Over the weekend, I read the book "Missed Fortune 101," by Douglas R. Andrew (http://www.missedfortune.com/index.aspx). In his book, Mr. Andrew describes an unorthodox strategy for saving for retirement: He advocates maintaining little or no equity in one's home during the accumulation phase while investing the principal payments and tax savings in equity-indexed universal life insurance. In retirement, the premium payments can be withdrawn for income (tax-free, of course), and then, once the premiums have all been withdrawn, the investment gains can continue to be withdrawn tax-free by taking out loans against the cash value of the policy at an effective rate of 0%. The policy death benefit and any remaining cash value will pass to one's heirs tax-free.
Because I was skeptical of some of Mr. Andrew's claims, I searched these forums and the internet for any potentially helpful commentary on this book, but came up with very little. Scott Burns did review it in a couple of his columns, but he didn't go into as much detail as I would have liked. Those columns can be found here: http://tinyurl.com/aajda and http://tinyurl.com/dl9et.
After spending the weekend reading and thinking about the book, I decided that it might be helpful to others if I were to post some of my thoughts here.
In some ways, Mr. Andrew's strategy is similar to my own. I do believe that it is often better to save for retirement than to pay down the balance on one's mortgage. However, there are some points on which Mr. Andrew and I disagree.
First, Mr. Andrew believes that home equity has a 0% effective rate of return. On the contrary, the rate of return is equal to the interest rate on the mortgage. The fact that the rate of return is nonzero is evident because an individual who has paid off his or her mortgage will have less after-tax expenses than an individual who has not. However, this is a minor point for me because I agree with Mr. Andrew that funding a retirement plan would be a better use of one's money.
Second, Mr. Andrew believes that an individual who invests his or her mortgage principal payments and tax savings in universal life insurance will end up with a larger after-tax retirement income than if he or she had invested instead in a qualified retirement plan, such as a 401(k), 403(b), or IRA. This assertion would be true if an equal dollar amount were invested in both cases and if the after-fee investment rates of return were equal. However, Mr. Andrew fails to account for the additional tax savings that would be generated by contributing to a qualified retirement plan in addition to maintaining a mortgage. If these savings were also invested, thus ensuring an after-tax disposable income that would be equal in both cases, then both strategies would produce the same after-tax retirement income, assuming that the individual's marginal tax rate remains unchanged over time. (It is worth mentioning that a Roth retirement account would also produce the same end result under these assumptions.) Furthermore, I believe that investing in a 401(k), 403(b), or IRA would be the better choice because the fees and expenses incurred would likely be less than those of a life insurance policy. However, I do admit that I had not previously considered the possibility of investing in life insurance after maxing out my annual retirement account contributions; I might consider using this strategy when that time comes.
Third, Mr. Andrew believes that it is better to increase the balance of one's mortgage over time by refinancing every few years as the house appreciates in value and to invest the cashed-out equity. While I concede that one might achieve a larger after-tax retirement income using this strategy compared to maintaining a constant mortgage balance, I prefer the latter option because of the psychological benefits: the sleep-at-night factor.
Of course, for those who prefer to pay down their mortgages (I don't want to open up the arbitrage can of worms), these last two points are moot.
Because I was skeptical of some of Mr. Andrew's claims, I searched these forums and the internet for any potentially helpful commentary on this book, but came up with very little. Scott Burns did review it in a couple of his columns, but he didn't go into as much detail as I would have liked. Those columns can be found here: http://tinyurl.com/aajda and http://tinyurl.com/dl9et.
After spending the weekend reading and thinking about the book, I decided that it might be helpful to others if I were to post some of my thoughts here.
In some ways, Mr. Andrew's strategy is similar to my own. I do believe that it is often better to save for retirement than to pay down the balance on one's mortgage. However, there are some points on which Mr. Andrew and I disagree.
First, Mr. Andrew believes that home equity has a 0% effective rate of return. On the contrary, the rate of return is equal to the interest rate on the mortgage. The fact that the rate of return is nonzero is evident because an individual who has paid off his or her mortgage will have less after-tax expenses than an individual who has not. However, this is a minor point for me because I agree with Mr. Andrew that funding a retirement plan would be a better use of one's money.
Second, Mr. Andrew believes that an individual who invests his or her mortgage principal payments and tax savings in universal life insurance will end up with a larger after-tax retirement income than if he or she had invested instead in a qualified retirement plan, such as a 401(k), 403(b), or IRA. This assertion would be true if an equal dollar amount were invested in both cases and if the after-fee investment rates of return were equal. However, Mr. Andrew fails to account for the additional tax savings that would be generated by contributing to a qualified retirement plan in addition to maintaining a mortgage. If these savings were also invested, thus ensuring an after-tax disposable income that would be equal in both cases, then both strategies would produce the same after-tax retirement income, assuming that the individual's marginal tax rate remains unchanged over time. (It is worth mentioning that a Roth retirement account would also produce the same end result under these assumptions.) Furthermore, I believe that investing in a 401(k), 403(b), or IRA would be the better choice because the fees and expenses incurred would likely be less than those of a life insurance policy. However, I do admit that I had not previously considered the possibility of investing in life insurance after maxing out my annual retirement account contributions; I might consider using this strategy when that time comes.
Third, Mr. Andrew believes that it is better to increase the balance of one's mortgage over time by refinancing every few years as the house appreciates in value and to invest the cashed-out equity. While I concede that one might achieve a larger after-tax retirement income using this strategy compared to maintaining a constant mortgage balance, I prefer the latter option because of the psychological benefits: the sleep-at-night factor.
Of course, for those who prefer to pay down their mortgages (I don't want to open up the arbitrage can of worms), these last two points are moot.
