This is where the conversation of life insurance and annuities come in. What are your opinion and your view on life insurance, like using life insurance as an alternative to that? And annuities, I asked you two questions you can address one at a time. So someone has a million bucks. Let's assume they need, I'm just going to call it 300 grand in what we'll call our root reserves. How would that, what would that process look like to get that 300 grand put into a life insurance asset? that could replace what root reserves does. So yeah, that's a question. That's quite cool. I guess I should give some context around that question. Well, let's first of all, what type of rate of return are you hoping to get in a root reserve when it comes to bonds? So it depends upon, of course, where interest rates are. But let's say long-term, anywhere between four and 6%. Okay. And that's taxable? Taxable? Or is that usually a tax-free? It depends. So if all their assets are in a 401k, or I should say a traditional IRA, a Roth IRA, Right. depends. So that versus a brokerage account. So part of it depends upon where is it actually held, but for the most part, it's either going to be held in an IRA or it's going to be held in a brokerage account. Okay. So this, this, yeah, this is where we'll have a discussion. So I would say this is where like, this is where potentially annuities could come in. If someone's coming to you and doesn't necessarily have a ton of years, like they're, they're coming to you and saying, Hey, I want to retire in the next five years. Life insurance may or may not be a factor depending on how you can fund it. Sometimes you can front load life insurance policies. where you can put majority of money up front in a life insurance and then pay small portion ongoing. And or sometimes you could just make a contract and just put all in one, you don't necessarily get some of the tax benefits that you would, but it's like you don't have to have that ongoing. And usually it would be a long period of time, it would be very competitive, especially if you factor in. So I think that's the point where we probably would see different. So long period of time, right? Yeah, I guess I think of there's a concept, there's bond like returns. and a life insurance policy plus additional benefits. Creditor protection, death benefit, tax-free loans, things of that nature. I absolutely agree. If you're looking at it from a certain point of view, and that certain point of view over 20 years, over long periods of time, bond like they're there. Like you've personally shown me illustrations. When I think bond like returns, at least in the context of what we're doing, is I don't care what this bond is going to do in 20 years. You want it now. I need it. Right now, I know you can fund policies in a way where you're prioritizing the cash value accumulation. But you won't get a positive IRR and a life insurance policy for the first three years. Correct. To prove your point. So I think that's probably, if you're an investor saying, okay, for the next 20, 30, 40 years, I want a very stable return, call it four or five, six, whatever percent. I think there's a lot of validity into what you're saying. Tell me where I'm wrong on this, the way I'm looking at it. Caleb comes to me, he's got a million bucks. We need to put 250 grand into something that it's fully available in the next five years. Like if there's a serious market downturn, I'm not waiting 20 years for this thing to hit its IRR target. I might need it now. The IRR, many of these things, maybe probably all these things is negative the first two, three plus years, correct? So I think from that context, if it's being used the way we're looking at it, almost like an immediate emergency fund in the event of a market downturn, I don't see how that plays a role here. versus if it's someone that's saying, because what I'm looking, I think of in both terms of what is someone's risk tolerance as well as their risk capacity. The difference there is that five-year bucket, I think of it from the terms of risk capacity. And again, huge disclaimer, like this is not universal. There's a lot of other stuff that goes into this, but risk capacity means how much risk can we take because we have the financial mechanisms in place, the root reserves in place to buffer you from the likely downturn. You might come to me and maybe you have a $10 million dollar portfolio. and you only want to spend $50,000 of it. Now, my first piece of advice is, Kev, you probably spend more. Let's assume like, no, I got awesome pensions and social security. I don't need anything. $50,000 per year on a $10 million portfolio is a half percent withdrawal rate. You could theoretically stick all that in the market and get a dividend yield of two, two and a half percent. And you're already at $200,000 to $250,000 just in dividends alone. I don't care what the stock market does. Dividends typically remain pretty resilient. Not always, but typically, 2000, 2002, for example, market dropped 50%. percent. dividends were cut on average of one to 2%. So it's like that dividend rate remains pretty sticky. I might say if you're comfortable with it, you could have 100% stock portfolio because your income need is being met. Your risk capacity says that you could have 100% equities. You as an individual, very good chance you're gonna say, James, I don't feel comfortable being retired with 100% of my equity. Especially. Yeah. So that's the difference. So risk tolerance is more of a feeling, more of an emotion, more of what type of fluctuation are you comfortable with. Even if from a financial standpoint, you would be totally okay with an overwhelming majority of your assets in the market. That is a different conversation where it's not just a five-year bucket. We might layer on top of that. more to dampen some of the volatility, more to ensure that we're not hitting the severe lows that an all equity portfolio might have. That's where I could see something like that. If you have the next 20, 30 years, we need something to get these types of returns and also as additional benefits like life insurance, more so than a root reserves type concept. Let's first talk about someone in their 20s, 30s, and 40s. Knowing what you know about life insurance, you know, a lot more than the average person when it comes to insurance. You say that if, you know, knowing that the root reserve concept is valid and knowing some of the other benefits, you shared some of the talking points that you have, you know, tax beneficial growth when set up and used properly, it protects your family, which we'll talk about legacy in a second and taxes. It's interesting that taxes and legacy are all part of your process. You have credit protection. It's, you know, with... You could factor in, and this might be a stretch, but if you factor in all the benefits you're getting, I could confidently say that you're probably getting a result of maybe like a seven to 9% return on those dollars. If you look at the other benefits when you're factoring in, like what the cost of interim insurance would be in that time. So nothing, you're not hitting any crazy home runs, but. Let's talk about that. I would actually love to know some of you because I have a lot of respect for what you all do because I've seen some of the work and it's clearly superior to a lot of the other people. Which the bar is not set high. The bar is not set high, unfortunately. You guys cleared it. I personally, obviously this is not a recommendation, all my actual liquid investments are 100% stock market. I have like emergency fund and cash reserves, which is a combination of either just cash in the bank or like short-term treasury bonds. Walk me through how, and let's even assume it's in a brokerage account. So like I do my Roth 401k. That money's there. That's obviously tax-free. But if I'm going to put money in a brokerage account, let's assume it's going to get long-term returns of the market. I think what you're saying is, well, when you factor in the tax hit of that, when you factor in some of the other things you don't have, maybe insurance protection, what you're paying for term, because I have two term life insurance policies, there's a case to be made for life insurance. Is that right? You're right. I know it's not apples to apples, but how could that be superior if we're more talking about the investment piece than just say a brokerage account where I'm investing in? great companies all around. Yeah. So this is this where you're in your 30s. So what is the question? So so seven to 9%, I think I heard you say, correct? Yes. Let me clarify. How am I getting seven to 9% equivalent compared to I'm assuming you're making some tax assumptions? Yes. Yeah, I'll walk you through that. So in a in a life insurance policy, we're overfunding it a lot of I don't want to be an apologist for the life insurance space. Because as you know, there's a lot of bad. policies, actors out there. So assuming what we're doing is we're max funding an insurance contract to give early liquidity and really give a cash, like a lot of our clients get immediate cash value and it's a lot. And usually we're breaking even, which means you have more money than what you've put in in year four or five and beyond. When we're looking at internal rate of returns, this is like after everything, this is like actual cash on cash growth. we're looking from anywhere from three and a half percent on the very low end to like five to five and a half percent on the high end. But yes, you have to look out 15, 20 years. Now, that's assumed when you look at an IRR calculation, that's not just saying in year 15 or 20, you're finally earning four or 5%. You have to look back. That's assuming every single year. So one of the things to just to even address when someone's early in retirement, yeah, you're taking a hit the first couple years. But life insurance is a contract that ultimately leverages your death in a sense. And so if you can think long term, whether you're starting retirement or whether you're in your 20s or 30s, you have to understand that this contract, it's valuable knowing that you will die someday. And so that is one thing I want to address. So how do I get the 7% to 9% if I'm admitting that whole life insurance is only going to earn 4% or 5% internal rate of return? Well, when life insurance is set up and used properly, that money grows tax-deferred, you can use it tax-free with a policy loan, which we can talk about in a second if you'd like. And then you're obviously the death benefit is income tax-free. And so when you just factor in taxes alone to like assets that normally you have to pay ordinary income, I get if in some assets you would maybe pay capital gains. But if you look at assets that have true liquidity, like a high-yield savings account, you have to pay ordinary income on those assets. So you factor that everyone's in a different tax situation, but now you take that four or 5% tax free. And now you just, you would have to earn greater in an alternative account just to keep up because you have to factor in taxes. Does that make sense? So now, now we could, depending on if you're in California or if you're in any state, states are a little bit different. Now you're bumping that up to six, seven, or potentially 8% based on that logic. And we're not even touching on Now you have a permanent death benefit that term insurance, most likely you're just going to drop that off eventually and self-insure you'll have enough. You wouldn't want to pay term insurance when you're 70 or 80. It just would not financially make sense. And so you have a permanent death benefit that I would argue that is amazing and superior to estate planning. And you have other benefits like creditor protection, other things that are like, it's impossible to necessarily put a value on the value of safety or creditor protection. Or or all that's where you start factoring in and that's where you kind of get this like wishy washy number of being like, well, IRR is a really poor way to measure insurance because we're just comparing it to other like investments like bonds. But if you understand life insurance as a contract, as a protection element, that's when it's like it could check the box of a bond and do some of these other things. That's where for me, I was like, that's where I wish it would be used more, talked more about in financial planning. Because I do think it could act as your root reserve, but also enhance some tax advantages in the future. and legacy and estate benefits in the future. And by default, potentially allow you to spend more, knowing that you might not have to self-insure. And we'll all even ask you things like reverse mortgages. They can have a bad rap out there. But if you had multiple millions of dollars of permanent death benefit, and you could potentially spend out an asset more efficiently in a tax advantage way and give your kids options between money or the house, that opens up. Whereas if you didn't have that. a reverse mortgage would almost be off the table. So I would almost look at a life insurance policy can create more options in the future because you're not just leveraging or hedging interest rate growth, but you're also leveraging and hedging your mortality, your ability to die. And you have a contract that kind of shares both of those risks. Yeah. I'm not opposed to reverse mortgages. We'll come back to this. I think my biggest issue is sometimes when those comparisons are done, you invest in a brokerage account. Sure, you get growth, but you pay tax on that growth. If you are a really uninformed investor and you're constantly turning your account and all these gains are short-term capital gains, you're paying the highest federal marginal rate, I think that's true. But I think that's also solved by just be a better investor. And I think you have this trend of just buy the S&P and chill, which isn't maybe the best thing, but kind of a much better thing than what people used to do, which is actively trade everything. You want to know what's the tax equivalent return. Let's assume I do get 10%. Again, that's just past 100 years. This is 1926. The S&P's average, I think, like 10.3%. That's including the Great Depression. That's including the 2000s where it lost money. That's including the 19th set. That's including all the really bad years. The annualized rate of returns over 10. Let's assume it does that going forward. No guarantee. Yeah. Who knows what happens? That's a safe assumption. Just to use this. Let's assume that of that 10%, 3% is a dividend. And you take that as a qualified dividend because you've met the holding requirements. So for every 10%, 7% of that is capital appreciation. 3% is a qualified dividend. The capital appreciation, you don't pay any taxes on until you actually sell. That's right. So let's assume I'm investing. I'm investing for my future. I'm not touching that. 3% of it is a dividend. If it's a qualified dividend, I'm paying taxes at 0, 15, or 20% at the federal level, plus potentially the Obamacare surcharge, net investment income tax, if my income's over a certain amount. Depending on what state I'm in, I may or may not have state income taxes on that dividend. But let's assume that dividend is taxed at 20%. Because it's all qualified dividends are taxed at long-term capital gain rates. 3%, 20% of that is taxed. Essentially, it's like 1.5%. No, 0.6%. I'm sorry, 20% of 3%. So your after-tax return, you could argue, is 9.4% in that case. Not bad. Are you factoring in paying taxes? I'm saying you defer taxes. You defer taxes, but when you defer taxes, you have to pay that eventually. It's paid eventually. But let's just assume I keep growing this thing. I mean, there's all kinds, obviously, there's all kinds of things you could do. Shareable giving, right? Do you gift your appreciated assets down the road as opposed to gifting cash? When you're retired, there's a 0% federal tax bracket for long-term capital gains. If you're married, family, and jointly, your taxable income is under 96, I think it's $96,700 or something. And by the way, taxable income is after the standard deduction has been taken. So like you can have six-figure income and pay nothing in taxes on the first level of long-term capital gains that you're realizing. So, I mean, if you're smart about the way, the timing of when you realize some of these assets, we're talking about life insurance, the death benefit. Like that's not for you. That's for your future generations. Well, what if we made this brokerage account part of that future generation thing? They're getting a step up in basis. So even if I bought Tesla at a dollar and my $10,000 investment is now $4 million and they inherit that, that's all tax free. So I think you're absolutely right in a lot of ways. But I think a lot of those issues are alleviated if you just... If you invest smartly. If you invest smartly and know the tax consequences of what you do or don't do or the timing of when you do it. Yeah. So, I mean, that was one of the things that I want to definitely get into when we talk about taxes is there's... You clearly have wisdom around like how people can invest and do it in a tax advantage way. Going back to life insurance, in your research, because I know we've talked, is there any play that you would be like life... permanent life insurance plays a role? Or is it your humble opinion, even if you're 20 or 30, knowing what you know, by term, invest wisely. And at the end of the day, you're getting that's a choice that you believe you're going to have a better elf, you're going to get a greater return, have more cash flow. And like you're making a bet that you're actually going to be better off and you're still protecting your family with term insurance, but you'll get to a point where your retirement will be better in your opinion. And then you will ultimately and you won't have a permanent death benefit to give your family, but you'll have a portfolio to be able to roll over. I don't want to put words in your mouth, but is that my opinion? Taxes are obviously a huge part of this. Like once you're over a certain net worth amount, estate taxes become a huge thing. They're unavoidable. That's a 40% tax like this. irrevocable life insurance tax. And you're on a trajectory if you're not already to have an estate tax problem. Right. And also you don't know what it's going to be in the future. So I think there are some advanced planning cases where a hundred percent makes sense to consider this. Probably the core issue is what you and I have talked about. There's a lot of people selling these insurances that don't really know how they should be sold or where they fit. And so everyone gets one and typically it's their buddies out of college that are just starting a job and don't need this policy before there's other things they've done. Yeah. there are absolutely cases for it. I think that I see far fewer cases where it's a value add than I do. This is actually hurting you. Right. If you take the concept of almost self-insuring or using your assets to give on to the next generation and you step up the basis and all, you feel like you actually spend less versus like you could make the argument if you had $7 million of permanent life insurance with cash value component, and let's just say it earns 4%. So it's that root reserve concept that allows you to potentially get 5% or 6% spending down. But you could even make the argument that, no, you have $7 million that is a part of your estate now. So maybe can we spend 9%? Again, not financial advice, but you don't necessarily care about keeping principal. You can maybe spend down more aggressively knowing that you have a life insurance asset. And that's what's so difficult is, yeah, we're looking at the... internal rate of return, which might be similar to a bond, but now you have, you have the death benefit that's hard to factor in. What would be your response to that of like, can you, would you agree that if someone had a permanent death benefit, they could choose to potentially spend more aggressively versus the person that didn't, if they cared about legacy? If you don't care about legacy, then it's kind of like a horse apiece, but you care about legacy. Do you feel like you have more options with having a permanent life insurance as a part of your portfolio versus not? I think theoretically that's a very good point. I'm just thinking like practically speaking, the thing that prevents most clients I've worked with from spending is not this fear of spending down the inheritance their kids are going to receive. It's more of just like a part of who they are. So I don't know if it's like, hey, Caleb, your kids are going to be fine. Like just that's not the thing that's preventing them. That's not to say like that couldn't be a very valid thing for a lot of people. I also think a lot of people don't necessarily have a, and this is where it's not universal. Not many people like I want to leave. every like I want to leave these massive amounts to kids it's like I want to leave enough to like they're supported they can help their kids they can do so I don't I don't know it's a good question I have I can't think of someone where I'm like yeah that would have a hundred percent help them but that does not mean universally that's not a good thing to have
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