Rebecca Hotsko (01:53):

So much great content on your website. I want to jump into some tax advantage investing as our first topic today. So recently, we’ve been talking a lot on the show about what’s happening in the current markets, what are the best investments right now.

Brian Martucci (02:09):

Sure.

Rebecca Hotsko (02:09):

But I think just as important as learning what to invest in is how to invest in the most tax advantaged and optimal ways. So I wanted to start off by having you talk about the two main tax advantaged accounts millennials should consider, so what are the main differences between them, and then how should millennials think about which two contribute to each year.

Brian Martucci (02:31):

So the two main accounts we’re talking about for folks in the US are Roth IRAs and traditional IRAs. That’s kind of confusing. They’re both individual retirement accounts, but they have some important differences that you should be aware of if you’re new to this space. So on the Roth IRA specifically, there’s an income cap for contributions. And if you’re a higher earner, you make over about $129,000 a year if you’re single or about $204,000 a year. If you’re a joint filer, you can’t… Well, you start to phase out and then pretty quickly you can’t contribute anymore. A traditional IRA doesn’t have that contribution limit. You can always contribute to a traditional IRA. The contributions aren’t always tax deductible for your federal income taxes. There are income caps on those as well, which we can talk about in a moment, but that’s kind of a big difference. You can’t directly contribute to an IRA if you’re a higher earner.

Brian Martucci (03:29):

The taxation on these two accounts is different as well. The biggest difference there is that your traditional IRA contributions are tax deductible in the year that they’re made. So let’s say you contribute $2,000 to a traditional IRA in 2022, you can deduct that from your taxable income on your 2022 tax return. And then you will pay taxes on the gains in that traditional IRA way down the road when you’re retired probably and starting to take distributions from it. A Roth IRA, the contributions are not tax deductible in the year that they’re made. So you contribute $2,000 to a Roth IRA in 2022, it doesn’t affect your tax liability for the year. But your gains way down the road are tax free so when you take a distribution, that money is tax free, which is really nice. And any dividends in either account, any dividends or distributions from whatever you’re invested in, that go into the account are not taxed while the money is in the account. So that’s why we call them tax advantage. They both have tax advantages.

Rebecca Hotsko (04:41):

So those are great overviews of kind of the differences between the accounts. I think next I would love for you to go through different scenarios of how and when millennials should think about which they should be contributing to each year. Should they choose the Roth IRA? The traditional IRA? Both? Let’s walk through a few different scenarios and talk about each.

Brian Martucci (05:06):

Sure. Yeah. So I think we can break it down into three main scenarios. And just blanket caveat here that you should always… Everyone’s situation is different so please do talk to a financial advisor if you have any questions at all about how to think about this. But the three main scenarios that we can really talk about here are, one, contributing everything to a Roth IRA, exclusively contributing to a Roth IRA. The second is exclusively contributing to a traditional IRA. And the third is to split contributions between the two accounts however you see fit. So 50/50, 70/30.

Brian Martucci (05:46):

And importantly, for millennials, for the people listening to this podcast, I would imagine we’re all, I guess, if you go by the strict definition of the generation, definitely under 50. And that’s important because for people under 50, the annual contribution limit to either type of account or both accounts in total, so any IRA, is $6,000 per year. So you can’t contribute more to any of the IRAs that you have. You can’t contribute more than $6,000 in a year. So if you have a Roth IRA and a traditional, you can contribute 3,000 to the Roth IRA, 3,000 to the traditional, but that’s it. You can’t contribute 6,000 to both. You can contribute 6,000 to just a Roth IRA or 6,000 just to a traditional IRA, but you can’t contribute 6,000 to both.

Brian Martucci (06:32):

I think that trips off a lot of people up. They think the limits are for each account, but it’s for both. When you’re over 50, there’s an extra thousand dollars that you can contribute to IRAs every year, it’s called a catch up contribution. These limits, they tend to change not necessarily every year, but they do go up. So you can bank that the 6,000 limit will go up at some point in the future.

Brian Martucci (06:55):

But for the first scenario, we can talk about contributing all 6,000 or as much as you can to the Roth IRA. You might want to do this because Roth IRAs are a little bit more flexible on how you can access the money. So it’s a retirement account. And ideally you keep the money in the account for many, many years, until you’re much older, closer to retirement. But a Roth, there are more exceptions I guess you could say, if you really need the money, when you can withdraw from the account. So 59.5, 59 and half is kind of the key age. There’s a 10% early withdrawal penalty if you withdraw earnings from a Roth IRA before 59 and a half, if the account is less than five years old. So you have to have keep the money locked up for five years or you’re incentivized to do so.

Brian Martucci (07:44):

But there are a few exceptions that a lot of millennials will encounter in the near future and big ones are first time home purchase, college expenses and birth or adoption expenses. They’re also exceptions for disability and some health related exceptions as well. Now, the first time home purchase is limited to $10,000, I believe. That helps you get to a down payment, but unfortunately in a lot of real estate markets that’s not going to get you your full down payment, but certainly helps. And so if you’re thinking that you are going to want to invest in a tax advantage way but you feel like you’re probably going to need some cash for some big life changes in the near future, a Roth is definitely a good tool for you to have. So if you want to max that out when you’re younger and maybe your income’s a little bit lower on the expectation that you’re going to need it, you’re going to need the money before you retire, that’s a good strategy.

Brian Martucci (08:41):

And then again, a Roth distributions when you’re older are tax free. So that is a nice advantage. If you feel like your income is going to be higher when you’re older, so let’s say you plan to keep working way past 59. Everyone wants to retire 59 and a half, but realistically, most of us are going to be working longer than that. If you have that salary income, that’s going to bump up your tax liability. And any distributions that you take from the Roth IRA are going to raise that even more. So you’re going to be taxed at a higher percentage on those. Or sorry, any distributions that you take in a taxable way are going to add to your tax liability. So the fact that Roth distributions aren’t taxed is really helpful.

Rebecca Hotsko (09:24):

Is one of the main benefits then of the Roth IRA versus the traditional IRA is that early withdrawal of contributions you can fully take them out, versus the traditional one you’re more locked up?

Brian Martucci (09:37):

That’s right. Yeah. You also have more flexibility to take out the contributions. The withdrawal penalty specifically applies on the gains. So it won’t be as hefty as if it applies to all the contributions, but that is still, yeah, it’s a huge benefit. There’s just more flexibility on how you can withdraw in general.

Rebecca Hotsko (09:54):

Right. And I think that could be very useful for, like you mentioned, millennials who are maybe thinking of saving for a home and they know they might need that money in the next five, 10 years versus it being tied up. And then what about the next one? So the traditional IRA.

Brian Martucci (10:11):

Yeah. So a traditional IRA is sort of like… That’s not quite a mirror image of the Roth, but it is a little bit different. And that’s really important, I think, for millennials in the here and now. Your contributions are tax deductible in the year they’re made with a traditional IRA. So if you have a higher income now, it gives you an immediate tax break during the year. Let’s say if you max out your traditional IRA and contribute $6,000 this year, that’s $6,000 in income that is not going to be taxed on your federal tax return. But there is an important exception to the tax deductibility of a traditional IRA. And we might talk more about employer sponsored plans and a little bit, but if you are covered by hiring plan at work, so like a 401(k) is the most common one, then there’s an income limit on your tax deductibility for your traditional IRA contribution.

Brian Martucci (11:05):

So those are similar. They’re a little bit stricter than the Roth IRA contribution limit. So for a single person, if you make over $78,000 a year and you’re covered by a 401(k) at work, even if you don’t contribute to the 401(k), you can’t deduct your traditional IRA contributions. You can still contribute no matter how much you make, but you don’t get that tax benefit right now. If you’re a joint filer, if you’re married, it’s a little bit more generous. So if only one spouse is covered, if you’re filing jointly, then the deduction limit is about 214,000 on your joint return. If both spouses are covered, it is 129,000 on your joint return. So again, you can always contribute to a traditional IRA, but you just don’t get that tax benefit if you’re a higher income.

Brian Martucci (11:54):

But that said, it’s still a great benefit for those who can take advantage of it. And because there’s no income limit on contributions, that traditional IRA is something you can always put money into if you want to invest in a tax advantage way. And we can talk about backdoor Roth contributions in a little bit. I don’t want to get ahead of myself there.

Brian Martucci (12:15):

None of us can predict the future, but a traditional IRA is really helpful for people who are pretty sure, or fingers crossed but really working toward being retired, retired by the time they start taking distributions. I believe you have to start taking distributions at around age 72. So it’s past retirement age. You can take them before that, but if you want to wait as long as possible so that your money has more time to grow. But yeah, if you’re still working at that time and your income is still quite high, the tax that you pay on those distributions from your traditional IRA, that’s going to be a significant hit you’re going to get. Your net is going to be a lot lower than you would like it to be. So a traditional IRA is great to shoot for if you’re planning to retire before you start taking those distributions.

Rebecca Hotsko (13:01):

What situation would make sense where a millennial might want to contribute to both?

Brian Martucci (13:08):

So I think the short answer is that if you’re not sure what you’re going to be doing in 30, 40, 50 years, then it’s a good strategy to hedge your bets. If you want to just split it right down the middle, assuming you’re eligible for both, contribute 3,000 to a Roth, 3,000 to a traditional every year. That way it’s called tax diversification, where you’re still going to have a tax hit on those traditional withdrawals, but they’re not going to be as big as if you would put all of your eggs in that basket. So if you’re not sure if you’re still going to be working as you get older or where your tax liability’s going to be for other reasons, then I would say go ahead and split them.

Rebecca Hotsko (13:48):

So then you also mentioned the decision might change or be affected if an investor also has an employee sponsored plan like a 401(k). Can you talk a bit more about that?

Brian Martucci (14:00):

So a 401(k) is just a great retirement tool in general. It’s a great tax advantage account. If you are eligible for retirement plan at work, which a lot of people are, then those income limits to IRA, except traditional IRA, contributions really start to bite. But I would say if you are eligible for a 401(k), you should think very strongly about investing in it in addition to your IRAs, especially if your employer matches your 401(k) contributions. A lot of employers will match a certain percentage of contributions. It’s usually calculated as percentage of income. So you’ll see a maybe 3% match, a 4% match, 5%. Some employers are even more generous. If you can contribute at least that much to your 401(k), you will get an equal amount of money from your employer. And that’s the closest thing to free money that you’re ever going to get, sort of an inheritance or winning the lottery. It’s sort of a no brainer.

Brian Martucci (15:05):

Those 401(k) contributions are always pre-tax as well. Or I should say they’re usually pre-tax. There is also a Roth 401(k) where you can structure your 401(k) contributions as Roth contributions for tax diversification. But most people just stick with the tax deductible contributions, which is usually the default. So you can deduct whatever you contribute. You can’t deduct your employers match, but again, it doesn’t really matter because it’s basically free money. So I would say if you’re trying to think about how to prioritize your investments, your tax advantage investments, if you are eligible for 401(k) and you have an employer match, your first priority should be contributing enough to that 401(k) to get the full employer match. Those contributions come right out of your paycheck so you don’t really feel them as much. It’s just kind of like tax withholding from your paycheck. Your net pay is lower. And again, it’s basically free money.

Brian Martucci (16:03):

After that, then you can think about, “Do I want to contribute to a traditional? To a Roth? To both?” and your next priority then should be maxing out your IRA. If after you max out your IRA contributions you can afford to contribute more to your 401(k), then absolutely go ahead because that’s going to further reduce your tax liability in the current year. And you can contribute up to $20,500 in 2022 to a 401(k). So the tax deductible contribution limit is much higher than for an IRA. And that number goes up almost every year. So it will continue to increase by at least a few hundred dollars every year.

Rebecca Hotsko (16:48):

So you mentioned that if you’re over a certain income level, you can invest in the Roth IRA, but there is one exception and that’s a backdoor Roth IRA conversion. So can you just talk a bit about who’s eligible and when it might make sense to do this?

Brian Martucci (17:04):

A backdoor Roth contribution is a pretty common tool for higher earners to reduce their tax liability over the long term. The way it works is you have… For it to work, you have to be above the income threshold to be able to deduct your traditional IRA contributions. So often the way it works out is if you would file any taxes with a spouse, one or both of you is eligible for employer plan. Your traditional IRA deductible contribution limit is going to be much lower. So you can still contribute to a traditional IRA, but you can’t deduct those contributions in the current tax year. There’s no benefit. However, you can transfer those contributions to a Roth account that you’ve opened and the money just goes into the Roth account and the tax treatment then becomes like a Roth IRA tax treatment. So you don’t pay taxes on the distributions way down the road.

Brian Martucci (18:06):

You also, for this to work, have to be over the eligibility limit to contribute to your Roth account. And so it really does affect. It’s a benefit for, I don’t have the number off the top of my head, but let’s say top 10 or 15% of earners I would think. But if you’re fortunate enough to be in that echelon, it’s a real benefit. I will say there are some… It’s not super involved, but there’s a tax reporting obligation that you have. You to file a form for your cost basis with the IRS when you make those contributions. It gets pretty complicated pretty quickly, but there are certain triggers that can mess up the tax treatment so that you may end up actually owing taxes on your backdoor Roth conversions. Like if we do an IRA rollover from an old employer plan, that kind of gets off into the weeds.

Brian Martucci (18:58):

The last thing I’ll say about that though is Congress has tried to do away with the backdoor contribution. It’s really a loophole. A lot of people don’t like it. So they’ve tried to do it with it in the past. It hasn’t been successful so far, but there is always a risk that the loophole will be closed and you won’t be able to do this anymore. I imagine if that happens, everyone who did the conversion in the past is probably safe, but you won’t be able to do it moving forward or you’ll risk tax penalties.

Rebecca Hotsko (19:30):

Can you talk a bit about how millennials should think about allocating their investments in each account?

Brian Martucci (19:36):

I think the broadest way to think about it is that in your tax advantage accounts, it makes more sense to have higher tax or tax inefficient investments in general. So yeah, dividend paying stocks are a good example. One example of a type of investment you want to hold in your tax advantaged accounts is like an actively managed mutual fund that pays capital gains distributions that are then taxed as capital gains. If you have that in a taxable account, you have a higher tax liability even if you don’t sell the mutual fund. So if you want to invest in actively manage mutual funds, those are good to have in a tax advantaged account.

Brian Martucci (20:15):

Another type of investment that you wouldn’t want to have in a tax advantaged account is like a tax free municipal bond. So if you have state or local bonds that aren’t subject to income tax, then there’s no benefit to having them in its tax advantage account. You actually lose the tax benefit cause they wouldn’t be taxed anyway in that account. So that sort of investment, which is fairly rare especially for millennials who tend to take more risk with their investments. But if you have that sort of investment, you’d want to have that in your taxable brokerage account.

Rebecca Hotsko (20:50):

Next, I want to chat with you about life insurance. You’ve written a lot of great articles on this topic. So can you walk us through what millennials might want to consider getting life insurance for and who might it not make sense for?

Brian Martucci (21:03):

It’s a lot of different scenarios. Everyone’s different, but there are a few reasons that you would want to buy life insurance as millennial, even as a young millennial like pre kids, if you’re planning on having kids. One is if you are the breadwinner in your household or you contribute significant income to [inaudible 00:21:22] household. That’s especially true if you have dependent because they’re going to rely on that income moving forward.

Brian Martucci (21:29):

Another big one is if you have jointly held debt. So really common example is a mortgage that you’ve held with a spouse or is co-signed by a relative or student loans that are co-signed by a parent. Or even jointly held credit cards that have significant balances, that would be a burden on your survivors. And that even does include an apartment lease, so even if you don’t own your home. It’s not automatic that if you share an apartment with a spouse or a family, that the landlord is going to break your lease if you die in the least. So your survivors will still be on the hook and that can be thousands and thousands of dollars if you die early in the lease.

Brian Martucci (22:12):

So all those kind of financial reasons are strong arguments in favor of getting life insurance even if you don’t really feel like you’re close to death. It’s sort of an awkward topic to talk about. And also just from a practical perspective, life insurance is pretty much always more affordable when you’re young. Age is holding everything else constant. It’s the most important factor in determining the cost of your life insurance. So every year that takes by is a year that life insurance coverage gets more expensive. It’s not like it’s a one and done thing, you can buy a little bit of life insurance now so that you walk in lower premiums and then if you decide to need more, perhaps because you have kids that you weren’t sure that you were going to have, you can always get more down the road.

Brian Martucci (22:57):

It’s also more common for life insurance companies, especially for younger folks to just waive the medical exam requirement. So in the past, it has been pretty much standard that if you’re getting more than a certain amount of life insurance, you’re going to need to go through a medical exam. Now a lot of companies offer like million dollar policies or even more without a medical exam. You’ll pay a little bit more in your premiums because the insurer won’t have as good of a sense of the actual risk that you present to them, but it can still be a big benefit to skip that medical exam if you’re frankly concerned about what it might turn up. And life insurance companies are super picky. So even an anomalous result in your year end screening, they can just be like, “Nope, we’re not cover you’ or you’re going to get a way higher premium. So that’s sort of a risk benefit calculation that you can make.

Brian Martucci (23:50):

And then the last one is just that funerals are really expensive. Even a modest sendoff you’re looking at $10,000 or more probably, all things considered. If you don’t have that cash lying around, that can be a serious burden on your survivors.

Rebecca Hotsko (24:06):

So then I’m wondering about the millennials who might not want to consider this at all.

Brian Martucci (24:12):

I think it’s hard to predict the future. My advice, which some people might take issue with is, even if you don’t think you need life insurance now, you probably will at some point. That said, if you are pretty sure you fall into one of the buckets I’m about to mention, then you can go without it. One is, if you’re single and you don’t have dependents or significant debts. Over time, you’re going to build up your network, especially if you’re single and you don’t have kids to pay for. You’ll just never run into a situation where your debt is going to be a burden on anyone. There will be a funeral, but that will be a manageable burden probably for whoever is going to be in charge of that.

Brian Martucci (24:52):

And again, if you’re in a partnered relationship where you have dependence, if your net worth is high enough that your death, your premature death is not going to create an undue burden on the household, then you’re probably safe without life insurance. Although I will say that even if you’re a stay at home partner or parent, your labor is valuable. And the numbers, people throw around a lot of numbers, but it’s probably if you add up all the… Especially if you have dependents, you add the childcare component of that, you’re looking at a six figure contribution every year to the household. So that is something to think about, when you’re gone there’s not going to be anyone doing that labor. And so it might still be nice to have a life insurance policy so that your survivors can more easily manage the financial components of your absence.

Rebecca Hotsko (25:48):

What about someone who doesn’t have kids yet, but they know they’re planning to in the future? So what are your thoughts on, should they buy life insurance now before the child arrives or wait until after?

Brian Martucci (26:01):

I would say it depends on your age and your net worth. That’s the short answer. The younger you are, the more time you can afford to wait because premiums will still be relatively low. But at the same time, when you’re younger, you’re also likely to have a lower and maybe even negative net worth where life insurance will be really helpful because you won’t have cash lying around to cover the expenses that you might leave behind. Even you can kind of look at it, here, just to throw out a hypothetical. Let’s say you’re 27 and you’re partnered up and you are thinking about having kids in the next, let’s say five years, you could probably wait until the kids arrive. Let’s say you’re 33 and you can start to think about, “Okay, this is how much daycare is going to cost. Here’s how much college is going to cost way down the line.” Your household expenses will make more sense to you at that time. They’ll be more abstract when you’re single and you know you want kids, but it just seems like a foreign situation.

Brian Martucci (26:59):

But on the other hand, if you’re older, so let’s say you’re like 39 or 40 and you really do want to have kids but it’s not imminent and you’re looking well into your 40s, maybe even adopting or surrogacy, it’s kind of a brutal calculation, but you might not want to wait. You might want to get life insurance now so that it’s there when you’re ready. Especially if you’re thinking about having kids on your own, you’re not going to have a second income to help out. And so it’s all the more important that you have some financial protection for your future children.

Rebecca Hotsko (27:34):

Now that we’ve talked about who might want to buy life insurance, can you discuss the different types of life insurance?

Brian Martucci (27:41):

So there are two main types, term life insurance and permanent life insurance. Within permanent, there are several different subtypes. I think the one that what most folks have heard of is whole life insurance. Then there’s also universal life insurance, variable universal life insurance. The biggest difference between term and permanent life insurance is that term life insurance has a fixed term. So you’ll see references to a 10 year policy, a 20 year policy, a 30 year policy. Usually, it’s between 10 and 30. You can renew the life insurance policy after the initial term ends, but it’ll be like astronomically expensive. So the vast majority of people who get term life insurance, they just care about being covered during that term, whether it’s 10 years or 30 years or something in between. And if they outlive it, which is a good thing really, then they’re not covered anymore. And unfortunately, the premiums that they paid into the policy usually just disappear. You don’t get them back. You can get a, what’s called a return of premium policy where you get your premiums back, but that costs a little bit more. So that’ll raise your premiums.

Brian Martucci (28:49):

For permanent life insurance, and we’ll just use the example of whole life insurance, the term is indefinite. It lasts basically your entire life as long as you continue paying the premiums. Some life insurance companies will cut it off at the age 100 or even older, but most people don’t make it that long. Your permanent life insurance, your whole life insurance policy builds cash value over time really, really slowly at first. But it does after a few decades, it’ll be a significant nest egg that you’ll be able to… You can withdraw from, or more commonly people take loans against it. It’s sort of like having equity in a home that you’ve lived in for a while without all the hassle of home ownership. So it’s kind of nice. We can talk more about how it actually stacks up as an investment, but it is technically a long term investment that can kind of sit alongside your other investments.

Rebecca Hotsko (29:51):

For millennials wondering how should they decide whether to go with a term policy or whole, I know there’s a lot that goes into that, but is there any key things that you can just help them first think about?

Brian Martucci (30:05):

Yeah, sure. I would say that term life insurance is better for the average millennial who is planning a family or has significant joint debts that they want to make sure are taken care of. That way, you’re covered for the entire term. So let’s say you’re 30 now. If you get a 30 year term life policy and you continue paying the premiums, you’ll have life insurance coverage until you’re 60 years old. And that is usually enough time.

Brian Martucci (30:35):

As people continue to work, they get raises. They pay down debt. If you have a mortgage, you’ll be paying down your mortgage and you’ll have a lot of equity in your home eventually ultimately. By the time you get into your 50s and 60s, a lot of people have pretty high net worth. And if they die, they’re closer to retirement so they don’t have to replace very much income and they have a lot of money sitting around that… I shouldn’t say a lot, but you have a positive net worth that can pay for your funeral, can leave your surviving spouse or independents with an inheritance that they can use to make up for your absence. So that’s why term life insurance is a good bet for most folks.

Brian Martucci (31:18):

Permanent life insurance is good, especially whole life insurance, if you want the extra assurance of having a parallel investment like bucket of money that is not directly tied to the stock market. It has a predictable rate of return. You can borrow against it. It’s like against having a second house kind of without all the hassle that come with that. The returns on a permanent life insurance policy are not going to be as good over the long term as they would be if you just stuck your money in a diversified stock market ETF and waited 30 years. But for people who are more risk averse, that’s not really the point. You’re not trying to maximize your investment. You’re trying to make sure that you have that asset there when you need it. And while it’s not quite as good as a government guaranteed bond or something like that or an FDIC insured bank account balance, it is definitely less risky than, again, just putting your money in the stock market especially if the market crashes right before you need that money, you’ll have some regrets.

Rebecca Hotsko (32:27):

So one thing I’m wondering is I’ve heard when using whole life insurance as an investment, it usually only makes sense once you’ve already maxed out your other registered accounts, or like you said, when you maybe already have enough savings for retirement. What are your views on that? And when should millennials think about using this as an investment?

Brian Martucci (32:49):

Sure. Yeah. Yeah, absolutely. I think a good way to think about whole life insurance is that it’s sort of a plus investment. Once you’ve maxed out your eligibility for all the other tax advantage accounts that you’re eligible for, and that includes your 401(k), so that the $20,500 deductible contribution limit every year, that’s a lot of money. But if you’re hitting that every year, then you should think seriously about whole life insurance because again it’s going to create that kind of parallel bucket of equity that you can tap and that isn’t directly correlated with the stock market.

Brian Martucci (33:24):

So one common situation where you might want a whole life insurance policy is if you have a dependent who will need lifelong care support. So a child with special needs, a relative with special needs, probably not a parent because they realistically won’t be around long enough for that cash value to build up, but definitely a child or someone in your generation that you can borrow against the policy to help support or even withdraw from the policy to help support that person and pay for their care without jeopardizing the equity in your home. You don’t want to lose your home. It’s a really difficult decision if you’re going to be losing your home potentially.

Brian Martucci (34:02):

The other use case that isn’t as common is if you’re going to be subject to the estate tax. So the threshold right now for the federal estate tax in the US is about $12 million. Unfortunately, most people never make it that far. That limit could decrease. It has been lower in the past and it could be lower again. Right now. It’s not a big issue for a lot of folks. But if you are fortunate enough where you expect to die with assets valued greater than $12 million, then your whole life policy can be used to offset that tax burden. It’s a guaranteed tax free benefit for your heirs and they can use it. The estate taxes really steep I should say. It’s like almost half of the value of the estate over that threshold, I believe. So it’s definitely worth it to do whatever you can to reduce that burden if, again, you’re fortunate enough to be in that situation.

Rebecca Hotsko (34:54):

I guess what kind of returns are you looking at when you’re using this as an investment product? Can you talk a bit more about that?

Brian Martucci (35:03):

Yeah, the short answer is it depends. Whole life insurance is really complicated. Every policy is different and there’s a lot of fine print. It’s not just investing in a stock or an ETF or even a mutual fund. And so the return will vary. That said, it’s safe to say that after fees and expenses and commissions potentially, the long term return is going to be lower than the historic long term return of the stock market, like the total stock market, which I think depending on how you calculate is between 8 and 10%. But the big advantage of looking at whole life insurance as an investment is that the return is predictable. For whole life insurance, it is generally fixed. And while it’s not quite as safe as like a government insured bank account or a government bond, it is much safer than picking random stocks and just hoping that they go up and don’t go down. So if you’re risk averse and the idea of investing in individual stocks makes you queasy, then whole life insurance is definitely something you should look at.

Rebecca Hotsko (36:14):

I guess another piece I am wondering about is the ability to borrow against it. So that seems like a lot of millennials might like that if they’re looking to make a large purchase or if they don’t have a lot of other assets. Can you just speak a bit more about that when they could borrow against that money in the use cases?

Brian Martucci (36:34):

Yeah, yeah, absolutely. So the over time… And we should say that whole life insurance takes a long time to build up that cash value. It’s really slow. Again, every policy is different, but during those first years, the first decade, even longer, that cash value is going to be really, really slow to build. Most of the premiums that you pay are going to go toward the actual death benefit, the insurance component. And as a sidebar, that’s why whole life insurance is so much more expensive than term life insurance because you’re paying for lifelong protection. The policy is going to pay out when you die because it’s always going to be in effect as long as you pay the premiums. And you’re also putting money essentially into an investment account that has a guaranteed rate of return.

Brian Martucci (37:20):

So the way the insurance company works, that is, it takes the premiums that you pay early on and puts them toward the death benefit so that it has more time to invest those premiums and make sure there’s enough money to pay your death benefit. And then the cash value’s kind of like a bonus on top of that. But if you keep your policy enforce for 2030 years, you’re going to have a pretty good nest egg. And then the cash value starts to build pretty quickly at a certain point, because it starts to compounding interest, right? It sort of takes off if you can wait that long. But you can borrow against it within certain restrictions, but you can do anything with that loan basically. And it’s generally tax free. So you can use it.

Brian Martucci (38:00):

Again, it’s kind of like a home equity loan, but you don’t have the risk of the bank taking your house if you stop paying the loan. The worst thing that happens is you reduce the death benefit. If you don’t pay back the loan by the time you die, the death benefit is reduced by the outstanding amount of the loan. There is an interest rate on the loan and it’s not nothing. I’ve seen like 8%, which is better than credit cards certainly, but it’s probably not as good as you could do on like a home equity line of credit. And you can use that loan for the proceeds of the loans for pretty much anything you want and you can withdraw from the policy as well. You can also either top it back up or not. If you do that early on, there are pretty significant charges involved called surrender charges. And again, that gets really complicated. It’s really specific to the individual policy, but basically you don’t want to take any of your cash value in the first, I’d say 10 or even 15 years. After that, it gets a little bit more forgiving.

Brian Martucci (38:55):

And finally, you can use the cash value of your whole life insurance to pay your policies premiums. So as you get older, maybe you’re after retirement, you’re living on a fixed income, your income is lower, you can kind of draw it down your policy over time and really reduce that monthly expense that you’ve been carrying up until that point.

Rebecca Hotsko (39:13):

So now that we’ve talked about all the different kinds, can you walk through how someone would think about how much life insurance to get? I know that there’s a really complicated calculation with present values and a lot of assumptions.

Brian Martucci (39:28):

Sure.

Rebecca Hotsko (39:28):

But I’ve also heard that there’s kind of a short answer where using just standard assumptions for inflation, interest rates and your paycheck, you can kind of end up with almost 10 to 15 times your gross income. What are your thoughts on this? Do you kind of have a short method?

Brian Martucci (39:44):

That’s true. Yeah. And that’s a great way to think about it if you don’t want to bother with inflation calculations and expectations that may or may not pan out. I’d say the sort of living dangerously threshold is 10 times your gross income. If you want to be a little bit more conservative, 15 times could be a safer bet. So if you make, let’s say $80,000 a year before taxes, that’s $800,000 policy if you use the 10X method. Or 1.2 million if you use the 15X method. Again, everyone’s situation is different, but that’s a lot of money. Or I should say it sounds like a lot of money. It’s not a ton of money in terms of income replacement in the grand scheme of things, but it’s probably going to be enough to keep your dependents fed and clothed and maybe even cover their education and also address any of the jointly held debts that might survive you.

Brian Martucci (40:35):

There’s a little bit more complicated method that a lot of people like to use called the DIME method, D-I-M-E. It stands for debt, income, mortgage, and education. So the idea here is that you add up, each letter represents a type of expense or income, in the case of income. You add those all up to get the amount of coverage that you need. So debt would include jointly held debts, including a mortgage. If you have dependents, you can include things like childcare expenses in there because those are really hefty expenses. Income is your gross annual income multiplied by the number of years that your surviving partner or dependence might need to live off of it, which it isn’t assumption that you have to make, but if you’re not sure where to start, 10 or 15 is fine. And then your mortgage, a mortgage is such a big debt that it’s usually considered separately. And education is future college education expenses or private secondary education if you’re paying for that.

Brian Martucci (41:36):

So of course the DIME method gets you a higher number than just 10X-ing or 15X-ing your income, but it is a way to kind of account for all of the big life expenses that you’re not going to be around to cover. And so that can provide some peace of mind if that’s what you need.

Rebecca Hotsko (41:52):

The last thing that I want to talk to you about today is investment planning with kids. So for some of our listeners who either have kids or are planning to in the future, let’s talk about some of the things that they may want to consider starting with, should they open a joint tax full investment account for their kids? What are your thoughts on that?

Brian Martucci (42:12):

Yeah. Great question. I think that’s been instinct for a lot of new parents who are kind of financially savvy to open an investment account for their kids right off the bat. I would say you don’t need to do that right away. It shouldn’t be a priority when your kids are really little. Frankly, it’s of no use to them for the first few years of life as an educational tool, because they’ll be too young to understand it. Kids understand more about money than we give them credit for, but a three year old is going to have a limited understanding of that. And more importantly, well, I should say the higher priority on the investment side for new children is to open and fund tax advantage education accounts right away, 529 account or Coverdell account.

Brian Martucci (42:53):

If we were talking about whole life insurance, if you’re inclined, there can be advantages to taking out a life insurance policy on your kid as well. The benefit of that is that it doesn’t count as an asset for them, whereas a custodial investment account will count as an asset for them. Down the road, the fact that they have this asset that has value could affect their eligibility for financial aid from a college that they’re going to. And that can make a huge difference in your out of pocket cost or how much you have to borrow to finance their education.

Brian Martucci (43:27):

So I would say hold off on the custodial investment account until the kids are a little bit older. If you want to invest on their behalf, the order of priority should be education savings accounts that have tax advantages and then maybe small whole life insurance policy. If and when you have kids, you’ll definitely get a whole bunch of stuff in the mail about Gerber Life Insurance policies and you can evaluate that when it comes.

Rebecca Hotsko (43:52):

That was great. Thank you so much for joining us today. So before we close up the episode, where can the audience connect with you and learn more about your work?

Brian Martucci (44:02):

Sure. So you can find all of my writing on moneycrashers.com. I write about credit cards, banking, insurance, investing. Pretty much everything we talked about today I’ve written about. And you can find me on LinkedIn as well if you want to get in touch professionally. But yeah, this was great. I had a great time.

Rebecca Hotsko (44:20):

All right. I hope you enjoy today’s episode. Make sure to subscribe to the show on your favorite podcast app so that you never miss a new episode. And if you’ve been enjoying the podcast, I’d really appreciate it if you left us a rating or review. This really helps support us and it’s the best way to help new people discover the show. And if you haven’t already, be sure to check out our website, theinvestorspodcast.com. There’s a ton of useful educational resources on there as well as our TIP finance tool, which is a great tool to help you manage your own stock portfolio. And with that, I will see you again next time.

Outro (44:57):

Thank you for listening to TIP. Make sure to subscribe to We Study Billionaires by The Investor’s Podcast Network. Every Wednesday we teach you about Bitcoin. And every Saturday we study billionaires and the financial markets. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.