Where Will We Be 10 Years From Now?

Today, thanks to the effort of the Federal Stimulus, the Dow Jones is at the highest point we have ever seen. Considering that interest rates are at historic lows and the Federal Government is still spending $30 billion per month (now the 5^th round of Federal Stimulus in the last 6 years), this recent market surge can easily be viewed as a statistical marvel. Not to mention that our nation's highest income tax bracket is at 35%, almost half the historical average. Yet, against conflicting economic data, here we are in the best possible position we could ever hope for. The question is, given the volatility we have had over the last decade, what do you think our financial world will look like in 2024?

However the stage is set 10 years from now, there are moves that you can put into place today to help protect yourself against inevitable changes. For starters, Federal tax rates have nowhere to go but up. Make no mistake about it, tax rate hikes are just around the corner. There is only one way for our nation to pay back the $4 trillion dollars we have spent over the last 6 years: raising taxes. Let's take a closer look at this for clarification. Historically, since 1913, that average marginal Federal tax rate exceeds 60%. This is a far stretch from our highest tax rate today of 35%. Given we have accumulated more debt over the last decade (by over 10 times faster) than any time period in US history, how long do you think it will be before we see our first Federal income tax increase? So, what does this mean for you 10 years from now?

It means you will have less net income than you have today. If we assume that the Federal tax rate jumps by 7% over the next decade, with inflation averaging 3% annually, you will have well over a 30% decrease in net spendable dollars with the income you make today. When you take into account that the main source of retirement income for the working class is in the form of a 401k, IRA, SEP, or similar type of pretax dollar investment, it becomes very clear how much spending money you stand to lose to Uncle Sam. This is why it is crucial to protect your future income from imminent tax hikes, while locking in market gains at their highest point.

One way investors are able to protect their future income is through Indexed Universal Life (IUL) policies, a form of permanent life insurance. These vehicles allow you to accumulate funds exempt from any market volatility, providing impressive moderate returns, while also allowing for tax free withdrawals throughout your retirement years. In order for IULs to have tax advantaged withdrawals, your policy must be set up as a Non Modified Endowment Contract (Non MEC). Non MECs have to pass the seven pay test (a funding formula derived from the IRS for purposes of tax free income) in order to enjoy an income exempt from Federal income tax. If any IUL policy fails the seven pay test, then all withdrawals are taxed as ordinary income tax on a First In – Last Out accounting basis. Non MEC policies have all the same tax free exemptions as a Roth IRA without many of the restrictions. Non MEC IULs do not have low annual limits or withdrawal penalties prior to age 59 ½ like a Roth IRA does. Nor do Roth IRAs pay out accelerated death benefits based on the amount of premium you fund the policy with.

Lets take a closer look at how a Non MEC IUL can provide a moderate return amidst a volatile market. Since an IUL is a fixed product, if the market goes down you will have a minimum guaranteed (floor rate) return regardless of how far the market may fall. These guarantees can be as high as 2% depending on which policy you chose. Conversely, if the market goes up, these policies will match you dollar for dollar up to as high as 14% (cap rate). Because these products protect you against market loss, you cannot earn above the cap rate. Insurance companies are able to offer these returns through concepts of annual reset and indexing. Each year, on the anniversary of the policy date, a chosen market index (such as the S & P 500) determines how much interest is to be credited to your policy. There are different variations of interest crediting, which can include dollar cost averaging. Just imagine if you were able to eliminate the downside of the market prior to 09/11/2001 with a cap of 14%. Although not typical of past market results, you would have drastically outperformed the stock market.

With a Non MEC IUL policy you will be able to protect your money from both market downturns and the imminent threat of rising taxes. Given that the market is at its highest level, what better timing could you ask for? Top financial institutions are warning of a market correction around the corner and the Federal Government is looking for an end to the Federal stimulus for good. Yet today the market is at the highest levels and Uncle Sam is still pumping in $30 billion monthly of Federal stimulus. Over the last several years the rules that govern the economy seem to be set in opposition, and I fear that this trend will continue, followed by tax increases and periods of volatility. Without taking precautions against these financial threats, how do you intend to offset the volatility and rising income taxes? These concerns have prompted many investors to look into Non Mec IULs as a viable solution to an unpredictable market.

A Correction Around the Corner

Recently, the market has climbed to an all new high. Yet the higher the market goes, the less investors seem to care. One of the main reasons for this is that only about 20 companies of the S & P 500 reached 52 week highs in the market; the lowest number in a year. Furthermore, the benchmark US 10 year note saw a drop in yield of 2.44% last week, which is the lowest in 12 months. So, why is the market at an all time high? How can the market justify this growth? It's the Federal Stimulus along with the government holding down interest rates.

The Federal Stimulus, which exceeds $4 trillion since 2008, continues monthly at $35 billion. This is a huge unnatural catalyst for the market. Granted, the Federal Stimulus has proven successful; however, it is only a short term solution with negative long term effects. The Federal Stimulus can only push the market so far through monetary injections before drastic volatility follows. Investors are well aware of this. Over the last 6 years the market has been quite the roller coaster. Only now we are at the highest point of the roller coaster with nowhere to go but down. In a phone interview with Bloomberg, Hayes Miller, head of multi-asset allocation for Baring Asset Management Inc, said “Breadth is suggesting that the market is stopping. This is not a good starting point for buying equities at this price.” This suggests a correction is around the corner. Citi Group CFO John Gerspach said last week that trading revenue could fall as much as 25% in the second quarter, and JPMorgan Chase & Co. estimated a 20% drop. The question is will the cycle of stimulus continue like it has over the last few years? The evidence seems to point that way. If the market does take a 25% drop, how much Quantitive Easement will the Fed pump into the market to offset the correction? How much will that add to our Federal Deficit, and how much longer can Wall Street ride on the coat tails of Uncle Sam?

Volatility is a trend that we will see for the next several years. Fortunately today, investors have been able to recoup losses over the last decade thanks to Uncle Sam's efforts. However, with a growing Federal Deficit and extreme deflation, volatility will continue. With the market at its highest level in history, there couldn't be a better time to redirect your portfolio to financial guarantees. Now is the perfect time to use the Federal Stimulus to your advantage before it may be to late. Differentiated strategies must be explored to keep financial goals for your portfolio on track. So how do you navigate through a choppy market to achieve retirement goals? You simply trade away the down side of the market with a moderate return, known as annual reset. Annual reset is a concept that requires financial institutions to match deposits into fixed assets on a dollar for dollar basis, as opposed to leveraging assets with ratios as high as 20:1, which cannot bypass volatility. Annual reset will ensure that you can never go backwards on the growth of your portfolio. Truth be told, this strategy has outperformed the market since 2000. Investors and retirees alike are repositioning leveraged assets to products offering annual reset for several benefits, including both lifetime income and exempting themselves from any volatility in the future.

Without financial concepts that use annual reset, how can you ensure your financial goals are met? What many fail to realize is how disastrous a market downturn really is. Let's take a closer look at this. Let's assume for simplistic purposes that the market takes a 50% downturn. If that downturn was followed by an immediate 50% upturn, you are still down 25%. An easier way to see this is to start 4 quarters and take 2 away (50% loss). A 50% gain of $0.50 is $0.75, putting you a quarter short of where you started. So respectively, any loss must be followed by a much higher gain in order to get you back to even. The question is, how many downsides can you endure before you are unable to pull your portfolio above water, let alone achieve your financial goals. Annual reset bypasses this negative event and allows you to only move forward.

With unnatural solutions like the Federal Stimulus, the market will continue to have extreme highs and lows contrary to what the natural numbers represent. A sure way to navigate through these extremes is to trade away all future volatility with moderate upsides. This will ensure that unforeseen events brought on by a struggling economy will not disrupt your personal financial goals.