Accredited Investor Case Study – Episode 177

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[00:01] Welcome to the Prosperity Podcast, fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your host, bestselling author, Kim D.H. Butler and No BS Money Guy, Todd Strobel. Hey everybody, welcome to the Prosperity Podcast. This is No BS Money Guy, Todd Strobel. We’ve got bestselling financial author, Kim Butler with us today. When our listeners continue to watch our analytics and see what people like, they like to see case studies from time to time. We have a case study that we’re going to be working on today for somebody who would be considered financially well-off. They qualify as an accredited investor and a lot of people think that if you meet

[00:54] that accredited investor mark, which is basically a million dollars worth of assets, not counting the equity in your house, that all of a sudden you have no more financial worries. And the truth is, because somebody in that range has a lifestyle that they’ve gotten used to, there’s as much to worry about, if not more, has been my experience. Welcome, Kim, what do you think? Well, hello, Todd. I’m happy to join in on this conversation because I’m a big believer that cash flow issues don’t go away. They just get bigger zeros. And whereas at one point, you know, maybe it was your $600 mortgage that was a challenge. Now it’s your $6,000 mortgage. And for some people, it’s your $60,000 mortgage on your big commercial building or what have you.

[01:45] So, yes, this is something that is so important to everybody. And, you know, it’s such a shame that our society has gotten so focused on net worth when cash flow is what causes people the biggest problem. And cash flow is also something that is not talked about. It’s not looked at. It’s not focused on. For whatever reason, net worth has become the measurement. And net worth means so little. People’s cash flow is what dictates whether they go to Rooskris for dinner or, you know, the Taco Bell or, you know, maybe that’s an extreme example. But cash flow is what provides that differential. So that’s what we want to be focused on. And there’s also this fictional thing we call retirement. So many times, a financial advisor inadvertently will present that somehow or another in

[02:39] retirement, your expenses go down and that you’re just going to sit in your house, watch TV and do absolutely nothing. When the truth is, this could be the most active and expensive time of your life because you have the time, the money, and hopefully the health to enjoy yourself. Absolutely. As you should be. And we all know Todd Langford’s favorite saying, every day is a Saturday and you’re going to spend less. So yes, we want you out there being active, contributing. And oftentimes that does not only enable more spending opportunities, but really requires it of you. So we want to help people increase their income. And this case that we’re going to talk about is an interesting one. Why don’t you give us the facts?

[03:28] Super. Well, we’ve got a doctor who’s 60 years old. He’s currently working for a hospital and has a salary of $175,000 a year. By the way, that is a W-2 position. So I imagine his taxes are taking a huge hit for that. He has a spouse who’s 60, who’s currently not working. She raised the children. They have a house worth $600,000 that currently is paid for. There’s no mortgage against it. He has accumulated $2 million in an IRA, and he has $1 million in CDs just kind of for his emergency fund. That would be part CDs and part cash. It’s in a bank. He also, as far as life insurance goes, he purchased a $5 million term policy. It was a 30-year term, and it was really cheap when he bought it, but it’s about to expire this year.

[04:29] And in order to renew that policy would be quite expensive. So Kim, kind of start there and see what suggestions you would make. Well, I love dealing with this kind of person. It’s so beneficial to add in the seven principles of prosperity to their financial situation because it really blows the doors open and enables us to do so much with what they have. His situation, while it’s not super, super wealthy, his situation is going to be just fine if we can just reorganize a little bit and actually increase his cash flow and reduce his risk. Because the additional fact that is real clear from him is that he is super scared of the stock market, does not want his IRAs, which are sitting in mutual funds,

[05:22] to stay there, and yet he’s enjoying his work. He knows that he needs to keep working, which of course we supported immensely, and that that IRA needs to keep growing. So while he’s over 59 and a half, and he obviously could take money out of the IRA, that’s not what we recommended. So I’ll start with that. And one of the things that we work with our clients always is our mantra of go slow and start small. So in this case, we introduced the life settlement arena to him for his IRAs, and life settlements are available for accredited investors, which Todd, you wisely stated earlier, a million dollar net worth not including your home, or 200,000 of income if you’re single, 300 if you’re married.

[06:10] So in this case, this gentleman qualifies on net worth, and yet we’re not going to recommend that he take his entire two million dollar IRA and put it in life settlement funds. We’re going to have him go slow and start small. Now that statement is only determined by him. Only he can say what go slow means, and only he can say what start small means. So it may look like something of the following. He may move half a million dollars, 500,000 of his two million dollar IRA, to one of our life settlement funds, and then get his account open, get his confidence up, start to see the monthly emails that I send people that are interested in life settlements so that they can get confident about the maturities

[06:58] and that this product is doing what it’s supposed to be doing. And as a rough rule of thumb, he can estimate to have low double digits of a return on those dollars. Now go slow, start small may mean something else to somebody else. It might mean a million. It might mean a hundred thousand. And some of the funds do have a hundred thousand dollar minimum, so that’s always a good starting place. But as a general rule of thumb, we want to get these IRA dollars where they can continue to grow and not shrink, remembering that our personal risk tolerance is zero. We don’t have a tolerance for losing money. And that then would enable his IRA to do the job that it’s supposed to do, which is grow and not shrink.

[07:44] And right now it is not needed to produce income. It is only needed to grow. Does that make sense so far for the first step? Yep. Fabulous. So moving on to the CDs and the cash that’s sitting in the bank, we like to see that money start to create income. Now he doesn’t need that income right away, but if we can use the practice of creating income now while he’s 60, while he’s still working, then when he decides to retire or starts to make his life more elegant, that’s my new word now. I don’t like to hear people talk about, I want to slow down. I just don’t think that’s good for us. Human beings to be in slowdown mode. But if he wanted to make his life more elegant, he could then be in practice of receiving income.

[08:40] And so we would do this with the bridge loan investments. We’ve got a variety of them that provide an income stream anywhere between 7% and 10% or so, just as an example. And that income stream right now when he doesn’t need it could actually be used to buy a whole life insurance policy which would then start to slowly, this is going to take time, build up dollars that would replace his emergency opportunity fund. So literally we would take maybe half of those million dollar CDs, move them slowly over to the life insurance policy, probably take about 10 years or so, maybe even a little bit longer, and let that life insurance policy slowly build up to provide his emergency opportunity fund for him

[09:34] so that he is no longer relying on a bank. So these CDs are earning less than 1% and they’re taxable. And we would be moving that money into life insurance cash value where it would earn 3% or 4% without taxes. And that’s net of all the costs, net of the cost of the death benefit, net of the cost of the commissions, net of the cost of running the mutual company that provides the whole life product. So he’s doing a major improvement there in his cash. Earlier we did a calculation with a financial calculator on that kind of difference. So let’s say that his CDs are at one and that his cash value life insurance is going to be at three. And a lot of people would think, oh, that’s just a 2% improvement.

[10:24] No, it’s actually a 200% improvement. And you can think about this. If you just took $100,000 and you said, okay, over let’s just say 10 years, I’ll just do this calculation as I’m talking here. If we take our 100,000 and it earns 1% over 10 years, then that would be $110,000. If we take our 100,000 and we get it to earn 3% over 10 years, that would be $134,000. Well, 134,000 is clearly more than 2% more of $110,000. And that’s without factoring in taxes. That’s right. That is not including taxes. So just people get really confused around interest rates. It’s very, very common. People in our industry do it. The lay person, of course, does it. And so I didn’t mean to go too far down that bunny rabbit trail.

[11:33] But the bottom line is we’re improving his cash position 200%. My concern is if I have 1 million in CDs and I’m using a CD that renews every year, what happens when interest rates go up? Might they pay more than what my insurance is paying me? Oh, that’s a great question. And the answer is that the insurance will go up also. So we’re in 2017, the dividend from the insurance companies are in that 3% to 4% range. But that will change also. As interest rates in our economy go up, then interest rates at the insurance company will go up also. Now, they may not be at the same pace. They may not be right away. The banks may rise above them very, very briefly. But as a good rule of thumb, I have seen in my study of history,

[12:30] life insurance companies typically pay about two or three points above bank rates. So right where we are right now with 1% at the bank and 3% at the insurance company or four, depending on the age of the insured, that distance, if you will, it’s not a discrepancy, that distance is an approximate, accurate distance between the banks and the insurance company’s interest rates. A couple things I’d also like to mention is this isn’t a standard whole life policy, is it? No. In our example, we would have a heavy pay-to-peditions writer which would enable this physician to build his cash value quicker and that would build that emergency fund faster and use up the money at the bank faster. And again, the money at the bank is actually going to go to the bridge loan

[13:28] which is then going to create the income to pay the life insurance policy. And one of the things that people get caught up on is wanting to pay as little into that life insurance policy as possible. But your question helps people understand that this is a special type of policy, high cash value, low death benefit, and they want to actually pay as much into the life insurance policy as possible. Now, he may have some term insurance in addition that he would buy today. That’s going to depend on whether he still has children at home, where his spouse is in relation to her assets, etc. But this whole life will be the foundation of his overall personal economy. Then the bridge loans will be there to create the income

[14:15] and the life settlements will be there to create the growth. And when you really boil it down, accredited investors or all investors are truly looking for their dollars to do three things. They either need those dollars to be liquid for emergencies and opportunities, they need those dollars to grow like IRA money medium to long term, and or the third thing is they need those dollars to create an income spring. And so this is what is available with this three legged environment that we’ve just described. Now, I’d have to tell you, my grandfather always said that they’re just crazy to buy insurance at 60 because it’ll just cost more than it’s worth. What do you say to that? Well, one of the things people forget is that this death benefit

[15:05] rises. So on this gentleman, I haven’t done the research on it yet, but let’s just say that he buys a million dollar whole life policy. And so that million dollars, literally the very next year is going to be a million one and the following year, a million two and then a million three, four or five. And it’s going to keep rising, rising, rising and it’ll rise exponentially after a while. In other words, not just by a hundred thousand. And so because of that, the fact that the death benefit keeps on rising literally until he’s 120 years old, that death benefit will rise every single year, as long as those premiums continue to be paid. And he may not continue to pay the premium. So that’s fine.

[15:49] Then the death benefit will still rise just not as quickly. But that is what makes the life insurance worth so much more because the rising death benefit keeps pace with inflation. And so he will never be in a position of the death benefit being worth less than what he’s put in. The more he puts in, the higher the death benefit grows. You mentioned up to 120. So it seems like people are living longer. So wouldn’t that make the insurance? I mean, if you were to look at the same amount of insurance over the last 50 years, it probably is cheaper than it would have been 50 years ago. Yes, absolutely. The mortality tables changed in the 1980s and they changed again, I think, in 2006. And that’s when we went from age 100 to age 120 or 121

[16:45] being the standard life expectancy table that gets used. And so, yes, that’s telling us something. The insurance companies, the life insurance companies, are feeling like living to age 120 or 121 is going to become normal. Just like living to age 100 today is fairly normal. Your strategy sounds great, but what if the doctor can’t qualify for life insurance? Oh, that’s a really good question. So we could definitely look at his spouse. We could definitely look at his children, assuming that he has even adult children is fine. We could build this emergency slash opportunity fund on children and or spouse. We could use grandchildren as well, just if he does have some. But they’re so young and these policies have to be so small because the children are young

[17:39] that it’s really not a position of strength. It’s much better to look at the grandparent in this case or the adult children. Let’s say they were in their 30s or even 40s and we could use them instead. Additionally, we could go back and see if that term insurance is convertible. My guess is it’s probably not, but we should always be asking that question. What about my children? If I were to buy life insurance on my children, I’m still the owner of the policy. Is that correct? Yes, that is correct. So I get to keep the interest rate. That is correct. You’re the owner. You pay the premiums. You’re the beneficiary and you get the value of the cash value and it’s increasing. Hopefully, you will outlive your children and then transfer that policy to them.

[18:31] But of course, if they did happen to predecease you, then you would get the death benefit as well. What if I wanted to give the policies to the children? Is there any way to do that? Oh, yes, absolutely. You can actually give a life insurance policy to an insured without gift tax and if there is gift tax issues, gift tax is actually the more efficient tax to pay rather than a state tax. So you’d be better off using up your unlimited credit, the unified credit that you have available that’s a million dollars. You’d be better using that up and paying the gift tax than you would leaving dollars in your estate to pay a state tax later. Okay. And then another quick question. My $2 million that I’m in my IRAs,

[19:26] you’ve got me taking $500,000 out to go into these life settlements that pay 10% or so. The other $1.5 million that I’m in there, my question is what should I do with it? And since I am old enough, should I maybe at least start drawing the interest off the account to help fund one of these life insurance policies? Yeah, that’s a great question. My general rule of thumb is if you’re super concerned about the stock market, put your IRA money or whatever is in the stock market into a cash account or a money market account that’s underneath that umbrella of the IRAs. I’m generally not a fan of pulling money out of the IRAs until you have to. And it kind of depends on the situation. If that IRA is all about just being saved and given to the children,

[20:21] then yes, you’re better pulling it out, paying life insurance premiums with it and giving the life insurance to the children. But if the IRA is truly there for you to use, you’re better off deferring that as long as possible, getting that account as big as possible. And then when you turn 70 and a half and you really are forced by the government to start to spend that money, don’t only take required minimum distributions. Instead, spend that IRA down. Really purposely plan to reduce the IRA to zero over the course of say 10 or 20 years. So these are strategies that we work with people on. If they need a lot of advice, we take them through our prosperity pathway. If they just need some product, in other words, a better place to store that money,

[21:08] put that money, make it grow, make it create income, then we’re happy to help. And we don’t charge a fee to do that. We’re just happy to help with the products. Whereas if they feel like they really need full service planning, then we have a fee platform whereby we can do that. Awesome. Well, again, we have somebody here who obviously knows how to save money. They’ve been a disciplined saver. The biggest fear I would think at this point is going to be inflation. And that’s positioning your money so that it grows fast enough that you can buy tomorrow what you could afford to buy today. Absolutely. And staying ahead of inflation is important. Staying in control of your money is important. And also, peace of mind is important, which,

[21:58] if you can get yourself into a position, though it may take time. Because I find that what most people do, once they get comfortable with the life settlements, is they end up putting the bulk of their IRAs there. Might be in two or three or four different life settlement funds, so it’s heavily diversified still. But as time progresses, they tend to get more and more confident with that and put the money in where it will never shrink again. One last question, and we’ll let you go. You know, if I’m a busy doctor doing my thing, most of my colleagues just pay somebody to take care of their money. And it’s kind of a hands-off deal where I don’t know what’s going on. How much of my time am I going to have to invest

[22:43] to learn how to do all this stuff? Yeah, that’s a good question. So it’s really very minimal because this is an easier environment to learn about. There’s not as many moving pieces and parts as is true in the stock market. And so the learning curve is fairly short and not very steep. And the best part is once learned, the money goes in there and it just doesn’t do anything other than grow. You do not have the roller coaster ride environment that you need to be paying somebody to constantly keep an eye on things. And frankly, I’m not sure they do that good of a job of keeping an eye on the roller coaster ride because it’s so uncontrollable. But in our environment, there is no roller coaster ride.

[23:27] So consequently, there’s no management that’s needed of this environment. Little bit of work once a year and you’re good to go. Super. Well, if somebody has more specific questions, where would they, how could they reach you? Hello at partners number four, prosperity.com is specifically for our podcast listeners. And I’m happy to entertain questions, send information ahead of time and schedule calls if that’s what people are looking for. If they have additional questions they want to handle. So again, that’s hello at partners number four, prosperity.com. And again, that would be for people in all 50 states, correct? That is correct. Yes. Okay, super. Well, thanks so much to Kim Butler. Again, there may be people who are either in this situation,

[24:11] maybe better than this situation or maybe like the rest of us trying to get into this situation. Either way, a prosperity economics advisor is there to help you answer your questions and make sure that you’re optimizing your money. That’s getting it to do the best possible jobs and as many jobs as it can. This is Todd Strobel, the No BS Money Guy for the Prosperity Podcast. Say and take care, everybody. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you, visit us at partners for prosperity.com. If you liked this episode, make sure you subscribe and leave a review.