I was recently looking to set up a Solo 401k to park some cash and avoid some taxes. So, I did what a lot of you might have done – I asked my friends on Facebook for recommendations.
One seemed to pop out, so I called him up and told him what I wanted to do. He is a financial planner and could help me get some accounts set up. We chatted a bit and scheduled an appointment for the following week.
A week after the initial appointment, I’m running him out of my house and throwing his entire folder is in the trash.
What happened? That’s where it
I was a grad student with $60,000 student loans and $20,000 cash in the bank. Don’t ask me how that happened, but that’s where I was.
I thought it would would be a good idea to invest it in the stock market. I put the whole $20k into a couple of Funds with USAA.
Two weeks later Lehman Brothers collapsed. Almost overnight I lost close to half my portfolio’s value.
Fortunately, I was a student of Economics and I understood dollar cost averaging. I kept adjusting the portfolio and bringing my average down. That allowed me to recoup most of my losses around 6 months later, when I sold everything.
Then, I never invested in stocks again. Still, in 2019 I have less than 1% of my net worth in the stock market.
This year we’re going to have to pay a small amount of taxes (a rare thing when you own rental property). So, my accountant suggested setting up a 401k to eliminate my tax burden.
Tax-Advantaged Accounts in Real Estate
It’s not widely known but you can invest in real estate using an IRA or 401k. I won’t get into it a ton here, but it’s definitely true and people do it all the time.
On a side note, there are two basic types of retirement accounts. Ones where you put your money in PRE-tax, and get taxed upon withdrawal, and one that is POST-tax, where you get taxed now and withdraw later with no additional taxes.
Based on what my accountant told me, I knew exactly how much I could put into a 401k in order to reduce my taxes the most. But, I still had questions about how I should allocate, if I could put money in both pre and post-tax, and other questions.
While I’m an expert in real estate, I’m definitely not an expert in these other areas, so I thought I’d seek the help of someone who knows these things.
Meeting My Financial Advisor
After our call, we scheduled a time to meet. It was kind of weird to me, but he wanted to come to my house. Perhaps this is normal but I feel like it’s more common to meet at the professional’s office, and if he works from home then meeting at a cafe or something similar.
Our first conversation was fairly generic. He asked, what are my goals, how much do I want to save for retirement, how much do I want to have for monthly income, how much to save for my kids education, etc.
It’s tough for me to answer these because my investments are not conventional. Real estate income provides the bulk of my income, then some online assets such as this website provide some additional revenue that is mostly passive.
It’s also difficult because I don’t see “retirement” as a specific age such as 62 or 65 or whatever. I look at myself as currently retired because I’m living the lifestyle now that I want. My hobbies and passions may change over time, but the overall lifestyle of financial freedom won’t change. Ever.
But, I do want to start building up my stock portfolio, so I tried to play their game as best as I can. He promised to work on it for the week and we’d reconnect the following week to go over his plan
The Financial Plan
He came back over my house one week later with about 10 folders and 100-200 pages of printouts. I’m a numbers guy, so I was excited to go through it all and see what they had figured out!
He started by saying he had found 10 “holes” in what I was doing and he had a plan to fill each hole. It seemed a bit excessive to me but after thinking for a bit, I realized once again that I’m not very conventional. So, under traditional financial planning, I’m sure everything is messed up even though I’m better off than most!
The Holes in Our Financial Plan
The first two “holes” in our plan were life insurance for my two young children, and a savings/investment plan for them.
OK, I had never thought about life insurance for them but I do have a 529 account for each of them, and planned on giving them each some rental property as they got older.
Regardless of that, he estimated that I should save at least $120,000 for each child for college if they went to an in-state public school.
Filling The Holes
In order to achieve that, he suggested I get something called “indexed universal life insurance” (IUL). Basically, it’s a whole life insurance policy where some tiny amount of your premium accumulates a cash value.
By paying $6,000 per year for one of my daughters and $7,500 per year for the other one, I’d fill both of the holes. I’d get life insurance for them and also have an investment account worth that amount by the time they were each 22.
Breaking it Down
In a nutshell, I would have to spend $6,000 per year for 17 years and $7,500 per year for 20 years to follow his plan. In total I’d have to spend:
- $6,000 * 17 = $102,000
- $7,500 * 20 = $150,000
- Total = $252,000
So, I’d need to spend $252,000 in total to get life insurance and save the minimum amount of $120,000 each for their college, or $240k total. It sounded way off to me.
What About Term Life Insurance?
Well, the first argument I had against it is that children simply don’t need life insurance. Insurance is there to financially protect a family should you lose income, and children don’t produce any income. As devastating as it would be to lose a child, the family finances would most likely improve afterward.
But, maybe there is an important reason to have some life insurance for them that I was missing, so I entertained the idea. I asked, why not get a cheap term policy for them and invest the difference in a low cost S&P 500 index fund?
He almost freaked out when I suggested that! He spent over an hour explaining why this IUL is the best option for us. While he was talking I was doing two things. First, I was contemplating if I should just kick him out of my house. The other thing I was contemplating was some math.
I grabbed a calculator and just crunched some basic numbers:
- Cost of Term policy – $250/yr?
- Contribution – $5,750/yr $479/mth
- Accumulate for 17 years
- Interest Rate – 7%
- Total = $186,870
- Cost of Term policy – $250/yr?
- Contribution – $7,500/yr $604/mth
- Accumulate for 20 years
- Interest Rate – 7%
- Total = $314,639
Just to clarify, the idea would be to get an inexpensive 20 year term life policy, then take the difference and invest it. So, instead of having $6,500 paid toward the fund, I’d subtract out the cost of the term policy first, then invest the rest.
So, I could save a total of $501,509 for their college education if I followed my plan vs $240,000 if I followed the financial adviser’s plan.
The Next Holes in The Plan
When we originally spoke to him, there were a few holes we already identified. The big one was life insurance for me and my wife. The next hole to discuss was this one.
Our goal is if the two parents both passed at the same time, that our children could inherit our entire real estate portfolio debt free, setting them up for life.
He wanted to give us each a $1m term life insurance policy which is only about $600 or $700 per year (so basically a rounding error in our finances), which is a little less than what we actually need based on our liabilities. He planned to fill the rest with another IUL policy.
This time, he wanted my wife to pay $13,500/year and for me to pay $12,000 per year into the policy. As the numbers above already showed, getting a term policy and investing the rest in the S&P 500 will beat the pants off an IUL.
The Solution to Everything Is an IUL
I realized eventually that the solution to every problem was an IUL. In total, he wanted me to spend about $39,000 per year on these insurance policies.
Just to put it into perspective, if you invested $39,000 per year into the S&P 500, you’d end up with about $1.7 million in 20 years as compared to perhaps 1/3 of that in the IUL.
Granted, you wouldn’t have life insurance until the day you day with the guaranteed payout. But it seemed a bit weird that every hole was filled with a whole life insurance policy. So, I decided to do some digging…
…and found out that whole life policies have the largest payouts of any financial product – up to 90% commission on the first year’s premium. Meaning, he would have made up to $35,100 if we followed his plan.
I Could Be Wrong
I’m not a financial advisor or financial planner. I have no licensing or schooling in that subject. But, I’ve been around the block a few times and know when I’m being sold to.
There are certain things that I don’t believe you should ever be sold
- By doctors about your health
- By dentists about your oral health
- About your future home or investment by a real estate agent
- By anyone called an “advisor”
I’ve never been sold to from a doctor, but I’ve been sold to by many dentists, agents, and now an advisor.
Dentists shouldn’t be trying to sell fillings, crowns, etc. Your teeth are your body and part of your health. Convincing people they need procedures for their health when they don’t is unethical.
Agents that don’t know anything about investing trying to convince you this is a great investment as borderline unethical. Also, they shouldn’t steer you into one house or upsell you on price to get more commission. But, it’s hard to get too mad because they are literally called “real estate salespeople” so their job is to sell.
And anyone with the word “advisor” in their title should not be selling you anything at all, period. Their job is literally to advise. Don’t sell expensive and unneeded financial products while pretending to be giving good advice. Too many people are not savvy and will buy everything they are sold.
Not All Financial Advisors are a Scam
It’s time to contradict the title and explain that Financial Advisers are not a scam and whole life insurance policies are not necessarily a scam either.
But, your advisor is not putting your interests first if they are giving a whole life or IUL policy as the solution to everything. Instead, they should exhaust other less expensive methods to accomplish your goals FIRST. If you aren’t maxing out an IRA or 401k already, you probably don’t need to be discussing other retirement options yet.
Always consider how they are being compensated! If they are paid to sell products, that is most likely what they will do. Even though they have a fiduciary responsibility to you, it’s human nature to follow the money. Try to find someone who is paid a fee by you for information or for results.
And always remember the reason why you called them. I spent over 5 hours meeting with and chatting with this financial adviser. I called him to help me with a 401k and it wasn’t something we ever discussed. We spent all of the time talking about insurance and never discussed the reason I called him!
3 weeks later I’m no further along with getting my retirement account set up.
Have you had any bad experiences with a financial advisor? Comment Below