It's a tough story. Newlyweds in their early 20s buy their first home with no money down. They sell it nine months later to build a new...
It’s a tough story. Newlyweds in their early 20s buy their first home with no money down. They sell it nine months later to build a new one, with no money down.
Two years later they sell and build yet another — all with no money down. Four years go by, and the house has doubled in value. The young couple has a magical $150,000 in equity.
Then the economy softens.
Home sales slow just as the couple’s income disappears. They sell what they can to make the mortgage payments. They put the house up for sale. But it doesn’t sell.
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Nine months later, the house is sold at foreclosure to the mortgage lender. The couple’s equity has disappeared. Their credit is shot. The $30,000 loss the lender eventually took selling the house appears on the couple’s credit report for the next seven years.
That experience, discussed in his book “Missed Fortune 101” (Warner Business, $24), made a deep mark on Douglas Andrew.
He says none of us should have any equity in our homes. We’d borrow every possible dime from our homes, preferably with interest-only mortgages, and we’d invest the money in safe assets.
We wouldn’t keep any money in 401(k) or traditional IRA accounts, either. But if we did, we’d figure out how to drain them without tax consequences.
Indeed, Andrew will show us exactly how to do this through seminars advertised in major newspapers. “Withdraw up to $60,000 annually from your IRA or 401(k) with no tax consequence.”
Such ads get your attention if you’ve got a bunch of money in tax-deferred plans, own your house outright, and have virtually no debt. Your life is a “taxable event” waiting to happen.
Andrew has the answer, in a nutshell: Liberate your trapped home equity by selling your home. Buy a new one with a large mortgage. Invest the liberated equity in a life-insurance policy that is fully funded as quickly as possible.
Let the interest deductions on your new mortgage offset withdrawals from your qualified plans. Finally, borrow the annual yield on your life insurance cash value, tax-free.
The book is one of the most interesting books on insurance I’ve read in years.
I would love it if everyone could convert their taxable retirement savings into tax-free savings. After all, I’m the guy who has been harping on the taxation of Social Security benefits and the inevitable rise of future tax rates.
Unfortunately, those who attend the advertised seminars are likely to be very disappointed if they act on Andrew’s suggestions.
When someone tells me, as Andrew does on Page 43, that I will pay out more in taxes when I retire than I ever deferred using qualified plans while working, I worry. You can’t compare dollars of taxes saved in 1970 with dollars of taxes paid in 2010. It’s bad financial reasoning.
Every illustration in the book is based on a 33 percent state and federal tax rate. In fact, few face such tax rates. The smaller the tax rate, the smaller the benefit of moving your investment to a tax-free investment.
Given the choice, many people would choose to have a large mortgage and money to invest rather than a smaller mortgage and no money to invest. They make that choice because they think it is easy to earn more than the mortgage rate. In fact, with mortgage rates approaching 6 percent, it is difficult to find yields over 4 percent. Very few insurance companies are crediting more than 6 percent to policy cash values.
When we take out a mortgage, we sign a contract to pay interest for up to 30 years, at whatever the rate. When we invest in an insurance contract, the insurance company guarantees a return of only 2 or 3 percent. The policy illustration may show a higher rate, but the guaranteed rate is 2 or 3 percent. As a result, your ultimate tax-free income may be far less than expected. Indeed, it may be zero. This possibility is not mentioned in the book.
Questions about personal finance and investments may be sent to Scott Burns at The Dallas Morning News, P.O. Box 655237, Dallas, TX 75265; by fax at 214-977-8776; or by e-mail at email@example.com. Questions of general interest will be answered in future columns.