The Value of Debt in Retirement Why Everything You Have Been Told Is Wrong Thomas J Anderson Cover design: Wiley Copyright © 2015 by Thomas J Anderson All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at www.wiley.com/go/permissions Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose No warranty may be created or extended by sales representatives or written sales materials The information in individual chapters of this book is to be considered in a holistic way as a part of the book and not to be considered on a stand-alone basis This includes, but is not limited to, the discussion of risks of each of these ideas as well as all of the disclaimers throughout the book The advice and strategies contained herein may not be suitable for your situation The material is presented with a goal of encouraging thoughtful conversation and rigorous debate on the risks and potential benefits of the concepts between you and your advisors based on your unique situation, risk tolerance, and goals Y ou should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993, or fax (317) 5724002 Wiley publishes in a variety of print and electronic formats and by print-on-demand Some material included with standard print versions of this book may not be included in e-books or in print-on-demand If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com For more information about Wiley products, visit www.wiley.com Library of Congress Cataloging-in-Publication Data: Anderson, Thomas J (Certified investment management analyst) The value of debt in retirement : why everything you have been told is wrong / Thomas J Anderson pages cm Includes bibliographical references and index ISBN 978-1-119-01998-5 (hardback); ISBN 978-1-119-02001-1 (epdf); ISBN 978-1-119-02000-4 (epub) Finance, Personal Retirement—Planning I Title HG179.A5597628 2015 332.7084′6—dc23 2014049407 This book is dedicated to two very special sets of retirees who have given me the insight and unconditional love necessary to write this book: Grandpa John & Grandma Kay Kay Marty & Julianne Smith Contents Foreword Acknowledgments Introduction Caution: You Could Burn Your House Down Baking a Cake! Notes PART I: BASIC IDEAS AND CORE CONCEPTS Chapter 1: A Better Path A Successful but Controversial Debut The Fifth Indebted Strength Who Can Benefit from This Book? Not Only Millionaires! (But They Can, Too) Everyday Example #1: Immediately Better Credit Card Debt Getting beyond the ABLF and Focusing on Retirement Notes Chapter 2: Debt in Retirement What Some Popular Retirement Books Get Right—and Wrong—about Debt The “Good versus Bad” Debt Camp Bach Where We Started: The Irresolutely “Against Debt” Camp The (Very Small) “Sometimes It’s Okay to Have Debt” Camp Everyday Example #2: A Bridge Loan over Troubled Quarters Notes Chapter 3: Why and Whether to Adopt a Holistic Debt-Inclusive Approach in Retirement A First Look at the Three Main Types of Debt: Oppressive, Working, and Enriching Seven Rules for Being a Better Debtor In the Company of Longer Life Spans Winging Your Way to a Successful Retirement: The “Whole Chicken” Approach Everyday Example #3: A Holistic Business Recipe for Success Notes PART II: THE POWER OF DEBT IN REDUCING TAXES, INCREASING RETURN, AND REDUCING RISK Chapter 4: Returning to the Return You Need Cash Flow and Incoming Money: The Ultimate Key to Resource Management You Have to Get Your Numbers Right! Regardless of Your Net Worth, Distributions Are Rarely Constant over Time in Retirement How Much Can You Safely Take Out? How You May Be Able to Increase Your Rate of Return How Is This Possible? A Big-Picture Overview Risks and Problems Everyday Example #4: Retiring the “Loan” Survivor Notes Chapter 5: The Power of Debt Meets Our Ridiculous Tax Code Some Brief Preliminaries: Income versus Incoming Money The Websters: A Tale That Taxes the Imagination Your De Facto Tax Advisor An Inconvenient Truth How to Pay Almost No Taxes in Retirement: A Few More Examples Everyday Example #5: “Auto” You Not Be Sure You Are Getting the Best Loan? Notes Chapter 6: Risk Matters More Than Return Why Your Personal Risk Tolerance May Not Matter A Simple Understanding of Risk An Overview: “What Time Is It?” A Detailed Understanding: “How the Watch Works” Proof That Debt Can Reduce Your Risk in Retirement Everyday Example #6: A Lot to Think About? Not Really Notes PART III: HOW TO GET THERE: A GLIDE PATH Chapter 7: The World Is Full of Risk—Especially Now Not Your Usual Serious Caution Learning from What Companies Do—Value Liquidity! What about Interest Rate Risk? Fixed versus Floating Rate Debt Investment Risks: It Isn’t the Debt That Matters, It Is the Quality of Your Investment Decisions! Asset Allocation and Investment Considerations A Six-Step Approach to Diversified Investing in Retirement Lessons from Math and History Suggest Caution Be Careful What You Watch! My Opinions on Asset Allocation Notes Chapter 8: The Sooner the Better Understanding the Implications of These Ideas for Your Life Plans Getting a Handle on Whether You Should Adopt a Strategic Debt Approach The Need-Want-Have Matrix Watch Those Ratios! A First Glide Path into Retirement What If You Are Not Optimal Today? Dying with Debt? Final Mortgage Considerations Notes Chapter 9: Conclusion A Checklist Review Bringing It All Together: A Strategic Debt Strategy in Action A Last Word: The Value of Debt in Retirement Notes PART IV: GUIDES Guide 1: Leaving a Legacy General Giving Philosophy The Benefits of Giving While You’re Working Giving to Create Income Notes Guide 2: Managing the ROI of Retirement Retirement “ROI”: Resources, Outer Pragmatics, and Inner Dynamics Retirement Is Coming: A Holistic Roadmap of the Territory before You Retire Meta-Management against a Background of Accelerating Change Staying Effective and Informed over Time Resource Management for the Long Haul Partial Retirement/Partial Income You Can Test-Run Retirement Real Estate, Small Business Ventures, and Personal Guarantees Medicare Long-Term Care Insurance Thoughts on Life Insurance Reverse Mortgages How You Should (or Should Not) Factor in Inheritance Outer Pragmatics: Real World Concerns, Issues, and Details Legal Planning Medical Planning Residency Planning Life Planning Inner Dynamics: Meaning, Purpose, and Pleasure in Retirement Sharpening the Saw Particular Considerations on Retirement and ROI for the LGBT Community Notes Guide 3: How to Help Your Family and Buy the Stuff You Want and Need Act Like a Company/Think Like a CFO Principles When Financing the Purchase of a Desired Item Managing Credit Card Debt Helping Your Kids with Their Credit Card Debt Helping Your Parents Buying a Luxury Car Buying a Boat/Airplane/Art/Antiques/Jewelry, Paying for a Dream Vacation, Financing a Hobby (Horseback Riding, Car Racing) Paying for Fractional Ownership (Home/Plane/Boat) Helping Out Our Kids and Student Loans Homes: Downsizing/Moving/Building Purchasing a Second Home: Pluses and Minuses Rent versus Buy a Second Home One Hundred Percent Financing: The No-Down-Payment Real Estate Purchase Option Notes PART V: APPENDICES Appendix A: About the Companion Website Appendix B: Details for Chapter Understanding the Ideas of Chapter 4, with Charts and Tables Notes Appendix C: Chapter Detail Understanding RMDs The Liger at Work Again Understanding Cost Basis and a Step-Up in Basis Notes Appendix D: Details for Chapter 6— A Study of Withdrawal Rates in Retirement Background: How the Percent Rule Came to Life Trinity Study Results Trinity Study: Unfortunate Timing Notes Appendix E: A More Detailed Discussion on Risk, Return, and Correlation Notes Appendix F: More Detail on ABLF, Risk Details, and Official Statement of Disclosure and Understanding More Detail on ABLF Statement of Disclosure and Understanding With Respect to ABLFs Additional Important Notes Notes Glossary Bibliography About the Author Note Index EULA List of Tables Chapter Table 3.1 Chapter Table 4.1 Chapter Table 5.1 Table 5.2 Table 5.3 Chapter Table 6.1 Table 6.1 Table 6.2 Table 6.3 Table 6.4 Table 6.5 Table 6.6 Table 6.7 Chapter Table 7.1 Table 7.2 Chapter Table 8.1 Guide Table G2.1 Appendix B Table B.1 Table B.2 Table B.3 Table B.4 Table B.5 Appendix C Table C.1 Appendix D Table D.1 Table D.2 Table D.3 List of Illustrations Introduction Figure I.1 Strategic Use of Debt in Retirement May Help You Chapter Property taxes: second homes and in Websters' scenario Prospect Theory Purchase of desired items, principles for Purpose, in retirement Purpose loans, asset-based loan facilities and Ramsey, Dave Rate of return creating, traditional vs potentially lower-risk way enriching debt and future net worth and increasing risk equally important as risk in terms of standard deviation and strategic use of debt and targeting relative to cost of debt test running retirement and Trinity Study and Real estate commissions no-down-payment purchase option residential, inflation and Recreation Reeve, Christopher Refinancing: debt mortgage Reinvestment risk, bonds and Relative debt, risks to economies and high levels of Religious community, retirement and Remodeling costs, second homes and Renard, Jules Rental contracts Renting, second homes Repairs, rental contracts and Replacement number, goals-based asset-allocation strategy and Replacement ratio Required Minimum Distributions defined from IRAs starting age for understanding Residency issues, Outer Pragmatics Planning Table and Residency planning Residential real estate, inflation and Resource allocation, life insurance and Resource management for the long haul in retirement “ROI” roadmap for measuring ROI of retirement and strategic debt and Restaurant business, holistic recipe for success Retirement: creating projected yearly budget for death and delaying getting beyond ABLF and focusing on LGBT community and not being on track for, things to consider test running value of debt in Retirement home, securities-based line of credit and Retirement planning, correct numbers needed for Retirement “ROI”: resources, inner dynamics, and outer pragmatics in roadmap for measurement of Retirement savings assets, creditor protection status of Return: Efficient Frontier, and optimal combination of risk and right trade-off between risk and Return on investment, capturing the spread and Reverse mortgages Reward, risk and Risk/return tradeoff actual expected Risk(s): asset allocation and bonds and Chinese Pompeii and debt and reduction of, in retirement debt ratio ramp-ups and diversification and Efficient Frontier, and optimal combination of return and endogenous as equally important as rate of return equities and exogenous high-yield bonds and liquidity, flexibility, and minimizing in investing, six strategies for multiple, investing with leverage and in municipal, corporate, and high-yield bonds municipal bonds and potential, identification of reward and right trade-off between return and standard deviation and understanding Risk tolerance defined needs and personal RMDs See Required Minimum Distributions Rollover risk, investing with leverage and Romney family, effective tax rate for Roth IRAs: making right assumptions about no distribution requirements for retirement income and traditional IRAs versus Rubin, Gretchen “Rule of thirds” Russell Sage Foundation SAGE Samuelsson, Marcus Savings Scenario analysis: for paying almost no taxes in retirement: more examples for ultra-high-net-worth investors in Websters' example for withdrawal rates in retirement Schilling, David Schwab Schwab-Pomerantz, Carrie Second homes depreciation of direct or opportunity costs and fractional ownership programs and liquidity and no-down-payment purchase option for purchasing: pluses and minuses renting versus buying taxes and operating costs for up-front transaction costs for utility aspect tied to Securities-based line of credit See also Line of credit credit card debt and dream retirement home and flexibility of terms and fractional ownership paid for with giving strategies and optimal debt ratio and Securities-Based Loans Self-mastery Sequence of returns in accumulation with distributions importance of, with/without debt lower volatility portfolio with no debt lower volatility with no debt in reverse one million dollars—no distributions reverse order understanding importance of withdrawal rates in retirement and withdrawal reverse order Seven Habits of Highly Effective People (Covey) Sharpening the Saw (Covey's seventh habit) Shiller price earnings multiple Short-term gains, missing out on Sinking funds Small business loans, as working debt Small business ventures Social/emotional activities, examples of Social Security benefits conservative and aggressive ways to approach LGBT community and spousal benefits strategies and tools for Websters' example and professional/detail notes on Social Security Administration, Life Expectancy Calculator Social support “Sometimes it's OK to have debt” camp S&P 500 Spiritual activities, examples of Spousal benefits, Social Security and Standard deviation: of portfolio, debt ratio relative to risk measured in terms of Standard of living, maintaining Standby Letters of Credit Statement of disclosure and understanding State taxes State tax exemption, municipal bonds and Staying effective and informed over time Step-up in basis: defined strategic debt strategy and Stock market (U.S.), historic trends in Stocks: annualized withdrawal rate as a percent of initial portfolio value Bengen's percent rule and borrowing portfolio, withdrawal rates, and developed international emerging-market math and history framework applied to non-borrowing portfolio, withdrawal rates, and rate of return and returns with/without debt, 1946-2013, annualized withdrawal rate as of initial portfolio value Trinity Study, withdrawal rates, and U.S Stop Guessing With Your Money theme Strategic Debt Philosophy adopting and getting handle on factors to examine in context of four key qualities or Indebted Strengths of increasing life spans and ultra-high-net-worth investors who don't know about Strategic debt strategy in action average person and avoiding misapplication of goals tied to net worth and rate of return and step-up in basis and wise use of Stress testing, portfolio, for broad range of outcomes Student loan debt: helping kids with retiring Super rich, strategies of Surrenders, life insurance, tax liability, and Survivability enriching debt and increased, Five Indebted Strengths and value of liquidity and Survival issues, impact of financial distress and “Sustainable Withdrawal Rates from Your Retirement Portfolio” (Cooley, Hubbard, and Walz) See also Trinity Study Synergy, defined Taft, William Howard Target date funds Taxable income, in Websters' scenario Taxable investment accounts: hybrid borrow-and-sell model and lines of credit set up against Tax advisors, consulting with Tax deductible expenses, in Websters' scenario Tax deductions, giving while you're working and Tax-deferred accounts: Required Minimum Distributions and taxable accounts in combination with Tax-efficient situations, debt aversion and Taxes: estate planning and life insurance surrenders and portfolio line of credit and proper debt strategy and near-elimination of rental contracts and in retirement Roth IRA versus traditional IRA and second homes and Tax laws, complexity of Tax loopholes Tax penalties Taylor, Candace T bills, annualized withdrawal rate as a percent of initial portfolio value Time horizon Title insurance, second homes and Titling of assets “Top-down” approach, retirement calculations and Total assets, enriching debt and Total Money Makeover (Ramsey) Total taxable income before deductions, in Websters' scenario Tracing rules Transaction costs, up-front, second homes and Transportation Travel Treasury Bills Trinity Study: comparison: “traditional way” versus an alternative allocation with gold and debt giving and inflation addressed by main objective of stock and bond portfolio and, summary of unfortunate timing of updated version of summary table withdrawal rates in retirement and Trusts TurboTax TaxCaster tool (Intuit) donations for the Websters final estimated taxes due for the Websters house deductions for the Websters income tax estimate for the Websters other deductions for the Websters other Liger examples and personal information for the Websters tax deductions for the Websters total taxable income before deductions for the Websters Ultra-high-net-worth investors: lower yield with levered portfolio and return for Strategic Debt Philosophy and two scenarios compared for without a debt strategy Umbrella policy insurance Uncertainty Uniform Lifetime Table (IRS) United States: over-indebtedness in, problem solving and percentage of world economy comprised by United States Department of the Treasury U.S bonds U.S stocks U.S Tax Code U.S.-centric portfolios, projected returns in Vacation homes Vacations, paying for Valuations, expected returns and Value of Debt¯ Value of portfolio, ABLFs and risk with Vanguard Variance Volatility of asset portfolio, debt-to-asset ratio and high-yield bonds and income from portfolio and international bonds and standard deviation and Volatility risk, investing with leverage and Volunteering WACC See Weighted average cost of capital Wall Street Journal Walz, Daniel Wanting debt, questioning yourself about Want-need-have matrix Wants, optimal debt ratio glide path and Watts, Allen Wealth amplification, enriching debt and WealthManagement.Com Wealth managers, finding and working with Wealth-transfer planning Wealth transition Websters' scenario and strategic debt strategy balance sheet donations final estimated taxes due generation of sufficient cash flow in retirement house deductions income tax estimate other deductions other income personal information portfolio professional/detail notes on taxable income tax-deductible expenses total taxable income before deductions Weighted average cost of capital Weimer Republic, Germany “Well-diversified” portfolios, correlation and Wellness “Whole chicken” approach, to successful retirement Wills Winner's Circle, The: Asset Allocation from America's Best Financial Advisors Withdrawal rates in retirement annualized return rate as a percent of initial portfolio value borrowing portfolio, survivability, and borrowing portfolios have higher success rate in every portfolio allocation borrowing portfolio withdrawal equation debt ratios and percent rule and historical returns and methodology for study on non-borrowing portfolio withdrawal equation portfolio success rate with inflation-adjusted monthly withdrawals: 1926 to 1997 portfolio success rate with inflation-adjusted monthly withdrawals: 1946 to 1997 returns with/without debt, 1946-2013 Trinity Study: unfortunate timing and Trinity Study results Trinity Study summary: 50 percent stock/50 percent bond portfolio Wooden, John Working, giving during years of, benefits of Working debt amount of assets held by those with assets, debt overlay, and in continuum of debt evolution of, over time examples and impact of need-want-have matrix and opportunity to change course and retirement and difficulty in acquiring World economy, United States as percentage of World-neutral view, of asset allocation Yield to maturity, bonds' future returns and Zelinski, Ernie J Zuckerberg, Mark WILEY END USER LICENSE AGREEMENT Go to www.wiley.com/go/eula to access Wiley’s ebook EULA ... (Certified investment management analyst) The value of debt in retirement : why everything you have been told is wrong / Thomas J Anderson pages cm Includes bibliographical references and index ISBN.. .The Value of Debt in Retirement Why Everything You Have Been Told Is Wrong Thomas J Anderson Cover design: Wiley Copyright © 2015 by Thomas J Anderson All rights reserved Published by... The Olin School of Business at Washington University in St Louis that is helping further develop some of the academic studies outlined within this book I would like to highlight the efforts of