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What We’re Missing When It Comes To Our Middle Class — Playin’ ‘Hide July 30, 2008

Posted by shaferfinancial in Uncategorized.
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Today we have a guest post from none other that the Bawld Guy!  As regular readers know, we think much the same when it comes to investing and retirement.  Enjoy and don’t forget to check out his website at

http://www.bawldguy.com/

In my opinion, the all time political football in America has been the middle class. They either don’t make enough at work, taxed too much or too little (too little?), or have disappeared altogether. None of those arguments are what continually keeps my attention. Not even close. Taxes? Middle class families figure things out and manage to survive the idiots in D.C. and their ‘help’ one way or the other. How ’bout college for the kids? Again, they figure it out. The #1 concern I’ve always had when it comes to the American middle class is what’s waiting for them at retirement.  In my view, the debates over middle class job income, or even their net worth to a certain extent, misses the target for which they should be primarily aiming. What I’m not saying very well is that saving and investing in and of itself is the very reason the vast majority of our middle class is gonna be living out a life sentence instead of enjoying a wonderfully planned retirement. How so? They’re listening to folks who apparently gotten the memo on what’s workin’ and what’s not. What are middle class folks being told these days? Slam as much money into the government’s qualified plans for retirement as possible. They sell this easily by hawking the annual tax savings allowed contributors for each dollar they invest in their qualified plans. The only retirement being enhanced in a major way by most qualified retirement plans is Uncle Sam.  

Here’s how. 

Take a middle class couple contributing to their 401(k)’s from 30-65 years old. Each year they they save anywhere from $3,000-10,000 in state/federal income taxes. In 35 years let’s say they’ve saved a total of $250,000 in taxes. If after 35 years they’re combined plans have reached $2 Million, and they figure a way to obtain a 6% annual return for their retirement income, they’re potentially in trouble. Their house is no doubt free and clear. They have no tax shelter of any consequence. In reality, they arrive at retirement with at best, $120,000 a year in income. They’ll most likely be liable for the highest income taxes possible. Let’s say they pay about $35,000 in combined state/federal taxes. This means by the time they’ve been retired 14 years, they’ll have paid just short of twice what they ‘saved’ in the previous 35 years. And that’s it ’till death. Please tell me in what scenario does saving $250,000 in taxes for the privilege of paying out twice that amount in less than half the time, make sense. Why not investigate alternatives allowing you to not only create a far more abundant retirement income, but also keep more of that larger income? Why not also do this while building tax sheltered and tax free income? Indeed, why not? Here’s what I’d be pleased for you to take away. Don’t keep your eye on a few tax dollars saved each year. Keep your eye on the real ball — your retirement income, and it’s after tax safety. Stop allowing Uncle Sam to play ‘hide the pea’ with your retirement plans. That pea is your gold.

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Comments»

1. joetaxpayer - July 31, 2008

For those who save (10-15% of gross if my math is right) and get a decent return across 35 years, the number above raises new and troubling questions. For those in this situation, there’s a need for some effort to avoid that tax bite. But, as we look at what people are actually finding themselves with at retirement, the million dollar plus pre tax account is the exception, not the rule. I’d have to ask how you reconcile the above with statistics that say we are saving less than zero, on average? To ask a non-rhetorical question – what percent of retirees, now or 30 years hence, do you feel will need to worry about saving their way to these high rates at retirement? My July 16 post cites an AARP study from which I extrapolate the answer to be “less than 15%.

Joe

2. Joshua - July 31, 2008

Can you give me some examples of what I should be investing in if not my Roth IRA or 401k? Thanks!

3. BawldGuy Talking - July 31, 2008

Joe — Just as critics of the 80’s income tax cuts didn’t factor in the behavior of taxpayers, I’m thinkin’ AARP might be repeating that approach.

True enough, the average 50-something guy with a 401(k) finds himself with a balance of less than $60,000. 30 years from now you and I know we are talking about GenX & Y folks. They appear to me to have impressive learning curves.

My crystal ball is as cracked as yours, but I’m thinkin’ they’ll not want to repeat their parents’ mistakes.

That said, as a real estate investment broker it’s not been uncommon for me to run into people having two comma balances in their qualified plans already. Granted they’re not the rule, but they’re there in numbers. You should hear their voices (silence) when they learn what’ll happen upon their retirement, and then when they die.

Thrilled is not a description I’d use.

Avoiding the tax bit at that point is, uh, challenging. They avoid the 10% penalty by way of age, then use Rule 72 (David, make sure I have that rule # correct.) to draw 20% yearly our for four years and a day. They pay taxes then put the money in EIUL’s. The income is then tax free, and upon their death there’s no tax ‘cuz the EIUL is by definition not a part of the estate.

4. BawldGuy Talking - July 31, 2008

Josh — Join David’s academy.

For sure you should own investment real estate. But should also have another basket to replace the 401(k).

I’ll let David help you with the ‘other’ basket.

5. shaferfinancial - July 31, 2008

I’m sure Bawld Guy will be posting answers to your questions soon, but I wanted to address them also.
Joetaxpayer: You are absolutely right about the failure of folks to save for retirement. I help my clients by pointing out strategies that work. But the real problem is one of the mind. Passive investing doesn’t work. Folks need to become active investors, putting into place proven strategies, rather than strategies designed for someone else’s benefit. Bawld Guy has pointed out the fallacies of 401K tax deferals. Another problem with the save/invest strategy is that folks don’t or can’t keep it up for the required 35 years. Life intervenes, and when you run the numbers with big gaps, even using the catch-up limits, you are still left wanting. Then you add the reality of the rate of return for folks in mutual funds (4.4% last 20 years) and you have your answer to the riddle why so many folks are going to retire poor.

Joshua

Thanks for the question and just by asking it you are starting to seperate from the herd. But first you need to change the way you think from passive to active investor. Then you need to look at the strategies that work and choose one you are most attuned to. Attn: here is my plug :-). That is exactly what the Shafer Wealth Academy is designed to accomplish http://www.shaferwealthacademy.com! Do not underestimate the need for a change in thinking; most of the data of the wealthy states this as the most important requirement!
There are three places that studies of the wealthy point us to:
1. Real Estate (The least risky)
2. Niche Businesses (either ownership or primary investment)
3. Concentrated equity investing (the most risky)

Personally I do all three weighted heavily to the least risky!

6. joetaxpayer - July 31, 2008

I read Last Chance Millionaire and a bit on it, at http://www.blog.joetaxpayer.com/archives/149
I pulled a brochure for the only EIUL policy I could find, the Pacific life Accumulator II, which was what I posted about. I was unable to find the fees that are taken out, or is 0% an absolute floor?
It struck me that the trade off was this; I give up about 2% (the S&P dividends, the credit is just on the index, right?) plus gains over 12%. I gain the clipping off of any negative years. I’m interested in better understanding the mechanics of this type of policy. Most things that sound too good to be true have an unadvertised downside.
The book also discusses borrowing to fund such a policy. Is such a loan tax-deductible?
Joe

7. shaferfinancial - July 31, 2008

Joe,

The “last chance millionaire” is a probematic book because the author glosses over the issues with EIUL’s. A much better book is “The Home Equity Management Guidebook” by Rocky DeFrancesco. It is much more on the technical side, which I think you would like much better than the sales pitch of Mr. Andrews. Most importanly, he outlines the way you can get home equity to a EIUL without losing the mortgage interest deduction. He works the numbers so as to demonstrate how they work and warns against problems that might occur. Also up front on the expenses, which are front loaded. Take a look at Aviva products, because they are the market leader and do more EIUL than anyone else. Indianapolis Life has a series I like to use.

8. shaferfinancial - July 31, 2008

In short, the guarantee is usually 2% for each leg (5 or 6 years) which comes from conservative investing, while the S & P match comes from options on the index. I have several posts that looks at it from different angles also. Here: https://shaferfinancial.wordpress.com/2008/02/20/a-hurricance-of-reactions-to-my-life-insurance-post/
and here https://shaferfinancial.wordpress.com/2008/05/27/life-insurance-who-owns-it-and-why/ and here https://shaferfinancial.wordpress.com/2008/05/28/equity-indexed-universal-life-insurance/#comment-446

Joe, remember that it never goes below 0% on any given year and that negative numbers hurt you more than positive numbers help you. So when you do your analysis keep this in mind. The proper comparision would be total return not average rate of return.

In these posts I make it clear that EIUL’s are not what I call wealth building products, but are hedges against inflation and taxes. Don’t expect double digit returns there. I run with an after expense assumption of 6.5% to be conservative, while the historical assumptions are 7.5-9%. In other words EIULs are good places to put your wealth once you have wealth creation machines in place. Insurance has a time honored estate management place in folks portfolio!


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