A hearty welcome to Grandma’s Wealth Wisdom with your hospitable hosts, Brandon and Amanda Neely. This is the only podcast for strategies to grow your wealth simply and sustainably like grandma used to. Without further ado here are your hosts.
Brandon: Hey, I'm Brandon, and welcome to Grandma's Wealth Wisdom, where we work with you to build wealth Grandma would be proud of.
Amanda: And hey, I'm Amanda. Welcome. We're really glad you're going us today for Episode 36. Today is the most popular 22-year-old. Today, we're going to be talking about a retirement saving option that Grandma did not have access to. In fact, it's so new that it's only 22 years old, and if it was a person, it would maybe be going into its senior year of college or had just graduated college. But it is super powerful right now.
Brandon: Wait, you're saying a retirement vehicle that's 22? [0:01:05.5]
Amanda: Popular. Yeah, and popular. Yep. Yep.
Brandon: Oh, wow. Okay.
Amanda: We're going to be talking about why it's so great and then we'll discuss some of the downsides.
Brandon: So we'll wrap up with a less common option you have to do a Roth-type strategy differently and avoid some of the downsides that it has. This Roth-type alternative was Grandma's go-to strategy.
Amanda: Yeah, and just to be clear - it's weird calling it Roth-type because Roth is a congressman, Mr. Roth, and the Roth IRA was named after him. This Grandma's go-to strategy is not a Roth. It was created hundreds of years before the Roth existed but we can say it's a Roth-type because it has some similar benefits, but also some big differences from the Roth IRA.
Brandon: This Roth guy got some ideas from Grandma, maybe, possibly. [0:02:00.8]
Amanda: Maybe, possibly.
Brandon: Hmm. So here's a little warning. This is a longer episode than usual and there's a lot to talk about to give a fair assessment between both the Roth and Grandma's strategy. So thanks for listening, and let us know if you like this format and we'll do it more often and do some bigger or more deeper dives, I guess we could say.
So let's start with the positives. What easy way can we tell the Roth is great? Why is it so awesome?
Amanda: Yeah. I really liked how an author named David McKnight addressed this question in a book he wrote titled The Power Of Zero and here's what he wrote in that book: "Any time the IRS put limits on what you can contribute to a retirement program, your antenna should shoot up. A general rule of thumb is the more austere the limitations, the more attractive the investment vehicle." [0:03:01.1]
What David is saying, writing here, is that the Roth is so great and you can tell this because the Internal Revenue Service severely limits the amount you can put into it each year. Now for some background - the Roth IRA was created in 1997 and the reason that politicians said that they created it was to give the middle class the option to pay taxes on the seed inside of on the harvest.
Brandon: Hmm… the seed instead of the harvest. That seems interesting. I think didn't we do an episode on that called We Have Got a War To Pay For, all about taxes?
Amanda: We sure did.
Brandon: Yeah, so if you want to hear more about the seed versus harvest, go to that episode called We Have Got a War To Pay For.
Amanda: So I just said that politicians said that the Roth IRA was created to give the middle class an option and the reason we can say that is because the Roth was created as part of this Tax Payer Relief Act of 1997. Can you tell us a little bit about that, Brandon? [0:04:13.2]
Brandon: This act signed into law. It was signed into law in August of 1997. It's one of the largest tax reduction acts in US history. This legislation reduced tax rates and offered new tax credits for tax payers across the board.
Amanda: Yeah, but the politicians were the ones that said this is really for the middle class and …
Brandon: Of course. That's what they always say.
Amanda: Well, and I found this New York Times article from 1998 when we were in tax season and people were looking at what was the implication of this tax act, and here's what the article says: "Last August, with speaker Newt Gingrich at his side, President Clinton signed the Tax Payer Relief Act of 1997, praising it as a milestone that focused most of its benefits on the middle class through a $500 child tax credit, education tax benefits and the new Roth individual retirement accounts." [0:05:12.3]
So in other words, what this New York Times article is saying is that President Clinton said that this act was to benefit the middle class, so it must be true.
Brandon: Now we want you to decide for yourself. So in our show notes, the New York Times article is there and it's a very interesting read from 2019 and it's fun to look back and see kind of where we're at 10 years later.
Amanda: 22 years later.
Brandon: Oh yeah - 22 years later. Yeah, you're right. So anyway, we will put that in the show notes. So what we're going to mostly do is focus on Roth IRA, but there's also a variation called the Roth 401K. Now there are slightly, but important, differences between the two. So Roth IRAs are common for saving outside employer-sponsored plans, whereas 401K are more common through your employer or Roth 401K. [0:06:14.4]
Amanda: Yeah. And to break down the essential components of a Roth IRA, if you're not familiar, you pay your income tax on the money that you receive as income and then you put a portion of that income into the Roth IRA and because you’ve already paid taxes on it, you can later withdraw the funds, tax free, as long as you follow the rules. There are also no required minimum distributions once you turn 70-1/2 years old and so basically after you're 59-1/2, you can pretty much use the money whenever and however you choose.
Brandon: So between whatever age you start and 59-1/2, you can pick and choose when you want to participate and how much, up to the limit set by the IRS, of course. As long as you have earned income or at least that amount, you can contribute. [0:07:08.9]
Amanda: Right. Some good positives with this Roth IRA and it's a nice alternative to the traditional IRA - I think it's pretty easy to understand why it's become so popular.
Brandon: For example, if you're taking a tax deduction by putting pre-tax money into a regular 401K at work, you can hedge your risks of taxes increasing by using a post-tax strategy like a Roth IRA. Then you've got a taxable bucket and a nontaxable bucket. When you're older, you can change which one you use depending on what's happening with income taxes. Because the reality is we don’t know what will happen in the future.
Amanda: Precisely. For those who think their income taxes might be higher in the future, the Roth IRA gives them an option to pay the taxes now rather than in the future. [0:08:01.5]
Brandon: So what's not to love about the Roth IRAs? There's a lot of things to love about it, but what's not to love? What are the downsides, Amanda?
Amanda: I've got a whole list. Let's see, there are five big things on my list. The first one is fees. The average fees in an IRA total 1.5%; that's coming out every year. Those fees include platform fees, third-party administration fees, actuarial fees, fund fees, sub advisor fees, investment advisor fees and so on and so forth. There're a lot of fees. They average 1.5% and they're taking out every single year.
Brandon: So the average, as we have learned sometimes, it can be higher or lower. It doesn’t … we don’t know. There're a lot of fees that can erode your balance over time. In one scenario we'll talk about later, we saw these fees reduce the fund by over 50,000 over 30 years. So because of fees, it reduced the funds and that's just the average of the fees. [0:09:04.8]
Amanda: Right. The second downside is that you can lose money. You have several options for where the funds in your Roth IRA go, but at least everyone I've talked to and all the Roth IRA accounts that I've come across in working with clients, every single person has had at least some of their funds in stocks, mutual funds, index funds, exchange traded funds - something like that. With these types of options, risk is involved.
Brandon: So besides the fees, your funds can be eroded by the ups and downs of the market. We all know there're ups and downs in the market - that's just the reality of the market.
Amanda: Correct. The third downside is that there are limits. You can't contribute if you don’t have earned income or if your earned income is too high. Then when you can contribute, at least in 2019, you're limited to just $6000 per year if you're under 50 years old. [0:10:05.8]
Brandon: At least that's at the time of this recording, right?
Amanda: Yeah, in 2019.
Brandon: Now this is important: If I all I have is passive income or if I stay at home while my spouse works or if my spouse and/or my income goes above a certain level, which we all hope it does always increase, I can't contribute to a Roth IRA anymore. This can limit how much I want to save for the future.
Amanda: Right. Then the fourth downside is that the funds are locked up until you're 59-1/2 and there's only a few limited options for penalty-free access before you get to 59-1/2 years old.
Brandon: So also, another important thing is IRAs don’t even have a loan feature like 401Ks do. So if you are in a bind or you need it for certain things through the course of your life before you're 59-1/2, you can't even access that money using it as a loan. You can't collateralize your own contributions. Does that make sense? [0:11:15.2]
Amanda: Yeah, that makes sense. There's not a loan feature. It's just another way that they lock up your funds until you're 59-1/2.
Brandon: Collateralize doesn’t make sense there, but you know what I'm saying…
Amanda: Yeah.
Brandon: … it's kind of like using your money for whatever.
Amanda: Right. So fifth and final downside, at least for the episode today is that the IRS controls the rules and can change the rules at any time.
Brandon: What, wait - they can change the rules? What I've heard others speculate is that if they change the rules, they might let you keep your account, but not contribute another dime to it. I mean, what would you do then? And again, that's the government owns that so…
Amanda: Right. And it's pure speculation what they're going to do, how they might change the rules. But yes, Roth IRAs are government programs so the government is really in charge of the rules. [0:12:09.1]
Brandon: Yeah, which is interesting. Now that we have covered the upsides and downsides, what is an option for a Roth-type account that most people aren’t aware of?
Amanda: I’m just going to go out there on a limb and say it: Whole life insurance. Yes…
Brandon: Uh-oh, now I've jumped off. Just kidding.
Amanda: No, no, no. I did say life insurance. Sometimes this can be referred to as the rich person's Roth. It was actually the Roth-type account that Grandma used way, way, way before the Roth was created.
Brandon: Even before congressman Roth was born, people were using this rich person's Roth. I wonder if they called it rich person's Roth before ….
Amanda: No. Because they didn't have to be rich to use it either.
Brandon: Yeah.
Amanda: And we're going to refer to this strategy as Grandma's strategy. [0:13:02.8]
Brandon: Just like a Roth IRAs you can put money into Grandma's strategy and use cash value that's built up over time to buy groceries in retirement. So you can use it in the future for retirement things when you're over 59-1/2.
Amanda: Or before. We'll get into that. But …
Brandon: Which is different than the Roth, so.
Amanda: So that's kind of in a nutshell. You put money into Grandma's strategy and then you can use the cash value that builds up over time in a lot of different ways. But just as a quick warning, there are different types of … you know, just like there are different types of mutual funds and ETF, some better than others depending on your purposes, there are different types of whole life insurance, some better than others depending on your purposes. You'll want to work with someone who specializes in this area. [0:14:00.7]
Brandon: There are even types of whole life insurance that are tied to the stock market. With Grandma's strategy, your funds are never invested in the market.
Amanda: This makes Grandma's strategy a great supplement when you have a bunch of money already in the market with your 401K through work, for example. You can hedge your bets by saving outside the market as well by having this as a component in your overall strategy.
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Brandon: What are some of the upsides of Grandma's strategy compared to a Roth IRA, Amanda? [0:15:06.1]
Amanda: You can contribute, called paying premiums for life insurance, and you can do that no matter how much income you have. Your contribution can also be much more than that $6000 limit for Roth IRA. That's a big upside. If you want to save more for your future, you are able to. Secondly, you also get to protect you and your family.
Brandon: When you hear "life insurance," most people think of a large payout to their family when they die. They never actually see the money, and that is furthest from the truth with these type strategies.
Amanda: Right. The best life insurance policies have lots of living benefits as well. You can use the cash value to buy groceries or invest in real estate throughout your lifetime. You have access to those funds, but there're also some other benefits too that a lot of people don’t know of. For example, you can get an accelerated death benefit rider that could advance up to 75% of your death benefit prior to your death if you get a chronic or terminal illness. [0:16:15.8]
Brandon: We all know we could die at any age, but we could also get cancer or something else like that. I hope none of us get that, but it's possible. What if you could have a much larger sum of money than you could actually save to cover cancer treatments? What if you could get that benefit at no extra cost to you? Wouldn't you at least want to explore that option?
Amanda: Right. And if you… so that's a big benefit that you get protection for your family and for you within your lifetime. Third, if you have earned income but you lost it later, maybe because you retire early or you become a stay-at-home mom for a few years, you build up so much passive income, whatever - you can continue to contribute to Grandma's strategy. [0:17:04.8]
Brandon: Another limit of the Roth IRAs that Grandma's strategy doesn’t have.
Amanda: Right. Then, here's a big bonus of Grandma's strategy - there is guaranteed growth that's actually some pretty nice growth.
Brandon: You will want to look for guarantees that are backed by 100-year-old companies, older than 100-year-old companies, and give you some great liquid cash in an uncertain future. There are no guarantees with a Roth IRA, but with the companies we set people up with, there are those guarantees in place.
Amanda: Right. I think maybe the only guarantees with the Roth IRA are the fees. Right? Then on top of the guaranteed growth, with Grandma's strategy you could also receive dividends.
Brandon: You'll want to look for companies that have been paying dividends every single year for over 100 years. Again, that longevity of those companies. [0:18:03.2]
Amanda: And with a good track record. Right. We got two last benefits. I think one of the best benefits in our opinion is this penalty-free access to your funds anytime.
Brandon: Yeah, especially with this ____ movement, I think. It's super important for young people. We don’t want to wait for age 60 to be able to use our money. We can use our funds to take advantage of an opportunity in our earlier years - to start a business or invest in real estate, all kinds of things that we can use our funds before we're 59-1/2. You could also use the funds in an emergency - when we honestly don’t want to use it, rather than going into debt or use the funds to possibly even pay off your debt. We have done both of those and we have done the other thing where we have used it for strategies to take advantage of opportunities, actually all three of them. [0:19:04.4]
Amanda: The final upside we'll cover today and maybe this one is my secret favorite benefit that I don’t talk about nearly enough is that women tend to benefit from Grandma's strategy more than men. Men still have good results, but women, because we tend to live longer, we can see more growth. We can see more uses for our money, those kind of things. Women out there listening, this benefit is for you.
Brandon: I would say on the flipside, I mean I anticipate I'm probably going to die before you so you're going to see a lot more growth on that side too. So, anyway.
Amanda: Yep.
Brandon: But there are downsides as well, and we want to make sure you understand those. We want to make it an apples to apples kind of thing here.
Amanda: Three of the main downsides of Grandma's strategy is that at the beginning, there is the cost of insurance and you'll see that the funds that you put into your policy, not 100% of those funds are going to be there because of the cost of the insurance. So that's something that you'll see at the beginning, in particular. [0:20:14.9]
Brandon: Just in the beginning, right, and then it changes, I think. Or it doesn't change, but it outperforms.
Amanda: Right. Yeah. That's a whole separate conversation. We will have to come back and do more of a deep dive into that. Secondly, another downside is that this is the kind of strategy that you're going to want to make a plan to have ongoing premiums, ongoing contributions. You don’t want to just fund it for a couple of years.
Brandon: There are exceptions, but you're typically looking at least a 7-year commitment. Remember with the Roth IRA, you can contribute some years and not others. With Grandma's strategy, you have some flexibility, but you don’t want to do it if you're planning to stop after just a few years.
Amanda: Right. There are some consequences if you do that that are negative. Third, you have to qualify health wise. There is a medical exam that's involved in putting Grandma's strategy into place. [0:21:13.2]
Brandon: Or at least have an insurable interest who can qualify for you. If you're too sick, maybe they are in better health and they're an insurable interest. You can leverage them. That's a downside though.
Amanda: Yep. So two very important notes as we wrap up today. First of all - the earlier you start with either of these strategies, the Roth IRA or the Grandma's strategy, the better. You'll have the power of compounding interest working in your favor. The longer you have one of these in place, the more opportunity you have for growth.
Brandon: It's even better with Grandma's strategy because you'll have the power of uninterrupted compound interest working in your favor. Again, that's a key difference between the two. If you want to learn more about that, see episode 3 titled The Stitch In Time Saves Nine to see what we mean about uninterrupted compound growth. [0:22:08.8]
Amanda: Yep. Second very important note, and if you are tuning out, please tune in right now. This is the most important thing we're going to talk to you about today. We want to help you make sure you consider your options with someone who will rock you through the pros and cons because they've done the research and they benefit from helping you make the right decision for you. In fact, to go along with this episode, we have developed a new calculator. With this calculator, you tell us your age and your gender, and then we'll show you how a Roth IRA and a Grandma's strategy compare and contrast with one another. We're going to do all the math for you and then you can decide which you like most. No strings attached. No bias. Just honest math. [0:22:55.7]
Brandon: So if you want us to run that calculator for you, we'll do the math. You just have to pick 20 minutes from our calendar to review the output of the calculator together. To schedule a visit, Grandma'sWealthWisdom.com/Roth.
Amanda: During this 20-minute appointment, we'll spend 5-10 minutes giving you an overview of the numbers, kind of just going over how we got to them, how to read the numbers. Then the last 10-15 minutes, we'll explore some pros and cons together. Then you can decide where to go from there. In order to test this calculator, I actually ran the numbers for myself. I did see very clear pros and cons depending on different variables that I wanted to consider. I want to be 100% honest with you. Sometimes when I looked at the numbers in a particular way, it looked like the Roth IRA would be a better choice. Other times, when I asked different questions, Grandma's strategy looked like the better choice.
Brandon: Would you say that decision ultimately comes down to personal preference and how one of these strategies would fit into a person's overall portfolio and financial goals? [0:24:06.9]
Amanda: Yes. I think that's a fair assessment. It really comes down to what you want your money to be doing for you in terms of which one of these strategies would fit with you best and the math will help you decide.
Brandon: Yeah. That's a good question - what you want your money to do for you.
Amanda: Yep.
Brandon: Be sure to schedule that calculator review at Grandma'sWealthWisdom.com/Roth. Then join us next time for an episode we titled Trying To Get Ahead. We'll be exploring how individuals try to get ahead in life and if it's really working.
Amanda: In this next episode, Brandon shares one of his biggest pet peeves that comes up every single time we're driving around this great city of Chicago. Be sure to tune in. Until next time, keep building your wealth simply and sustainably for your own future and the future of our grandchildren's generation.
The topics presented in this podcast are the general information only and not for the purposes of providing legal, accounting, or investment advice. On such matters place consult a professional who knows your specific situation.
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