Income for Life #31. Interview With Brad Gibb

Transcription

1 Income for Life #31 Interview With Brad Gibb Here is the transcript of our interview with Income for Life expert, Brad Gibb. Hello, everyone. It s Tim Mittelstaedt, your Wealth Builders Club member liaison. We ve got another Income for Life webinar today. I ve got Brad Gibb from Paradigm Life back on the line with us. Brad, you there? Yep, I m here, Tim. Thanks for having me. Yeah, good to have you back. So, just to remind our members: you work with Patrick. You re one of the experts there on staff who are helping people set up their policies. If you guys don t remember Brad, he had his accounting business, and he left that all to work full-time in the insurance industry, because he really believes in Income for Life and the applications. And so, I thought we d get Brad back, because he has an interesting take on something that we ve debated quite a bit about in the Income for Life series. As you remember, we went over comparing Income for Life vs. the 401(k) just pairing them up against each other and see what it would look like after a 30-year period. And a lot of you still are struggling with the 401(k) being a bad vehicle writing in, saying things like, You re getting the employer match, and higher returns, and you just can t reconcile the fact that you re earning four to 5% in your Income for Life policy. So, Brad you had some good insight on this, I thought. So, I thought we d just get your take on 401(k) s, and you have a good example with real estate. First off, what is your take on that? The whole Income for Life vs. 401(k)? Yeah, and it comes back to clearly identifying what it is we re comparing, and it goes back. A good way to think about this is ask the question: What is a 401(k)? What is it? I guess it s a place you can lock your money up and have some expensive mutual funds. Exactly. It s an account. It s not an investment. Nobody is investing in a product called a 401(k). You re putting it in what amounts to a

2 bank account with special rules attached. Then you use that money to go make investments. Right. The actual underlying investment is not the 401(k) itself. It s the stocks, and the bonds, and the mutual funds whatever it is that you purchase through that vehicle. And a useful analogy for that for the Income for Life listeners is the insurance policy effectively is the same thing. It s a vehicle that we re going to use to make investments. One of those investments is the life insurance policy itself. And we ve gone through the competitive rate of return that that provides. But today, we want to jump into what else could I invest with using this system that then I can compare against the individual stocks, bonds, and mutual funds I would be buying in the 401(k)? Got it. So, to do that, what we really wanna focus on again today is how we make money. Now, in stocks, bonds, and mutual funds, we know that there s typically a rate of return, and it s tied to the capital growth of the underlying investments. In the Income for Life, with the Cash Flow Banking System, we focus on a couple different rules or principles we want to take advantage of in order to help us generate wealth. Those principally being appreciation, leverage, cash flow, and tax advantages when they re available. We re gonna look at how we can help quantify those benefits that are available through this system that aren t typically available through the 401(k). Got it. And I think you re gonna use real estate as an example, just to go through these principles? Yeah. And we re gonna use real estate, because it espouses all four of these areas. There s nothing necessarily it s not a requirement to invest in real estate, but we re gonna use real estate just as an example of how we can generate much more wealth by using that set of principles as opposed to the set of principles available to us under the traditional 401(k).

3 So, we could replace real estate with any other type of investments that allows us access to these same principles. Could be your own business; it could be oil and gas; it could be a number of different things that we could substitute in. But real estate s something that I think we can all get our heads around, and make a simple example out of it. To do that, we re gonna use a couple calculators. Don t be afraid we won t have a quiz on the math here. We ll try to make it simple. But we re just gonna use a couple calculators here. One is gonna be a future value calculator, and all that tells us is if we start out with a certain amount of money today, after 30 years, what s that going to be worth? Or what value is gonna be there? That s gonna help us. The other calculator that is probably new to most of us here is this rate calculator. And what it s intended to do is if we start with an investment, and as that investment grows over a certain period of time, if we know what the end value is, this tells us our effective annual rate of return. This is gonna help us quantify the benefit of all these four different ways that we can utilize to create our wealth. And it ll make a little bit more sense as we get into it, but that s what this calculator s gonna decide, and really this focus today is gonna be on this rate calculator. Good. To jump in, we re just gonna walk through this individual piece by piece, and we re gonna say let s start out by let s say that we buy a $400,000 duplex, or four-plex, or if you re in Southern California, maybe a studio apartment. If we start out with a $400,000 apartment building, or unit, or whatever it is $400,000 is it gonna be worth the same amount of money we paid for at 30 years from now? No, you have inflation, so you could probably expect your property to appreciate at the inflation rate, I would imagine. Just to give viewers an expectation for what that is if we look at inflation since 1914, it s been right around 3.2%. If we back up just since 1970, we re up over 4%. Let s use a 3.5% rate for today s example.

4 Let s say that this increases at 3.5% per year. It s gonna grow to be worth $1.1 million, give or take. Well, now we know over here that our ultimate investment is gonna end up being worth $ million after 30 years. But what was our cash outlay to acquire this property? Did we have to pay the full $400,000? I guess if you re using financing, you probably only put 20, 25% down, so I would say $100,000. Yeah, let s be conservative. Say we put 25% down. We put in $100,000. Now, this is where that first principle enters in the equation leverage: using somebody else s money to acquire the asset. We still get all of the appreciation on the property, and at the end of 30 years, we ll have that mortgage paid off, so we re gonna truly have an asset with no encumbrances worth $1.1 million, but we only had to outlay $100,000. to acquire it. So, rather than it being a 3.5% rate of return, it s gonna bump us up to just over 8%. So that 8% number, that basically just means if I had $100,000, and I grew at 8.39% every year, I d wind up with that $1.1 million. Is that what that s saying? Exactly. So, if every single year, you earn 8.39%, that $100,000 would grow to be worth $1.1 million. That s pretty good right there. This is only one of really the four ways we re gonna illustrate taking advantage of this other set of rules. So, with real estate, this is one way we re gonna make money. The property s gonna appreciate. We re gonna pay the mortgage down. Second way well, I guess it s not the only way we re gonna make money. No. So how else does a rental property put money in our pocket?

5 I guess if you buy it at the right price, like Mark suggests, at a gross rent multiplier under eight, you d probably have some cash flow every month. Yeah. If you don t, you better check the property, because that s really objective our rental property s cash flow. So, to make the cash flow example simple, we re gonna use what we call a cash on cash return. I m not sure how much you guys have touched on that, but make sure our readers understand. The reason we re gonna use a cash on cash return is we want to separate out some of the other things that we ve talked about. So, we ve already accounted for paying the mortgage down. We ve already account for appreciation of the property. We just want to look at the return we make on our cash. So, Tim, in your opinion, what s a current, decent cash on cash return for a property? I guess it depends. On the couple properties that I ve bought so far, between 15% and 18%. I know Mark is between 10% and 15% on his properties. I know you ve got some properties. What do you think? Yeah. Again, the last couple properties I ve been between 18%, and I ve seen properties penciling out at 22% to 25%. So, a current market with high rental demand, low property values we re getting very good cash on cash. Let s maybe meter that back, and let s say we get a 12% cash on cash. Is that a pretty realistic number to Yeah, let s be conservative. I wanna be extra conservative, so let s use 12. So, 12%. So, if we put in $100,000, and we make 12% per year just in cash, that puts $12,000 in our pocket every year. So, to factor that in here, we re gonna say we put the $100,000 in. We take out $12,000 every year, and we still end up with $1.1 million. So, we do that. That bumps our return from 8.39 to So again, that would be an example of invest $100,000. Take $12,000 out a year for 30 years, and wind up with that balance. You d need to earn 15.8% every single year. Correct.

6 Wow, okay. So, we add the cash flow piece to it. We re doing pretty good. Now, there s another couple pieces to this cash flow that we don t want to miss. When we buy, day one, we re gonna be producing $12,000 in cash flow. That s based on what we can charge for rents. Now, are rents today gonna be the same 30 years from now? No. With inflation, usually landlords look to bump their rent a little bit every year to keep pace with inflation. Yep. That s gonna bring your rents up over time. But is your mortgage payment also gonna be increasing over this 30 year time period? If I m buying my real estate, I m going fixed, cause I just want the peace of mind of a steady payment. But my payment will stay the same, my rate ll stay the same. Yep, so this is another advantage that leverage adds to it. Saying we re able to fix our borrowing costs for a 30-year time period, and today at historically low interest rates. So, as we raise our rental prices, we actually get that coming to us in cash flow, because the bulk of our operating expenses stays fixed with our mortgage payment. Let s take a look at what that looks like. Go back over to our future value calculator. If we start with $12,000 a year in cash flow, after 30 years of let s keep that same 3.5% inflation rate, you re gonna be collecting $33,000 or more in cash flow. In the 30th year? Yeah, cause of inflation. Exactly, in that 30th year. So, let s average this out, and say we start with 12, we end with 33. So, if we want to take our average cash flow over that time period, we d just take $12,000, we add to it the $33,682, divide that in half, which in averaging it, gives us about $22,000 on average cash flow over that 30 year time horizon. Got it. It s not $12,000. That s what we start out with, but on average, let s even round down and again, stay on the conservative side, let s say we pull $20,000 a year on average from this property.

7 Wow. So, that bumps it up to 25%. Not bad, right? Right. So now we ve accounted for property appreciation and staying conservative just at the inflation rate. We ve shown paying the mortgage down, and using leverage, throwing $100,000 in, and now we ve factored in cash flow. Are there any other ways what other principles did we mention at the beginning that we want to make sure we re accounting for? I think the last one is taxes, and this is one that a lot of people miss that I ve learned a lot about recently, so yeah, go over this one. I ll be interested to see what you say. So, taxes is the last one now. I want to leave it for last, because it s the least important. We don t want to make investments only for tax reasons Sure. But if we can get the tax benefits for it, let s factor them in at this rate. So, this $20,000 that we collected income, for the average investor is that gonna be subject to income tax? Yeah. Good question, right? Most people would say, Yeah, we have to pay taxes on all our income. But there s something unique to real estate called depreciation. Now, depreciation is a paper loss, or just an accounting number that the IRS allows us to deduct against the income that that property creates. So, currently under our current tax code, we get to depreciate the purchase price of the property over a 27 1/2 year time period. So, we get to take a deduction against our income, as well as the interest we pay on our mortgage, as well as any other expenses that we incur directly related to the property maintenance management fees, property taxes, and the like. So, for most investors that are investing if you re putting about 25% down on the property in that range, you should be able to pull that $20,000 on a tax-free basis.

8 So basically, you re saying I pocket the $20,000, but because of all the different expenses and depreciation and deductions, I can basically report to the IRS, Hey, I didn t earn anything, and I don t pay any taxes on it. Yep, you show them the income of $20,000, and you show them expenses that are equal to or in excess of that, and there s no tax liability typically associated with it. Now, you want to check with your CPA and all of that, but for most investors, for the bulk of this time period, no taxes are usually due on that $20,000. I love that. Yeah, that s great. So, what does that mean to our rate of return though? If we were gonna generate this let s say in a traditional 401(k), when we pull income from our 401(k), it s gonna be taxable. Right. So, let s say that you re in a 25% tax bracket, and maybe a 5% percent state tax, or got a 30% tax liability. If we have $20,000 of income come on. Of course, the calculator s here more technology. You d have to generate $28,500 before taxes to leave yourself with $20,000 in after tax income. So, to compare apples to apples, and really make sure we re looking at this on a gross basis, your alternate investment would have to pay you $28,500 to leave you with really the same amount of wealth as the real estate would be leaving you with. That makes sense. So, if we put that in, that now bumps our return up to of course almost 40%. That s crazy. So, with these four different ways, that s what you re saying we basically would have to earn in our 401(k) to match it. Right. These are four principles that are very difficult, if not impossible, to take advantage of inside of your 401(k). So if, again, your 401(k)s just an account so if we compare the underlying investments that you re making the stocks, bonds, and mutual funds that most people are buying, compared to the underlying asset that you can buy through the Income for Life

9 strategy or the Cash Flow Banking, one of those options will be real estate. So with this $100,000 that could be in your 401(k), or could be in your Income for Life account, this would be the comparison. Those stocks, bonds, mutual funds would have to be producing at a 40% rate of return to be comparable to the true underlying investment we re out to get through the Income for Life strategy. Basically, your policy just gives you unlimited options. You could invest in anything, and take advantage of very, very smart investing strategies that you typically wouldn t have in your 401(k). But actually, aren t there ways in your 401(k) or IRA that you can invest in real estate? There are a few. It s very limited in scope. It has to be a self-directed IRA, so those that are currently employed with their employer that they re contributing to, it s not gonna be available to them. But once you leave employment, or if you started your own separate IRA, you can self-direct that IRA. And that s why I say that it s very limited, or near impossible to achieve some of this, because unless you re moving jobs, and you re put into a roll-over, you can only contribute a very limited amount of money into that self-directed IRA account. Whereas, with the Income for Life strategy, there really are no caps or limits on it. And then, second to that, obtaining leverage through an IRA is a very difficult proposition. Most of the time, the best I ve seen is around 20, 25%. There are a few options out there that might be a little more than that, but for the most part, we can achieve the same degree of leverage. And then, similarly, you re trading tax benefits, so you don t get the appreciation. You don t get to deduct property taxes and all of those types of expenses. So, we give up a lot of that tax benefit. So, there would be ability to achieve some of them, but certainly not all of them like we can have available to us in the Income for Life strategy. Yeah, that s good. This is really good. I m glad you went over it. I just wanted you to address this, cause I think a lot of our readers are still struggling, and it s no wonder why. There s a lot of information out there, and people think 401(k)s are a great place to put their money, but

10 There are some moving parts to it, and it definitely is a different mentality. But we have to compare really the underlying systems, which is what Income for Life is all about. It s a system a way of providing us opportunity to make investments. It s not the end goal in and of itself. So, hopefully this has helped viewers and readers really understand the larger picture of what is available through the Income for Life strategy. It allows you to invest in something like real estate, which could extend to your own business, rather than your kids borrowing college money at 7% or 8%, they could borrow from you. There would be lots of different options available that typically don t become available when we lock our money up in the system that is the 401(k). No, I agree, and I thought that was a good way to compare. I never thought of it that way, but really yeah, they re just two different accounts. And the things you do in your 401(k) are very limited, and you ve got tons of options with Income for Life. So, this is good. Yeah, I hope it s proved useful. Yeah. We just scratched the surface, obviously. We re gonna get into some more examples. I d like to specifically go through maybe the next rental property I do. Just look at some specific numbers by taking out a policy loan. But I just wanted you guys to see this to get a better overview, and just open your mind to the different possibilities that we have with our Income for Life policy. Thanks, Brad, for stepping in and explaining this. It s been really helpful. You re welcome. I enjoyed it today. All right. We ll have you back soon. Thanks. Bye.