EIULs and Missed Fortune

[James]

Well I find the Mortgage Professor to be very shallow on his history of loans, sure our fathers generation did do the 20% down and mortgage but their fathers generation and generations before basically knew nothing more than IO loans. In fact the 20% down and what we called a traditional mortgage isn't truly traditional based on time at all. In fact it wasn't till the 50's that what we call the traditional loan came about.

Than this so called professor says this is abnormal today:

But this was an unusual case: her mortgage rate was low, her tax rate was high, and her preferred investment was tax-exempt. A taxable investment would have to beat 4.75%. If the mortgage rate had been 6%, a taxable investment would have to beat 6%.

Now I suppose he is suggesting people with good credit rating, in higher incomes can not achieve a low interest rate in the last 20 years??? Where has he been? In fact most anyone with good credit should be around 5% or below in our recent low interest enviroment. Once again does this guy live in the seventies or did he post this stuff in the early 80's? Plus since I demostrated that having a savings vehicle that pays on compounding interest will cover and work even if it's up to 2% below the interest on the mortgage! Such as the 15/30 year mortgage, take out a 30 year mortgage instead of a 15 year one, difference of payment amount you place in a savings account that is earning up to 2% below your mortgage rate and in 15 years you side account would pay off the balance or be within a very narrow margin.

The 20% down and having equity within a house or any property is a suckers bet for the purchaser but an excellent protection for the bank or financial interest of the person holding the note. It gets no more simpler so I really don't know where this Professor guy is coming from?

 

[Guest]

OK folks,

READ CAREFULLY, COULD HARM YOU FINANCIALLY

Okay folks,

1. I do not endorse the idea of going into debt to the maximum extent possible.

2. I in no way endorse the idea of investing all your money in one product; diversification is the key to success.

3. There are some valid points in the Andrew program.
A. Use of debt to control assets. (Does not mean you have to go hog-wild and get the maximum debt possible.)
B. Use of Permanent Insurance as a means to secure funding for retirement. (And I do not endorse going into LI 100%, one should diversify and use other assets.)


What the New York CPA Society Says

You can thank Airborne1 for this. He questioned my posting on another thread and made me re-read this.

Note that the paper was written when the tax rates were higher and the IRA contribution limits were lower. I do not believe it matters. I believe that the priinciples espoused by the paper are still valid and worthy of consideration.

The CPA Journal Online

Insurance - a comparison to IRA accounts. (Individual Retirement Accounts) (Personal Financial Planning) by Adelmann, Richard L.


Abstract- Insurance may prove an alternative to Individual Retirement Accounts, the tax advantages of which were curtailed by the Tax Reform Act of 1986. Variable life insurance and variable annuities offer investors the benefits of enjoying higher returns than whole life insurance. Both allow investors to direct the value of their investment into a variety of investment pools similar to mutual funds. Variable life insurance policy holders are able to borrow on cash values tax-free. Investor borrowing from an annuity before reaching the age of 59 and 1/4 incurs a tax penalty because the borrowed funds are treated as a withdrawal. Younger investors with children, a mortgage, and heavy debts should be advised to opt for variable life while older investors who have substantially retired their debts should be advised to opt for a variable annuity.


The 1986 tax reform severely curtailed Individual Retirement Accounts (IRAs). There have been recent discussions in Washington, DC, to improve the tax benefits of IRAs. By the time this article is published, some action may have been taken.

Oddly enough, the tax deduction for $2,000 IRA contributions was never as powerful as the tax deferral on interest, dividends and capital gains inside the IRA. For example, if a taxpayer could have started an IRA at age 28 and contributed $2,000 per year for 37 years, the total contribution of 74,000 would only have generated $37,000 in federal tax savings even at the maximum 50% tax rate in effect in 1985. Over the same 37 years, if the funds could have been invested at 12% (the compound growth rate earned over the last 25 years by average equity mutual funds) the IRA would have grown to $1,363,780. That means an additional $1,289,780 of tax-deferred income between ages 28 and 65. Furthermore, the tax deferral could continue beyond age 65 to 70-1/2! After age 70-1/2 the deferral continues except for the mandatory distributions based on life expectancy.

While taxpayers and planners have verbalized the loss of a few thousand dollars of lifetime deductions, they may have overlooked the opportunity to defer tax on many dollars of interest, dividends and capital gains.
Insurance may provide the overlooked answer. Unlike IRA accounts, insurance has no $2,000 contribution limit and no requirement to withdraw at age 70-1/2.

Comparison Of Life Insurance Products that Shelter Income

Whole life insurance is a level-pay contract which is guaranteed by the entire net worth of the life insurance carrier, and possibly by a reinsurer. The guarantee is that if the owner pays the scheduled premiums, upon the insured's death the carrier will pay the face amount of the policy to the named beneficiary. To counteract the fact that the annual risk of mortality increases with age, the insurance company collects extra premium in the early years of the policy and puts it into a cash value account where it earns interest. The cash value belongs to the policy owner and is always available by loan or upon surrender of the policy.

The cash value account works two ways to keep the premium level: 1) The interest earned on the cash value helps pay the rising cost of the increasing risk; and 2) since the face amount of the death benefit is fixed, the cash value funds part of the benefit, so the insurance company's risk is only the unfunded portion. The policyholder is buying progressively less insurance as it gets more expensive. By age 95 or 100 the cash value account equals the death benefit. The actuaries have it all worked out.

The guarantees in whole life insurance are frequently criticized because they only guarantee that the cash value will earn 4.5 or 5%. The pricing is criticized because insurance company actuaries assume that modern medicine will make no further progress in extending life expectancies beyond what was average in 1980. In spite of screening for medical problems and dangerous hobbies, the actuaries assume their preferred insurers will experience the same mortality as the population at large.

Those criticisms are valid only for the preliminary pricing process. The insurance companies expect to beat every assumption. However, who knows what interest rates the investment people will be able to earn on new premiums received and on earnings reinvested 40 years in the future? Who knows what AIDS and related illnesses will do to life expectancies? If the insurance company achieves lower mortality rates through astute underwriting and achieves higher investment returns than it guaranteed, the difference will be rebated as a dividend in a guaranteed whole life policy from a mutual company or from a participating policy issued by a stock company.

A financial planner who recommends "buy term and invest the difference" should be prepared to show how his alternative plan can beat the life insurance security with the tax deferred investment growth. In the factual world "buy term and invest the difference" can result in "buy term and skip the advantaged investment."

Variable Universal Life insurance

A legitimate criticism of guaranteed insurance is that it missed an opportunity over the last 50 years. Cash values were primarily invested in Treasury bonds and AAA Corporate bonds. Over the last 50 years stocks have outperformed bonds by an average of 3% per year. Investors in whole life insurance have enjoyed lower returns than investors in equities.

To respond to this criticism, life insurance companies developed non- guaranteed products called "variable" life. Annual premiums are established based on expected rather than guaranteed rates of return and the policy owner is given a choice of investment pools (like a family of mutual funds) ranging from money markets, zero-coupons, junk bonds, blue-chip stock, emerging growth companies, and others. The policy owner can select one or several pools and switch from pool to pool. The frequency of switches is restricted by the policy. If the investment results exceed the return projected when setting the annual premium, the premiums can be reduced or the face amount of the policy can be increased. Alternatively, premiums must be increased or benefits reduced if investment results are unsatisfactory.

Annuities

The word "annuity" used to imply the reverse of life insurance. Whereas life insurance exchanged a lot of little payments for one big payout at death, an annuity contract exchanged a lump sum for a lifetime of guaranteed little payouts. Today the term "immediate annuity" is used for the classic annuity, to distinguish it from the many hybrids. Deferred annuities are hybrids which accumulate and compound principal over a period of time before they are "annuitized" or converted into a guaranteed annuity paying a guaranteed income for life and/or a certain period.

Deferred annuities offer the same guaranteed and non-guaranteed formats as life insurance policies. During the accumulation period there is a small life insurance contract guaranteeing the principal for life regardless of investment results. In a variable annuity the investor is responsible for directing the annuity values into one or more of a variety of investment pools similar to mutual funds (and managed by many of the same managers).

Tax treatment of withdrawals from variable annuities differs from that for variable life insurance. The variable life policyholder can borrow cash values free of tax if modified endowment rules are avoided. Any borrowing from an annuity is treated as a withdrawal and is subject to income tax and a 10% penalty before age 59-1/4.

The choice between variable annuity and variable life depends on the investor's profile. A young investor who has acquired more debts (i.e., mortgage) and responsibilities (i.e., spouse and kids) than assets, will need the variable life insurance because of its high death benefit feature. An older investor who has paid down the mortgage and educated the children can avoid the higher mortality charges and get a higher net return with periodic payout in an annuity.

A planner can counsel the younger investor to convert, by a Sec. 1035 tax free exchange from life insurance to an annuity as the situation changes later in life.

the classic annuity, to distinguish it from the many hybrids. Deferred annuities are hybrids which accumulate and compound principal over a period of time before they are "annuitized" or converted into a guaranteed annuity paying a guaranteed income for life and/or a certain period.

Deferred annuities offer the same guaranteed and non-guaranteed formats as life insurance policies. During the accumulation period there is a small life insurance contract guaranteeing the principal for life regardless of investment results. In a variable annuity the investor is responsible for directing the annuity values into one or more of a variety of investment pools similar to mutual funds (and managed by many of the same managers).

Tax treatment of withdrawals from variable annuities differs from that for variable life insurance. The variable life policyholder can borrow cash values free of tax if modified endowment rules are avoided. Any borrowing from an annuity is treated as a withdrawal and is subject to income tax and a 10% penalty before age 59-1/4.

The choice between variable annuity and variable life depends on the investor's profile. A young investor who has acquired more debts (i.e., mortgage) and responsibilities (i.e., spouse and kids) than assets, will need the variable life insurance because of its high death benefit feature. An older investor who has paid down the mortgage and educated the children can avoid the higher mortality charges and get a higher net return with periodic payout in an annuity.

A planner can counsel the younger investor to convert, by a Sec. 1035 tax free exchange from life insurance to an annuity as the situation changes later in life.

http://www.nysscpa.org/cpajournal/old/08135916.htm

So the NY CPA Scociety has stated that permanent insurance supplements IRA's nicely (NOTE: They did not say to go hog wild and buy all you can with debt).

[/u]

 

[Airborne1]

Well I find the Mortgage Professor to be very shallow on his history of loans, sure our fathers generation did do the 20% down and mortgage but their fathers generation and generations before basically knew nothing more than IO loans. In fact the 20% down and what we called a traditional mortgage isn't truly traditional based on time at all. In fact it wasn't till the 50's that what we call the traditional loan came about.

Than this so called professor says this is abnormal today:

But this was an unusual case: her mortgage rate was low, her tax rate was high, and her preferred investment was tax-exempt. A taxable investment would have to beat 4.75%. If the mortgage rate had been 6%, a taxable investment would have to beat 6%.

Now I suppose he is suggesting people with good credit rating, in higher incomes can not achieve a low interest rate in the last 20 years??? Where has he been? In fact most anyone with good credit should be around 5% or below in our recent low interest enviroment. Once again does this guy live in the seventies or did he post this stuff in the early 80's? Plus since I demostrated that having a savings vehicle that pays on compounding interest will cover and work even if it's up to 2% below the interest on the mortgage! Such as the 15/30 year mortgage, take out a 30 year mortgage instead of a 15 year one, difference of payment amount you place in a savings account that is earning up to 2% below your mortgage rate and in 15 years you side account would pay off the balance or be within a very narrow margin.

The 20% down and having equity within a house or any property is a suckers bet for the purchaser but an excellent protection for the bank or financial interest of the person holding the note. It gets no more simpler so I really don't know where this Professor guy is coming from?

Simple explanation, James.....And I'm agreeing with you above

The folks attacking this strategy may have SOMEWHAT of an expertise in 1 area or 2 or 3, but that's even in question as is obvious above.

But, how many truly so-called "experts" have an expertise in all of the following areas:

1. Mortgage rates (& how it relates to equity mgmt)
2. Mortgage amortization table vs. compound interest table
3. Stock/Bond Market rates of return
4. Insurance contracts
5. Tax law
6. Real Estate prices (local & national economy) & how it relates to the equity in your home.
7. State/Federal laws regarding home equity liability protection from creditors.

Not even CFPs pass the test. In fact, how many critics have touched on the majority of the points above ?

Here's what 1 CFP recently said, "for most homeowner's, it's their biggest asset, so they risk losing it all in a insurance contract". Google - "Voudrie". I swear I'm surrounded by so many mental midgets

He should try selling that notion to literally the tens of thousands of people who lost their homes in Katrina and elsewhere around the country.

Somwhere, I have an interesting statistic on the high % of foreclosures in which the homeowners had health insurance. Hopefully, I can still find it, but don't hold my feet to the fire on this.

A little hint on #7

If you live in one of 6 states which provide "full homestead exemption" (equity safe from creditor liability), and you think you are safe, you are DEAD wrong !

I assure you, Items #1 - 7 above are covered by most of the agents doing one-on-one FREE-only consultations. Notice I said FREE, not FEE. If you want to spend an extra $500 or more verifying the viability of your own application with a CFP, be my guest. Usually, the only extra money spent is doublechecking the math with your tax preparer ($100 - $200).

 

[Steve]

I appreciate all of the varying viewpoints on this topic, but I remain steadfast:

Eliminate Debt.
Actively Manage Budget.
Take advantage of qualified investments.

Insurance is insurance. Investments are investments. Aside from some tax situations, treating insurance as an investment instead of insurance is paying for someone to do what you should be doing without them. That's a loss. That's one reason (in Wisconsin, and I presume elsewhere) there are regulations strictly prohibiting insurance agents from representing themselves as "financial advisors."

I am not defending or endorsing BTID.
I am not defending or endorsing perm.

Every situation is different. Everyone can beat this to the ground, forever. Everyone is right, everyone is wrong.

The difference lies in those who are controlling their lives and those who aren't. 90% of the population (pulling the number out of nowhere!) lives on todays and tomorrows earnings. Fancy houses, fancy cars, great appearances, no substance.

 

[Guest]

It just occurred to me.

Some people are quite content to lease their cars. Those that do seem to really be satisfied.

Maybe, one can now start viewing a house as just never really owning one, just using one - - like a leased car - - and the payments are to the lienholder.

Ofcourse, we are now living in an era of pretty low mortgage rates, may not always be this low as when we had pretty high inflation during the Carter years. A high mortgage rate I suppose could throw a monkey wrench into this.

 

[Crabcake Johnny]

There is no glory in saving money or investing. Your friends and neighbors can't see that you have $150,000 worth of investments after five years of savvy saving/investing.

What your neighbors and friends can see is the Beemer and 4,000 sq ft house. And that is how you're judged.

Go ahead be be savvy. Buy less house than you can afford. Buy a resonable car and save your money. You are viewed as unsuccessful by your peer group and most likely they'd call you a liar behind your back if you said that you purposely bought a smaller house so you can put a lot of money into investments.

The rule would be "He's a liar. If he really had money he wouldn't be driving around in a 5 year old car."

 

[Steve]

There is no glory in saving money or investing. Your friends and neighbors can't see that you have $150,000 worth of investments after five years of savvy saving/investing.

What your neighbors and friends can see is the Beemer and 4,000 sq ft house. And that is how you're judged.

Go ahead be be savvy. Buy less house than you can afford. Buy a resonable car and save your money. You are viewed as unsuccessful by your peer group and most likely they'd call you a liar behind your back if you said that you purposely bought a smaller house so you can put a lot of money into investments.

The rule would be "He's a liar. If he really had money he wouldn't be driving around in a 5 year old car."

That drives me nuts. My kids are as guilty as anyone on this, and I have a hard time getting through to them on it. They say: "so and so is really rich -- they have such a big house." or "I wish we were rich so we could have a Jacuzzi like so and so." They don't get it.

If I wanted a big(ger) house, I'd get one. If I wanted a Jacuzzi, I'd get one. Values and desires are extremely different from expense and financial opportunity. Just because one can or can't afford it, doesn't mean that one wants it.

 

[Crabcake Johnny]

Someone I personally know has a $5,000 sq ft house and an AMG S-class Benz. The house is currently in foreclosure proceedings and the Benz has bald tires. I'm sure his neighbors think he's rich. I did.

My wife and I love to go out to dinner but it's a thin list of friends we can call who can afford to go out. However, most of them have two car payments. We have one car and it's paid off. I'm sure they think we're broke.

 

[Steve]

When you reach a certain level of thought (often corresponding with age, but on the other hand, many folks never get there, yet a lucky few get there at a young age...) one could give a rip about what someone presumes about ones financial status. I am debt-free. I give generously to a couple of non-profits that I care about. I am what I am, and the only thing that truly matters is that my wife and children are happy. (and me!)

Look in one driveway and see a Mercedes and no activity.
Look in another and see a Hyundai and the family out there laughing and playing tag or football or basketball. Who do you want to be friends with? Neither one is a wrong answer, but certainly different in values.

 

[Crabcake Johnny]

There's no problem with having that Benz as long as the payments are a small portion of your take-home, you truely make fantastic money and you're doing great with investing.

But if you own that Benz and you have no real savings and making the payments is a burden you probably suffer from a severe lack of self-esteem.

Your house house payment should be made with one week's net income. All your other bills should be made with the next two weeks leaving one full week for saving.

I'm at the point now where one week's pay is my entire month's worth of bills.