What Just Ain’t So

By September 6, 2019 October 1st, 2019 My Money & Me

“It ain’t what you know that gets you into trouble—it’s what you know that just ain’t so.” – Mark Twain

One of the most challenging parts of my job is trying to convince clients that something or other that they ‘know’ just ain’t so. This can be particularly frustrating when the topic in question represents either a significant opportunity or a potential problem. And that’s a shame, because not being open to updating one’s knowledge framework means that you either miss an opportunity or take a risk that could easily have been avoided.

How does this happen? Fairly easily, actually. Things change, first of all, and most of us simply don’t get the news. In addition, even well-meaning people often don’t completely understand the context into which they are delivering recommendations; they end up making assumptions that they shouldn’t, and that can change things significantly. And at other times the topic in question is simply more complicated, more nuanced, than people realize.

Here are some of my favorite examples of stuff many people ‘know’ that just ain’t so.

“If you make a lot of money, you can’t contribute to an IRA.” WRONG

If I had a dollar for every time that someone told me their ‘tax guy’ said they “couldn’t contribute to an IRA” because they made too much money, I’d be considerably richer than I am. The fact is that, as long as you have earned income, you can contribute to an IRA up to that earned income amount, subject to the annual IRA limit. Even if you earn a ton of money, and even if you are covered by another retirement plan, you can contribute to your IRA.

What is happening in this case is that the tax guy is actually answering a different question than the one you thought you asked when you uttered the words “Can I contribute to my IRA?” He is answering the question: “Can I get a tax deduction by contributing to my IRA?” And with regard to this narrower question, he would be correct. If you make a lot of money – and depending on how much and whether you’re covered by an employer’s retirement plan or not – you probably cannot claim a tax deduction in the current year for your IRA contribution.

But getting a current tax deduction and being able to contribute at all are fundamentally different things. The tax deduction is nice, but even the simple ability to contribute may have significant, long-term tax and estate planning benefits that you’d be missing if you didn’t consider it.

“I’m a sole proprietor and so I can’t have a 401(k) plan.” WRONG

I honestly don’t know where this misconception came from, but I’ve heard it many times – much to the detriment of many a sole proprietor. Perhaps the 401(k) providers that they spoke with told them that they didn’t provide Solo 401(k) plans for sole proprietors. Or perhaps someone else looked into the possibility and found the providers to be too expensive. However it happened, someone decided that it ‘wasn’t possible’ and the (wrong) word got around.

Here’s the good news: If you’re a sole proprietor, you can open your very own 401(k) plan and shelter a lot of money from current taxation. If you are at least 50 years old, you can contribute up to $25,000 from your imputed salary. After that, you can make additional profit-sharing contributions, much as you would to a SEP IRA. In fact, you can always contribute more to a 401(k) plan than you could to a SEP IRA, so for a little extra trouble you get a lot more tax deduction. And if you do it right, it doesn’t even need to cost a lot of money (though SEP IRAs are still cheaper).

Is there a downside? It depends. The biggest issue we typically see if that sole proprietors don’t realize that the rules governing 401(k) plans change dramatically once one adds employees to the business. So if you do have a Solo 401(k) plan, be sure to work with an advisor who understands how to help you prepare to grow your business by adding employees. Done right, it can be a benefit to everybody. If you ignore how the rules change, however, you’ll not be pleased with the outcome.

“Permanent insurance and annuities are always a bad idea.” WRONG

The idea that cash value (i.e., “permanent”) life insurance and annuities are universally bad is almost dogma in many circles, and actually for good reason. Over time there has been an enormous amount of abuse of these kinds of products. Every financial planner I know has her/his favorite horror story, a sad tale driven largely by the fact that selling these products has been ridiculously profitable for insurance agents, and compounded by the fact that these are always sophisticated products and are too often sold to individuals who do not fully understand what they are signing up for.

That all said, this is an area that calls for some reassessment. The insurance industry has gotten so much bad press over the years for overly complex and expensive products, coupled with abusive sales tactics, that at least some of the players are now starting to do what was once unthinkable: they are introducing “fee-only” insurance and annuity offerings that are designed to be more transparent and far less costly than the traditional versions.

Two very good things can happen because of this change. First, since almost 10% of the value of such contracts has been traditionally paid out as ‘selling cost’ (i.e., commission), getting rid of the commission altogether and reducing overall administrative/transaction costs to less than one percentage point of the contract makes a lot more of the client’s money available to benefit the client. This automatically improves the cost/value proposition of the products. But the second important thing is that the assumption that a fee-only advisor is going to be involved helps keep everyone a bit more honest. Fee-only advisors aren’t being paid to sell products and move on; they are paid to watch over their clients’ well-being on an ongoing basis. So, with fee-only insurance, the industry is accepting that there’s going to be closer scrutiny of costs and benefits, and thus greater transparency.

Will this make everything perfect? Of course not. But it is causing products to come on the market that offer clients more benefits at a lower cost than we’ve ever seen before. And at some point, some of these products are going to begin to make sense for certain clients, in certain situations. The well-known adage: “Don’t buy cash value life insurance; just buy term and invest the difference” has been true because the internal costs of insurance-based investments have been ridiculously high while their quality has been distinctly inferior. If, however, the cost of investing within an insurance product decreases dramatically while the quality markedly improves, then a reassessment is in order. Especially in a high-tax world, the potential benefits of paying for future insurance costs from tax sheltered investment gains can have a real benefit – if the costs are low enough if and the investments are good enough.

And while these products are never going to be right for everybody all the time, that doesn’t mean that are always wrong for everybody either. Things change.

Keep an Open Mind

Navigating the deluge of available information in the internet age is a huge challenge. No longer is it sufficient to have access to information; mere access is relatively easy. Being able to interpret this information, to sift out the relevant from the irrelevant, and put it all in context, is where the true value lies. So here’s a question that you can ask of your own financial advisor: “What is it that you have changed your mind about recently?” What kinds of things have become ‘untrue’ and require an update of our knowledge framework?

The answer that he or she gives you should be interesting indeed.

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