Announcer: Would you like an opinion on a financial matter you're dealing with? Whether it's about retirement, investments, taxes, or 401(k)s, Scott Hanson and Pat McClain would like to help you by answering your call. To join "Allworth's Money Matters", call now at 833-99-WORTH. That's 833-99-W-O-R-T-H.

Scott: Welcome to "Allworth's Money Matters." I'm Scott Hanson.

Pat: I'm Pat McClain. Thanks for joining us.

Scott: Yup. Glad you're with us as we're getting into the January mode here and kicking things off.

Pat: Yes. A new year.

Scott: Happy new year, all that kind of stuff.

Pat: New start maybe. Maybe...well, that's what we all call it.

Scott: It is a new start, I suppose, of some sorts.

Pat: I guess every day is a new start.

Scott: Well, of course. Anyway, we've got a ton to talk about today because it's been a...there's just a lot of news in the financial markets...

Pat: A ton.

Scott: ...to talk about. And of course, take some calls and I think have a little bit of enjoyment with you. As a financial advisor of over 30 years, here's my concern right now. Last year was a horrible year for the markets, right? Worst bond market in 40 years, stock market. S&P 500 fell 19% somewhat, Nasdaq fell 33%. Horrible year last year for investors, right? My concern is that people are going to be sold financial products that Wall Street creates right now with the allure of, "Oh, get your money out of this and put it here because this is a sure bet for you." And look, anytime you do anything to reduce volatility in your portfolio, reduce risk, you're going to give up return. I shouldn't say anytime. Vast majority of the times.

Pat: Yeah. Most times.

Scott: Yeah. If you're taking a diversified portfolio and you throw in the towel and you go into some equity index annuity or some other product that was created to give you the allure of protection, you're going to give up...

Pat: Upside.

Scott: ...upside. And typically, when you look at down markets like this, the returns the next few years, they tend to be off the charts.

Pat: Historically.

Scott: Historically.

Pat: This is all we can use to judge.

Scott: And I've reminded folks a number of times. When I started in the industry in 1990, the Dow Jones Industrial average was roughly 2,600.

Pat: And today?

Scott: It's over 30,000. Yeah. Through all kinds of bad markets. The .com boom, the financial recession.

Pat: I saw it. I saw it this week...

Scott: Don't give up on your financial points.

Pat: I was talking to a gentleman who inherited a bunch of money and he said, "You know..."

Scott: Had he already invested it?

Pat: It was invested when he inherited it, but he said, "You know, I've always done well in real estate, residential real estate. So, I took it all and I'm buying a vacation property." And I thought...

Scott: A vacation property? It's barely an investment.

Pat: That's an excuse.

Scott: [inaudible 00:03:13] a vacation property. Is he gonna rent it out some?

Pat: I didn't even follow up. I said, "Okay."

Scott: It's inherited money.

Pat: Yeah.

Scott: People always spend inherited money a little differently.

Pat: A little differently.

Scott: Not always, but the vast majority of the time.

Pat: Yes, yes, yes. But this too shall pass. This too shall pass. It is, but it is hard to live through.

Scott: Well, and if you look at like the FAANG stocks, Facebook, Alphabet, Amazon, Netflix...

Pat: Google.

Scott: Google. Did I get them all right?

Pat: Alphabet's Google. Yeah. But Facebook is now Meta, right?

Scott: Anyway, you understand.

Pat: It's called the MAANG stocks now.

Scott: The MAANG. Those got hammered last year.

Pat: Completely. Completely. And then look at other high flyers like Tesla. Tesla, I tell you, this is an interesting story to watch because Tesla, that was down roughly 75% last year. 70 some percent last year. And it started off the year, first trading day of the year was down double digit percentage-wise. It still has a market cap of over $300 billion. Ford and GM combined are less than a hundred billion. And let's not for a minute think that competition doesn't exist. And the whole idea that we're all gonna go electric will happen at some point in time. You know what I did find the most amazing thing, and I didn't see it anywhere in the press, is when Tesla actually came out with their trucks. They put them in a potato chip factory, a Frito-Lay potato chip factory in the Central Valley of California.

Scott: What?

Pat: And I thought to my...that's where the first test fleet of Tesla electric trucks went.

Scott: They tested them there or that's where they stored them?

Pat: No, this is where they're using them as a beta test.

Scott: Oh.

Pat: And I thought to myself... And I didn't see this anywhere in the press, I thought to myself, "What high volume cargo could you get with less weight than in a bag of potato chips?" Run a full cargo? Right?

Scott: Yeah.

Pat: They're full and I didn't see it anywhere in the press. And I actually mentioned it to my children, I said...

Scott: That's pretty funny.

Pat: "Isn't this amazing that no one kind of focused on what the problems with long haul batteries are the weight?" And so, if you wanna get rid of that problem, you would...you couldn't even carry feathers because they can pack feathers and feathers are heavy, but potato chips. And every time I see something like that coming out of Tesla, I always think hype, hype, hype, hype. This is a lot of hype. This guy can hype anything.

Scott: Well, what I think is really interesting right now is he took on a bunch of debt to buy Twitter.

Pat: A bunch.

Scott: And he's been known for...I mean, he's had to sell some Tesla stock as of late in part to pay taxes. The way some of the stock options work when somebody is granted options, it's one thing, but when they become in the money and they vest, depending on the type of options, it can be a trigger taxable event even though nobody sold the stock or anything. It's like if someone hands you a bunch of cash, it's suddenly compensation for you. So, he's been forced to sell some, but then he pledged a great deal to buy Twitter.

Pat: And you wonder if he's gonna start getting margin calls at some point in time.

Scott: Who knows what kind of structure they've all gotten? And who knows how much that's what's been the pressure on the stock?

Pat: Yeah. So, you know, if you have enough money, you can pledge almost anything to borrow money. You can pledge a portfolio, you can pledge a home, you can pledge future income. You can pledge almost anything if you're at a certain level or above. It's called private banking.

Scott: Yeah. I was also thinking, you look at Apple, right? They started out as a computer company and now they're a phone company. Essentially what they make is iPhone and then they control everything that flows through there. So, they make a bunch of money on the apps, that sort of thing. Tesla, I mean, it is Elon Musk, right?

Pat: Yes.

Scott: And he has these other ideas and he's created separate companies. Boring company, the space company.

Pat: Oh, good point. Man, and he has no problem going into raiding this existing company for talent...

Scott: Correct.

Pat: ...to bring to the new company. Well, it'll be interesting to just, you know, don't get caught up. This is the experience. Don't get caught up in the hype stocks.

Scott: Well, anyway, we mentioned at the start, like, don't give up on your financial plan. However, if you were overweighted in some of these tech stocks, particularly individual ones or crypto, you may not wanna wait.

Pat: Not everything comes back.

Scott: I was looking at companies that went public between 2020 and 2021 because hardly any companies went public last year, but we had...roughly, 600 companies went public IPOs in those two years. One in four, more than one in four are trading less than $2 a share right now. 25% of these companies that went public are trading less than 2 bucks a share right now.

Pat: And now there's fear of being delisted.

Scott: A desk door. Correct. So much for being public, right? And some of these like oatley, some of these...God, it's just...it's amazing to see...

Pat: Yeah. And a lot of them were SPACs too, special purpose acquisition companies, which, if you've been a listener of this program for any length of time, when those came out, we said be careful. Be careful. Be careful with the SPAC.

Scott: Anyway, frankly, this is...what we're going through, maybe we've been through, maybe we're going through, very healthy process for the markets. Because when you have companies that keep going up and up in price with no real reason, when you've got GameStop, AMC, people trading with...there's no regard to true fundamentals. Like, is this company ever gonna earn a profit so the shareholders can get repaid? When asset values just keep being driven up for no real reason other than it's going up in price because someone else is willing to pay more for it...

Pat: And Scott...

Scott: ...that doesn't last.

Pat: Back to those companies that went public, most of them didn't have any earnings at the time, they just had revenues.

Scott: And a hot story...

Pat: Yes.

Scott: ...because that was the time, particularly during the lockdowns, we had lots of time sit around. And I was looking at like all these day traders have given up.

Pat: A lot of them. Come on.

Scott: I mean, when you have...we all know... Most of us have heard at this point in time that the average active mutual fund underperforms its indexes. So, if you're buying a stock fund that's actively managed, 70% of the time it's gonna underperform the S&P 500.

Pat: But it's appealing. The story is appealing.

Scott: But if the professionals can't outperform the market, how is some guy in his pajamas in his mom's basement gonna outperform the market?

Pat: But the story is appealing.

Scott: Of course. I understand the story.

Pat: Get rich quick.

Scott: Yeah, it's easy.

Pat: It's easy. It's easy. And the crypto continues to...over the Christmas break, we saw, again, more companies file for bankruptcy. Now it's the crypto miners.

Scott: I thought that was funny. Yeah. A mining company, which...

Pat: A mining company.

Scott: ...I didn't even know they existed, publicly-traded mining companies.

Pat: Yes. Yes. Mining companies. They mine and you're thinking, "Mining. Those poor people digging into the soil." Right? The mining companies are big data processing centers that run algorithms if I'm saying this correct.

Scott: This is the most bizarre thing when you think about this, Pat. Here at a time, we're trying to figure out how to be more efficient with our energy consumption, right? Trying to move away from fossil fuels and yet we create some new currency. This is late in the technology boom. Create some new currency and say, "Oh, guess what? We're gonna have this really tricky code." We don't know who created into Bitcoin actually, with tricky code. And you're gonna have to figure out how to mine these. So, it's gonna take massive computer power, which is gonna take massive amounts of energy. And so we're burning all kinds of fossil fuels to try to find...to create more Bitcoin or whatever.

Pat: So, Core Scientific filed for bankruptcy chapter 11?

Scott: It went public through a SPAC.

Pat: Yes. And...

Scott: It was trading for 10 cents right around Christmas time. Don't know what it's at today.

Pat: They convert 97% of the debt into...oh, all the debt into 97% ownership of the company. Have fun with that kids. Have fun with that. They call it the crypto winter. And I think it might be a long, long winter. It will be years before we see spring again in the crypto winter. [inaudible 00:12:24]

Scott: I mean, I gotta tell you, we've talked about it before, I didn't quite understand it from the get-go, and...

Pat: Yeah. And the same Sam Bankman-Fried...Friedman? Fried? Sam? SBF.

Scott: Sam Bankman-Fried.

Pat: ...Fried continues to be all over the press. And he's gonna spend some time. He is gonna spend some time. He and his...

Scott: [inaudible 00:12:47] crook?

Pat: Yes. As it comes out, he pretended that he didn't know what was going on, but his lieutenants have turned on him.

Scott: Oh yeah. Several of them already filed, I mean, had cut plea deals already.

Pat: Yeah. Yeah. Yeah.

Scott: It was just your classic thievery.

Pat: But I did read a great op-ed, I think it was in "The New York Times" this week, about what happened to due diligence with investments. So, if you think about all of them...

Scott: That's what's bizarre.

Pat: Right? Is this SBF, which is the FTX, right? Which was...

Scott: They were supposedly audited.

Pat: Well, they didn't have a real audit. They didn't have a real...

Scott: Clearly.

Pat: But think about all of the recent scams. The electric company...

Scott: What was it?

Pat: ...the truck.

Scott: Yeah. Nikola?

Pat: Nikola.

Scott: We talked about that a few weeks back.

Pat: Theranos, right? They all have this something in common, which is...

Scott: Big story.

Pat: ...big story, opaque, hard to understand the financing and the economics behind it.

Scott: And a very eccentric founder.

Pat: Or someone that portrayed themself as being very eccentric.

Scott: Well, okay. Something's wrong with you when you wear black. You're a woman and you dress like Steve Jobs and you lower your voice to sound like you're, you know, she lowered her voice for a few years...

Pat: Okay. Yes, yes, yes.

Scott: ...on purpose. She started talking like this. She was odd, right? Can we say that? She's in prison now.

Pat: Well, it's just a great reminder.

Scott: That is to your point, and some...

Pat: [crosstalk 00:14:26] the due diligence.

Scott: ...some of the smartest venture capitalists invested in these companies.

Pat: And this theory was, this op-ed, his theory was that the fear of missing out is so great, even at an institutional level, that people will throw their own rational thought process out the window in order not to look like that they missed the next big thing. That was the thesis behind it. And I thought that's...look, it happens. We're all human. It happens at institutional levels. There's group think, right? The person that raises their hand and says, "I don't think this is such a great idea," often times in a large organization will be thrown to the side...

Scott: Get shunt. That's right.

Pat: "...and ridiculed for their beliefs. You see it with any group of friends that get together and talk about investments. Listen, I've been doing this for a long time. I remember in the .com going to the gym and people saying, "Don't you get this? Don't you get this?" I actually had a client once who fired me and said, "Pat, you will never understand how this technology works, and how much money is going to be made." And I said, "Well, okay." And we have seen it time and time again, and this too shall pass.

Scott: Yeah. We will get to the calls here briefly. You know what is fascinating is how quick tech turned. And you read now they blame it all on feds, but I'm like...

Pat: Why is it the feds' fault?

Scott: Because cost of money is more expensive now, they [crosstalk 00:16:09]

Pat: But the cost of money is more expensive for every business.

Scott: I understand how I go to, of course. Yes. That's why I think that's the joke when I read some of these things, particularly when you're looking at a well-established technology company that has good earnings. Like, I mean, you can't. But for a while, I remember thinking...it was hard to say, "When are we gonna have a tech recession?" Because I've been saying the last couple of years, like, I think the state of California, where most of these companies are headquartered and a lot of the startups are, Silicon Valley, in California, 1% of taxpayers pay more than 50% of the revenues to the tax revenues. Like, when is the tech company gonna have recession, the tech industry, and what's that gonna do to the finances of California? And we're just now starting to see that play out, but that tech recession came pretty quick.

Pat: Yes.

Scott: Because a year ago, looked like there was nothing stopping any of these companies. And if you went into this the last year well diversified with having the stocks that you own, they were for your longer-term dollars, not money you need to spend in the next couple years, you're well-diversified long-term, you had some diversification, had some cash to meet your daily living expenses, that sort of thing, you've weathered this fine and you will recover and you'll... over time. And if you weren't, it's not too...I mean, you still need to get to that point. And if you've been doing things on your own, you're nearing retirement and you're starting to question your own ability to do this, it's probably a good idea for you to talk with a financial advisor.

Pat: Yeah. At least get a second opinion.

Scott: And there's a lot of people who will hire an advisor when they're at retirement time because they're like, "I can't afford to make mistakes that I cannot recover."

Pat: Yes.

Scott: "I don't want to re-enter the workforce." Anyway, if you wanna join the program, you can send us an email at questions@moneymatters.com and we will schedule a time. The number is 833-99-WORTH. We're in Louisiana talking with Jennifer. Jennifer, you're with "Allworth's Money Matters."

Jennifer: Hi. Good morning, guys.

Scott: Hi, Jennifer.

Jennifer: So my question is related to umbrella insurance, and specifically, how do you determine how much you need?

Scott: Okay. Kind of a rule of thumb is equal to your assets, but I think everyone at a minimum should have a million dollars at a minimum. And then what you wanna do is start looking at your risk profile. So, if you have...tell me about your situation. Do you have teenage children? Do you have young children or are the kids all out of the house? Do you have grandchildren that come over often?

Jennifer: We don't have children.

Scott: Okay.

Jennifer: So, we do already have a million, which, you know, covers the value of our current house, car, cash. Now, what it doesn't cover and kind of really where my question is, so we have investment accounts that total...well, as of today, who knows what it'll be in the future? Right now $1.6 million, but that's all in retirement accounts. So, do we need to cover that?

Scott: The cost of get going from $1 million to $2 million or $3 million is negligible.

Pat: Negligible.

Scott: It's the cost of a dinner out, literally.

Pat: For the annual premium.

Scott: It's not that...have you had it priced?

Jennifer: To go up to $3 million, no, but, I mean, I know that the million is not that much.

Scott: Okay. And so what happens is...

Jennifer: It seems surprisingly cheap.

Pat: So, each successive $100,000 becomes less and less expensive because the idea behind the insurance how they underwrite it is, what's the likelihood of a claim at that level? And so, that's why liability insurance, umbrella liability insurance will get less and less the higher you go.

Scott: Well, until you hit a point, then insurance companies, they also ensure their bets. So, insurance company, they might say, "We're gonna underwrite and carry up to $3 million of liability. After that, we're gonna seek reinsurance." So, there could be...the cost moving from $2 million to $3 million might be less than the cost moving from $3 million to $4 million. Every insurance company is different. You can just get a quote though.

Pat: But if I were worried about it, I most certainly would move it to $2.5 million. It'll cost you a couple of hundred dollars a year. And, you know, especially for the listeners out there, when I... I have four children and they first started driving, I increased my liability insurance significantly. And continue to keep it high as long as they are on my insurance policies because that, quite frankly, you know, is where the danger comes in. You know, they're off at college, they're doing things that, you know, every young responsible adult should be doing, but mistakes are made. So, you know, I tell my clients all the time, "Million minimum."

Scott: I mean, the worst case scenario obviously is either you're...maybe you're in driving the car and you have the accident or someone in your family dies, and it's a young professional that has a high...

Pat: Yes.

Scott: ...high income that gets killed, and then suddenly the future value of that income stream is...

Pat: Massive, or...

Scott: Multiple millions.

Pat: You know, or they're in an apartment and bad decisions are made and things happen. So, you know, you hate to talk about it, but the cost of insurance for... So, for you [inaudible 00:21:58]

Scott: Well, if you wanna get really esoteric, it was Bill Clinton's insurance policies that did the... Who was the lawsuit against? One of the women who came after him back in the day. There was some lawsuit. I just remember reading it. His umbrella insurance policy covered his legal expenses for that...

Pat: Oh, Scott, what?

Scott: ...and I thought, "Well, okay." It covers all kinds of strange things.

Pat: But at the...

Scott: I'm not saying he was necessarily guilty of that.

Pat: At the same time, IRAs aren't necessarily protected from creditors, but company 401(k)'s plans are.

Scott: Well, you get up to a million dollars of protection on an IRA.

Pat: But after that. So, OJ Simpson, when he was sued, because the money was actually in a pension plan and not in IRA, most of it was protected.

Scott: Yeah.

Pat: But let's not go anywhere close to this stuff like we already have because we can sit in for an hour.

Scott: So, if you have behavior like Bill Clinton or behaviors like OJ, get as much umbrella policy as any company will sell you.

Pat: We shouldn't go there. But yeah, just go ahead and buy some more, Jennifer.

Jennifer: Okay. Thank you.

Pat: I appreciate it. Thanks.

Scott: And it's...

Pat: We can sit here for an hour and talk about all the instances.

Scott: Huh?

Pat: Oh. I was oh.

Scott: Well, you thought of something good. What?

Pat: Oh my. So, I went on a cruise 30 years ago with my wife, my brother-in-law, and my sister-in-law, 30 years ago, and we sat at a table and he was...this guy was a lawyer.

Scott: Was that your last cruise? 30 years ago?

Pat: No, I went on one probably 10 years ago.

Scott: Okay, anyway.

Pat: So, we started talking about what he did and this was disgusting. He...why am I sharing this?

Scott: I don't know because it's... I'm intrigued right now. You've got me...

Pat: I was like, "What do you do for a living?" He says, "Well, I sue homeowners' policies, insurance companies for people that caught STDs from a partner." I'm like, "What?"

Scott: What?

Pat: He said, "I make a claim against their insurance, their liability insurance, their umbrella insurance. If they were given a sexually transmitted disease in a partner, I go back and sue that person and then make a claim on their insurance policy."

Scott: Well, I guess it paid enough money for him to take a cruise.

Pat: And I'm like...I asked to be reseated because 30 years ago you'd sit on the same people every meal.

Scott: You're like, "I can't sit with this..."

Pat: Oh my God, I'm not doing this. I'm not doing this.

Scott: It reminds me of time years ago, 25 years ago, mutual fund companies would have...they'd invite you out to their headquarters and stuff and it was a different time back, way back then. That's when people sold commission and insurance products and everything else, commissioned mutual funds. And I remember I visited with Franklin Templeton for a dinner thing, it was some fancy dinner, and my wife was with me. And the guy at the table, I don't know if people realize this, but there are some people in financial services that have large egos. Maybe no one else understands that, but... So anyway, this guy would not shut up about talking about his wine collection, his massive house, his Ferrari. And I remember I told my wife I will...this is so many... I said, "I will never take you to one of these dinners again. I'm so sorry."

Pat: That was funny.

Scott: She's like, "Thank you." And I hardly go to anything like that either too because I hate those kind of guys who are...

Pat: Just businessmen's jail.

Scott: What? Those kind of dinners?

Pat: Yes. Businessmen's jail. We're gonna talk to Rudy in... Oh, we're out of time. We're gonna go to the break.

Scott: Yeah. We'll take a quick break and then when we come back, we will talk with Rudy. And we've got some more...lots of stuff here to talk about financially. So, stick around for more "Allworth's Money Matters."

Announcer: Can't get enough of "Allworth's Money Matters?" Visit allworthfinancial.com/radio to listen to the "Money Matters" podcast.

Scott: Welcome back to "Allworth's Money Matters," Scott Hanson.

Pat: I'm Pat McClain.

Scott: And we are... This is our first broadcast of the year.

Pat: It is.

Scott: It is the time of year when many people sit down, look at their finances, do some planning and think, "What am I gonna do different this year?"

Pat: I already did.

Scott: I did as well.

Pat: I increased my 401(k) contributions with the new limits that just passed.

Scott: How'd you figure out how to do that?

Pat: What do you mean? You go online and increase it.

Scott: Okay.

Pat: And then you [inaudible 00:26:22]

Scott: You personally did?

Pat: Myself and my wife.

Scott: Okay. That makes more sense. I'm trying to figure.

Pat: My wife is an accountant. And then we had the discussion whether we should do a deductible or Roth and explained my thinking behind what our decision was.

Scott: And are you doing a deductible or are you doing a Roth?

Pat: Deductible. Deductible. Yeah, I did deductible. Yeah. Yeah. But quite frankly, I live in the state of California and I don't know if I'll live here forever, so.

Scott: Yeah. Or if your kids will.

Pat: Yes. Or if my kids will. And by the way, we're gonna talk about it later on in the show about all the changes in the laws where now their required minimum distributions are now like the year 2033 will be 875.

Scott: There's quite a few. We will talk about that.

Pat: Yeah, we'll talk about it.

Scott: Let's go to calls here and talk with Rudy in California. Rudy, you're with "Allworth's Money Matters."

Rudy: Thank you, Pat and Scott, for taking my call. I'd like to focus on annuities which I'm using to defer some taxable income as well as accumulate wealth. And I like your comment on the annuity, I've invested in. First, you know, I really look forward to your weekly podcast. It's really the only educational investment podcast compared to the other radio shows that I stumble across. One of them talks about the fear of losing 50% in the market. So, they're pushing for annuities. And the other one, like that guy Fisher, he says he'd rather die and go to hell than sell an annuity

Pat: I know. That's a pretty...and I actually, when I saw that ad... When I saw that ad, I thought to myself, "Really? You're not being 100% truthful." Because I would...

Scott: I don't think it was a high proof.

Pat: ...I'd sell an annuity to Scott Hanson if stopped it me from going to hell.

Scott: That's true.

Rudy: So, I know that annuities are...they get pros and cons all over the place. So, some quick personal info. I'm married, adult children and grandchildren. I've been retired for over 10 years. I get a pension, social security dividends, and interests, no earned income, and I'm doing IRA to Roth conversions. And I got three more years before I have to do RMDs.

Pat: Okay.

Rudy: So, my conversions are based on the next Medicare incremental IRMAA limit. I don't wanna go over $228,000 because that'll cost my wife and I an extra 120 bucks a month each, almost $3,000 a year. So, what I'm trying to do is defer taxable income. So, I've invested in this annuity. Actually, I have two of them.

Pat: Oh. One second. So, how much money do you have in IRAs or pension plans?

Rudy: My IRA has about $2.4 million in it.

Pat: And how much do you have in non-qualified money invested outside of the IRAs in a brokerage account?

Rudy: I got a total of, now, just January, $5 million. It was $5.7 last year. So, about $3.5 million. $2.5 million, I mean, another $2.5 million.

Pat: Okay. In taxable accounts and brokerage. And how was that? So, tell me about the annuity. How much did you put into the annuity?

Rudy: The first annuity in the year...from 2013 to 2018, over that five-year period, I put in $300,000. It grew to $520,000, now it's about $450,000. And this annuity is a non-qualified earnings and exchanges within the fund, they're not taxed...

Scott: That's right.

Pat: Yeah, that's right.

Rudy: ...until withdrawal.

Scott: Yeah. You know, it's so interesting. So, annuity, I think I like annuities more for some of their features that they have. Many of them are just too expensive these days for new annuities. We have some clients that have annuities that they had purchased years ago that had guaranteed living benefits. They bought them more for the guaranteed income they would get in the future if something went south. The way the tax structure is set up today, I'm just not a big fan of non-qualified annuities in general.

Pat: So, you have $300,000 that you put into these non-qualified between 2013 and 2018, and then you have another annuity somewhere?

Rudy: Yeah, I started. It's the same type of annuity. The issue with this annuity, first of all, it's got an annual expense ratio of 0.025. It's a more [inaudible 00:30:52]

Scott: Yeah, yeah. You get them really cheap. Yup.

Rudy: Right. Okay. And you can invest in over 60 different funds. The only problem is that when you go to take money out, you have to take your earnings first.

Pat: Yes.

Scott: Yes.

Rudy: So, I got a... Right. So, I started another annuity so that if I wanted to buy a car or something, I could just take all the money out of this annuity and go buy, and I could do it with a lower amount of earnings. With this first one, I gotta take out the first $150,000.

Pat: And how much did you put in the second annuity?

Rudy: I started it at $50,000, right now it's at $46,000. I lost $4,000 this year. Right now, I got 60% in the total market and an S&P fund. And the remaining of it, it wasn't a bond fund, but in raising interest rate environment, I put it into money market, it's making 3.8%. Again, you could put it into as many funds as...

Scott: I understand. It's the taxation that we're in.

Pat: It's the taxation. So, here's the first question. Have you started...you have how many children?

Rudy: I have three adult children. They're between...they're like 40 years old and I get six grandchildren.

Pat: Okay. Have you started gifting to your adult children to get money out of your estate?

Rudy: No.

Pat: Okay. So, look, so you landed on a product as a solution. And so, I would step back for a second and think about this and think...well, look, the estate taxes under current law, you don't have any, but what you just described to me was is that you wanna get stuff out of your estate. You know you're not gonna spend all this money in your lifetime, correct?

Rudy: Right. But what I wanna do is defer income now so I could do more IRA to Roth conversions. I don't wanna keep on getting...

Scott: Yeah. But there's other options besides. The challenge with annuity, you put 100 grand in, you die and it's worth $300,000. That $200,000 of gain is taxable as ordinary income.

Pat: You'd be better off buying a variable universal life policy.

Scott: 100%. Absolutely.

Rudy: Okay. But isn't this the same as putting after-tax money into an IRA? All the accumulation getting...

Scott: Yeah. I'm not a fan of that either.

Pat: Yeah. I wouldn't do that. I mean, I put money into an after-tax IRA, and then I convert it to a Roth IRA the very next day.

Scott: But think about this. So, you said you had a 60-40 split. Another way to do that. What have you just bought? You put 60% and bought a total stock market index fund...

Pat: Which you did.

Scott: ...that yields less than what? See, total stock market yields about 1.2%, I think, somewhere in there, and then the 40% put in munis, which are gonna be tax-free.

Pat: Because what the problem you've...

Scott: And then when...let's assume that you put 100 grand in a total stock market and it's worth 300 grand when you pass on that, that gain is all it's done.

Pat: You never pay a dime in it.

Rudy: Yeah. You know, I put money into a munis funds a few years ago and then I realized when it comes to the IRMAA, the modified adjusted gross income includes [crosstalk 00:33:55]

Scott: You know what? You're talking about saving 3 grand a year in IRMAA?

Rudy: Yeah.

Scott: The amount of tax...the extra excess tax you're gonna pay on these annuities because you're not gonna spend them.

Pat: You're picking up pennies in front of dollars.

Scott: You won't spend these annuities unless the beneficiaries are charities.

Pat: Which isn't a bad idea at this point. Now, I wouldn't put another dime into an annuity. And I understand all the features that you described, right? But it doesn't make sense. And by the way...

Scott: An overfunded variable. Look, you can buy very low-cost life insurance policies. n overfunded life insurance policy would make more sense than this.

Pat: Absolutely. And just turn it into a modified...

Scott: That would be further down the road too before I would.

Pat: Yeah. But I'd start the gifting now. So, we have clients like you and you're like, "I don't wanna pay any more on this and this and this." And I say, "Okay. Here's a list of all the bad things." You've got the least bad thing you're worried about, I'm worried about the most bad thing. And so, these variable annuities that you're buying, you're creating a tax liability for your heirs. And we should not think about what we're doing to you, we should think about how much money are we going to give to the next generation...

Scott: If that's the goal.

Pat: ...if that's the goal.

Scott: And if it's not the goal, then maybe we think about other things about doing with these dollars.

Pat: But it wouldn't be huge.

Scott: And if part of your estate plan is for some go-to charity, maybe you put a little bit into a donor-advised fund along the way to give you a tax deduction today. There's a lot of different... But it seems to me that this annuity product, for s non-qualified annuity, because the taxation is so detrimental, I don't...

Pat: And it's the step up in basis...

Scott: How is it under the current law?

Pat: ...under current law.

Rudy: Well, lemme say, why is the taxation any detrimental as compared to any other investment that grows?

Pat: Because an annuity is taxed as ordinary income at death.

Scott: Not capital gain.

Pat: Not capital gain. And there's no step-up in basis. So, if you had just bought the total market, so you said I've got 60% in the total market inside of this annuity and 40% in cash, if you had just bought the total market, right? you're gonna throw out little bit of dividends, but not a lot. The capital gains are deferred.

Scott: And if you wanna take some cash, you can sell off the shares that have the least amount of appreciation.

Pat: And then what happens is that your death, they pretend that there was no tax ever on any of that growth. Ever. So, this annuity right now, you've...

Scott: With as much as I take, I wouldn't actually. With as much cash as you have, I would not recommend a total stock market index. I'd recommend a direct index strategy where you can actively manage your losses on an annual basis.

Pat: That's right.

Scott: That would serve you much better long-term than this annuity.

Rudy: Okay.

Scott: Our opinion. That was our opinion. Well, he called for our opinion.

Pat: I understand. So, what you're ignoring is the step-up in basis at death. And it's not, it's either you or spouse.

Scott: Or/and capital gain tax

Your capital

Pat: And capital gain tax on...

Scott: Which has been lower for forever, I believe. I don't know.

Rudy: Right. Now, I guess I'm looking at this deferred annuity as if it was like an IRA, which growth in an IRA is gonna be taxed as ordinary income as well.

Scott: That's right. Yeah. But you get the tax deduction.

Rudy: But I agree with you.

Scott: So, you've put up with the downside because you get the tax deduction going in.

Rudy: Right. Yeah. And I can't do that anymore without any earned income. So, maybe I'm too focused on this IRMAA.

Scott: That's right. You are.

Rudy: Because if I go over the $228,000 right now by $10,000, I gotta pay another $3,000. That's 30% just like...

Pat: I understand. But in the scheme of life, right?

Scott: But you're talking... Look, you're in the state of California, it's over 50% tax. Your gain on annuity, over 50% will go to tax.

Pat: So, you're worried about 3 grand and we just...and you recognized $100,000 in tax at some point in time that you didn't need to recognize. And so, you know, quite frankly, with a good financial advisor, we'd sit down and you're like, "What are your objectives? Is it to pass on as much money as possible? Is it to give money to charity? Is it to provide more income? Is it..." And then you go through the list and there is no, you know, magic bullet, there are trade-offs. And what you've done is you made a trade-off.

Scott: You make a lot of wise choices. Like, you're....

Pat: Oh, there's no question.

Scott: ...going to the Roth. I mean, you know what you're doing. Like, we're not...

Pat: There's no question. If you were sitting in my office today, the first thing we'd talk about is gifting money out of your estate if the kids are responsible. And that's the goal. But I assume that it probably is. And then we would look at direct indexing so that we could actually keep this portfolio so it generates almost no income whatsoever. And direct indexing is a mirror of the S&P 500 with individual stocks, but a smaller number. So, you've got a lot of...you've got a great representation.

Scott: Or you can do total stock market or you can do some international as well.

Pat: Yeah. And what you're doing is, rather than buying a total market and a mutual fund, you're buying the components internally. And by the way, if you haven't heard of this, the reason this is becoming much more popular is because the friction in trading has come to zero.

Scott: Yes.

Pat: And so, you could have done this 10 years ago, but the cost of trading costs were prohibitive. So, it offset why you would do this.

Scott: And technology is...

Pat: Much better.

Scott: There's essentially synthetic indexes. And you don't own a, let's say S&B 500, you don't own 500 securities. You might own 150 securities, but it gets close enough. It tracks close enough.

Pat: And then what happens is that if you have a loss in one, you could sell it off against the gain in one of those individual stocks and replicate the...still continue to replicate...

Scott: Anything closely.

Pat: ...the whatever, underlying index. And so, you need a level of sophistication in managing your money that isn't product-based. It should be goal-based, and then products should become secondary. You started with product because you were worried about this $3,000 tax, which, you know, you're picking up pennies in front of dollars. I had this conversation with...

Scott: I mean, all in all, you're doing a good [crosstalk 00:40:21]

Pat: I had this conversation with a client of mine a year ago, and he brought up the same thing. And I said to him, "You know what?" He said, "What, Pat?" I said, "We're not gonna fix that problem."

Scott: We're not gonna worry about it.

Pat: Because the cost of fixing it is too great.

Scott: We're not gonna worry about it. You're gonna pay the tax.

Rudy: And, you know, that's really good. I really appreciate listening to you. It opens up a lot of different thoughts. I mean, I don't get that, necessarily those type of debates with my own advisor there. You know, you bring up a lot of good points. And hopefully, everyone listening to you really appreciates.

Scott: [inaudible 00:40:59]

Pat: And Rudy, Rudy, you know what the problem may be? Is your advisor is responding to you and not leading you.

Rudy: Well, I'm with a brokers firm that has an advisor that talks about brokerage retirement. The annuity department is totally different.

Pat: You don't have advisor.

Scott: Yeah. You don't have an independent advisor.

Pat: Yeah. You've got a... I know where you...you're either at one of these big custodial firms and you go into a local retail office and the person's job there is to...they'd like to, they just don't have the time and energy.

Scott: Their compensation varies based upon the kind of products that people [crosstalk 00:41:36]

Rudy: I used to walk right past your office in Folsom to go upstairs to the one you're talking about.

Pat: Okay. Okay.

Scott: I appreciate the company.

Pat: Well, we're across the street now.

Scott: We might be more expensive though.

Pat: We are more expensive.

Scott: Yes, that is correct.

Pat: Yeah. We're absolutely more expensive, but it doesn't mean that it isn't worth the money.

Scott: Well, I understand. Yeah.

Pat: Yeah. Yeah. $15 billion says otherwise. So, anyway, appreciate the call.

Scott: Yeah, glad you called, Rudy. That was a good, interesting conversation. And look, it's that balance of that current taxation with how's it gonna impact us five years, 10 years, 20 years. And nobody knows the future, it's all probabilities of outcome.

Pat: Yeah. And Scott, let's not forget the friction in trading cost. When I talk about friction, you know, 10 years ago, you would have to pay if I bought this or bought that, or whatever.

Scott: 50 bucks or something. 35 bucks.

Pat: Whatever that number was.

Scott: 20 bucks.

Pat: And then the technology on top of it. So, I mean, we use tax smart trading strategies that have technology...

Scott: With our ETFs.

Pat: ...which makes sense for some clients.

Scott: I mean, if you've got less than a couple million bucks in those portfolios, it'd probably makes sense for that sort of strategy.

Pat: Yeah.

Scott: But when you've got several million and you're looking at investing, it's other options available today.

Pat: Yes.

Scott: And look, annuities by and large, there are places for them. I think last year as an organization, there was, out of our 19,000 clients, there were less than 20 annuity purchases. So, that gives you an idea how little we use them.

Pat: We do use them.

Scott: But 20 out of 19,000, there are times when it'll make sense. And some of the products years ago had these living boxes.

Pat: Oh, they were great years ago.

Scott: Yeah.

Pat: They were great.

Scott: And so, some people own those and they're really glad they owned them and still are.

Pat: And I used them back then and I'm glad I did then, but life changes.

Scott: Life changes. All right. Let's continue on. We're talking with Mark in Colorado. Mark, you're with "Allworth's Money Matters."

Mark: Hey, happy New Year.

Scott: Hey, happy New Year, Mark.

Mark: Let's see. So, I sold my home back in April and it's gonna be a little while before I buy a new place. I'm kind of waiting for perhaps a correction or the prices to kind of come back to earth. And so, I've got a big chunk of change sitting around. I've got about 200k and some change in an E-Trade high yield savings, and then about another 100 in stocks and mutual funds, heavily like dividend paying stocks and tech stocks. So, I'm just...

Scott: So, did you...let me ask you a quick question. So, when you sold your home, how much cash did you...what'd you sell the house for? How much?

Mark: 515k.

Pat: And what was the loan on it?

Mark: And so I have a little over 145k, I wanna say.

Scott: Okay. And so you took the proceeds, you put a couple of hundred thousand in savings and a hundred thousand in stocks?

Mark: Correct.

Pat: How old are you?

Mark: I am 39.

Pat: Married?

Mark: Yes, with three children.

Pat: And what caused you to sell your house?

Mark: We had our third child and pretty much outgrew the place we were living in. It was quite small, so gonna be looking for something larger.

Pat: And how much do you think you'll spend on a new house?

Mark: Oh, I would like to keep it under 800k, but yeah, I guess that kind of depends on the market. We need a five-bedroom, and I would love to go to the Black Forest area. And I think anything five-bedroom in that area is close to a million right now, or over a million even.

Pat: Okay. And how much do you make?

Mark: So, right now I'm actually unemployed, but I'm hoping an offer will come down any day now and I'll probably be making around 140k a year.

Pat: And does your spouse work outside of the home?

Mark: Nope, she stays home with the children.

Pat: Okay. And when you say the Black Forest, I assume that's in Colorado, not in Germany.

Mark: That's correct.

Scott: I was trying to think, "Where's the Black Forest?"

Pat: It's a local.

Scott: Yeah.

Pat: The only black forest I know of is the cake, and the place in Germany.

Scott: I just knew the one in Germany. I didn't think he was talking about moving to Germany.

Pat: So, I don't know if I would've put that $100,000...

Scott: I wouldn't keep it in stocks.

Pat: ...in stocks.

Mark: Okay. Yeah, it's been kind of painful already. I think I'm down like 14% or something like that.

Pat: And the reason behind that is your timeframe. Not that stocks aren't a bad place to be, but it's based on timeframes. And your timeframe is too short. Your timeframe...

Scott: We don't even know what your timeframe is.

Pat: You know, so I have a...

Mark: Yeah.

Scott: Because you're renting a place now, you might get a notification you gotta be out in three months and you can't...

Mark: That's right.

Scott: Right? And you can't find somewhere decent to rent, so you end up buying something.

Pat: So, I had the same discussion with one of my children and I said, "Look, it could be six months, it could be a year, it could be a year and a half, it could be two years, it could be based upon your life, it could be based upon the markets, but you want those dollars to be completely liquid without market risk." And that's why I would actually chalk that stock up and say that was a bad mistake, we take the hit, you know, if it's a $14,000 hit. And then your high yield account that you said at E-Trade should probably be yielding 3% plus?

Mark: Yeah, close to that.

Pat: Okay.

Scott: Yeah. I just looked to see whatever is the highest yielding account.

Pat: That's right.

Scott: You can go to like bankrate.com or, they'll tell you something.

Pat: Even, you know, six-month treasury. So, you can go treasury direct. That might be an alternative as well. It's just a little bit more work on your part, and there is some market risk.

Scott: Yeah. You're probably just better off in a high yield savings account where it's liquid.

Pat: That's right, 100% liquid.

Scott: And I'd be a little careful on confusing some wants and needs because you're 39. I don't know. We haven't even talked about your retirement, whether you've got tons saved or little saved, but...

Pat: Well, do you have money saved for retirement?

Mark: I do.

Pat: How much do you have saved?

Mark: I haven't looked at it in a while, but it's around 300k.

Scott: Okay.

Pat: All right.

Scott: I mean, you wanna be in a position where you can still save 10% to 15% of your pay towards old age money and...

Mark: Yeah.

Scott: And so, when you're looking at...you know, I'd really do some planning, run some numbers of, if you bought a $700,000 house today with a mortgage, what's that gonna look like? If it was an $800,000, what's that gonna look like?

Pat: A million. Whatever the number is. And...

Scott: So, you have an idea. Everything is a trade-off.

Pat: Yeah. And when you talk about Scott, you're talking about wants and needs. When he talked about, "Well, we need more room," I thought, "Meh, I grew up in a family of five kids."

Scott: And how big a house were you in? Five kids.

Pat: Eight, 1,600.

Scott: Did you have two bathrooms or one?

Pat: We added a bathroom.

Scott: Okay.

Pat: It was like the size of an RV bathroom though. It actually had one...it had a plastic door on it that would slid back and forth. Yeah, the difference between wants and needs. But for years and years, it was the two-bathroom.

Scott: You were all boys and one girl, right?

Pat: Yeah.

Scott: Your poor sister.

Pat: Oh, we stopped. So anyway, but when you go out to purchase that house, you wanna go in there with budget in mind and make sure that you could still continue to save money for your old age. All righty?

Mark: Yup. Okay. That makes sense.

Pat: Appreciate the call.

Mark: So, I have another thing to run by you. And then this would take maybe around 100k of it. It's kind of an investment opportunity with a company here in Colorado Springs where I would buy a home and lease it out to this company for five years.

Pat: Wouldn't touch it.

Mark: So, I felt like...wouldn't touch it. Okay.

Pat: No, wouldn't touch it.

Mark: No other details needed. Just don't touch it.

Pat: No, no. Wouldn't touch it. Would not touch it. So, what they're looking to do is actually get your cash, put leverage on your cash, and then work it for...

Scott: And if the markets...if the real estate market is flat, then you lose. And if it goes up, they win.

Pat: Yeah. It's...yeah, wouldn't touch it. You're not at that risk profile now where you could be taking $100,000 of this $300,000 with three kids at home.

Scott: I would keep... Look, this is cash for a house. Obviously, he sold at a good time last April, right?

Pat: We think. Time will tell, but...

Scott: Well, 20 years down, I'm sure the house that he sold will be worth much more than he sold it for, right?

Pat: Yes.

Scott: It goes through short-term cycles like everything else. But that cash that you took from that house, that needs to stay in cash because you put it somewhere else. Stocks are great for long-term investment, and long-term meaning five-plus years. If you need money prior to five years, or you think you'll need money in less than five years, you should not have any of it tied up in stocks because they're so volatile.

Pat: Yeah. It's too much risk.

Scott: Short term, they go all over the place.

Pat: Yes. Yeah. And this money should stay in the house. So, appreciate the call.

Scott: We're out of time. And we said we were gonna talk about the 401(k) changes, which we will talk about the next show. It's not that riveting, but...

Pat: It isn't. It isn't. It is not that riveting.

Scott: It's not that riveting, but it's important to note so we'll talk about it next show. Anyway, we're out of time. As usual, it's been good being with you. I wanna let everyone know we've got a call-in session. We're gonna be sitting in the studio taking calls Thursday, January 19th from 3:00 to 4:00 Pacific. Email us at questions@moneymatters.com right now to sign up. See you next week.

Announcer: This program has been brought to you by Allworth Financial, a registered investment advisory firm. Any ideas presented during this program are not intended to provide specific financial advice. You should consult your own financial advisor, tax consultant, or estate planning attorney to conduct your own due diligence.