By: Brandon Roberts & Brantley Whitley of The Insurance Pro Blog
1. The federal government has a plan. Whether or not you choose to accept it–is irrelevant. As the late Senator, Daniel Patrick Moynihan, once said:
“Everyone is entitled his own opinion, but not his own facts.”
The United States currently spends approximately 76 cents of every tax dollar it collects on four things: Medicare, Social Security, Medicaid and the interest on the National Debt. By the year 2020, experts believe that expenditures on the same four things will comprise 92 percent of collected tax revenue.
Since 1913, when the government first re-imposed the income tax, our tax rates have been volatile at best. The first income tax rate was 1%. By 1943, the highest marginal rate was 94%. Government spending is an addiction fueled by tax revenue.
Fast forward to today. The top marginal tax rate at which the wealthiest Americans pay taxes is only 39.6%. Taxes haven’t been this low in 80 years.
According to the Congressional Budget Office, if Social Security, Medicare, and Medicaid go unchanged, the rate for the lowest tax bracket will increase from 10% to 25%, the current 25% bracket will rise to 63% and the highest marginal tax bracket will go from 35% to 88%. That is the government plan.
2. 401ks are seductive. The 401k has become the default investment account for many Americans, primarily because of its convenience. A set percentage of pre-tax income is siphoned from your income before it ever gets to you. Your money usually has a matching contribution from your employer added to it and then it’s then whisked away to a mutual fund company.
The contributions you make are tax deductible, your employer adds money to it and the money grows without any capital gains tax implication. Out of sight, out of mind–truly a win-win.
However, there is an unintended consequence of putting too much money in your 401k. You are effectively entering into a business partnership with the IRS. The problem is that the IRS gets to vote on what percentage of your profits they will keep and they do it without any vote from you.
Unless you can accurately predict what the tax rates are going to be in the year you choose to take money from your 401k (or rollover IRA), you really have no idea how much money you have. That makes it a little difficult to plan. Don’t be seduced by a tax deduction today at the expense of much larger tax liability in the future.
3. The Roth IRA may be the good guy we were waiting for. We tip our hat to the intentions of the Roth IRA. It attempts to disconnect the tax-deferred option by diffusing the tax time bomb created with 401ks and other qualified plans.
The Roth gives you no current tax deduction but you receive the withdrawals tax free and that is a definite improvement over the 401k and traditional IRA.
In 2014, the most you can contribute to a Roth IRA is $5,500 if you are under 50 and you make less than $181,000 married filing jointly or $114,000 if you are single. When you consider the amount of money you will need to survive during retirement, the Roth IRA cannot do the heavy lifting.
We do like the Roth IRA better than the 401k or traditional IRA and if you can use it as part of your overall plan, you should.
Why you need to mitigate the effects of
market losses on your retirement savings
4. Time is not on your side. The platitudes of comfort offered up by the financial services industry will do little to help you. You know the ones…
Just hang in there–everything will be okay
Remember, we’re in it for the long haul
Don't worry, the market always comes back
Nobody can time the market
This sort of thinking and speaking to clients has never given us much solace. Many of the personal finance gurus will trot out charts showing that the market had a steady upward trend over the last 80 years.
They show you how much you would have lost if you missed being in the market on just a handful of the best days. It is compelling.
But it leads you to arrive at some misleading conclusions. The truth is that markets go through extended periods where investors lose money. And we agree with many of the gurus who tell you that market timing is difficult. Identifying market tops and bottoms has humbled more than a few professional investors.
To reduce risk, you must reduce your exposure to potential loss. If you had planned to retire in 2008 and all your money was invested in the stock market, you’d still be working.
5. Diversification is not always the answer. Conventional wisdom tells Americans that the best way to achieve your financial goals is to save systematically and to always make sure your savings are adequately diversified. It’s well-meaning advice but it’s not terribly useful. Warren Buffett says:
“Diversification is protection against ignorance. It makes little sense if you know what you are doing.”
We couldn’t agree more Mr. Buffett. Most people use financial products such as mutual funds to achieve diversification. It is widely known and reported that most mutual fund managers underperform the market as a whole.
Does it involve less risk and somehow become more intelligent to own small pieces of everything? It is more advantageous to focus your savings toward a high quality, stable, and consistently profitable strategy.
6. The problem with modern portfolio theory (MPT). The stock market is one of extremes and MPT is seen as the answer to those extremes. Experts will tell you that the average annual return in the market for the last 100 years is between 8-10% (depending on what they are calling “the market”).
Since 1926 the market has had only five years where the average annual return was between 8-12%. In the last 86 years, the stock market has had five “average” years.
The other 81 years are a combination of extremes–exhilarating highs followed by devastating lows.
Looking at data from 2002-2011 you will see that even using MPT, 2008 delivered an approximate -30%. In fact, the compound annual growth rate (CAGR) over that ten year time period is 5.6%. However, to achieve that somewhat meager return, you would have had to emotionally endure 2008.
Many MPT advocates will say, “A well-diversified portfolio is your best defense against market volatility” We think the best defense against market volatility is to decrease your exposure to the market.
7. Your sequence of returns is crucial. The sequence of returns will have less of an impact on the portfolio of someone with a long term time horizon who is accumulating assets for some date far into the future. But during retirement, the correlation of a person’s withdrawal rate to the sequence in which they experience positive returns and negative returns will have a dramatic impact on the ability of their savings to last.
During the accumulation phase of life, experiencing times of extreme market volatility can provide opportunity and your only real concern is the market value when you are ready to start your withdrawals.
However, when you retire or you start taking withdrawals from your nest egg, the sequence of returns becomes critical. If you have strong positive returns early in your withdrawal period, wonderful.
If you start your retirement with significant market losses, the likelihood that you will deplete your assets prematurely grows exponentially. There is no substitute for stability. Remember, hope is not a strategy.
Why you should consider using life insurance to accumulate wealth and to fund your retirement
8. It’s your money, spend it . You likely have an investment account that you have thought about accessing for an emergency or some major purchase only to hear your “adviser” lecture ad nauseum about how touching that money is a terrible idea.
What if instead of having to hear about how disastrous it will be to take your money out, we could talk about how it’s perfectly ok to spend your money? We would never suggest you become a spendthrift but knowing that you can spend your money as you see fit without committing financial suicide has a certain je ne sais quoi that makes it appealing.
Structure your life insurance policy correctly and you will still earn interest on the money you use from your policy to finance your purchases.
9. It will provide a substantial retirement income. Not all life insurance is purchased for the same purpose. While most would assume life insurance is a relatively straight forward purchase based on death benefit coverage compared to the relative premium cost, this assumption would be false.
Nestled in the deeper understanding of cash value life insurance–sitting right next to a finer understanding of personal finance–is the design and use of cash value life insurance not primarily for death benefit purposes, but for the specific purpose of generating tax-free retirement income.
This is an important point to make because there is a differentiation that must be made. Far too many life insurance agents with a rudimentary understanding of cash value life insurance, structure the product incorrectly when a client’s true objectives are wealth accumulation and retirement income planning.
When you are looking to use life insurance for building cash value as the primary objective, how your money is applied to the policy is important. Keep in mind that all policies are developed to provide cash value–that part is pretty simple–but there is a huge difference between incidental cash value, and the intended creation of cash value.
If designed correctly, you should have be able to use a cash value life insurance policy to supply you with 2-3 times your outlay as annual income during retirement. Of course, this is not guaranteed, and individual situations will vary, but the stability of the product makes it much more predictable than attempting to outwit the stock market.
10. Non-reportable income should not be underestimated. Choosing to focus our practice almost entirely on teaching our clients how to use cash value life insurance involves a fair amount of learning to go “against the flow” of conventional financial wisdom. There are myriad reasons to use life insurance as a cash accumulating asset.
It’s not just about the market neutrality (though that is certainly valuable), and it’s certainly not about the likely return (stocks will almost surely win long term). It is about understanding that personal finance is much more strategic than anything else, and cash value life insurance is a powerful weapon at your disposal.
When you combine its market neutrality, its stable return, its shelter from capital gains taxes and its ability to create a tax-free income, you have an incomparable financial tool. Consider the power in having an income stream that belongs to you and is not required to be reported for income tax purposes. Did you know that there isn't even a place on your tax return to include the income from your life insurance policy?
11. It will provide benefits to you when are still alive. Some life insurance companies offer the ability for you to access the proceeds of your death benefit before you die for the purpose of paying for long-term care if you need it. We know this is an often overlooked alternative to paying premiums for Long Term Care Insurance (LTCi) where people pay expensive premiums for coverage they hope to never use.
By using life insurance that has the provision to access the death benefit to pay long-term care costs, you pay premiums and your heirs will receive a death benefit if you die never having needed to use the coverage.
This benefit has little appeal to us (human beings) as it does nothing to satisfy our urge to make more money or pay less taxes. However, the need for long-term care is real and the expenses associated with it can completely ruin plans for a secure retirement. Consider this harsh financial reality: your spouse or significant other would be better off if you died than to be faced with the expense of paying for a nursing home or in-home care.
12. Life insurance is a non-correlated asset. The Wall Street marketing machine would have you believe that in order to build wealth you have to buy stocks (or products related to stocks). We talk to a lot of people on a daily basis who’ve had about all they can stand of investments tied to the market. Many of these people take on a substantial degree of risk everyday.
Most of our clients have achieved their wealth through a controlling interest in a privately held business or by prudently setting aside a portion of discretionary income from their much higher than average incomes. They’re familiar with risk but they favor taking risks that afford them some degree of control.
They choose to use cash value life insurance as a part of their overall financial planning strategy. And you can rest assured they do not choose to buy it from us because we have an unusually convincing or unique sales presentation. No, they choose to use life insurance because it works and we can prove it.
Consider this, cash value life insurance is among three different products that provide the unique ability to have tax deferred growth and tax-free distributions–the other two being the Roth IRA and municipal bonds. Roth IRAs are not realistic for many of our clients because of the restrictive limits for high net worth individuals and for those people considered to be high income earners (as we discussed earlier).
Municipal bonds are not nearly attractive as they once were. There is too much uncertainty surrounding the validity of bond ratings and there is a significant risk to principal values in an environment of rising interest rates. Do you think interest rates are going to rise from where they are today?
The money you accumulate in your cash value life insurance will receive a competitive internal rate-of-return and it will do so without the risk of capital loss that you endure with bonds.
If you're like most people, you're not yet sure that the strategy we are proposing is a good fit for you. That sentiment is 100% valid. Please take your time and feel free to browse our site thoroughly. There are nearly 400 blog posts and podcast episodes to choose from.
Here is a small selection that might help you get started and that you might find useful:
And here is a link to our weekly podcast–The Financial Procast. To hear previous episodes click the picture below.
After reading this, you probably have questions and that is perfectly understandable.
If you would like to direct those questions to us directly, use the contact form below. We respond within 24 hours to all inquiries.
People contact us on a daily basis to discuss how life insurance may fit into their financial plan, and we are happy to help answer questions you have about where these products might fit into your plan.
Or if you prefer, you can call us directly at 1-888-834-0909. You will speak directly to Brandon or Brantley.