Thread by @roncaruthers

1. Why your 401k, 403B and Traditional IRA's suck Part TWO of 2

With even MORE math.

On Monday, I wrote abouat a client that is 25, makes about $40,000 a year and has been contributing $12,000 a year to her 403b.... the public employee equivalent of a 401k or IRA.

2. And what I pointed out was that at her current tax rate, she was 'saving' $1,957 a year in state and federal taxes,

BUT,

she would have a huge tax bill coming due on the money she deferred AND everything it made that would be in the hundreds of thousands of dollars.

3. And that is JUST on the money that she's already put in there, which is currently worth $50,000.

If you missed that thread, you can read it here:

https://twitter.com/roncaruthers/status/1376716653401100289

4. So now....what DID I suggest?

First, since she doesn't get a match on ANY of that money, I suggested that she stop contributing to THAT account completely.

Yes, not ONE penny more.

Now, her taxes will go up about $163 a month, so she'll have $827 a month more in her check.

5. And, she's gotten used to living off what is left over, which is great, especially for living in SoCal.

So, we still want to put that money to work for her.....just not THERE.

Here is what I suggested:

First, open up a brokerage account with Schwab or TD Ameritrade.

6. I'd start contributing $300 a month a month there in ETF's or mutual funds.

Then, I'd take the $500 a month and put it into a properly structured cash value life insurance.

Also know to the RE guys as a IGIC or Investment Grade Insurance Contract.

7. Shout out to @IamChaseMaher for telling me about that term...I hadn't heard it before, but it's bascially what I've been recommending for my clients as a replacement for bonds in their portfolio for over 20 years.

WHY did I recommend this?

8 Well, it's because the life insurance has a pretty unique combination of benefits that offset the problems with the 403b.

The first is ACCESS.

When can she touch her 403b money?

ONLY when she leaves or retires.

MAYBE they'll let her use $50,000....but no guarantee they will

9. With the life plan, she has decent access to her money a couple of years in.

Based on the illustration I ran at 6% interest (more on this in a minute)

At age 35 (10 years from now) she has $68,088 available.

At 45: $206,183.

At 55: $474,850

10 And RIGHT before she presumably retires at 60, she has $684,440.

At that point, by the way, she has contributed $204,000, in case you were wondering.

But she can access those amounts at any time FOR ANY REASON....withOUT having to ask anybody permission or pay taxes....

11 ..... or pay a penalty....

UNlike the 403b (or an IRA or 401k, for that matter).

So that money can be used for expense, opportunity, or whatever she feels like.

NO questions asked.

Locking up all her money in a 403b for 35 years makes NO sense to me.

12. And from my personal experience, not having access to money when you need it is THE number ONE financial problem and THE number ONE cause of financial stress for most people.

I just solved that for her.

13. The next reason I recommended this type of account is stability.

Because the money is tied to external indexes but not IN them, she will NEVER take a market related loss.

So, again, this replaces the need for bonds or CD's in her portfolio.

14. So, an Indexed Universal Life insurance account goes up each year the indexes do, the gains are locked in for the year, and the numbers reset and start over.

If the index goes down, then the account gets a zero credit (but no losses),

The numbers reset, and we start over

15. BUT, we do NOT start over at a loss trying to get back to break even.

We start over exactly where we left off, so she'll be making NEW gains while people in the market are trying to claw their way back.

We win more by losing less.

16. The next reason (#3, if you're counting) that I recommend this is because she can turn the account into a life-time tax-free income when she's ready to retire.

If she retires at 60, at an assumed interest rate of 6%, her annual income will be

$54,823....forever*

17. The asterisk is because the official definition of 'forever' in this case is as long as she's alive up to her 120th birthday, which should cover her.

By the time she's 85, she'll have received....you ready for this?....

$1,425,398 COMPLETELY tax-free.

18. AND she still has a death benefit for her family (that is also tax-free) of $467,705.

Plus, this money will run for another 35 years if she keeps living.

Which is potentially another $1,918,805 in tax-free income.

19. But let's just stay with what she recieved through age 85.

How much tax would she have to pay to net $54,823 a year if the money was coming from her 403b?

If taxes are at 25%, she would have to withdraw $73,097 each year to net the $54,823.

That's an extra $18,274 a year

20. Over 25 years from age 60 to 85, that would equal....

$456,850 in taxes (!!!!)

Flushed RIGHT down the drain.

And, if taxes are higher in 30 years, which they likely will be, then she'd have to pay even more.

21. Last main point for now:

I know what you're thinking.

You're thinking: 'But Ron, you said this was going to earn 6%. How likely is THAT to happen?"

We ran an analysis:

80% of the time, she would actually have earned 7.84% OR BETTER when we back tested the returns.

22. 100% of the time, or in the WORST case scenario, she would have earned 6.42% or better.

So, even in the absolutely worst past return period, she would have done better than I showed in this example.

23 But, index returns are NOT guaranteed, so I deliberately show all my clients a 'worse than worst' case scenario.

24. So, to summarize, I'm making this recommendation for the following reasons:

-Access to the money;

-Stability, due to no losses:

-Steady income (certainty) for life;

-Tax-free income

25. And, don't forget: she was also saving $300 a month in a brokerage account.

At 7% return, at age 60, that would be worth another $540,316.

So she has that money as well.

AND she still has the $380,613 from the $50,000 that she has already saved.

26. Why a brokerage account and not a Roth IRA?

Well, she could do that if she wanted, but remember, right now, pretty much ALL her money is tied up in that 403b, so I want to even her accounts out a little bit by making more of her money accessible.

27. In a few years once that account is bigger, and her life plan has more access, I'll definitely recommend she redirect that money into a Roth IRA.

28. Final math:

We're agreeing to pay almost $2,000 more now a year to avoid paying $18,274 a year later.

That's $70,000 vs almost $500,000 so we win on that math all day long.

Even if you try to factor inflation in ($2k/year now vs. 18k/year later) the numbers still work out

29. Inflation is bad, but not THAT bad....at least not yet.

Oh, and don't forget, if she stays with the city, she's going to have a really nice pension, but IT is going to be fully taxable.

30. By having this life plan and NOT a 403b, she won't have to pull that money out and be possibly pushed into a higher tax bracket.

Hope you learned something you can use from this example.

/end

BTW, for those of you asking where you can learn more, here is a GREAT place to start:

@capital_sb had me on one of her #financeFridays on IG where we spent the entire time talking about using life insurance as another asset class.

https://twitter.com/capital_sb/status/1329919482442223617