Same about expectations on investing for retirement.

Some years are really good while others pale in comparison. But, unlike skiing, if you don’t set it up correctly the bad years can really hurt you. Here is what generally happens in bad years. People question their strategies [which is good], and many simply give up and stop what they are doing. This is even more intense when people are invested in instruments that go negative dramatically.

A critical point when thinking about investing for retirement

Somewhere along the way people’s expectations were set that this couldn’t happen. This is, perhaps, the critical point when thinking about investing for retirement. Set your expectations realistically and use strategies that don’t trigger psychological pain in bad years. If you have well placed real estate, then you might suffer some downward movement in your received rent during a recession, might even have some issues with vacancy rates, but this should have been all cooked into the numbers. Same with EIULs.

You might have a couple of years of no-gains, but on the other side you will get good gains. Same with your rentals. As long as you have set your expectations correctly, you will be fine in the long run and not do something dumb. And you made good progress even during recessions, just like my son improved his skiing even during a short season! Sometimes because of your expectations you don’t realize how much progress you really made.

BawldGuy Here: This might be one of Dave’s most valuable posts so far this year. The ups and downs of the national and sometimes local economies come and go like the seasons. That’s exactly why real estate and EIULs are worth their weight in gold. Over the long run, for different reasons, they both yield the results expected by investors. The investment world, like anything else is relative. When compared to the multitude of options from which the investor has to choose, real estate and the EIUL have been kings of the mountain so long, few even know what vehicles are next best.

If you know the yield on invested capital will be 10%, what’s better to have — $100,000 in 5 years — OR — $55,000 today?

I’ll leave the answer to you.

A reader made a comment. He asked if the income from an EIUL I’d quantified, was present or future value. The income was structured to begin 25 years from the inception of the policy.

My answer

Since it’s not realized for 25 years, it’s definitely not present value. A fair analogy would be those who use present dollars to buy real estate, borrowing more present dollars to finalize the acquisition. They plan to retire after slowly but surely paying the loan off with future cash flow + future job income, resulting in future debt free cash flow.

Much like the EIUL, real estate cash flow in retirement is, necessarily not ‘present value’.

Your question points out a downside to all cash flow generated by long term investment. We can never really know/understand the present value of future cash flow — at least until we’ve arrive at a particular point in that future. We can impute the unknowns in the equation to estimate it, but that’s all it would be, an estimate. Will it be worth more or less? The normal answer is that with assumed inflation, future dollars will be less valuable.

The thing is, though, the question you’d really like answered, is this.

Real estate values have, historically, pretty much tracked with inflation. The same is true of rents, more or less. Add the second retirement income basket that generates tax free income (EIUL), and you’ve successfully, at least to a great extent, insulated yourself from the dollar’s erosion.

The reason tax free income from the EIUL helps fight inflation, is more practical in nature. If your state/fed combined tax bracket is around 30%, this means the $100,000 EIUL annual income represents the equivalent of around $143,000. (just under) ‘Course, all that means to the real estate investor whose portfolio sports an EIUL, is that over a period of 15-35 years, retirement cash flows subject to taxes must be higher to produce the same income as those cash flows which escape taxation.

And the congregation replied, Duh!.

BawldGuy Takeaway: As Captain Obvious would say, “All retirement cash flow is, for those yet to retire, by definition a ‘future value’.” When a portion of that income is tax free, it effectively has helped shield the investor from years of inflation by the avoidance of taxation.

Therefore: In the above example, $100,000 of tax free income equals roughly $143,000 in taxable income. The major scoop here?

Tax free income in retirement is incredibly cool.

It’d also be cool if you called me at 619 889-7100. Rather write? Just click the Contact BawldGuy button up top. Together, we’ll figure out how to get you to the retirement you’ve always wanted. Have a good one.

I am working with a client who sent me an e-mail from another agent who he was working with originally. Before he received this e-mail he was still undecided as to who to work with. The funny thing is he simply asked some questions, good questions, and stated he had talked to another agent.

Here is the first paragraph [with all identifying sections taken out].

“With all due respect, I don’t have the time nor the inclination to attempt to justify our strategies with you if you are going to turn this into a “beauty contest” with other agents or products. I’ve been there, done that and it is a complete waste of time. Our strategies are not up for debate at this point. We could use any insurance company we wanted to but with our experience, we know what is best for the client and that is our one true aim.”

Unfortunately there are many in the financial fields that think like this whether it is insurance, real estate, or investments. For levity I will annotate this for you, but the point is deadly serious. Educate yourself about any product or strategy you are considering, ask questions, expect answers, and never work with someone who thinks they know what is best for you!

With all due respect [You’re a fool that can’t possible understand what I am talking about].

I don’t have the time nor the inclination to attempt to justify our strategies with you if you are going to turn this into a “beauty contest” with other agents or products. [I fear we don’t offer the best product and can’t explain the intricacies of why I think this product is better than others]

I’ve been there, done that and it is a complete waste of time. [Once folks understand how little I know I always lose the sale]

Our strategies are not up for debate at this point. [I can’t debate them because I only offer what I am told and have someone else tell me how to sell the strategy]

We could use any insurance company we wanted to but with our experience, we know what is best for the client and that is our one true aim. [Don’t you worry your little head about this, papa knows best what is good for you.]

This last sentence is the one that get’s me the most. What you want to bet what is good for the client [in their mind] is what is best for their pocketbook?

I know the people reading this will understand to stay away from sales people that think like this. Unfortunately there are far to many folks out there that think like this.

Hope you get as good of laugh as I did when I received this!

BawldGuy Here: First, thanks to Dave for the best written comic relief so far this year. Seriously though, I’m always imploring those calling me never to let me get away with sayin’ something ‘hard ‘n fast’ without backing it up in depth, and in detail, to their satisfaction.

As pros, all the contributors here understand that some answers aren’t the ones the questioner wishes to hear, but, well, the answer’s the answer. Again, thanks to Dave for my giggle of the day.

So Charlie came to me already the proud owner of an ancient three unit, located in his hometown in New England. He liked the idea of investing in Texas. Liked even better the concept of having a Purposeful Plan. Having lived frugally he’d saved more than enough to acquire a new duplex there. It closed awhile back. Part of his Plan was to get an EIUL (Equity Indexed Universal Life) started, once he’d closed his first purchase in Texas.

He gave David Shafer a call and together they started the process. Charlie called me out of the blue today to let me know it’s done. Here are the details. I think you’ll find them more than a bit interesting.

His monthly premium is $1,000 monthly. David structured it for 30 years. Charlie is to pay the premiums for 15 years. Then he’ll simply let everything simmer for another 15 years. Just before turning 60 he’ll begin to receive the income developed by the EIUL. In Charlie’s case it’ll be about $100,000 a year — for the rest of his days.

However, I’ve suggested a twist.

As young as he is now, Charlie will no doubt have employed strategies allowing him to sell one or two properties while paying very little or no capital gains taxes or depreciation recapture. I would have him execute this move virtually simultaneous to the end of his EIUL premiums. My experience says the dollar figure resulting from the sale(s) should be about $250-500,000. It’ll depend on how David says to get it done, but bottom line, those funds will be put into his policy either in one lump sum, or over four years and a day.

I’ll let David chime in at this point if he wishes, but my educated guess is that putting that much cash inside the policy 15 years or so before income is triggered, would increase the yearly income substantially. I wouldn’t be surprised at all if it increased by more than 100%, especially if the amount was at the range’s high end.

Charlie will likely carry out a tax deferred exchange in the not too distant future, using his New England triplex. I strongly suspect that by the time he’s in his 40s he’ll own many small income properties, finished off his EIUL premiums, and moved an equity or two into the EIUL. Let’s have some fun and look into our cracked crystal ball to discern his potential retirement income at age 50 and upward.

Retirement at 50

I’m gonna assume, being relatively conservative, and using my knowledge of Charlie’s ability to save, that he’ll have acquired no less than half a dozen small income properties. Probably more, but let’s error on the understated side of things. A tad over 20 years from now his real estate income might look like this.

Income of approximately $120,000 a year. That number is also fairly understated, but it’s one with which I’m comfortable publishing. It assumes that in 20 years his Net Operating Income (NOI) on all properties never increased, not a penny. Much of that income would be tax sheltered.

The decision Charlie would make at that point was whether he would sell one or two of them to pay the aforementioned lump sum EIUL payment. Ah, but there’s another option I’ve been keepin’ under wraps.

By the time he’s 50, Charlie will’ve owned these properties free and clear. Some for a few years, some for 7-12 years. Do ya see what’s comin’?

See, if he’s able to eliminate debt on all his properties by the time he’s 45, which is even money from where I sit, he’ll have more options available. Let’s take a look.

• Instead of selling a property or two, he can simply kick back and actually increase his premiums over the next 15 years. What would happen if he took $5,000 a month out of the $10,000 monthly cash flow and for the next 15 years applied it to his EIUL. This is where we must call on David Shafer to put in his 2¢ when he has time.

• Another option would be sell just one property, put the proceeds into the EIUL as a lump sum, then take the same $5,000/mo mentioned above for the next 15 years. There’s simply no way that either of these choices will not literally blow up his retirement income in the most positive of ways.

Bottom Line

As posted here Tuesday in ‘. . . Theoretical Retirement’, these numbers result from analysis solidly anchored in the principle that the real estate investment properties acquired stand the test of time — wait for it — AS ACQUIRED.

In other words, and in plain English: No appreciation and no escalation of any kind to the NOI.

Charlie’s ultimate income won’t be known ’til he actually retires. We do know what is a reasonably reliable lowball figure though. If he acquires just six properties, sells just one when he’s 45, keeps the rest while doin’ nothin’ else, his real estate income should be roughly $100,000 a year.

If he then elects to carry out my second option, his EIUL should be around $200,000 yearly, give or take. (That figure is an educated guess on my part. I plan to ask David for more or less exact numbers, which I’ll then publish.) Oh, have I been remiss in not mentioning the fact that all income derived from his EIUL is freakin’ tax free for life? Or that when he dies, his heirs won’t pay a dime of taxes on it?

When Charlie’s celebrating his 60th birthday, he’ll be smilin’ big time. His monthly income should be in the neighborhood of $25,000 a month — over 65% of it completely tax free. NOT tax deferred, or tax sheltered — TAX FREE.

Happy 60th birthday, Charlie.

You lookin’ for a birthday like that? Duh. Gimme a call and together let’s start makin’ it happen. You’ll reach me at 619 889-7100 — OR — send me a note using the Contact BawldGuy button up top. Have a good one.

Fear, greed, envy, distrust are all very strong emotions. I recently had a potential client bail on purchasing an EIUL that strongly demonstrates this process. I know that Jeff has seen this in play with his business, as have most people in a sales position. Sometimes when you expose the process people can adjust and overcome. Warren Buffett has been making statements for years with this in mind like this; “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”

I had a high income/high net worth surgeon contact me about an EIUL. He had already read a book on EIULs and had found me through my website. We have had more than a dozen long e-mails and several phone conversations. Obviously he was a detail-oriented man and spent much time putting figures into his spreadsheet. At the end of the process he said he was ready to proceed and we took an application.

A couple of days later I got an e-mail from him. His wife, who worked for a large insurance-based financial services company had told him she wanted to check out the product and the company he chose because she was unsure of the “risks.” She further said she had a contact that was an expert on EIULs. At that point I knew the deal was dead. She was basically saying she did not trust the product or the companies that offered them. All that rational work this executive had done up to then would be thrown out the window based on distrust and fear. As I predicted a week later I received the e-mail that stated they would not be purchasing the EIUL because the policy was one-sided with all the power in the insurance companies hands.

I’m not telling you this story to say this couple was wrong or right [it was their decision after all], just to demonstrate the power of emotions to derail our rational brain. He had spent hours pouring over the illustrations, even discovering little points that I was unaware of that favored EIULs. Built multiple spreadsheets to make sure there were no hidden charges. Run different numbers through the spreadsheet to see how the policy will react under different environments. His rational work came up with a purchase decision. And based on undefined fear their ultimate decision was a no-go.

Jeff has told me about similar situations with investment real estate purchases.

The financial data is complete with evidence that most people buy high and sell low, doing the opposite of what Buffett suggests. Stock traders pay big bucks to people who claim they can adjust a traders’ psychology to override their emotions.

We all need to work on conquering our fears and letting our rational brain help us. I always ask the question, what are my fears and are they based on reality before making a big decision. This helps me to separate out the two sides. I don’t always make the right decision, but rarely do I have to look back and say I let irrationality reign supreme.

Ultimately, I know our emotions will be in charge, but I feel better just exposing the process to the light of day and working on getting my rational brain some space to work.

BawldGuy Here: I had to learn this lesson myself many moons ago. One day, a favorite mentor pulled me aside. He knew I’d researched a particular property to within an inch of its life. He also knew I’d given it thumbs down as a result of my own objectively ruthless analysis. Yet, I was still gonna buy it — why? He told me it was irrational — nothing more, nothing less, but in um, somewhat more colorful language. I did an abrupt ‘about face’ and tore up the offer before it was sent.

From that day forward, ’til he passed away several years ago, he rarely called me anything but, “Boots on the ground, Brown”, which is a badge of honor I’ll wear forever. (This is the first time that story and/or name has seen the light since he passed.) What a treasure he was.

But he was right — and that’s exactly what David’s saying. Have a good one.

I have never been a big proponent of deferred annuities. Immediate annuities have a place for folks who want to assure themselves of a certain level of income for life. But deferred annuities in my opinion are more problematic. Variable annuities have the same problem as mutual funds with the big market downturns dramatically effecting outputs. But the biggest problem with deferred annuities is that they must be backed by short and immediate term products, which will give folks lower rates of return. The indexed annuities will always have much lower cap rates than the indexed life products for this reason. With an annuity the company must be prepared to give the money back at any time and therefore must use investing strategies that allow that type of liquidity.

Taxation

The other issue is that there is some taxation on annuities. Generally, any accrued interest will be taxable when income is taken.

For me, the deferred annuity is really no better than the current options most people have in their 401K/403Bs. It is being sold as a safer investment that beats the returns on certificate of deposit’s, but that is a pretty low bar to overcome.

For those who are in good health, Equity Indexed Life Insurance should be considered. Tax free income — low overall expenses — no negative years — and insurance that can protect one’s dependents or help heirs/designated beneficiaries.

BawldGuy Here: Please, do yourself a favor and don’t gloss over ‘no down years’. That factor alone is often the difference maker. Every time you have a down year in stocks or bonds you instantly climb onto the ‘investor treadmill’ runnin’ as fast as you can to get where you were before you had the ‘down year’.

For those who’ve never been on one, treadmills get you nowhere, but fast, and you get pretty tired during the process.

From a strategic standpoint this product is really hard to market time in general because it takes a month to process through the system and then up to two weeks to get the index leg started. With stocks and mutual funds you can purchase any time you want with little lead time and buy and sell multiple times a day if you like.

But let’s look at what advantage there is to waiting:

Example 1: You were so unlucky as to have your index leg created at a market top then what do you lose?

Well, in real terms nothing, but there are some opportunity costs.
At the end of year 1, say the market is down 50% from when you started you suffer no loss.  The index leg is done and you start a new one at the new starting point of 50% less than the original leg. When the market rebounds you stand to gain up to 15% per year.

Example 2:  You wait to time the market.

You have perfect timing and pick the market low [4-6 weeks in advance]. The most you have to gain is the 15% cap on the index.  But that is only if the difference between the time you establish your leg and the end of the 1st leg in example 1 there is a gain.  That is because each leg is established at the current level of the index.

The gain from waiting is the gain from the time the example 2 leg is established until the example 1 second year leg is established.  And the maximum that could be is the 15% cap.   The liklihood of perfect timing of a market low is pretty small and you add in the odds that the market rebounds significantly in that time between the establishment of the 1st leg in example 2 and the 2nd leg in example 1, and you have even smaller chance of that happening to any significant level.

Index Level 6 months 12 months 18 months

Example 1 1100—————————————550———————–650
Example 2 500—————-550———————–650

In this example you would have an additional 10% gain for example two in the first 6 months, but at the end of example 2 first leg to get the 15% capped gain. Example 1 already has reached its 15% cap in the second leg.

So you not only have to be very lucky on timing the bottom but you need to market to rebound very fast in that 6 month difference to get the advantage.

Historically the market goes down very fast and for a short period of time, while the market goes up less intensely but for a much longer period of time. Human emotion being what it is, combined with the fast drops explain why people tend to sell too late to get out of the down market and get in too late for a rising market.

Purchasing an EIUL

It is a very different thinking process than for stocks or mutual funds. Once again, this is why I love this product because it takes the short-term market variability almost totally out of the equation. And if you were playing the odds correctly, you would initiate the buying process immediate after a day like today where the market dropped significantly because the odds are that the market drop will be largely over 4-6 weeks down the road.

But the bottom line is that an EIUL largely takes short-term variability out of the equation because the losses are eliminated and each year the index leg starts over at its current level so the risk of buying in high is dampened significantly.

Leave market timing to the stock traders and sleep well knowing the short-term variability of the market doesn’t hurt you!

I’m workin’ on a post about that ‘investment’. Seriously, calling that an investment almost made me lose my lunch. If I was a standup comic, real estate investors going to NoCal with serious intent would provide me with endless material. They put almost 45% down so they could bathe in the monthly glory of a whole $500 in cash flow. They must feel proud. Sorry for the snarkiness, as I usually stop myself, but at some point sensible folk must draw the line in the sand.

I guess in NoCal, gettin’ a cash on cash return of .96% earns the investor braggin’ rights at the next neighborhood BBQ. Go figure. Don’t think it’s just those from the northern half of the state though. San Diegans are infamous for thinkin’ their real estate is blessed by the mythical real estate gods.

Max Whitmore’s advice last week

He called it, big time. A New York client told me following Max’s advice saved his 401k mucho dinero. Let’s hope Max gets the itch to write every now and again. We sure miss him here.

Chad Emerson comes through again — he’s so boringly predictable.

Had a couple clients receive a welcome email today from my favorite Texas lender, Chad Emerson. He let ‘em know their loan rate had floated down to below 5%! Never in all my two lifetimes in this business have I ever even dared to hope for an investment loan under 5% on a 30 year fixed term. The clients are jazzed, as am I. One of ‘em commented to me today that they’d never known a ‘banker’ to do business as Chad does. Said Chad was ‘The Man’. Preachin’ to the choir.

EIULs VS 401Ks and your retirement

Though I’ve easily written over 20,000 words on the topic, here and elsewhere, there are folks who might benefit from seeing here — and now.

Here’s the Reader’s Digest version. Just about everything that’s wrong or illusory about your 401k/IRA is what it should be, or real, with an EIUL. Here’s the best piece of empirical evidence I can offer while being exceedingly brief.

Those who had their money in 401Ks circa 2008, lost 35-50% of their hard earned retirement funds. Those who had EIULs in place? They suffered through a year in which they made 2% on their money. In other words, if you had $1 Mil in your ‘retirement’ plan in ’08 in the stock market, you lost $350-500,000. If you had it in an EIUL, you made $20,000. ‘Nuff said.

OK people, tomorrow’s almost here and I need a fix. Gimme a call at 619 889-7100 and we’ll put our heads together. Rather send me a note? Click on Contact BawldGuy up top. Have a good one.

His first concern was that the insurance company could “jack” up the fees once the policy was in place. There are limits put in place on the amount of fees insurance companies are allowed to charge and there are contractual limits. Now, first off I need to point out that with Minnesota Life they have never increased the fees associated with a life policy on policy owners since at least WWII. So, even though they could increase some of them, they never have [the exception is insurance charges]. The reason they haven’t is pretty simple, they manage their risk well and have never found themselves in the position of having to make up for poor reserve management by extracting more money from their policy owners.

There are several classifications of “fees.”

The largest of which [policy issue charge] is set at the time of delivery of the policy and will not change. The next largest is insurance costs and only changes when the new actuarial tables change. This doesn’t happen very often, last happening in 2005, as the changes in mortality happen very slowly. The actual increase, if any, is pretty small.

Finally, there are “administration expenses” which is really small and insignificant, that is charged when you make changes to the policy.

However, there is another class of issues that is more significant than the fees. That is the participation rate and cap rate. Participation rates can change by contract, but never has. This affects the interest you earn on the cash value in your policy. Currently, there are three different options for this that range from a participation rate of 100% to 140% of a stock index.

The other part that does move is the cap rate. This is the highest interest credit you could get each year. Currently, this is set at 15% for ML. In the past it has been 17%. The overall interest rate climate is the controlling factor here. Since the insurance company is backing the interest rate credit by a combination of fixed rate securities [treasuries, AAA corporate bonds, etc.] and by purchasing options in the market on the index if the overall interest rate environment is low [like now] then more money is needed to purchase fixed rate securities to cover the guarantee [3%] and less money is available for the options. Assuming the interest rate environment goes back up in the future to a more normal rate then the cap rates should raise along with it.

So far in the industry no one has ever raised expenses on current policy owners of EIULs nor have they lowered participation rates. The only part that has moved is the cap rates which moved down in 2009 -2010 after the interest rate environment moved down.

In short, EIULs have worked exactly how they have been advertised to work.

The final issue is the ability of ML to be a viable entity in the future. The commenter suggested that if AIG could go belly-up so could ML. And yes that is true, any entity could go belly-up. In the past 100 years there have been a handful of life insurers that have run into financial problems. When this happens the other insurers have rushed in and bought the life insurance book of business.

Writing life insurance is a very old business and by now the companies know how to price them so they are considered very valuable. Berkshire Hathaway just bought a large book of life insurance business last year. I have heard of no policy owner not getting paid on his or her life insurance policy because of insurer financial problems. That is a long positive history. In addition I only use companies that have a high Comdex rating [combines all the ratings]. Currently ML is rated a 94 [out of 100], which puts it in the top 6% of all insurance companies worldwide for financial stability and adequate reserves. Finally, I liked to point out that we just went through the worst recession since the great depression and ML is still solid. Of course, the government heavily regulates these companies if that is of any relief to anyone!

Philosophically, I am more concerned with the risk of higher taxes than I am worried about life insurance companies going out of business. I have owned an EIUL for about 6 years now and it has worked exactly as it was advertised. I sleep well owning and selling EIULs for companies that have been around for over 100 years. On top of that with a 9 year son the LI aspect is appealing. And when he hits college age, the life insurance policy, which should have several hundred thousands of dollars of cash value is not counted in the matrix for scholarships. It is a protected asset from lawsuits in my state. All those positive aspects overcome the negatives for me [there are always negatives].

I think that understanding how they work and being prepared for the parts that do change [cap rates] is the best antidote. At least it works for me!

Please ask any more questions you want to along these lines or any other.

Most people are happy to just go along with what everyone else is doing and hope it all works out well. So they let Wall Street and the government plan their retirement. How do you think that will work for them? Haven’t we seen exactly who Wall Street cares about? And the government, however well-meaning, would be the last folks I let plan my retirement.

We all think that we are great “thinkers,” so we discount the effect of propaganda on our psyche. Take a look at what almost every financial planner suggests. 401K/IRA/403B with mutual funds inside them. Maybe, do some fancy diversification buying bond funds along with equity funds. Whoopee!

How many out there are suggesting Real Estate? Ever wonder why? Too risky they say. Be careful they say.

Here is another brilliant bit of advice. Buy term insurance and invest the rest [in mutual funds no doubt]. But what they don’t say is that the average term life insurance policy lapses after year 2! So if you buy level premium 20 year term you have overpaid for those first years you own it and most people let it lapse well before it can become useful or even fairly priced. Term insurance is a cash cow for insurance companies, which is why so many relatively new insurance companies get into that business. The funny thing is that most of the financial planning industry came from accounting backgrounds if they have any formal training at all.

Yet, they advise the least tax efficient devices as possible.

For a moment, let go of all you have heard about life insurance. Now, think about this; historically EIULs have gotten an internal rate of return better than mutual funds. You can get $$$ out of a life insurance policy without having to pay taxes. You leverage your dollars in the first 15 years [or so] when most of the fees and expenses are being charged by having the life insurance component. If you die without finishing your financial plan the life insurance can complete your plan! And you will always have some amount of $$ going to your heirs no matter how long you live.

Does this sound like you are taking a huge risk? Does it sound like a worst idea than what most financial planners are suggesting? Does it sound like it might be a good fit for folks who also invest in real estate?

BawldGuy and I think it is a good fit. Around 1997 I stopped believing what financial planners were telling me. Since then my investment portfolio has thrived. Isn’t it time you do the same? Even though EIULs will never win a popularity contest?