Monthly Archives: February 2015

How to Turn Your IRA or 401k into a Paycheck Machine for Life

Since the early 1980s, 401(k)s and individual retirement accounts have become the dominant way that workers save for retirement. Yet many workers long for the days of traditional pensions when you could set your watch by how much income you could count on every month after your retired. Many people like that the pension fund (if it did as promised) would pay them and their spouses for the rest of their lives. To be fair, those old-style pensions had some serious flaws:

  • It was difficult and sometimes impossible to port with you when you left the company. Depending on the program and how it was administered, you could be left without a pension and without the money in the pension fund if you left the company before a certain number of years.
  • You didn’t control the asset base that created the income. After you and your spouse pass away, the income stream from the pension fund stops, and your estate gets no cash from the fund. This was even if both spouses passed away early and collected very little of the pension.
  • It was difficult to impossible to access any of the cash inside of the pension prior to actual retirement.

With the 401(k) and most other qualified plans, the flaws of the pension were in large part put to bed.

Now you have the full right to withdraw or roll over your portion of your 401(k) when you leave the company. You control the asset base, so when you and your spouse die, any remaining balance left inside of your qualified plan will go to your estate. It is easier to access your account via loans — assuming you abide by terms laid down by your plan administrator and your employer.

As is often the case when you fix a flaw in something, that repair caused a new set of flaws to emerge. With 401(k)s and IRAs, the burden of guaranteeing income and performance is shifted to the employee. This means that if you are invested in the market, then in good markets you could win, and bad markets you could lose.

Wouldn’t it be great if you could combine the benefits of pensions, 401(k)s and IRAs? Consider annuities. Annuities are offered through insurance carriers to take in big chunks of money and guarantee a payout over a certain period, based on that sum used to purchase the annuity. There are two types of income structure:

  • In the immediate annuity, income is started from the lump sum immediately after the annuity purchase.
  • In the deferred annuity, your lump sum can grow before you activate the annuitization phase. This structure will result in more monthly income from the extra growth and the number of years the insurance company will have to pay out on the contract.

Once you decide on what kind of payout you want, then you have three basic choices:

  • The fixed annuity will guarantee your principle never loses money in the market and guarantee modest growth during the growth phase. That rate might be 2 to 3 percent, so this is for the extremely conservative investor who believes in the old saying “I am more concerned about the return of my money than the return on my money.”
  • The variable annuity will go up and down based on the movements of the chosen market (usually the stock market). This product is more for the market player who believes we are in for a bull market during the annuity contract years.
  • The fixed indexed annuity will guarantee your principle is not lost, but your growth is not guaranteed. The growth will depend on which market index or indexes your annuity follows, such as the Standard & Poor’s 500 index (^GPSC).

With many annuities, you can add riders. The most common is the lifetime income rider, which for an annual fee will guarantee your future retirement income will increase every year regardless of the market’s rise or fall. As the name implies the insurance company will also guarantee your annual income for the rest of yours and your spouse’s life. This income will be guaranteed even if the underlying funds in the annuity are drawn down to zero.

Your 401(k) and IRA can be used to purchase an annuity with no taxes or penalties. Annuities do have potential pitfalls.

  • They are not very liquid. There can be substantial penalties if you withdraw the original purchase price from the contract during a certain period. This penalty will usually graduate downward to zero. This penalty will be determined by the carrier and the product, and it will vary by state.
  • Potential annual fees are inherent. Many fees can be reasonable and bring value (such as the lifetime income rider), but some fees buy you very little value and get prohibitive. Fees are generally higher with variable annuities due to their active money management. Make sure you are comfortable with the fees and know what you receive in return.

We work with these products so if you would like more information please visit us at Perpetual Pensions or call us to set up an appointment at 586.944.0794.

4 Wealth Drains that are Robbing You Blind Every Month (And You Don’t Even Know It)

The first and biggest “wealth drain” is taxes.

Our tax system is designed to penalize hourly and salaried workers while rewarding entrepreneurs and business owners. Salaried workers pay taxes based on what they gross, while business owners pay taxes based on what they net. To that end, most people think Fortune 500 companies getting something over on little guys. Keep in mind, you don’t have to be a big business to get great tax advantages. Even startups get huge tax benefits. So rather than complain, maybe you should run a business from your kitchen table

To qualify for tax deductions in that business, the IRS says you must intend to make a profit. When that standard is met, you automatically qualify for dozens of tax deductions that you don’t get as an individual. Most losses and startup expenses can be written off against other income from your job (limits apply, so get a good business CPA to work with you). Realize that nobody else (not even your CPA or tax preparer) cares how much you pay in taxes, so it’s your job to understand how the system work and how to use it effectively.

Losing the Chance at Compound Growth

Another set of huge wealth drains are market losses on investment capital that you control. When a stock or a piece of real estate drops significantly in value, it could take years for you to get back to even. And, of course, there are no guarantees that it will come back during your investment lifetime. The less capital you have invested, the less you can benefit from the power of compounding growth.

If the compounding curve of your money is broken by market losses or premature withdrawals, it has a massive effect on your final pool of wealth. For example, if you were offered a job that lasted only 36 days and you had two choices on the pay plan, which one would you take? (A) You could be paid $5,000 per day at the end of every day, for a total of $180,000. (2) Your second option is to be paid one cent starting on Day One, but your pay would double each day — be compounded by 100 percent — and payable at the end of those 36 days.

If you jumped at the $180,000, you missed the power of true compounding of money. If your coworker doing the same job chose the compounding penny, he wouldn’t be a millionaire. After 36 days … he’d be a filthy rich multimillionaire with a final check of $343,597,384. Obviously, your investments won’t experience such rapid (or consistent) compound growth, but do the math —
the power of the compounding curve is strong over time — if you don’t break it with big losses (which you can’t always control) or withdrawals (which you can).

Money Lost in Fees and Interest to Banks and Financial Companies

The next massive wealth drains we face are interest and fees paid to banks or finance companies. Money-lending has been around for thousands of years, and any business model that’s lasted that long is a winner — for the business. But when you’re on the borrowing side of the transaction, it’s a wealth drain, especially if most of your borrowed money is spent on depreciating assets

Now, people will tell you that if you can borrow money cheap and invest it in something that has a higher rate of return than the interest rate you’re paying, then you’re using leverage properly. That can be true, but those attempting such a move should be aware of the caveats. Try this simple exercise: Add up all the money you’ve paid out over your lifetime in monthly payments. Then compare that total to the amount of money you have saved for retirement and see which one’s bigger. (If you’re willing, we’d love to hear about your results in the comments section below.) Then think about how to be a lender, and not a borrower.

Depreciation of Vehicles and Other Large Assets

Another massive wealth drain comes from the depreciation of cars, boats, equipment, appliances and most other large assets we buy. Most people will lose more money on cars during their lifetimes than they’ll ever save for retirement, let alone all the other depreciating assets they’ll buy. But there’s a way to make money on these items.

Think of your financial life as a big pie. Don’t fall for the old magic trick and focus only on what’s happening to your one slice of the pie (i.e., your investment gains or losses). Instead, pay attention to the whole pie and put a stop to your massive wealth drains.

9 Reasons You Should Take a Look at Whole Life Insurance

Just a few short years ago, I was staunchly opposed to whole life insurance, because that’s what I was taught by national “gurus” 25 years ago. I wholeheartedly believed (as many people still do) that if you need life insurance, you should buy a term policy, then take the difference in premiums between whole life and term and invest it in mutual funds.

So when a good friend of mine sat me down and tried to show me a whole life insurance plan, I nearly refused to listen. Many of you reading this will feel the same way, and nothing I say will change your minds. That’s fine — you’re entitled to your opinion just as I was entitled to mine.

Thankfully, my friend showed me how a properly designed whole life insurance policy works. I soon realized that the gurus in my early years and the gurus of today were correct — based on the information they’d been given. The problem was their information was incomplete.

Whenever I hear a financial consultant (or anyone, for that matter) talk about less expensive premiums for term, I know they really don’t understand how this animal of properly designed whole life insurance really works.

With a properly designed whole life insurance policy, you get:

1. Principal protection guarantees of your money.Your cash value isn’t subject to market losses, as it is with mutual funds and other programs. When the stock market tanks again (and it’s never a question of if but when), you won’t lose a dime.

2. Guaranteed growth of your money every year. This will be interest-rate-driven based on the economy, but your account will move forward every year regardless of what the market does. This is compound tax-free growth and not the “average rate of return” you get with mutual funds. To be fair, in our current low-interest-rate environment, the growth rates are only in the 2 percent to 4 percent range but as you study further you start to realize the real wealth is not in the growth rate even when rates go higher.

Many financial advisers will tell you that your money would do better in a good mutual fund. But remember: When someone shows you an “average rate of return,” they can start taking that average from any time that benefits their example. This is not compounded growth but rather a factor of timing as to when you enter and exit the market. The stock market has wild swings; if that is acceptable to you, you should have much of your money in stocks. If not, maybe it’s time to consider a different way to think about investing. (Remember the period from March 2000 to October 2002, when the Nasdaq lost 78 percent of its value? It’s been 14 years since the dot-com bubble started to pop, and the tech-heavy index still hasn’t quite recovered to that level. If you like guarantees and stability then you have no business putting most of your money in the stock market.)

3. Dividends paid to policy owners are not taxable. Dividends aren’t guaranteed, but many reputable life insurance companies have been in business for more than 100 years and they’ve paid out dividends every year. The amount of that dividend will depend on several factors, but it boils down to how much profit the insurance carrier made. When properly paid to the policy owner, those dividends are not taxable.

4. A high starting cash value amount, based on what you contribute to the policy. Whole life policies that aren’t properly designed will have very little cash value in the early years.

But a properly structured life insurance policy will have high cash value percentages, even in its first year, and they increase every year. This becomes an important fact when you realize that access to your cash will help you grow wealth systematically regardless of market conditions

5. Access to your cash value at any age, at any time, for any reason — without taxes or penalty. This is a huge benefit of whole life policies compared to 401(k)s and IRAs, which impose multiple obstacles if you want to access your cash before retirement, and penalize you if the funds you borrow from them are not paid back by a certain time and at a certain interest rate. No such obstacles exist with a whole-life policy. So leave your cash in the policy if you wish, or borrow it back out and use it, the choice is yours.

6. The ability to use your account’s cash value to recapture lost depreciation on major purchases and interest and fees paid to banks. If you treat this pool of money inside the life policy like your own personal bank, you can loan it out to yourself and others to create wealth. (More on this in future articles, but suffice it to say for now that banking has been around in some fashion for thousands of years. Any business model that lasts that long is worth understanding and using to your advantage.)

7. Guaranteed insurance. Once the policy is in place, your insurance is guaranteed for the rest of your life. Many people assume they’ll be able to buy new insurance at any point in their life. But nothing is further from the truth — especially for those who’ve been diagnosed with chronic or terminal diseases. If you become seriously ill, don’t expect to be able to buy a new policy.

With many whole-life policies, you can add an “accelerated death benefit rider” for little to no cost, which will give you access to a large portion of your death benefit during your lifetime if you have a terminal or chronic illness. I just had a colleague with a client who was diagnosed with Lou Gehrig’s disease, or ALS, and was sent a check from his insurer for more than 70 percent of the eventual death benefit. He’ll be able to enjoy his remaining time without worrying how he will pay his bills.

8. The ability to combine your life policy with the worlds of real estate, private lending and auto financing to accelerate your wealth, both inside and outside of the policy. Just remember that any funds inside the policy are tax-free for life.

9. Death benefits. In addition to all the benefits you can make use of while you’re still here, at heart, this investment is still a life insurance policy, so when you eventually die, there will be a sum of money left behind to your beneficiaries — tax-free.

There’s a reason family dynasties have been using life insurance for generations to grow and protect their wealth. Even when subject to estate limits, these death payouts go a long way toward promoting the tax-free, inter-generational transfer of wealth.

Of course, insurance company policies and riders will vary by state due to state regulations and depending on the actual insurance carrier. But you won’t find another type of account or investment that has all these benefits in one investment — not 401(k)s, IRAs, mutual funds, stocks, bonds, precious metals, real estate, nor any other account.

Can You Really Afford Your Car Lease?

Last week I wrote about how to save boatloads of money buying the car of your dreams — but only after it is two or three years old. This week I want to talk about how leasing a car really works and offer some tips to save you more money on your next car.

OK, so what exactly is a lease? A lease is an agreement you enter into to rent your car for a predetermined length of time (usually 24 to 36 months) for a predetermined monthly payment, and for a set number of miles. These payments are always less than the payment would be had you bought the same car on the same day. The lower payment makes the car look more affordable on the surface, but inside that lease agreement are all kinds of terms that can cost you far more than just the payments.

To start with, why is the payment less expensive with a lease than with a loan for the same car? When you lease, you’re only paying for the estimated depreciation during the length of the lease rather than the entire loan balance you would pay back during that same time frame.

For example, you borrow $25,000 and sign a 36-month loan agreement at 5 percent, giving you a payment of $749, which is a pretty hefty car payment by today’s standards.

For many people, that’s simply too rich for their blood. But if you could swing that payment for those 36 months, you now have a free-and-clear car with a lot of life left in it and, if you were disciplined, you would continue to make that big payment — but instead of giving it to the bank, you could put it into a tax-free account. (More on that next week in Part 3.)

In contrast, when you sign a lease on that same car for 36 months, your payment might only be $300, which is much easier on your pocketbook. But after three years, you still have a balance to pay off if you want to own the car. This balance is called the residual value, and it must be paid off either with cash or a new loan. Most people won’t have the cash to pay off the car, so if they want to own it they have to take on another loan for several more years to actually get the car paid off.

Most people do neither of these things and instead turn in their car and get the next newest model, taking on yet another lease payment — and on and on until they’re old and gray.

In essence, a lease allows you to extend your payments on a car for six to eight years, and you end up shelling out far more in payments and interest (yes, there’s a hidden interest rate with a lease) for the same car. Sure, you have a lower monthly payment, but you have many more payments in total, sucking even more money out of your bank account.

So instead of just winging it, what if you actually employ a strategy for your next car?

If you can’t afford the three-year payment, then how about committing to no more than a five-year note? Can’t afford that either? Then the truth is you really can’t afford that car. Shop for something less expensive, perhaps a model year or two older, and buy that instead.

Then once you pay off your car, you should make a commitment not to buy another one for two years. That way you can continue to make your monthly payment — but to yourself — into a tax-free account.

According to IHS Automotive, the average length of time people hang on to a car is nearly six years, so you’ll go one extra year for good reason.

It will look like this in real numbers: You borrow $25,000 at 5 percent for five years on your next car, resulting in approximately a $470 monthly payment, which you pay for five years. Then you own the car free and clear. But then what will you do with the payment you were making? If you’re like most people, you’ll blow it on junk.

But you — you are not like most people. You have a plan.

Instead of adding to your junk collection, you could instead continue making that payment from your checking account every month — but now the money goes to a bank (or a pool of money) that you control. If you do this for the next 24 months, you’ll accumulate $11,280, plus the growth on that money (guaranteed and tax-free if you do it right), which would put you at a total of about $13,000 you’ve saved for yourself and your family.

That $13,000 in a tax-free account that gets just 5 percent compound interest will be worth more than $35,000 for you in 20 years. Could you do that on every car you and your spouse ever own? If you do, you’ll have hundreds of thousands dollars more for your family in the years to come.

According to the Employee Benefit Research Institute, the average American only has $56,000 in savings by the time he’s 65 years old. But by mastering this car strategy, you could have four or five times that amount over your lifetime, depending on when you start.

Now some of you are wondering why you still need to make a payment to yourself every month instead of just letting the unused money sit in your checking account. That’s simple: Human nature won’t allow you to truly “save” your car payments unless you get the money out of your day-to-day cash flow and easy access. Money is only truly saved if it’s focused — and not frittered away on other things we really don’t want or need.

Focused cash flow is the key to wealth, and the disposition and growth of that cash flow is critical if you want to get ahead and have more options later in life.

Have you ever “saved” money on a big-ticket item in your life? Where are those savings now? Precisely! Get in the habit of taking your “savings” and truly making them savings by getting them out of your cash flow account and into a separate tax-free account.

In today’s world, automobile ownership is a luxurious necessity. Sure, it’s nice to own a nice car, but over time the costs of doing so are enormous. You need a strategy to stop the wealth drains of depreciation and interest.