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New Way to Tap into Home Equity Appears! September 8, 2008

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Never say the financial markets are not inventive!  Now there are three companies (REX andCo., Equity Key and Grander Financial) that will give you some of your home equity in exchange for a piece of the future appreciation.  Of course, you need to have significant home equity to make the deal, and the percentage they are willing to forward to you is pretty small.  But in exchange for cash now, you give up 1/3 or 1/2 of your future appreciation.  I suppose they are filling a niche of folks who want to stay in their homes, yet don’t have the credit scores or enough income to get a traditional loan.  And of course they are competing against reverse mortgages; that shouldn’t be hard.  Regular readers know that I dislike reverse mortgages for the fees and the compounding interest which eats up home equity fast.  Here, at least, you can share in future appreciation as well as share the risk for any depreciation of value. For those of you curious here is a web site for REX and Co. http://www.rexagreement.com/index.php/

But, why this product?  Well, it is the result of poor financial advice being handed out by financial planners. For years, the financial service industry (banks, financial planners, etc.) has pushed the idea of paying off your mortgage so you enter retirement with no mortgage.  The result of following this advice is millions of people with paid off homes and little retirement savings.  As inflation eats away at their savings and health care costs escalate retirees find themselves caught between a rock and a hard place. 

Banks pushed reverse mortgages at these folks as a way to remain in their home and suck the equity out of it.  Now beyond the obvious predatory nature of reverse mortgages, hidden from view, is the reality that these folks would be much better off having more retirement income with a mortgage, than little income without a mortgage.  Too late for these folks.  Now I have written before that people that find themselves in this position are much better off selling the home, buying an immediate annuity and renting a nice apartment.  Their expenses go down, they get additional retirement income for life, and live in a much more manageable place. 

For those folks still working, pay attention.  If you don’t have a mortgage or are trying hard to pay it off, stop.  Get out that equity now, and put it to work for you before you have to give up all that equity to a bank in a reverse mortgage or give up a chunk of the future appreciation in these new products (why own a home if you are not benefitting from the appreciation?).  If you have a couple of million dollars to get you through your retirement, then you can afford to have a paid off home, if not you can’t.  Consider selling the home if the market is OK and you are on the verge of retirement with moderate amounts of wealth.  Renting is really not a bad experience for seniors.  Many real estate investors would love to have a nice stable senior couple rent their property and would bend over backwords to make it a great experience.  I know many of these folks! 

Just a Reminder of my Seminar on Thursday February 27, 2008

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Learn how to significantly improve your future


by using already existing assets

Free Seminar February 28th, 6-8PMTampa Palms, Compton Park Meeting RoomPresented by David Shafer, Ph.D. RSVP 813.910.8020 Marimark Mortgage & Shafer Financial

A hurricance of reactions to my Life Insurance Post! February 20, 2008

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Holy Smokes, lots of phone calls on my post about Cash Value Life Insurance!

Most were insistent that I prove my point on the investment value for life insurance.  But I have already run the numbers based on realistic assumptions and so have others and the outcome favors the life insurance contract.  So I have challenged myself to find a set of assumptions that leads to a different conclusion.  So here it is, enjoy!

Let’s look at two cases:

Assumptions:  The  S&P 500 Index returns one third what it has historically returned or 4% going forward.  Now lets compare putting $100,000 into a indexed universal life insurance contract as opposed to $100,000 into a low expense, indexed mutual fund.  Assume a 45 year old man in good health.  Further lets assume the mutual fund was in a 401K wrapper for tax deferral.  And finally lets assume a 15% marginal tax rate, the lowest possible which means they live in one of the five states that doesn’t have a state income tax. 

First the life insurance contract. In order for it to abide by IRS rules and avoid being a modified endowment contract it must be funded over 5 annual payments.  So we start with $100,000 make our first $20,000 payment and then put the balance of $80,000 in a money market getting 3%.

That buys us $400,000 worth of insurance which we index to the S&P 500 Index.

So if we die after 10 years we get $400,000. Our rate of return is 14.4%

If we die after 20 years we get $400,000.  Our rate of return is 7.2%

We live to our life expectancy of 80 and we get $400,000.  Our rate of return is 4.1%.

But wait you say, you can’t get to that money in a life insurance contract.

Wrong, you can access the surrender value anytime you want taking out policy loans.  At age 67 there would be $170,000 to access.

But there is more to this strategy.  You could use the interest earned in that money market fund you created to fund the life insurance to buy more insurance or you could just let it be.  After your five payments are made there would be $6400 in the account.  Let’s assume you took the interest and purchased an additional 20 year term policy with it.  You could purchase a $150,000 policy.  Remember, you will accumulate no cash value with this so it is just added protection which will add to your wealth before retirement if you don’t make it.

Now you have $550,000 if you die after 10 years.  Rate of  return is 18.6%

At the 20 year mark you die and you have $550,000.  Rate of return is 8.9%.

At 80 it would be the same (4.1%) since the term policy is no longer in force.

Now let’s compare that to the mutual fund.  Once again it is an index mutual fund tied to the S&P 500 Index with a very low overall expense ratio of .5% (average is 2.5%). The rate of return for the fund is 3.5% (4% Index rate minus .5% expense ratio).

If you die after 10 years you would receive $141,060.  But there are income taxes due (your heir has to pay it). We assumed the lowest marginal tax rate of 15% so you pay $21,159 in taxes and end up with $119,901 for an after tax return of 1.8%.  Not good!

OK, you live to retirement age of 65.  You have $198,979, but you gotta pay taxes on that so it reduces the amount to $169,132.  Your return is 2.7%.

You live to 80.  Congratulations!  If you have not used the account.  You have $333,359 in the account.  After taxes it is worth $283,355 for a return of 3.1%.

Let’s review:

                                      LI                                              MF

10 year R/R                 18.6%                                        1.8%

20 year R/R                  8.9%                                         2.7%

35 year R/R                  4.1%                                         3.1%

Available cash at 65   $148,000                              $169,132  

Bottom line is that you have significant better rate of returns from the life insurance at a cost of $21,000 in cash flow at age 65.  A toss up in my book.   

Let’s do this if the S&P 500 Index returns in the future what it has in the past because it dramatically changes the calculations.  Your marginal tax rate goes up to 25% because you have to withdraw an amount that puts you in a higher tax rate. You also have a estate tax problem that cost you if you leave it in the mutual fund until age 80.  All other assumptions stay the same, but the historical return of the index is 12%.

                                       LI                                         MF

10 year R/R                   18.6%                                  9.7%

20 year R/R                    9.6%                                   9.8%

35 year R/R                    8.5%                                   9.8%

Available cash at 65   $429,377                              $661,155  

So what I have done is to put the real numbers from insurance software against the best case of a mutual fund.  So, if you have a mutual fund with an expense ratio of .5% which is 2% below average and you never access it.  If you live to your age expectancy.  If the market returns the same as it has historically done. If you are in the lowest tax rate possible and live in a state with no state income tax.  And finally, if when you need the money the market is not in a down period then you come out ahead putting your money in a mutual fund.  If any of these things are different then you don’t.

So there it is, I believe I have made a case for the mutual fund over cash value life insurance!  Had to work hard to do it!

I think this demonstration answers the question, is cash value life insurance an investment easily.  It doesn’t answer the question which is best for you.  Only you can look at your situation and answer that.  For me, I have a large equity indexed insurance contract and still own mutual funds from previous employers retirement plans.  Although, I am starting to sell the mutual funds in favor of a single stock.  But that is a story for a future post!

PS I let my securities license lapse, so anything I have said should not be considered in any way or form investment advice.

Do you continue to do what we know doesn’t work? January 18, 2008

Posted by shaferfinancial in Uncategorized.
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I have been having some interesting discussions out in “blogville” on the issue of equity management and financial planning.  Bascially, there are many folks who not only defend the status quo advice but are unwilling to even consider alternative ways of thinking.  Now I am used to that when talking to some lay people about mortgages, investing, and wealth creation but what has struck me is the vehement unwillingness for so called “experts” to look at the actual results of the financial advice being given by these folks.  They have rules that seem to be set in stone no matter what data is given to them bringing into question those rules.

For the last two generations the mainstream financial advice goes something like this:

Debt is bad, so first you must lower your spending until you have removed all debt (except your mortgage).  Next you must take the difference between your new spending level and your income and pay down your mortgage and invest in mutual funds (preferably inside a tax-deferred vehicle).  This will allow you to retire with no mortgage and much invested $$ that you can live on.  From here the advice is really about how to increase your rate of return from mutual funds or maybe include an annuity or cash value life insurance.

Now this advice sounds great, especially when you show people that the stock market has returned 12% over the last 40 years, and how making monthly investments into your account can increase the value by dollar cost averaging, and how skipping that expensive cup of coffee every morning can turn you into a millionaire.  It is a great theory.  But this advise has been around long enough to measure its success.

Here is where the rubber meets the road.  Since we have all these folks who were given this advice, we should have lots of very successful retirees and near retirees who have no financial retirement worries, right?

The median (half above, half below) amount in retirement accounts for those 55-64 years of age is $88,000.  Wow, doesn’t seem like much does it.  Median total assets for this age group is $248,700.  80% of folks have less than $300,000 in total assets.  Much of the difference between total assets and amount in retirement accounts is in the form of home equity.  See those people were listening and paid off their mortgage before retirement.  Where is their million dollar retirement accounts financial planners like to talk about?

Here is some more data that is not talked about.  Average returns for individuals investing in mutual funds is 9-10% less than what the market has returned.  Maybe this explains the missing $912,000.  Well partially anyway!

Now a majority of current retirees have a defined benefit plan.  However only about 39% of those that retire this year have a defined benefit plan, instead they have to rely on social security and their 401K/IRA savings.  And the percentage of folks with a defined benefit plan goes down every year in the future.

Folks there is troubling brewing in retirement land.  Not that there isn’t already issues.  Living here in Florida we watch as many retirees see their retirement incomes eroded due to inflation and rising expenses for new needs like medicine.  Many of these folks live in mortgage free homes.  They are now falling for the newest scam….idea called reverse mortgages.  Some, the smart ones, are selling their homes to access the home equity and turn it into retirement income.  

This is the result of the financial advice given to this generation of folks. 

Yet, many, no most, of the “experts” are still giving the same advice.

Oh, I know they will say these folks just didn’t listen, or lacked discipline, or had some bad luck.  They will point out the rare success story, but the bottom line is the numbers don’t lie.

$88,000 in retirement funds!