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This is my first financial book review. Unfortunately, it is a negative one. However, over almost three decades as an Enrolled Agent and Certified Financial Planner licensee I have seen all-too-many people engage in financial misbehaviors, sometimes egged on by “advisers” or others, to let this go without extensive comments.
A Review of Doug Andrew’s
Review by Doug Thorburn, EA, CFP
Every flimflam man knows that the con must be carefully layered around a kernel of truth for credibility. Missed Fortune 101 by Doug Andrew succeeds in this by wrapping a number of preposterous ideas and prevarications around four basic and true axioms. They are: (1) income is taxed in what are essentially “chunks,” (2) the only relevant tax rate for decision making is the marginal rate, (3) tremendous wealth can be created by borrowing at one rate and investing at a higher rate, and (4) universal life insurance can be a valid investment by which to build wealth and a tax-free income stream. Everything else in this book is not only utter nonsense, but potentially lethal to one’s financial health.
The author arrives at two basic conclusions. We should borrow out of our homes and invest the proceeds at a higher rate, preferably in something sold by Andrew and his sales force, which may include many Amazon.com reviewers giving the book four- and five-star reviews. Universal life insurance serves as Andrew’s means to this end. We should also suffer the consequences of withdrawing from our IRAs and other retirement plans now rather than later, since the tax from such withdrawals will only get worse. Naturally, the leftover funds (heavily diluted by taxes) should be invested in the same insurance policies, which supposedly offer a higher—and safer—yield than whatever the retirement plans were invested in. By page 5, I realize I’m reading a book-length sales pitch and con that has the potential to wreak havoc in my clients’ lives (I’ve been an Enrolled Agent tax professional and Certified Financial Planner licensee for almost three decades). One otherwise highly intelligent client asked me to read the book because he was thinking about implementing Andrew’s plan. If one client told me he was thinking about this, how many others might forget to inform me—or get bamboozled by salesmen before I’m even asked for an opinion? Worse, two elderly clients over 80 years old were almost conned into hocking their fully-paid-for homes by annuity salesmen who, in my opinion, were attempting to implement a variation of Andrew’s ideas. One client was told he should borrow $600,000 against his $800,000 home, the proceeds from which would be placed into investments similar to those the author suggests (equity-linked annuities rather than equity-linked life insurance), providing about $40,000 in commissions to the agent, who appears to be one of Andrew’s protégés. This is not just inappropriate counsel—it’s full-blown elder abuse.
Anything this full of nonsense is difficult to critique. Where to even begin? I’ve settled on the idea of listing the multitude of problems by category and providing examples from each, which results in an unorganized analysis. Unfortunately, it’s the only approach short of writing a book-length retort that conveys the risks inherent in implementing the ideas in this tragically defective book. In addition, in the interest of proper analysis, numerous quotes of Andrew’s are included, which due to sloppy editing and poor writing may make the reader cringe. The words and italics in quotes are his, except where I had no choice but to add or change a word to make sense of the otherwise unintelligible.
Flaws in Missed Fortune 101 include:
(1) “…if a married couple with a combined annual income of $70,000 has $10,000 of deductible interest…their taxable income is reduced to $60,000. In a 33.3 percent combined federal and state tax bracket, this couple would actually save $3,333 they would otherwise pay in tax.” The fact that other deductions, including personal exemptions and state income tax, would put this taxpayer into a lower bracket, where the likely savings would actually be closer to $2,100 is ignored.
(2) “A $6,000 interest expense deduction on an itemized tax return has the same impact as a $6,000 qualified plan contribution. They are simply reflected in different sections of the return.” Sure sounds logical, doesn’t it? Sorry, but it’s often wrong due to the fact that qualified plan contributions (deductible IRAs and other retirement plans) reduce Adjusted Gross Income (AGI), which may increase allowable rental losses, reduce taxable Social Security and increase both the Low Income Savers Retirement Credit and the Earned Income Credit. Not only does reducing income via an interest deduction fail to reduce AGI, but if the taxpayer doesn’t already itemize deductions, tax savings will be less—and sometimes even zero.
(3) He implies that ordinary investors can double their money for 20 periods with a comparison chart of one dollar pre-tax and one dollar taxed-as-earned, doubling in value every “period” for 20 “periods.” If you double $1,000 and keep doubling the result ($1,000 turns to $2,000; $2,000 turns to $4,000; $4,000 grows to $8,000; etc.), after 20 doublings you’ll have $72,400,000 if you pay tax of 25% on the growth every “period.” If you do the same and avoid tax, $1,000 grows to over $1 billion after 20 doublings. Sorry, but few if any investors in history have consistently doubled their investments for 20 “periods.” Yet he asks, “In which environment would you prefer to accumulate wealth?” The absurdity of the example is obvious for those who get past the appeal to man’s baser instincts, such as greed, to actually ask the question, “What are the odds?” The implication of “periods” as “years” suggests that anyone can double his net worth 20 times in one lifetime. The fact that 60 years of such investment success at 25% or so compounded annual returns isn’t mentioned, nor is the fact that those few in history who have succeeded in generating such extraordinary wealth didn’t do so by investing in insurance contracts or, with few exceptions, in other people’s businesses.
(4) In a section he calls “the five savings options,” he inexplicably omits leveraged rental real estate and rental income as a way to invest, save and create an income stream. He ignores the idea that retirees might keep their non-leveraged rental property with rental income partially tax-sheltered by depreciation. Instead, he assumes that such property is sold and net worth (on which income can be earned) is diluted by taxes. He also ignores Congress’s greatest gift to taxpayers in recent memory: Roth IRAs. This is a glaring omission that the reader can learn more about from a number of articles posted on my web site.
(1) Because, as he says, “Qualified [retirement] plans defer taxes, which results in increasing tax liability” (please recall italics in all quotes are in the original), Andrew concludes we should never invest in such plans. Let’s say you invest $6,000 per year for 35 years in retirement plans. At a 33% tax rate (his assumption), you save $69,300 in taxes over 35 years. At a 7.75% rate of return (his assumption) your ($6,000 x 35 =) $210,000 investment ($210,000 - $69,300 = $140,700 after-tax cost) grows to $1,054,000. You withdraw roughly $98,000 per year over 20 years ($1,960,000) before the account is depleted. He decries the fact that you’d pay $646,800 in tax on the withdrawals assuming a flat 33% rate. He ignores the fact that you’d net $1,313,200, or over nine times the after-tax investment.
(2) Similarly, “Deferred taxes usually result in an increase in taxes,” as if this were a problem. Yes, deferring allows you to earn so much, the ultimate tax is higher. And yes, if your income is $1 million, you pay a heck of a lot more tax than if it’s only $100,000, which is a nice problem to have.
(3) “…you will pay back every dollar you saved in tax on twenty-five years of contributions during the first four and a half years of retirement…If you live twenty-two years after retiring, you’ll potentially pay back five times more in taxes during the distribution phase than you saved in taxes during the contribution phase.” “The simple fact is, deferred taxes equal increased taxes.” This is convoluted thinking at its finest. Andrew completely ignores the fact that after-tax net income increases along with taxes if you successfully increase your retirement savings.
(4) “…Your home may likely sell much more quickly and for a higher price with a high mortgage balance rather than a low mortgage balance.” What the heck does the balance on my mortgage have to do with what a buyer is willing to pay me for my house? He explains that you can sell the house “subject to” the mortgage, but omits the fact that there are few if any loans without a “due on sale” clause, which makes a “subject to” sale illegal. In one example, he claims selling the house “subject to” could increase the sales price of a $300,000 house by as much as $100,000. Perhaps it could, if you’ve got a 3% 30-year fixed-rate loan without a due on sale clause in a 6.5% market—in other words, in your dreams.
(5) “…taxes are actually an asset. For example, a road or highway—paid for by taxes—is a public asset.” Sorry, taxes are funds sometimes used to buy assets, but they are—and never will be—assets.
(6) “When you pay down your mortgage, you decrease your assets.” No you haven’t. You’ve redeployed one asset—cash—into another asset—the property on which you have paid down the debt.
Broad, sweeping and misleading generalizations
(1) “I will prove in this book that no method of paying extra principal on your mortgage is the wisest or quickest method of accomplishing financial independence.” Few who own their homes free and clear of debt would agree with this sweeping generalization.
(2) “When you sell a home and purchase a new residence, it would behoove you to establish the highest amount of acquisition indebtedness possible, by paying little or no cash down payment.” Andrew ignores the higher interest and property mortgage insurance costs of loans in excess of 80% loan-to-value ratios. Since this is one of his key recommended strategies, this is an extraordinary omission. He even advises that we all sell our homes and repurchase with 100% financing with the goal of freeing up equity to invest in Andrew’s recommended universal life policies. This strategy overlooks—and I could find no mention of—the increased property tax in states such as California, where taxes are based on purchase price. It disregards fixed transaction costs, which usually amount to about 10% of the price—which on a house sale amounts to an enormous dilution of net worth. (Selling for $500,000 and buying for $500,000 reduces net worth by the purchase and selling costs, usually about $50,000.) It ignores what often totals tens of thousands of dollars of moving costs, not to mention the time, hassles and stresses of moving, which many consider to be among the top five stressors of life.
(3) “If not consumed, [retirement funds] may be taxed a second time when [they transfer] to non-spousal heirs.” Such funds are taxed only once, unless the estate is subject to estate tax, which affects very few people—a crucial fact on which he fails to elaborate. But, here and elsewhere, that wouldn’t suit his purpose: frighten people into acting in ways that increase commissions for mortgage brokers and insurance salesmen, even when entirely inappropriate.
(4) “Unfortunately, non-spouse heirs far too often end up with only about 28 percent of the money that was left in their parents’ IRAs and 401(k)s.” Too often? How many people do you know with net taxable estates exceeding $2 million ($4 million for a married couple), part of which consists of retirement plans? Only at this level is it even possible for both the estate and income tax to whittle down the net value of retirement plans left at death to as little as 28%—and it requires the death of both spouses and an heir in the highest tax brackets to do so. Moreover, there are a multitude of strategies that can be implemented to avoid this result, including bequeathing the retirement plan to charity.
(5) He suggests selling a $500,000 house on which there is no mortgage and buying a new house for $500,000 with a $400,000 mortgage at 6 percent. He justifies this by arguing, “$23,091 of taxable IRA/401(k) income is washed away (offset) by $24,000 of mortgage interest (Schedule A) deductions—meaning the IRA/401(k) distribution was in essence tax-free.” No, the income is not offset. The tax is reduced by the interest deduction, where it could be left alone, but then increased by the withdrawals—and this doesn’t count any taxable income on the $400,000, which cannot be invested all at once in the insurance product he’s going to recommend. In addition, this assumes that the taxpayer would be itemizing without the mortgage interest (rare, especially for retirees) and that the gross income doesn’t “wash away” other deductions or credits due to AGI phase-outs, or result in additional income due to AGI phase-ins. (I explain the negative tax issues with AGI phase-ins and phase-outs in my series of articles entitled “What’s My Tax Bracket?” at www.DougThorburn.com.) As mentioned elsewhere in this review—and because the omissions are so serious, they bear repeating—he also fails to mention the roughly $40,000 in selling costs on the home (which, if sold by owner, would generally sell for a price closer to net, or $460,000), the higher interest rate on an interest-only loan (which won’t last forever anyway), and loan costs of perhaps $10,000.
And finally, I’d like to know how he proposes that his clients pay for the mortgage—if not the IRA withdrawal, which is supposed to be “repositioned,” then how?
Over-simplifications based on false assumptions
(1) He assumes throughout that you can obtain a fixed-rate interest-only loan for 35 years. There weren’t such loans before the sub-prime implosion and piercing of the real estate bubble; there certainly aren’t any after.
(2) He assumes mortgage interest will always save 33.3% in tax, which rests on the assumption that taxpayers have itemized deductions other than interest in excess of the standard deduction throughout their lives, as well as income high enough to put them into this bracket. Retirees and lower- to middle-income taxpayers, especially those in low- or no-income tax states, often have little in the way of such deductions and are often in lower tax brackets. The bracket doesn’t even begin for married couples age 65 and over in high-income tax states with no deductions until income exceeds $80,000.
(3) He says that “by doing what banks and credit unions do…you can safely use the principal of arbitrage to generate even greater income…By borrowing money with an equity line at a net cost of 5 percent and using the loan proceeds to earn 8 percent, you are making 3 percent more than the cost of the funds.” If it were only that simple we’d all be wealthy. He would retort that banks and credit unions do it all the time. Sure, if you’re a bank, it’s your business—and even some banks and, notably, hedge funds with some very smart people at the helm have screwed it up. His recommended method—purchasing universal life insurance policies that may earn 8 percent per annum—will not do so during years in which the variable components of the insurance, usually stocks, earn less than 8 percent. And in any year that such policies earn less than the cost of the borrowed funds, the borrower loses the difference between the earnings and the after-tax cost of borrowing. According to insurance experts this occurred for several years in the early 2000s. As other reviewers have pointed out, he completely ignores any downside risk.
(4) His assumption that individuals can act like banks is absurd on another level as well. Individuals can never borrow funds at the (often far lower) rates that banks pay. Think about it: banks pay zero on balances in checking accounts, 2% in many money market funds and 5% on CDs. They lend this money at 6.5% and higher. Andrew expects us to borrow at 6.5% and somehow consistently earn a safe return of 8%. Were it only that simple.
Questionable predictions and grand assumptions
(1) “…Effective tax rates will likely be higher in the future”; future tax rates will be higher “because of the congressional track record over the past several decades,” which he implies was an era of increasing tax rates. He concludes that we should generally withdraw funds from retirement plans now, rather than later at what he foresees will be higher rates in the future. Yet maximum tax rates were reduced from 70% to 28% in the 1980s. The fact that they have since increased doesn’t mean they always will, particularly in view of the fact that international competition, which has forced rates down considerably in many countries, will keep downward pressure on our rates. Tax rates are nowhere near the 50% and more that we suffered before the 1980s and those for many lower- to middle-income taxpayers, for whom his book seems to be intended, have dropped.
(2) “I dispelled the myth-conception that you are likely to be in a lower tax bracket when you retire than when employed.” Throughout the book, he grandly assumes that incremental retirement income will be taxed at the same rate retirement plan contributions saved while working. Not only does he offer no statistics verifying this claim, but in my experience most retirees are in a lower tax bracket than they were in pre-retirement. However, he’s right about one income class: those in the 15% bracket or lower generally should not make contributions to deductible plans, since they could easily end up in a higher bracket later. This is generally not the case for those in the 25% bracket or higher, particularly if living in a high income-tax state. His goal is best served by his assumption, since he wants the reader to “reposition the funds to a non-qualified account” and pay the taxes now rather than later. The “non-qualified” account is, of course, his recommended universal life policy, from which he and his followers make rather large commissions.
(3) “Conservatively, [our cozy retirement cabin] is appreciating at least 7.2 percent per year. Based on the Rule of 72, our cabin will double in value every ten years…[and our $100,000 cabin…] will easily be worth…$800,000 in thirty years.” This is an extraordinary assumption. Very few areas in the country during the late, great real estate boom of the last three decades have done that well and most areas are likely to fare far worse in the foreseeable future, post housing-bubble implosion (an admittedly grand assumption on my part—but I’ve got a good long-term track record on this — SEARCH BY "SUBJECT" FOR "REAL ESTATE."
Assertions and generalizations which, when analyzed, either make no sense or are just plain wrong, resulting in advice may be lethal to your retirement
(1) “Home equity has no rate of return when it is trapped in the house...” This is outright nonsense. The return is what you save in interest or rents.
(2) “The effective tax the average American paid prior to 1986 was 13 percent of income. Today it approximates 20 percent, due to fewer allowable deductions.” Then how is it that federal government expenditures have remained in the 18-22% range since WWll? Does he really think the budget deficit was (18% - 13% =) 5% to (22% - 13% =) 9% in years prior to 1986?
(3) “It doesn’t make sense to postpone tax for some perceived advantage in the future.” The criticism is valid at low tax brackets—I constantly admonish clients whose tax rate is 15% to avoid investing in pre-tax retirement plans (except to the extent an employer matches those contributions) and, instead, to invest in Roth IRAs. However, if tax rates were 90%, would it not make sense to postpone tax in every possible way? What about 50%? Or 33%? Of course it makes sense…if the investment makes sense and you think you’ll be in an equal or lower tax rate in the future. In fact, depending on the time frame and type of investment, you can be in a higher tax rate and still come out ahead by postponing tax.
(4) He informs us that those in the 15% tax bracket withdrawing retirement funds now would “probably pay no higher income tax rate on that money than you would if you withdrew the money later.” The problem is he not only ignores the value of tax deferred compounding, but also the early withdrawal penalty of 10% plus state income tax averaging 5%. Implicit in this assumption is the idea that withdrawn funds will not be spent before becoming fully invested in his contracts. This may entail a five-year investment program from which the investor cannot deviate without experiencing adverse tax consequences. Unfortunately, married couples in the 15% tax bracket may well find other uses for the money along the way.
(5) He concludes that if not done before, “roll-outs” from IRAs commence at age 59 ½ over a five year period and that some younger people under age 50 should commence withdrawals despite the imposition of early withdrawal penalties. The value of tax-deferred growth is ignored—he says, “either pay the IRS now or pay them later,” as if the “when” is irrelevant. He also never mentions the fact that the funds available for investment shrink by the tax paid on the withdrawal. His “repositioning of funds” repositions (at the rate he often uses) 33.3% of your funds into the hands of government.
(6) He says that the tax-free product into which he suggests you “reposition” your home equity and retirement assets will earn a solid 8% per annum and that you never pay taxes on those earnings. Other commentators more expert than I in insurance products have already thoroughly debunked this claim. The insurance products are variable life insurance products. While they have downside protection, if they increase in value by less than the after-tax cost of the mortgage you lose. And he wants retirees—or those near retirement—to leverage and expose themselves to such risk?
Inane or incorrect assertions
(1) “Lee Brower, president of Empowered Wealth, LLC, states, ‘Traditional estate planning has done more to destroy American families than the federal estate tax could ever do!’ Why?” One reason is, “It encourages extraordinary consumption.” I know of no such plan, except for a few extremely wealthy people who want to make sure nothing is left for their alcoholic or other-drug addicted progeny and who have no charities to which they care to leave their funds.
(2) He states that the interest on an equity line used to purchase universal life insurance from which you contemplate borrowing is deductible (under IRC section 264(a)3, it isn’t), or if somehow deductible for purposes of the regular income tax (again, it isn’t) that the interest deduction isn’t rendered impotent due to the Alternative Minimum Tax (it usually is at AGI levels over a range of $150,000 to $250,000).
The chart on page 226 is crucial to Andrew’s argument, as he compares the growth of his favored investment, an indexed universal life policy, with various alternatives. He calculates that $6,000 per year yielding 7.75% in an IRA grows to $620,548 after 35 years. This is flat-out wrong. It grows to $836,746 even using his ridiculous assumptions of a 5% sales charge on each investment and a .75% yearly management fee. Without sales charges and management fees (and many IRAs invested in stocks and mutual funds have grown at a far greater rate than 7.75% after such expenses), $6,000 yearly grows to $1,053,872 in the same time period.
For a reason known only to him, Andrew assumes that a mutual fund outside of an IRA yields a far higher 10% per annum. Again assuming 5% sales charges (laughable, if it weren’t so tragic) and a .75% yearly management fee, he calculates a $640,523 value at the end of 35 years. This is so way off base it’s amazing no one else seems to have commented on it. Any compound interest calculation shows that yearly investments of $5,657 (net of his absurd 5% sales charge) at 9.25% (after his assumed .75% management fee) grows to $1,427,785 after 35 years. I can’t even arrive at a figure as low as his assuming his net after-sales-charge investment and management fee, along with yearly ordinary (100% short term capital gains) tax on all growth. Even then, the hypothetical investment grows to $668,210 after 35 years.
Ignores other risks and costs
(1) He glosses over the typically high surrender charges in most universal life insurance contracts, about which others have written.
(2) He fails to mention the risk factors inherent in failing to complete the plan and the fact that oftentimes the insurance agent’s commissions are heavily front-loaded, which minimizes the incentive for the agent to make sure the customer follows through with the plan.
(3) He doesn’t disclose the commissions paid to agents that other reviewers have pointed out can be oversized.
Sloppy editing of facts
(1) “The 10 percent rate for taxpayers whose regular income tax rate is less than 25 percent was reduced to 5 percent for 2003 through 2007 and then to zero for 2008.” He’s referring to the capital gains rate, which isn’t clear, for taxpayers in the 10% and 15% brackets, the latter of which he omits. This should have been, “Taxpayers in the 10% and 15% regular income tax bracket pay only 5% on long term capital gains in years 2003 through 2007 and zero in 2008.”
(2) “One requirement [for withdrawing tax-free income from a Roth IRA] is that a distribution may not be made until at least five years after the first contribution is made.” This is incorrect. A distribution of earnings cannot be made until at least five years after the first contribution (and certain other conditions such as being over age 59 ½ are met, which he correctly lists). Principle contributions, which are withdrawn before earnings, can be taken at any time.
“The sooner you empower yourself with the knowledge to attain financial independence, the greater your net worth will become.” Duh.
“The secret to wealth accumulation is to use the best P.L.A.N.—an acronym for “Perpetual Life of Asset Nurturance™”. The book is chock full of similar trite self-important slogans and platitudes.
The book is filled with other such “trite or banal remarks or statements, especially those expressed as if they were original or significant,” including, “It’s a lot better to have and not need than to need and not have,” “Always position yourself to act instead of react to circumstances over which you may have no control,” “Borrow funds with the most attractive terms possible,” and “Houses were made to house families, not to store cash.”
Platitudes with a sales pitch
“Let’s assume Jim and Mary need to net $75,000 per year to meet medical expenses and live the lifestyle they would like during retirement (such as visiting their children and grandchildren, golfing, and taking a trip or two each year.)”
“Withdraw the funds in your retirement plan and pay the tax” becomes “strategically reposition [your] IRA and 401(k) contributions or distributions”; “borrow out of your home and hope you can earn more than the cost of borrowing, which is inherently risky” becomes “manage the equity in [your] current home…to maintain liquidity and safety and earn a rate of return.”
Poor writing, patronizing and berating of those who disagree with him
(1) For the first several chapters, he continuously reminds us of what he’s going to tell us. “…As I will explain in chapter 6”; “In chapters 6 through 8, I will be teaching you…”; “I’ll explain more about this in chapters 9, 10 and 11”; and “This book will teach you how…” Why doesn’t he just tell us now what he says he’s going to tell us later? Better yet, just tell us when ready and stop warning us that you’re going to tell us.
(2) At the end of each chapter, he lists the concepts covered. Often he lists concepts that were not covered, but which we are supposed to read into his writing, such as this one from chapter 1: “There are two ways to handle information: ignore it as false or increase your level of understanding to accommodate new ideas.” This is a subtle way of berating those who may disagree with his opinions. Obviously, we are supposed to accommodate his ideas or we’re complete idiots.
(3) There are probably hundreds of examples of poor sentence structure, over-use of adjectives, too many words and improper use of commas. “…Premium payments can be varied, fluctuated, and adjusted according to circumstances…” should be, simply, “Premiums can be adjusted.” “If times really got tough in the economy, I would prefer my money be easily accessible in case I choose to liquidate my funds” is overly wordy. How about, “If times got tough, I would prefer that my funds be liquid”? And to think that a number of reviewers’ comments included a “well-written book” accolade!
Sometimes several categories are combined. In one, assertions which, when analyzed, either make no sense or are just plain wrong, is combined with faulty logic and sloppy editing. He assumes that Jim and Mary Followthecrowd will pay $25,000 in tax on their $75,000 retirement income, since it’s stacked on top of Social Security and “other” income and they have few if any deductions in retirement. He fails to point out that for this to be true, their “other” income, including Social Security, would have to exceed roughly $88,000. Then he contradicts himself by implicitly assuming there is no other income, since if Jim and Mary need $75,000 to live on, they’d have to withdraw $112,500 per year out of their retirement accounts, “and the account would be totally depleted in fifteen years!...Thus, Jim and Mary would run out of money in their IRAs and 401(k)s at age 80—probably several years (at least) before their lives ran out.” He’s already assumed there’s other income—in which case they wouldn’t need to withdraw $75,000 per year out of their retirement accounts. If that was their only income, they would need roughly $90,000 to net $75,000. Throughout this monstrosity of a book, Andrew uses variations of the typical bunko-artist salesman ploy: scare you into agreeing to do whatever he says because life will be filled with disasters if you don’t. On the contrary: your financial life may turn into a catastrophe if you do.