get mostly references to Mr. Burns' article. The way that the article is excerpted, though, it looks like a bunch of positive reviews at first glance. Also, most of the other blogs just excerpt the first couple of sentences from the article and use that as part of a post, maybe automatically. Seems like very few of the posts had much stuff that wasn't cut and pasted. Unfortunate — people doing a search may not realize that Mr. Burns' article on Missed Fortune 101 criticizes it.
Mr. Burns misses the point and certainly ignored the math. He is correct in that this type of plan is not suitable for him; age is an issue. Mr. Burns is slightly older than the 55ish age limit on this type of alternative investment. I would also like to point out a few errors in his logic; the high cost of insurance and commissions are the same thing, an agents commissions are the cost of insurance along with the risk of death. There is no additional commission paid directly to the agent by the client as Scott alludes to. The assumptions are flexible, you can assume 5-7% as well. People do not like to be wrong about anything; especially if they have saved in a plan for 35 years of their life. He mentions big shortfalls if the life company only returns 2%; would anyone be happy with any investment company that returned 2%, no. Also when an investment company loses money, i.e. they are down -10%, the insurance company still has to credit the policy at the guaranteed rate, i.e. 2%. There is no perfect answer Taking advantage of other peoples money (home equity) to fund your retirement is the idea behind Andrew's strategy. Sure, there are no guarantees in the market but with Mr. Burns' technique (the status quo approach) you are assured of one thing, paying more in taxes. Not gonna do it.
Peter, thank you for your comment.
If things go well then you earn more on the insurance than you pay to service the HELOC. If things go bad, you earn the guaranteed rate (2%, say) but still owe the interest and/or principal on the HELOC, which will probably be a bit more than 2%. That's the scenario I want to stay away from.
When I first entered the life insurance world I noticed that the UL life policies stayed ahead of the droping interest rates and never, I repeat, never saw the so called guaranteed rate on most policies. And if they had they would have still proven to be better that what was out there at the time. Becuase we have seen the bottom literally fall out on interest rates reaching all time lows, my premonition says, the sine wave is headed up not down.
Now….how does the insurance industry with it's fixed products keep above the drop dead rates? Simple, you don't find their money chasing unreal returns that can crash at a change in hats.
The issue of a HELOC…please talk to a mortgage advisor, for the variants in mortgage lending is far more sophisticated that it use to be and there are ways for someone to do quite well with the arbitrage of those "lazy, idle dollars".
One quick question….have you ever read part B of a prospectus? There is not one "investment" product on the market that doesn't have percentage points taken out of investment dollars. Commissions and comissions and commissions. Money managers, brokers, agents…they all get paid. Unless you read the bible sent with each fund you really won't know what you are paying.
Plus….low and behold…you can lose the who darn thing…or lose just a little and still pay taxes.
I've never know any advisor that would seriously recommend that someone keep there money buried under their bed because it won't cost them any money to make more money. And if you are in business and don't employ money you make to make more money….well, then you will always just be getting buy becuase Unlce Same will just take more and more and more……
The bottom line here is PLEASE DON'T OVER SIMPLIFIY WHAT LEVERAGING CAN DO FOR SOMEONE AND DON'T STAY IN DENIAL THAT THERE COULD BE A BETTER WAY!
Jer
Hi Jerry, thanks for your comment!
Leverage is a good thing when it's used wisely. Using it to buy a house when it's a fixed payment you can afford today is a good use of leverage. I know what my payment will be in 2015, if I even have a payment by then.
Turning to Mr. Andrew's plan: Can you guarantee that my rate of return will outpace the rate I'm paying to borrow the money in 2015? Just because you've never seen policies hit the guarantee doesn't mean that they can't. If I've borrowed at 6% to earn at 4%, I'm in deep trouble.
Mr. Andrew's predictions are aggressive and depend on a lot of things going right, but that's only part of it, and it's not just about Mr. Andrew.
There are any number of people with any number of plans and promises who will help homeowners with highly appreciated real estate extract money from their houses, fund whatever, and go deeper in debt, while at the same time taking a piece for themselves.
Lots of people have great ideas on how to spend other people's money. The question is: Would they themselves get into what they're selling? If not, then there's a problem.
Your comment about whether or not people get into what they sell is a valid one. Ironically, Mr. Andrews does get into what he sells–heavily. He refinances as often as prudent and possible (that is more dependent on appreciation than on rates), and carries several insurance buckets on himself. His lifestyle pays for itself and does so handsomely.
About the idea of depending on a lot of things going right–doesn't every other retirement plan out there depend on the same things going right? If interest rates on mortgages fluctuate, at the same time, interest rates on investments will also fluctuate. Mr. Andrews teaches that the rates are relative. You mention knowing what your payment will be–this plan can work with a fixed rate, 30 year mortgage. I can know what my payment will be in 2015 as well. And on top of that, I can know that I will also have the minimum growth of the policy, and likely a great deal more by 2015!
M.B.H.
Lets talk concept. I don't think you quite get that if you pay 6% simple interest and earn 4% compound interest that you will cross over in year 23. 23 years on 100,000 at 6% it will cost you $138,000 in interst but if you earn 4% compounded you will have earned $146,472. Now if you happen to get a tax deduction for mortgage interest expense it will be better. If you are in a 25% marginal baracket and have enough other deductions to get the full deduction you will have only had $108,000 in cost. the crossover is actually in 12 years.
This assumes that you only earn the 4% which is probably a little low over this period of time.
Hi Al,
Don't I have a $100,000 debt hanging over my head? There is a crossover, but I still owe the $100k! When does that get paid back? How?
Matt, very true, things need to go right for most retirement plans. It seems a more prudent choice, though, to not fund retirement plans with borrowed money. You may take a loss, but at least you won't have fixed payments to a bank on top of that.
OOPS… I left this on the old discussion thread I think… so reposting here:
a) IRS currently disallows mortgage interest deductions for loans used to fund single premium annuities or single premium life insurance policies, folks. OK so they don’t check too closely *except* in an audit. Want to rerun the calculations including back taxes and penalties owed upon audit? Or count on having paid premiums in over a few years so it won’t *look* like a single premium intent? Hmmmmmm indeed! This scheme fails on the “Z” factor… being able to sleep at night. Sorry, but my clients are old fashioned… they prefer their nights sleep, and so do I!
b) One of the great investment tests is, “If things go south, how bad is it?” Life insurance is marvelous at what it does, but being an investment is not one of those things. If things go south in the early years, one could cash in the policy to pay off the additional mortgage, more or less. In the middle (accumulation) years, cashing in the policy is accompanied by an income tax bill on the gain. In the later years… don’t even think about it; the only prudent way out of the total policy loan interest due is to die so the death benefit makes you whole… which works, if your life in 30 years fits what you plan today.
c) How many of us could have predicted our circumstancees today, 30 years ago? Better not make that bet with your house!
Update on item (a) above… I called the IRS… interest on a loan used to purchase single premium life, endowment or annuity contracts is NOT deductible as investment expense. But home mortgage interest (the money used for practically *ANY* purpose) IS deductible, within the $100,000 of "equity debt" loan limitation.
So I stand corrected! Thought I'd better report.
mbh
You can pay off anytime you want after the cross over. You may not want to pay off then but you will certainly have the ability to.
Hi Jerry, thanks for your comment!
"""Leverage is a good thing when it’s used wisely. Using it to buy a house when it’s a fixed payment you can afford today is a good use of leverage. I know what my payment will be in 2015, if I even have a payment by then."""
You will have a payment by then, unless you can come up with the money in some other investment vehicle (without using the probably 100's of thousands of capital in your house) or suddenly make a great deal more at your job than you previously did (because if you could afford more, you would already be dumping that into your house with no benefit (because unless you refinance and start your amortization schedule all over again your payment doesn't change even though you pay down your principle in a 15 or 30 year fixed)
On top of that, you don't know what your payment will be unless you commit 100% to not refinancing.
you must know 100% that you will not be tempted to refinance by a lower interest rate (which in most cases will not save you much money, even in the long run, and again, resets your amortization schedule) or to cash money out of your house for any reason.
and if you really believe that you can't earn more that you pay in interest, then leverage is never a good idea. It just means, by your way of thought, that people who can't buy a car or house for cash, shouldn't have one. if you wanted to argue that the leverage and payment allows someone to own a house or a car, you could make the same argument for leverage allowing someone to OWN anything, even a retirement vehicle. Oh, right, so you might say that the leverage gets the ownership of the property so the appreciation on the home is profit, and therefore makes sense. than take your conservative attitude and build a conservative plan with a minimum GUARANTEE of 4.5% appreciation on your life insurance policy and death benefit. can you guarantee 4.5% on your housE? no, and you still like it beacuse it averages 7%, just like a whole life policy. (there is a strategy for someone ultra conservative)
and that house that you so wonderfully plan to have payed off by some miracle of an influx of money (maybe from a life insurance policy a family member still had on the books because it was a permanent policy, not term) is probably where you are going to look when you find your 401K and pension are not enough for your retirement.
you also clearly do not have a full understanding of the concept in a life insurance investment VEHICLE, because it isn't like a stock or a bond, its a vehicle that you can put your money through and invest in other things. you could overfund a policy with $100,000 over 5 years, and in year 5, use 100,000 for a real estate investment. you WILL make money on the arbitrage of borrowing even before you consider what you make on your investment, and that 100,000 is going to grow as if it were present in the policy.
In any case, you don't need to worry too much about having life insurance because with your attitude towards finance, you will never have an estate so large as to really worry about passing it on to anyone. you will simply re-leverage your house in retirement to make up for the plan you didn't make for yourself, and pass on your house with a large debt and taxes to your heirs, who will have to sell the home they grew up in, to pay those taxes.
I'll be here all week, im a financial professional, and this isn't the strategy i use for all my clients, but it is almost always a key item included in a responsible financial plan.
(your 401K is invested in the stock market. risky. not only that, but I constantly see returns of less than 1% on these accounts because the people who coordinate them are the HR departments. The fund managers only have to convince a captive audience of employer and employees that the account they have always been taught to use is the best one, and they have the worst fund managers in the world, because they don't need to perform to keep a CAPTIVE audience. all they have to do is sell the HR department.
if you are in a 30 year fixed and refinance even every 15 years, you are never paying a significant portion of your principle. go to bloomberg.com and read the amortization schedule.
good day
how is this program holding up today with the stock market crashing and housing market?
The majority of these posting were in 2005, its now August 6, 2009. I think it is safe to assume that Mr. Burns would like to take back these words: I want all of those “lazy, idle dollars†that are “trapped†in my house staying right where they are, thank you very much. I like them there just fine — lazy, idle, and trapped. Mr. Burns unless you secretly took Mr.Andrews advise – there no longer Lazy, idle or trapped!