All posts by Ethan Samuels

How To Prevent Taxes From Destroying Your Retirement?

 
 
 

Short Answer:


You cannot. We’ve all heard it. In this life, two things are inevitable: death and taxes. But unlike death, the effects of taxation can be mitigated.

Income taxes mean something very different for a 35-year-old professional than they do for a 70-year-old retiree. For the professional, they are a nuisance that can be tolerated. After all, the 35-year-old can continue to work and to earn what was lost to taxation.


For the retiree, money that gets lost to taxation amounts to a permanent loss of capital.


This becomes especially important as it relates to retirement dollars, particularly for veterans and federal employees who contribute to a traditional Thrift Savings Plan (TSP). While at the height of their earning potential, professionals often deduct TSP contributions from their taxable income. After all, these deductions can land them into lower income tax brackets while helping to fund their retirement. It seems like a win-win scenario until it comes time to take distributions.


A Hidden Retirement Tax Bomb

Since ​every dime contributed to a TSP was contributed pre-tax, every dime that gets distributed gets taxed as ordinary income even before it hits your bank account. Just as there are tax penalties for taking distributions from a TSP before the age of 59 ½, once a TSP account holder turns 70 ½, there are tax laws requiring that the account holder take Required Minimum Distributions (RMDs) so Uncle Sam can get his hands on that tax revenue.

This ​becomes especially important when retirees liquidate TSP accounts in a bear market. In this case, the retiree has just watched his/her account drop in value and wants to cut bait and run, lest he wind up pouring good money after bad. But now, the cash that the retiree has just removed from the TSP counts as income and the United States Treasury sends the retiree a hefty tax bill. This is a retirement tax trap that leads many people to spend down their lives’ savings to zero long before they planned. Talk about adding insult to injury.


A Simple Solution

Thankfully, this scenario is 100% avoidable. A retiree is allowed to roll as much of a TSP as he/she wants into a Retirement Rescue Plan with no taxation penalty at all. Once rolled into into this plan, the entire value of the TSP is treated as principle, thus guaranteed against loss, so no individual ever has to take distributions as a result of negative returns again. Once the retiree does start to take distributions, the plan begins providing annual payouts that only stop when the he/she and his/her spouse are deceased.

These distributions are taxed as ordinary income, but there will be a steady or growing income payout every single year, regardless of cash value or market performance. This does not completely remove income taxes because Uncle Sam will have his due, but it changes the nature of the retiree’s income taxation. No longer will income taxation result in a permanent loss of capital. The capital that this retiree lost to income taxation will be replaced the following year, just as it did when this retiree was employed. The only difference is that now the retiree no longer has to work to get paid!!!


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How To Choose The Best Life Insurance

A Rapidly Evolving Industry

In the noble profession of financial advice, insurance sales, and financial planning, there are as many theories about the ideal financial planning tool as there are dollars to be made. There are nuances to every product, and there are many different solutions that may work to meet a client’s needs. As time passes, interest rates change, life expectancy increases, and solutions evolve. Financial advisers must remain abreast of these changes and keep their clients similarly informed. Far too often, financial advisory companies emphasize the client acquisition process at the expense of the client servicing process. The idea of “one and done” is used as financial advisers, forever chasing their next commission check, keep filling their calendars with new consultation appointments, and often neglect the clients who occupy their current book of business — and for good reason. Yesterday’s deals do not pay today’s bills.

Within this ruthless market, there are those who argue that a client would be better served by buying a term life insurance policy and putting the rest of his or her disposable income in the securities market. Why spend thousands of dollars a month on a policy that lasts forever if you may not need all those death benefits past a certain age? Just get a policy with an expiration date. Put the rest into a managed account. The stock market has greater accumulation potential than an insurance policy.

Cheap Costs More

This school of thought speaks to a person’s tendency towards frugality. It also caters to financial services companies that make most of their money through the accumulation of assets under management. They make their annual 1.49% management fee and their “active managers” are off to pursue additional clients to increase their firms’ assets under management (AUM). On the surface, this school of thought seems sensible. A person’s family is covered in the event of a loss of life, and their assets are accumulating tax-deferred growth in the securities market in order to provide a comfortable retirement nest egg.

There are a few issues with this particular school of thought. Namely, the term “invest the rest” is rather vague. There are many investment objectives. There are nine different asset classes in the securities market that all have symbiotic, but often inverse, relationships with one another. These include equities such as U.S. Large Cap stocks, U.S. Mid Cap Stocks, U.S. Low Cap Stocks, International Developed Stocks, International Emerging Stocks, Real Estate, Bonds, and Cash. Every single one of these asset classes falls under the legal definition of security.

A “security” is an investment asset in which some or all of the principle is placed at risk of loss. 


A Modern Safe Approach

There is another school of thought that emphasizes the tax efficiencies of cash value from permanent life insurance. Term insurance policies are very inexpensive because 98% of term life insurance policyholders either outlive their policies or cancel them. With only a 2% probability of paying out, these policies are easy money for insurance carriers. Permanent life insurance offers tax-deferred growth and tax-free distributions of cash value growth. Though they offer lower rates of returns than the securities market, particularly the stock market, they do not offer risks of loss due to market volatility. As a result, a well-planned, well-funded permanent life insurance policy can be an excellent source of safe dollars.

Into the fray comes the Modern Life Insurance policies. This is a form of permanent life insurance that allows a client a great deal more freedom when it comes to funding their policy. But with greater flexibility comes greater responsibility. In a permanent life insurance policy, premiums that are paid in fill two buckets. The first bucket is the cost of insurance (COI). The cost of insurance is determined based on the company’s morbidity table, where it determines the probability of a person of a given age passing away. It is the amount of funds that must be kept aside in order to pay out every insured at a given age in case of his/her death. The older and less healthy a person is, the greater amount the COI is. As a person ages, it costs more to insure him/her. Permanent life insurance solves this problem by being priced out to fill this bucket within the first 5-10 years that the policy is in force. As this bucket is filled up, the excess is paid into a second bucket, cash value. This cash value is liquid, not subject to income taxation, and grows outside of the market. Universal Life Insurance allows a client to choose how quickly the funds in his or her policy accumulate value by setting his or her own contribution schedule and adjusting it as he or she wishes to. It is thus incumbent on the client’s financial adviser to maintain a long-term relationship with the client, keeping the client aware of the rates of return and the company’s overall expense ratio.


The History No One Tells You

In  the 1980s and early 1990s, both schools of thought for financial services operated like the Wild West. It was the era of Jordan Belfort and Barry Minkow and the San Marino Savings and Loan Scandal. On the Life Insurance side, the manner in which Universal Life Insurance was peddled in that era could well be compared to the manner in which a Stratton Oakmont day-trader hooked a new client. While we could argue about the accuracy in which Martin Scorsese’s Wolf of Wall Street portrayed Belfort, the manner in which Stratton traders conducted business was quite accurate. With dollar signs behind their eyes and an eye towards collecting another fat sales commission, these young men would extol the virtues of this stock and that one, advising their clients to invest all they could. Now, although the senior-level Stratton Oakmont Traders were fully aware of the illegality of their actions, they recruited sales teams composed of less than the best and the brightest. Often, many of these floor-level traders had little understanding of the illegality or even the immorality of their activities. This double-blind robbery could leave many unsuspecting clients fleeced out of their money, yet none the wiser as to what had happened to it.

In the sales of Universal Life Insurance, a similar type of double-blind swindling was taking place. When life insurance sales agents got in front of their clients, they showed their clients illustrations with grossly exaggerated rates of return. These rates of return were illustrated at 11% compounded annually. This definitely sounds awesome, almost too awesome to be true. In the 1980s and the early 1990s, interest rates were very high. Yet, in all investments, past performance does not guarantee future behavior. In high-interest-rate environments, many agents representing well known companies sold Universal Life Insurance policies with such illustrations. Buried in the fine print, however, is the insurance company’s investment spread. Essentially, these spreads are the difference between “earned” rates from assets versus “paid/credited” rates to insurance contracts. This disparity and the right of a company to adjust it would have serious ramifications regarding the disparity between illustrated rates of return and actual rates of return. 


Many of these companies offered lower spread during periods of high interest rates with the right to readjust the spread during periods of high interest rates. Keep in mind that when a life insurance company collects premiums from its policy holders, these premiums are placed in the company’s overall investment portfolio, which is composed primarily of high-end real estate and high-yield corporate bonds. The returns obtained from these investments are relatively stable, but also correlated with interest rates. To mitigate against this, insurance companies can keep their operating expenses low. This keeps the spread from fluctuating wildly. Unfortunately, the aforementioned companies failed to do this, causing their spreads to expand wildly when interest rates dropped. Add this to the fact that the illustrated rates of returns were exorbitant. Further add the fact that these illustrated high rates of return caused many agents to recommend that their clients under-fund their universal life insurance policy, and you have a situation in which many universal life insurance policyholders who have paid into their policies for 15-20 years request an in-force ledger only to find that their policies are devoid of cash value and are in danger of lapsing.

Know Who To Trust

This is a tragic situation akin to one faced by victims of Ponzi schemes. It is made all the more tragic by virtue of the fact that less than one insurance sales agent in a hundred even knows what an investment spread is. We had a rash of people who were swindled by sales agents who did not even realize that they were swindling their clients.

When reading these stories, no one is saying to paint all investment advisers or Registered Investment Advisers with the same brush as the Belforts, the Minkows, the Madoffs, and the Ponzis. In this same vein, it would be equally foolish to paint all companies that offer permanent life insurance solutions, particularly the more modernized Life Insurance solutions with the same brush as those who perpetrated the aforementioned bad faith sales. Yet, in a marketing email sent to a prospective sales agent one company attempted to use the settlement to a class action lawsuit against Transamerica to point out the “dark side of universal life insurance,” as if all universal life insurance transactions would lead to the same bleak outcome as that which befell the plaintiffs of this class action lawsuit.

This underhanded oversimplification is a tool to incentivize people to place more of their investment assets into securities. This can be a decent accumulation strategy. Of course, the securities market is fraught with volatility. With volatility comes the opportunity for growth. However, investing exclusively in this arena leaves many people subject to the double sequence of returns risk and income taxation risk, which leaves many people who work hard and save well penniless in their old age. This is especially important because investment firms and financial wirehouses can wax poetic about their accumulation capabilities and rates of return that their assets under management achieve, but they offer ZERO advice on how to DISTRIBUTE assets under their management. Why would they? Every dime taken out of their clients’ investment accounts is one less dime under their management and cuts into their 1.5% annual management fee. Yet, what good is an account balance if a person cannot spend it?

Fixed products in the insurance market can be a great way to mitigate against the risks of income taxation and market volatility and have many built-in ways to prevent a client’s account balance from reaching zero, while providing a client with a tax-efficient, principle-protected liquidity.

It would be the height of hypocrisy to advocate the use of fixed products to the total exclusion of securities products. However, the nature of the relationship between investors and their advisers must change. These relationships must be cultivated the way a family cultivates a relationship with its family doctor. The family must trust the doctor’s integrity. The doctor must be willing to make himself a trusted adviser to the family. The doctor must abide by his Hippocratic oath to first do no harm. The family must keep in regular contact with the doctor, so that the doctor can respond in kind to the family’s changing needs. The doctor must keep up with the latest medical trends in order to provide his patients with the most up-to-date advice. Such relationships lend themselves poorly to the rapid transactional practices of financial advisory firms and insurance companies.


It is in this vein that financial advisers must determine the interests of their clients and accordingly recommend a uniquely tailored blend of insurance and securities-based instruments. As the clients’ situation evolves, so must this blend evolve. That recommendation may involve term insurance, it may involve permanent insurance, it may involve large stock positions, or bond positions. There is no panacea, nor is the same advice necessarily applicable to any two situations, except for this: Do your homework. Do not pass judgment on an entire asset class based on one story. And above all, make sure that you evaluate your situation with a knowledgeable expert that you can trust.

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How to Make Your Retirement Savings Last Forever

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Conventional Retirement Wisdom

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You might be saying to yourself, “OK, I have a certain amount of funds at my disposal from my TSP. If I plan on living 30 more years, I should plan to liquidate no more than 4% of my account’s value per year. Then, hopefully, with the market consistently turning up positive returns, such as the S&P 500’s 6.5% average, I could make my funds last.” This conventional wisdom is why there is such a demand among senior citizens to become employed as greeters at Walmart. There simply is no guarantee that a TSP or 401K, if left invested in the securities market, will not run out. For those all too many people who have the misfortune of taking distributions during a down market, a new source of employment is the only way to cover their needs.But there is a solution that “They” do not want you to know about. When we say, “They,” we mean the  administrators of your qualified retirement account, and your “wealth advisers” at the big name investment advisory firm. “They” do not want you to know about it for one simple reason: if you employ this solution, less of your funds will be under their care, and their annual 1.5% fees will decrease. But you accumulated the funds in your thrift savings plans, 401k’s and other retirement accounts to provide for yourself and your family, not to ensure profitable quarters for your wealth adviser or his firm.

Old Name, Modern Solution

The solution is a Fixed Indexed Annuity or an FIA. This is not your grandfather’s retirement vehicles.  This solution provides a combination of security, income, and longevity unmatched in any securities market anywhere in the world. How? The answer is simple. A “fixed” product is one that guarantees principle protection, backed by the full faith and credit of the United States Government. That guarantee is of the same validity as the FDIC insurance that your bank guarantees for your money. In short, the ENTIRE value of that TSP, when rolled into a FIA, becomes principle and is therefore guaranteed to NEVER experience negative returns again.

How the FIA Provides Security

It puts these asset classes through the following 3-step process.

  • Step 1: Evaluation. The asset classes’ 6-month performances are evaluated.
  • Step 2: Selection. The top performers are selected.
  • Step 3: Weighting. The winners are weighted by performance and the index is adjusted accordingly.

This 3-step process is repeated monthly in order to re-balance the portfolio, within which the cash value of the FIA grows. The annual performance is averaged, and based on the average performance, interest is credited to the now-principle-protected cash value. This index has averaged 6.3% annual rates of return to the S&P 500’s 6.51%, with 71% less volatility and a guaranteed minimum rate of return of 0%.

How To Make Your Retirement Savings Last Forever

Once a retiree decides to take distributions, the cash value is divided up into equal pieces. The older the annuitant is and the longer the funds have been accumulating, the larger each piece is. Based on the size of each piece, an annual payout starts coming into the annuitant’s bank account. Once the payouts start, the only way the payout stops is if the annuitant, or if he/she is married, both co-annuitants die. Even if both co-annuitants make it to the age of 120, and completely exhaust the cash value of their funds, the payouts never stop. It is still the only way that a TSP account holder can beat the market simply by living. Each retiree is a little different. Each TSP account holder has different needs and different priorities. Each FIA can be customized to account for these differences. To find out how to structure your own FIA, click the following link and you will be connected to one of our licensed advisers.

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How To Know How Much Money You Need For Retirement

The Ultimate Life Question

This is a question that plagues many a federal retiree and veteran. Many veterans have worked for decades in service to their country, retired, then obtained employment as civilian contractors. They are earning a salary and their military pension. Many of these veterans are also contributing like clockwork to their Thrift Savings Plans (TSPs). As they hit their sixties and they realize how close they are to the day they will want to stop working, they start looking at their TSPs a bit more closely.

Typically, the Thrift Savings Plans are invested in indexes that have shown high average rates of return. The S&P 500 is holding steady at an annual average rate of return of 6.51%. These veterans look at their portfolios within their TSPs and think, “OK, 6.5% rate of return per year on average looks pretty good. My portfolio should be well into the 6 figures, inching towards 7 figures by the time I retire. If I retire at 70, holding at this rate of return, I should have just about a million in that account. My financial adviser says I can withdraw 4% per year —. $40,000 per year for the rest of my life. That’s not a ton of money, but it should be enough to live on.”


But each person has to ask themselves, “How much do I need to retire?”

Sequence of Returns Risk

When people look at their TSPs this way, they fail to take into account the sequence of returns that have led the S&P 500 to average this rate. This rate of return also takes into account market corrections, such as was the case in 2008, when market returns averaged a 40% drop in value. It is truly impossible to predict when this will happen again, but it is also the height of naiveté to assume that it could not happen just as we plan to retire.


Consider the cases of two military retirees who follow the exact strategy that I listed above. They each have close to $1,000,000 saved up in their TSPs. They liquidate 4% of these TSP balances per year. One starts taking distributions with market returns that start at -23% and later rebound and increase. His TSP is depleted by the time he turns 78. The other starts taking distributions with market returns that start off at 26% and then start to drop. His TSP lasts him past retirement and leaves a healthy legacy.

Everyone hopes that they will have the latter retiree’s fate, but it is impossible to guarantee that in the securities market. Both retirees used the exact same accumulation strategy. Both had the same amount going into retirement. One simply had the misfortune of retiring during a bear market. The other did not. It was entirely bad luck that led the former to have to get another job in his late seventies just to make ends meet.

This story is a cautionary tale. It is not enough to just accumulate value inside your retirement account. To protect against the fate of the former retiree, you need to have a distribution mechanism in place. At US Vet Wealth, we can help you ensure that your TSP will never run out, regardless of market behavior. 


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Do you have old qualified retirement accounts such at TSP, 401K or IRA?  Are you worried about how to position your assets for your retirement?  Then you need this guide!


How To Be Smarter Saving For College

The 2019 College Bribery Scandal

By now, we have all heard about the scandal in which at least 50 sets of wealthy parents have “donated” at least $25 million and counting in bribes to a number of colleges in exchange for admitting their children. We are all appalled, but not shocked, at the way that wealthy, influential people are using their money to bypass the rules of admission that apply to the rest of us. What appalls me even more is how none of these children have failed out of any of these schools to which they seemed unable to qualify for admission on their own. This fact is emblematic of the reality that we must confront: that while college tuition is higher than ever, the academic value of a college degree is lower than ever.

 
This fact should surprise no one with a degree in basic economics. My wife and I are expecting a new baby. This has prompted us to make many changes in our lives. We decided where we wanted our baby to attend school, then sold our condo and moved to an area closer to this school. We spent a great deal of funds to furnish and outfit our new apartment. We shopped conservatively with an eye towards both frugality and taste. Our experience demonstrates the behavior of a first-party buyer. We are using our own funds to purchase items we plan to use ourselves. We are conscious of both price and quality.

Our best friend is having a birthday party for his 3-year-old daughter. We know that the daughter loves a certain castle. We are conscientious bargain hunters, so we are looking for the best price offered for this castle. In this scenario, we are second-party buyers. We are using our own funds to purchase something for someone else who will use it. We are less concerned with its overall quality and more concerned with the price for which we can get it.  

Let’s say that I have an aunt whom I haven’t seen in years, with whom I do not get along. Let’s say that my father gave me some money to buy her a gift on the condition that I use all the money to get her that gift. In this case, I am using someone else’s money to buy something for someone else for whom I don’t have too much affection. I will not be concerned with price, since it is not my money I am using. Nor will I be concerned with quality, since neither I nor anyone whose opinion matters to me will be using it. This is the definition of a third-party buyer.

 
I bring this up because every single expenditure made by any government is that of a third-party-buyer. That is, a buyer using money it did not earn to buy a good or service it has no intention of using. In this case, purveyors of this good or service have no incentive to improve the quality or lower the cost of the good they provide. In the case of student loans, through the creation of the Higher Education Amendments of 1992, the Higher Education Reconciliation Act, and the creation of the Federal Family Education Loan Program (FFELP), Uncle Sam has injected over $1.7 trillion in federal tax dollars into institutions of higher education. These federal programs have made it simpler than ever for students to obtain the means to finance a college and graduate education.

The Negative Side Effect

And what has been the effect? Private college tuition is averaging $50,000 per student per year. This does not include room and board or the costs of textbooks, fraternity dues, etc., because why not? Students are being granted access to federal loans without having to provide any collateral or even decent credit scores. Enrollment is increasing across the board. The marginal costs of increased enrollment require higher prices. And Uncle Sam is underwriting all these loans. Increased enrollment, while increasing marginal costs, also increases the probability of increased drop-out rates.

As such, these same institutions that have all these incentives to increase tuition rates are also incentivized to lower the degree of academic rigor offered by their classes. This happens across the board with scandal after scandal of grade inflation, students protesting perceived unfairness of exams, and professors increasingly pressured to favorably grade substandard academic work. Realizing all of this, it becomes painfully clear why so few of the students who were granted acceptance to these institutions of higher education through the bribery and cheating of their parents have encountered such little academic adversity. The system of academic meritocracy that colleges once embodied is abandoned at the gates of many of these institutions.

 
I studied at the University of Chicago. I also walked on to the swim team. I dealt with the rigors of a 5-hour-per-day swim practice schedule combined with a full academic course load. I got some of the first C’s of my life on midterms. I remember feeling the sense of doom and panic when I saw these marks and discussing strategies with my academic adviser to overcome these marks. I had to come to grips with the fact that I either learned the material well enough or I did not. If I did not, then I had to find the right way to apply myself rigorously enough to understand the material. These lessons were painful, but they helped me develop the academic muscles and calluses necessary to build my own path to success once I left the ivory tower.

Everyone Gets a Medal!

Today, these painful lessons are not taught in colleges or in any other institution frequented by young people. Messages that our young people receive emphasize how special they are and how the world should bend to their will. Social media is replete with examples of students protesting for softer academic treatment and administrators and professors acceding to their demands. An American college has become less of an institution of higher learning and more of a social club with a credential factory, bestowing on its inhabitants unearned credentials and connections. The utility of these credentials and connections may be quite high, but the character-building lessons and academic meritocracies are largely absent.


Children who never have to struggle become adults who are not willing to work. As parents and stewards of our country’s future, we can and must do better. We have outsourced the job of instilling responsibility in our children to government-funded educational institutions and colleges. This cannot continue. I am very fortunate to have had parents who instilled these values in me, and I plan to work as hard as they did to instill these values in my baby daughter and all my offspring to come.

Learn about a New Approach

The Junior Veteran Opportunity Plan (JV Plan)  allows us a rare opportunity to strike back. As a new parent, I want the best for my child, but I also want her to learn how to earn it for herself. For this reason, the day she was born, my wife and I set up a JV Plan for her. We are contributing $400 per month. The cash value growth rate has averaged returns comparable to the market. She is the insured. We are the owners. As she grows older, my wife and I plan to go over the growth with her, showing her what this account is worth. By her 18th birthday, the cash value will be worth roughly $150,000.

If she keeps her grades up, does her school work, stays out of trouble, and shows us that she is mature enough to handle the responsibility, on her 18th birthday, my wife and I will transfer ownership of the account to her. She can spend the entire cash value on whatever she needs, be it tuition, rent, room and board, etc. But it will be at my discretion and that of my wife when or whether we transfer ownership to her.

The beauty of this is that even if she spends 90% of these funds on college-related expenses at this age, the cash value can and will regenerate. She can contribute to it herself as she gets older, and she can even use it as a tax-free retirement account for herself when she gets older.


She could choose to behave the way that Felicity Huffman and William H. Macy’s daughter is behaving, making Instagram videos expressing excitement about partying, blowing off class, showing no maturity, etc. In which case, I have no obligation to transfer control of these funds to her. I can spend them myself on a new car.

 
Using the JV Plan, we can simultaneously protect our children from the effects of the bloated student loan system and instill in them the value of earned rewards and privileges and give them the leg up we desperately crave for them. The ability for parents to choose when/if to transfer custody of these accounts to their children and the lack of obligations for the children or parents to spend these funds exclusively as a college savings plan or on education-related expenses in general, also goes a long way towards re-balancing the equation in favor of parents and students. Unlike a 529 college fund, with this plan, children have sources of funds that they can choose to spend on college tuition, or just as easily choose to spend on a starter home or to open a business. Before you know it, education will be purchased more often by first party buyers. Purveyors of education will have to weigh the opportunity cost of education against one of the aforementioned options. They will have to rein in what they charge for tuition and reemphasize the quality of their education. In short, colleges will have to start competing for our dollars again.

 
In this way, not only can we use the JV Plan to provide the best for our children, but we can use it to introduce some free market competition back into our educational institutions, and thus improve the quality of higher education for all children.


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