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Sarah Stanley Fallaw

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Published On

May 21, 2019

Dr. Sarah Stanley Fallaw (co-author, The Next Millionaire Next Door) shares the findings of her research into how millionaires become wealthy, and what she found has changed since her father’s groundbreaking book The Millionaire Next Door was released in 1996. Plus, what should you do with universal life insurance policies with large cash values? Will you pay income tax on a Roth conversion made after you move from California to a no-income-tax state like Texas?

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Show Notes

(00:47) Dr. Sarah Stanley Fallaw: The Next Millionaire Next Door
(21:06) What Should I Do With My Cash Value Universal Life Insurance? (video)
(39:14) Will I Pay California Income Tax on a Roth Conversion After I Move to Texas?

Transcription

What does it take to be the millionaire next door, and how has that millionaire changed since the book with that title, by Drs. Thomas J. Stanley and William Danko, was released in 1996? Today on Your Money, Your Wealth®, Thomas J. Stanley’s daughter, Dr. Sarah Stanley Fallaw, shares what she learned in writing The Next Millionaire Next Door with her father. Thomas Stanley passed in 2015. Dr. Fallaw completed their book and released it in late 2018. Plus, Joe and Big Al answer your money questions: what to do with universal life insurance policies with large cash values? And will you pay California income tax on a Roth conversion made after you move from California to a no-income-tax state like Texas? I’m producer Andi Last, and here with our guest are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

00:47 – Dr. Sarah Stanley Fallaw: The Next Millionaire Next Door

Joe: Dr. Sarah Stanley Fallaw.

Sarah: Yes exactly. Thanks for having me. Glad to be here.

Joe: You are an industrial psychologist, you’re Director of Research at the Affluent Market Institute and the founder and president of DataPoints.

Sarah: Yes.

Joe: And you have a book that came out, it was a couple of decades after your father wrote one of the better personal finance books, The Millionaire Next Door, and so the book that came out is The Next Millionaire Next Door.

Sarah: Yes absolutely. So it’s been kind of been a family affair if you will for a long time< and the book came out in October and it really looked at how things have changed over the last 20 plus years in terms of what self-made affluent Americans look like.

Joe: Yeah. Your father’s book was like mandatory reading when I got into the business about 20 years ago. Well let’s start here for some of our listeners, we have a lot of listeners that have probably lived under a rock and are not familiar with your father’s book.

Al: Yeah, or they’re younger

Joe: Could be. Could you tell a little bit about the research that your dad did in his book, and then why 20 some odd years later you guys decide,” hey let’s do this again.” I’m curious on the studies and the research that you did what you found was different and what you found was it was the same.

Sarah: My father was a marketing research professor for a long time, that was his focus. He really was focused on understanding affluent Americans and kind of how they became that way. And one of the segments that he found early on in his research back in the 80s was this self-made blue-collar millionaire, which he eventually deemed “the millionaire next door.” And so he really looked at the behaviors and the attitudes and the lifestyle of these folks that were able to take their income and transform it into wealth on their own, again, without inheriting a bunch of money or signing some kind of major league contract or something like that. And so that book was published in ’96 when I was, let’s see, a junior in college. I think that’s right. And really, what he found, again, that there were certain habits – of course a lot of us know what those are and it’s pretty straightforward. But in ’96 it wasn’t. So things like being frugal, spending time managing your investments, all those things that kind of we know today lead to wealth were sort of new, if you will, back then. And so, over the last several years I began working closely with him, and as the 20th anniversary was coming up, we started looking at maybe things have changed. Maybe with the advent of a lot of the technologies that are out there that can help you manage finances and also distract you from managing finances, what’s changed? And so we began that journey to see what was different and if there was anything different.

Joe: Junior in college. So your dad writes this epic book, probably finance wasn’t on the radar at that point, or were you going to follow in your father’s footsteps at that point?

Sarah: Yeah so. So I was a junior at the University of Georgia and I had other things going on. Do you know what I mean? (laughs)

Joe: You know what Sarah, I was a junior myself the same year, but I was a junior at the University of Florida.

Al: And he had other things on his mind too.

Joe: Yeah trust me,I had a lot of other things on my mind as well.

Sarah: Yeah, so it’s funny, again, I am a psychologist so my interest has always been why we do the things that we do, and finance was not, it was NOT on the radar, for sure. That was not something that I was interested in. I loved the research side of what he did. So the survey research, and the methodologies used, and all of that. But it really was later on, after having worked in human resources technology and human resources specifically, that I began seeing, “hey, there’s a way to take this information and actually create assessments,” which is what my company does. But then again also study how people can be more satisfied in terms of the job that they have. Well, if they’re managing their finances at home well, things are going to be better in terms of their job satisfaction and performance and things like that. So that’s kind of how we kind of merged together if you will. several years ago.

Joe: I’m thinking we probably crossed paths at the biggest cocktail parties.

Sarah: In Jacksonville, right. We may not remember it, but… (laughs)

Andi: Since you were both juniors in college, yes. (laughs)

Joe: I guarantee you we probably don’t remember that. (laughs) Well, that was many years ago.

Sarah: Yes. Many years ago. That’s right.

Joe: Too bad I haven’t grown up yet. (laughs) So tell us what’s changed? There were millionaires then. There are millionaires now. Are there different habits? Are people doing different things to find that wealth?

Sarah: So the differences are primarily in the spending. So for example, we see quite a difference in terms of how much they’re spending on homes and things like that. Of course, there’s some inflation and things like that that we have to take into account. And we also see, of course, there’s an increase in the number of millionaires in the study we did a couple of years ago, in terms of their education. So having a bachelors degree is almost like having a high school degree was 20, 30 years ago. And so we see more millionaires that reported going to graduate school and things like that as well. So of course, those are extra costs that you have to think about. But in terms of the behaviors and sort of the things – again, being frugal, spending time managing your finances and things like that, those haven’t changed. And the differences between people that are really, really good at building wealth over time and those that struggle with it, even if they have the same income, for example, those differences still appear. Things like being frugal, having a budget and really sticking to that, especially in the early part of their journey, if you will.

Al: Boy, I’ll tell you when I first read your dad’s book years ago, to me it was really refreshing, because when you’re younger you kind of have the impression that the people that become millionaires either inherit the money, or they have a really big income or something like that, and you see people driving fancy cars and, “gosh, I wish I was like that. I guess I won’t be like that.” And then you realize that a millionaire – it’s more of a mindset. It almost doesn’t really matter what your income is, as long as you’re spending below your means and the people that get there – and that’s why it’s such a neat premise is that anyone can become a millionaire next door. The actual principles haven’t really changed that much.

Sarah: That’s right. And I think too we’ve had people mention to us on multiple occasions that, “OK well, even a million dollars isn’t that much anymore,” which I say, “Well, then tell that to someone that doesn’t have that yet.” (laughs) And things like that. So it really too is just kind of your definition of financial success. Maybe it’s a million dollars, maybe it’s two million dollars, but the same behaviors, the same kinds of habits are gonna get you there.

Andi: The ability to use that million dollars – in 1996 it went a lot further than it does now so maybe the next book will be The Billionaire Next Door.

Al: Right, or the Multi-Millionaire Next Door.

Sarah: The Deca-Millionaire, right, exactly.

Joe: I saw a study in San Francisco there’s like one out of every 11,000 people is a billionaire. That’s pretty incredible.

Sarah: That is incredible. Yeah definitely.

Joe: Piggybacking off what Alan says, let’s say if I was an individual that made $50,000-$60,000, and it’s like, “there is no way that I could ever amass a million dollars.” Was there a certain income range where you found it in the studies that if someone made a certain amount of income they had a better chance? Or was it even if someone made $60,000 a year, it was their habits of being frugal and making sure that they saved, where the income didn’t necessarily matter?

Sarah: So we’ve done a lot of different studies out there in addition to the millionaire study that was in the book. And what we found is regardless of sort of your age or your income level, if you have these certain behaviors, kind of behavioral patterns if you will, things that you do all the time, they tend to predict net worth regardless of how old you are or how much you make. So if you take two folks, they’re making the same amount, they’re both 40 years old. One of them can ignore what their neighbors are driving. They take on responsibility for their financial success. And again, they’re more frugal and they maybe make better decisions in terms of being confident about their finances – that individual will have a better chance of building wealth over time. And if you’re not in that camp, so today maybe you’re lacking some confidence or knowledge about finances, or you tend to really pay attention to what’s going on on social media related to where people are going on vacation and who got a new car and all of that. Those are things that you can change. Those are things that you can change over time. And so I think that, again, even if you’re today not in a position if you will in terms of your habits and behaviors to build wealth, the good news is that you can change those.

Joe: We’ve had several people on this show that have written books in some are good, and some are…

Sarah: Oh dear.

Joe: Not so good. But there are a few books that inspire or make people change. And your book did that in a sense – you read through it and you’re like, I don’t care where you’re at. You can get to a certain level if you just change minor behaviors. And it’s just little tweaks. I think, what, Sabatier…

Andi: Grant Sabatier and his book Financial Freedom.

Joe: So then it’s like here, all you gotta do is just maybe save an extra dollar a month – or extra a percentage. A percentage of my income, it’s a dollar, all right? (laughs)

Al: True, It’s one and the same. (laughs)

Joe: It’s same-same. it’s like okay, I can see these baby little steps, they help me to get the wealth. And I think with your book, it’s like, anyone can do this if they have the right mindset and if they can put themselves in the right behaviors. And if you can get that mindset or get excited or get motivated to take control of your finances, I think that is so much more powerful than reading a book of tax code or other things.

Sarah: Yeah. Definitely. I think that’s where the psychology comes in for sure is setting goals that are meaningful to you and keeping that in mind as you make those small changes. Because if somebody tells me I need to only go to Starbucks twice a week and that’s going to be part of my plan, that’s meaningless if I don’t have this sort of overarching goal of saving a certain amount or preparing for my child’s college education or something like that. So I think that that’s where that comes in, and you’re right they are baby steps. There’s a great book by Charles Duhigg called Habit where he really – he’s not a psychologist but he dives into the psychology of changing some of those things that are just habits for us. And I really like the way that he talks about making some of those small changes so that they actually stick.

Al: My parents were born in the Depression years and they’re still around in their 80s and they learned how to be frugal just because that’s what everybody did during the Depression – there was no choice. They stuck with those habits their entire life. And now they’re retired of course, and they’ve got plenty of money but they can’t spend. And is any of your research for folks that get into this mindset – which is a great mindset, but how do you kind of then at some point be able to say, “We’ve done a great job how can we enjoy some of this a little bit more?”

Sarah: Yeah. So we don’t study that too much, other than to say that those same behaviors that allow you to build wealth allow you to sustain wealth. But to your point, if it’s time to sort of spend and enjoy what you’ve made, that too takes that habit change because you’ve spent your entire life trying to accumulate and save and be very thoughtful about that. Obviously, they’ve got behaviors that are – they had some very significant life experiences that led them to those behaviors, so now it’s really going to take some work to sort of change those over time. But certainly, it’s the same kind of steps that you go through to change, to take someone that’s not living below their means and have them kind of focus on that.

Joe: Were there any major surprises writing The Next Millionaire Next Door?

Sarah: I think the big surprise to me was, we focused a lot on sort of investing mistakes in the book and in the study. We asked sort of practical applications of some of those cognitive biases, like gambler’s fallacy and things like that. And we found that millionaires they reported making quite a few mistakes in terms of investments. And I think to me what that signaled was, again, for individuals who think, “investing is not for me. I’m not taking a chance. I saw what happened in 2007, 8, 9,” millionaires, they spend the time to study their investments. They are continuing to invest despite some of the things that have happened in the past and the choices that they’ve made. It’s that time that they spend, again, building their knowledge and really doing a good job at investing that’s allowing them to be successful. So I thought that that was pretty interesting given that there are so many studies out there now talking about Millennials, Gen Y folks, that are saying, “investing is really not for me.” And so that’s, again, another reason why understanding how people that are successful at building wealth, they’re good role models.

Joe: Without question – and the behavior side is really intriguing. I guess it’s been now over the last 10 years – it’s probably been longer than that, where behavioral finance is on the forefront of, you can have a really crappy mutual fund but as long as you kind of stick with your plan, you’re probably going to do a hell of a lot better than most investors because they’re getting in and out of the overall markets or there’s the recency bias and everything else. I saw a study of 57% of people that own exchange-traded funds get out prior than a year. it’s crazy. So they’re day trading products that should be just kind of bought and held for the long term. You dive into the behavioral side of things. What are some of the things that people can do just so we’re not idiots? What the hell do we gotta do to stop this?

Sarah: Well we talk about that a little bit in terms of kind of the holding period. So millionaires are not day traders and specifically, prodigious accumulators of wealth, which is a fancy way of saying people that are really good at transforming their income into wealth, they tend to hold their investments for quite a while. So again, I think on average it ends up being about three to five years, so they’re not in and out of the market too terribly much. And so that’s one of the pieces as well. I think that, again, going back to kind of what you can do – these folks tend to spend time managing their finances and set aside time to do that. We’ve seen that consistently whether we’re talking about people that are sort of emerging affluent, they’re just kind of on their way, to those that are millionaires and deca-millionaires. They set aside time each month. Time that’s not distracted by social media or what have you to really focus on building knowledge and understanding what’s going on in their financial lives, not keeping their head in the sand, that kind of thing as well.

Joe: Do you have, like a crazy amount of pressure? What I mean by that is that you and I are similar age, and your father wrote this book that kind of changed the lives of a lot of finance people and then plus everyone else, and then you come in and you write this great book and you have all this research and you know all this stuff about behavior. I mean, do you ever spend money on like really stupid stuff?

Sarah: (laughs) Oh yeah. Oh yeah.

Joe: And then do you feel like super guilty about it? You’re like, “Oh my God, I am like the queen of this and I should not be buying this.” And then do you just go and there’s like whole guilt thing?

Andi: Do you hear a little self-reflection here? (laughs)

Al: She’s not going to psychoanalyze, you know. (laughs)

Sarah: I can analyze myself, so and my father too, he wrote about individuals that build wealth over time, and so that’s part of what I study. That doesn’t mean that I don’t make the same mistakes that I talk about that you shouldn’t make. And luckily, I’m married to someone that has those behaviors in spades, and I’m more of the, “oh, the money will come in somewhere. We’ll figure this out.” That’s not, in terms of spending money on stupid stuff, I definitely have done that. And again, my focus is always on the income side as being an entrepreneur, and less on the financial management side.

Joe: What’s the stupidest thing you’ve ever bought?

Sarah: I think I bought Krispy Kreme donuts because I got an E-trade account and I thought that was so exciting.

Joe: You mean the stock or actual donuts??

Sarah: The stock, no not the donuts.

Joe: Oh I was like, come on!! (laughs)

Al: A baker’s dozen.

Joe: “The worst purchase I’ve ever made in my life, I spent $8 on a donut.” (laughs)

Sarah: No, no, the real thing and yeah, that was called stock picking, and that was before I realized what that meant and how ill-prepared I was to actually do that kind of thing. So that was probably the silliest thing that I’ve ever done.

Andi: So how is the stock doing now?

Sarah: I don’t know. It’s long gone. (laughs)

Joe: Bought high…

Sarah: I handed that over to my accounting department. (laughs)

Andi: Bought high and ate it and it was tasty. (laughs)

Sarah/Joe: Yeah.

Joe: Dr. Sarah Fallaw – killed it. Thank you so much for hanging out. Where can people find your book?

Sarah: Yeah you can go to datapoints.com/the-next-millionaire-next-door or you can find it on Amazon for sure.

Joe: The Next Millionaire Next Door. Dr. Sarah Stanley Fallaw, I really appreciate you hanging out, this was a lot of fun.

Sarah: This was fun. Thank you for having me.

Read the transcript of this interview in the podcast show notes at YourMoneyYourWealth.com and find links to Dr. Sarah Stanley Fallaw’s website and to purchase your copy of The Next Millionaire Next Door. In the coming weeks on YMYW, Travis Shakespeare (yes that is actually his name) will tell us about Playing With Fire, the documentary he directed about the Financial Independence/Retire Early or FIRE movement – that begins playing in theaters around the country on June 1st. “The Land Geek” Mark Podolsky will tell us the benefits of investing in raw land, retirement income expert Jamie Hopkins returns to YMYW, and so much more. Subscribe to the Your Money, Your Wealth® podcast or our podcast newsletter so you don’t miss a thing – find links in the podcast show notes at YourMoneyYourWealth.com. And now it is time to bust open that email inbox. If you’ve got money questions or just want to talk Krispy Kreme and millionaires with Joe and Big Al, go to YourMoneyYourWealth.com, scroll down and click the Ask Joe and Al On Air button.

21:06 – What Should I Do With My Cash Value Universal Life Insurance?

Joe: Kevin from San Diego. This thing is long, long, long. So we might have to take this in bite-size pieces here, Alan. So Kevin from San Diego he writes and he’s like, “Hey, I’m trying to figure out what to do with Universal Life policies that have large cash values. As cash value grows, the amount of actual insurance coverage declines (since I could get the cash value without dying). I think I’d like to get access to this cash value, or at least understand other ways to get access than cashing out or dying. Some background. I’m 58, bride is 55. I have a military pension and some disability income. I’m also still working for another couple years. The disability payment stops at my death, the military retirement is reduced to 55%. So I wanted the insurance to cover those potential drops in income. I could also use it for long term care if a doc says I am going to die soon when I enter a nursing home (an accelerated death benefit or something like that). I won’t need the insurance for inheritance/estate taxes – I don’t expect to die with that much money.” OK, thanks for that little backdrop, Kev. Thanks for your service, first of all. Little military retirement. So then he bought some life insurance because he’s got a pension. And so if he were to die, his bride-to-be would only receive 55% of the pension. His V.A. benefit I’m guessing, is that’s what he has, the disability benefit would go to zero, because I’ve never ever in my history of financial planning Al, have met someone that has a military pension that does not have a tax-free V.A. pension.

Al: (laughs) It is pretty common, isn’t it? Everyone gets disabled somehow.

Joe: Somehow. A scratched something.

Al: Yeah. We would have been disabled years ago. That’s why they put us on radio. (laughs)

Joe: But Kevin thank you for your service. So he’s got these universal policies, Al, he’s trying to figure out what the hell to do with them. So he continues to write: “I have a universal life policy with $245k coverage and cash value of $91,000.” So he’s really covering about $160,000, the insurance is $160,000 because $90,000 is his, $245,000 is what the insurance is, you take the difference. That’s really what he’s paying.

Al: Yeah, and I think a lot of people don’t really understand that. So you’ve got a policy, if you pass away, your beneficiary, presumably your bride gets $245,000. So that’s great. But you have a cash surrender value today, which is your own money, of $90,000. So as you said, the actual insurance value is the difference between the two, because you could take the $90,000 right now.

Joe: “Which is paid up in 2021.” What paid up means for those of you keeping score here, is that he would not have to pay any more premiums into the policy. So now that cash value of $91,000 will continue to pay that coverage, the $91,000, of course, goes down in value because the cash value is now paying the premiums instead of our friend Kevin that’s paying the premiums out of cash flow. He’s got another, he’s got another “fully paid up one with $57k coverage and a cash value of $25k.” So he’s got 25, again, you do the math, split in half, whatever, he’s got about 25, $27,000. “I also have 2 term policies – a $300k policy expiring 2024, and a $350k policy expiring 2021. My bride has $203k in universal life with cash value of $61k. And a $30k term rider that ends in 2024. She is a retired part-timer with a $400 monthly pension from PERS. Killing it.” Boom. “I don’t need to replace her income. The life insurance value of the permanent policies grows a little bit each year, but not as much as the cash value. Cash value generally is growing about 5% each year – about half of it would be tax-free if I cash it out (basis is 50% or so). I could borrow 70% of cash value, too. The kids have moved out, still a mortgage but just some wedding and grad school tuition assistance. My health is not good enough to get a preferred rate if I buy new policies. Overall, we are in pretty good shape, with $1.6 mil in investable assets split between TSP/401(k)/457/Roth IRAs and a brokerage account. Once we sell the house and leave California, we should be set, so the insurance is really lagniappe.”

Al: Lagniappe.

Joe: Yeah. You don’t know what lagniappe means?

Al: Yeah, it’s a bonus.

Joe: Yeah it’s just like an extra gift. Lagniappe, I say that all the time.

Al: Don’t really need it, yeah. ‘Course, Andi had to look that up for us.

Joe: Yeah., because I would have said langen-gappy.

Al: I would have said lagneeapee. (laughs)

Joe: Lagniapeepee. (laughs)

Al: I guess the G is silent. (laughs)

Andi: Nice job on pulling that off, guys. (laughs)

Al: The insurance is really a lagnia-pee. (laughs)

Joe: It was a lag-nye-a-pe-pe. (laughs)

Al: You think he did that on purpose because he knows we can’t pronounce things?

Joe: Probably. Lag-nee-a-pe-pe. Yeah. So. let’s… (laughs) Oh Kevin, if I were to charge by the words here. Holy buckets. What should he do with these policies Al? You know what? One thing he didn’t really tell us is how much is his pension? You know what I mean? So the life insurance policy, if he dies, is that enough to cover his bride, to cover that pension?

Al: Yeah. Because the survivor benefit is only 55%. So in other words, 45% of that pension would go away. And the V.A. disability would go away.

Joe: Here’s what I would do. If I was Kevin, I would run two scenarios. I’m gonna be like – because he’s leaving California. I don’t know where he’s going. Why would you want to leave California, Kevin? Probably because the cost of living here is very high and the taxes are through the roof? Besides that?

Al: Yeah. Besides that, it’s a great place to be.

Joe: Great place to be. So he’s splitting. So he needs to figure out first how much money is he spending? How much money are you as a couple spending?

Al: Yeah. And what’s the need if you were to pass away – I think that’s what you’re concerned about.

Joe: Right. He’s got $1.6 million. He’s got a military pension, a V.A. pension. He’ll have Social Security. He’s pretty young, right? He’s 58, so he’s got 10 years to bridge, roughly, a little bit less than that for Social Security. Depends on when he retires. She’s retired, she’s killing it. She’s 55 making 400 bucks a month part-time, but then… So it’s like, you’re leaving California how much money do you want to spend? Here’s your fixed income. Is that covering 100% of your living expenses? If it is, I would get rid of the insurance altogether. I’d cash that thing out because if you die, you have $1.6 million that’s going to your bride. That would be plenty to cover her needs.

Al: Yeah. So in other words, even though the fixed income would go down, there’s this big pool of money.

Joe: There’s that pool of money to cover to pay for the other 45% of the pension that’s leaving plus whatever you’re V.A. is.

Al: And as you mentioned, the insurance coverage really isn’t that high when you consider a lot of this is already your own money. The one policy which is smaller, almost half of it is your own money.

Joe: Right. Man, you’ve got a lot of insurance, Kevin. Was your neighbor an insurance agent or your brother in law? (laughs)

Al: Now, on the other hand, Joe, if Kevin were not in good health at all and felt very short, impaired life expectancy…

Joe: Yep, of course, he’d keep it.

Al: Yeah you keep it right?

Joe: Sure. Because then you look at the internal rate of return. Because you look at $91,000 growing to $245,000. Let’s say Kevin’s gonna die in five years, well $91,000 growing to $245,000 in five years, that’s a pretty high internal rate of return.

Al: Probably not going to happen.

Joe: All tax-free to the beneficiary? Of course. So you can look at it that way too, say, “what’s my life expectancy? I’m a pretty healthy guy. I got ten years to live 15, 20, 25, 30, 35 years to live. The death benefit’s gonna be $245,000.” You take that $90,000 out, pay a little bit of tax, some of it’s going to be return of basis. Now you have full access to it. And then what’s your break-even? How long can that $90,000 go to $245,000? What’s your internal rate return? If you think the insurance is better, because at least the heirs are going to get it, but it sounds to me he wants to burn through everything, right? And says, “Hey, the kids or whatever, they’re there out of the house, they’re all good.” It sounds like he was a really good saver, he’s got $1.6 million. You probably needed the insurance at the time to protect your income. I don’t know, you met your bride. I mean the bride, is that like bride-to-be or wife?

Andi: That’s wife. He calls her his bride.

Joe: Oh that’s so sweet.

Andi: It is.

Joe: I thought it was like hooking up with my bride. They’ve probably been married for 30 years.

Andi: Yeah exactly.

Joe: They’re probably high school sweethearts. That’s what it sounds like.

Andi: And every day is like wedding day.

Joe: It’s so good.

Andi: It’s awesome.

Al: That’s what you want.

Joe: Yeah I’m still waiting for it. I want to be like Kev. I want pensions and $1.6. Leaving California and my bride.

Al: A little disability income tax-free.

Joe: It’s gonna be awesome. (laughs) Yeah, but I wouldn’t know. That’s how I would look at it, you got any other comments on this?

Al: Well I’ll put it this way for most healthy people, I would not keep the insurance.

Joe: And I like how you point to yourself, like (points to himself) myself. (laughs)

Al: Yeah like “most”. Because I think you can do better with the cash value on your own.

Joe: Well do the math. Let’s figure it out. So for those of you that have cash value in insurance, a few things that you want to look at. We’re running an example here that Kevin had a $245,000 or $250,000 death benefit in his life insurance policy. He has $91,000 of cash value. He didn’t even tell us what the premium was, because he is still paying premiums for another couple of years. We assumed that there was no more premiums. So then the question was, do I keep this or do I get rid of it? So you can run a calculation. So Al ran a calculation one way and I ran it another way, so it depends on if you’re left or right-brained to see what makes the most sense for you. (laughs)

Al: So I’ll go through my calculation, which is it’s looking at the $91,000 and what could that earn on its own, like outside of the insurance policy. Now, of course, there would be taxes, we’re keeping this really simple. So in other words, if you take $91,000 and you do a 6% rate of return, that’s pretty conservative, over a 10 year period you would end up with $163,000. So let’s compare that to the life insurance policy, which is $250,000. So if you think you’re going to live less than 10 years, you might just want to keep the policy, right?

Joe: You would, yeah.

Al: Because you’re not going to do better than that unless you take a lot of risk.

Joe: Or unless you need capital to spend.

Al: Sure. Now a 20 year at 6% would be $291,000, so you’d be better doing that than having the insurance, and a 30 year would be $523,000, so you’d actually do a lot better than the insurance.

Joe: So Kevin is 58, correct?

Andi: Correct.

Joe: So the likelihood of Kevin reaching age 88, I would say is probably 60, 70%?

Al: Yeah. Or at least 50.

Joe; I mean that’s today. Just wait for 20 years. I mean, they’re going to be putting little chips in our bread and we’ll live for 120. You got cancer? No problem. Here’s a pill. You don’t think so?

Andi: I think that would be awesome. I’m signing up tomorrow. (laughs)

Al: So yeah. So just today Joe. So a 65-year-old male, the average is age 84. And so you’re saying now when he gets to that point, there will be a lot more medical advances and I tend to agree with that.

Joe: Sure. I mean you can see the advancements – each week, each month, each year there’s a little bit more.

Al: So in other words, another way to say this is 30 years is not unrealistic at all. So for Kevin to get to age 88, that’s very possible.

Joe: So how I ran this for Kevin is that I looked at if you got $91,000 and that is going to pay out a $250,000 death benefit. And let’s assume that Kevin reaches age 88. So 30 years. What is his rate of return? It would be 3.31%.

Al: So in other words, inside the insurance policy, what did that $91,000? 3.31% is what you need to get to $250,000.

Joe: Right. So let’s say if you had $90,000, you invested for 30 years at 3.5% roughly, you would have $250,000. So then how you look at it is to say, over the next 30 years, do you think I could achieve a higher rate of return than 3.3%, or am I good with that guarantee? Because that’s his guarantee – he’s going to die. We know that that’s a guarantee. We just don’t know when. If he dies prior to, let’s say 88, well then that internal rate of return is a lot higher. If he dies past that 88, then that internal rate of return is lower. So it’s just looking at, A), do you need the insurance given the small facts that we know about him, I would say probably not because he has a lot of other assets.

Al: He’s got a good pension and he’s got a lot of other assets for his bride to take over.

Joe: Yes. And too, it doesn’t sound like he wants to give a legacy, “hey, let’s build this thing up.” The final thing that I would do is, I betcha that policy is pretty old. But I don’t know, I’m guessing here because it looks like Kevin loves to buy insurance and he’s probably already checked this out. He says his health is not really necessarily in great shape.

Al: Yeah. Because he was maybe looking at either redoing it, getting a different policy or maybe an additional policy.

Joe: I would say still check it out, because that $91,000, let’s say if he bought that policy 20 years ago. So the cost of insurance, the tables that they used 20 years ago are completely different today. The life insurance industry was completely different 20 years ago than it is today. Because you more or less had mutual type insurance companies – Mutual of Omaha, Mass Mutual, Northwestern Mutual. You know the names. So what has happened to these big life insurance companies is that they de-mutualized and now they’re stock companies. And so in a mutual life insurance company, the policy owners are the owners of the company. So if I own a policy, I own the company. In a stock company, the stockholders are, right? That’s us if we want to buy Lincoln Financial, we’re a stockholder. We want profits. We’re demanding, right? We have a board of directors. Let’s fire the CEO. Let’s do this, right? Capitalism. And so what has happened is it drove pricing because there’s more competition. It’s like, “sell more policies, sell more policies,” it’s driving pricing a little bit lower, plus actuarial, we’re live in a lot longer. So the price of insurance today is completely different than what it was maybe 20 years ago. So it might make sense for him to look and say maybe that $90,000 of cash value could buy him, I don’t know, maybe $400,000, because they’re doing the same math that you and I did, bud.

Al: Yeah, that’s right. And the other thing too, like let’s just say that that worked, and then he could do a 1035 exchange and so he wouldn’t have to pay taxes on any built-in gains inside the cash value.

Joe: Right. So it’s a tax free-transaction. You don’t need the money. You look at, the insurance company is saying, “OK, the internal 3.36%. We could give him a little bit more than that because it’s just arbitrage,” they’re taking that money, they’re investing it in something else and trying to get a higher rate of return. Just like you could do on your own. So I mean, you just gotta think outside the box here and figure out what’s the best for you. So, God, I don’t know, man that’s long-winded question and answer.

Andi/Joe: It was thorough!

Joe: We are very thorough here at Your Money, Your Wealth®. If you give us a question, we’re going to take the time and figure it out.

If you’re trying to make a decision about life insurance, check the podcast show notes and binge all the free insurance resources we’ve got. Find out if a universal life insurance policy a good option for you, watch our videos about various types of annuities (variable annuities and fixed indexed annuities), learn the basics about life insurance and long term care insurance, and hear Joe go off on a rant about a Reddit discussion on financial planners selling insurance. It’s all in the podcast show notes at YourMoneyYourWealth.com. If after all that you still have a question, drop the fellas a line by hitting the Ask Joe and Al On Air button at YourMoneyYourWealth.com.

Incorporating Life Insurance in Estate Planning

39:14 – Will I Pay California Income Tax on a Roth Conversion After I Move to Texas?

Teresa she wrote in from San Diego: “Greetings, your TV program is most informative I’ve come across.” Wow. The most informative TV show she’s ever come across. Teresa, that is fantastic. And then she says, “Thank you.”

Al: Yeah. It’s very nice.

Joe: “My situation is, I’m going to retire at the end of this year. I live in California but I’m going to move to Texas early next year. I want to convert my 401(k) dollars and IRA to my Roth IRA after I move to Texas and wait two years to claim Social Security. My question is, because I earn the savings in California, do I have to pay California income tax on the conversions? Or not pay income tax as I’ll be living in Texas?”

Al: Good question, Teresa, I got some good news for you, and that is, when you’ve got an IRA or a 401(k) and you move to another state, when you pull money out of those accounts, when you distribute monies out of those accounts, it’s taxed in the state that you’re currently resident of. The same goes for a Roth conversion. So if you decide to convert part or all of it, all of that tax is taxed in the state that your residence of, and by the way, as you probably know, Texas has no income tax and so, therefore, there would be no state tax on the conversion. So that is a way to go.

Joe: There is federal income tax but no Texas tax.

Al: Yeah. Exactly.

Joe: So there are some forms of income, however, that does follow you.

Al: Correct. So, for example, Teresa, so if you have – maybe you’re like Greg and you’ve got a rental property. And if you move to Texas with that rental property, still a rental property, even though you’re a Texas resident, because the property itself is located in California, it’s what they call “sourced” in California. And so you get taxed on California taxation, even though you live in Texas. Another one would be, like if there’s a small business that’s located in the state and you get a K-1, meaning you’re like a part owner, so you get your share of the profits. Well, that would be taxed potentially in California too if it’s a California business. And the way that works is, you pay tax in California first. Then you pay tax in the state that you live in, and then you get a tax credit in the state you live in. That’s generally how it works. Now in this case, if that were the case since she lives in Texas, there’s no tax credit because there’s no tax to pay in Texas.

Joe: What about stock options?

Al: That’s a great question. That’s a little fuzzy. I would say the basic rule is this: the stock options the unexercised options in most cases when you leave a job, your employer requires that you exercise them within 90 days. And in general, the employer is supposed to include that in the state of residence where you actually earn the money, not your current state of residence. So you could be living in Texas then. So you should be getting a W-2 with your California wages for that year plus the stock option income in that year. Now, I have seen otherwise Joe, and there’s confusion on this and I have seen companies do it otherwise. But that’s the basic rule when it comes to options it actually comes back to the state where you earned it.

Joe: Great question Teresa. All right guys, we’ll see you next week, the show is called Your Money, Your Wealth®.

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Special thanks to our guest, Dr. Sarah Stanley Fallaw. Check out the podcast show notes at YourMoneyYourWealth.com to find links to Sarah’s website and her book, The Next Millionaire Next Door, to share this interview on Facebook, Twitter, LinkedIn or via email, and to subscribe to the Your Money, Your Wealth® newsletter and podcast for free.

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