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Thomas: Hello and welcome to Opening Arguments, this is episode 352. I’m Thomas, that’s Andrew. How’re you doin’, Andrew?
Andrew: I am fantastic Thomas, how are you?
Thomas: I’m good! I always love when we have Phil Ferguson on the show ‘cuz I’ve got a little bit of an accounting background but it’s been long enough that I basically don’t remember anything so, you know, [Laughing] it’s always fun to get a little refresher on a finance topic and we’re gonna talk about the SECURE Act and find out just how secure it is, I guess.
Thomas: [Laughing] Is it a good thing, is it misguided or is it gonna be good law? We’ll find out.
Andrew: And remember, I said seems like it’s probably a good bill to me. This is not foreshadowing in any way whatsoever.
Thomas: [Laughs] So with that said, why don’t we just get Phil on the line and – of course, Phil gives his background in the interview so if you’re not familiar with Phil hang on and he gives a good little bio of why he knows what he’s talking about. So here we go, let’s go to our interview with Phil Ferguson.
Interview with Phil Ferguson
Thomas: And we are joined by Phil Ferguson as we teased last week. How ya doing, Phil?
Phil: I’m well, thank you. I survived the giant long gap between these two segments.
Thomas: Hmm, I bet you were fretting the whole way though.
Thomas: Desperate to know what the T3BE answer is. Well we’ll find out later on in this show, that of course comes later, but in the meantime we’ve got a lot to talk about. We’ve got what I hear is the SECURE Act, I thought that was typical American double-speak, but turns out it maybe is a secure act.
Thomas: I dunno, does it have some relation to the words used to name it?
Andrew: Well I can set sort of the legal landscape. I wanted to get Phil in definitely to figure out exactly what the provisions mean and how they affect our listeners. The SECURE Act is the “Setting Every Community Up for Retirement Enhancement Act” which is, uh, a lot of work went into figuring out that acronym, I think.
Phil: I think you’re right.
Andrew: [Laughs] It was part of the omnibus end of year appropriations bill for 2019, it is actually – and Phil, I kind of hate you a little bit for making me read this, but let’s be honest, I was gonna read it anyway. It begins on – and I am not making this up – page 1,532 of the omnibus House bill. I can’t promise – it’s like 2,100 pages long all told, I can’t promise you that I’ve read all 2,100 pages, but [Laughing] I have read way more than any person ought to have read of this bill, and I’m confident way more than meh, 90 sitting Senators and 400 sitting Congressmen, so-
Phil: And I’m confident, way more than me. How’s that?
Andrew: [Laughs] Well hopefully you’ve read the relevant provisions! [Laughs]
Phil: I did find a nice summary document.
Andrew: Aw, dammit! I’ve gotta start doing that! [Laughs]
Phil: It’s kinda tricky because sometimes it does come down to the details and what people think are the relevant summaries and then what it really means, someone later then finds oh, but if you tilt your head this way five degrees and that word has two meanings you can get something different out of it. We’ll see what happens.
Andrew: Yeah. So let me describe what I know about the history and chime in, because now we’re sort of heading into your territory. My understanding is that in broad outline, the idea is – and this is sausage making legislation. It’s got provisions that people like from both sides of the aisle. In recognition of a fundamental fact about our economy, which is that in order to retire virtually everybody is going to rely on private retirement savings, the days of pensions are long past and the days in which social security was adequate are also long past, so in recognition of that principle and also in recognition of the fact that people are working longer and later into their careers, largely driven by point number one.
So that’s, obviously we have various political candidates, they’re all from the Democratic party – The Republican party’s position is government should do nothing – who maybe want to talk about the structural conditions that underlie that, but this is meant to do something in the interim in recognition of those two points. This bill was largely pushed by Democrats but has a lot that is designed, like I said, sausage-making wise and was held up on multiple occasions by good friend of the show Ted Cruz.
How am I doing on that summary, Phil?
Phil: I think that’s perfectly accurate, and when you’re done wrapping up we can get into the details at your leisure.
Andrew: There we go. So why don’t – we’ve had you on the show before, one of my favorite episodes, the Saving for College is for Suckers.
Andrew: I highly recommend, I’ll link that in the show notes.
Thomas: For your kids. Saving for college for your kids, right?
Phil: Yeah, yeah.
Thomas: That’s for suckers, yeah.
Andrew: And Phil, for those who weren’t with us the first go round, tell us a little bit about who you are, what you do, and why we dragged you on here.
Phil: Sure! A couple things, I have been doing my business, Polaris Financial Planning, for about 24 years and so if someone’s gonna ask “why have this guy on?” this is my living, I’ve done it for more than two decades. I also have a podcast, the cleverly titled “The Phil Ferguson Show” which is about 1/3 finance or investing and 2/3 atheism, I am number one in that category.
Andrew: [Laughs] In atheist financial investing? That’s excellent!
Phil: Yes, exactly.
Phil: And it’s a thing that I thought maybe I’d get a client or two out of it, but it created a floodgate because apparently no other financial planner in their right mind would dare to market to the atheists because it would taint their reputation.
Phil: So it’s not that I’m a big fish in a small pond, I’m a little fish, I’m the only fish in this pond.
Andrew: [Laughs] It’s a koi pond.
Phil: Yeah! I talk to other advisors about handing over some of the extra people that wanna hire me and they’re all very excited ‘cuz, like almost every business, finding new clients is one of the hardest things, and they’re very excited about this prospect of me handing over clients for them to bill. They get this point where they say “where are you getting these clients from?” and I’m compelled to give a straightforward and honest answer and then they lose all interest.
Phil: When financial advisors turn away basically free money I – boy, that tells you a lot about the stigma of what it means to be an atheist. Some other references currently, until the middle of February I’m on a hold and not taking new clients. Prior to that my minimum was $500,000. I’m putting in some new software so if that makes me more efficient I’ll have room for a few more new clients, but of course if you just wanna listen to the show, the Phil Ferguson Show, you can learn. Everything I do I cover for free and I’ve had other advisors tell me I’m insane because I’m giving away the keys to the castle.
Phil: And so the people that call me and wanna hire me are basically saying “I like what you’re saying, I like your strategy, I’m just not gonna do it. I have other shit to do in my life or I don’t wanna deal with it,” and/or husband and wife, husband and husband, whatever, it can create a point of contention because if you buy a stock one spouse wants to hold it, one spouse wants to sell it, who knows which one is right. They don’t, and if I’m making the decisions if it goes bad, they can at least-
Thomas: They can at least blame you.
Phil: That’s right, I’m saving marriages here!
Phil: So this is important. [Clownhorn] So that covers a lot of my background. The other thing is I often expose what I think are [Inhales] devious? Deceitful? Not criminal activity, because a lot of what happens to investors that might be considered amoral or immoral, it’s not illegal.
Phil: So I will break down the mathematics of how an annuity works, how a reverse mortgage works, how saving for college works, how long term healthcare insurance works, and we go through maybe what the promotional pitch is and then we go through the actual mathematics.
Thomas: I’ve got a morals question for you.
Thomas: A morals finance question. What if I’m a member of Mar-a-Lago and Donald Trump says “hey, I’m about to go kill somebody in Iran, so apropos of nothing, maybe buy up some defense stocks,” and then a bunch of people buy up some defense company stocks. How’s that? Is that moral?
Phil: Yeah, I would consider that to be an unethical action. I don’t know that it would necessarily be illegal-
Thomas: Strong claim! [Laughs]
Phil: Insider trading implies that you know something unique about the company and in that case if you’re just buying all military stocks-
Phil: -you have advance knowledge of what the government is gonna do, not necessarily anything specific to a company.
Thomas: Oh, wow! I didn’t realize that. So if you just know something about the world-
Phil: I’m not staking my reputation. A, I am not an attorney.
Phil: But any case that I’ve ever heard of-
Phil: -not that many, it’s somebody knew something specific about a company, a stock, not about an industry.
Andrew: I can vouch for that, I would also add that one of the seminal cases in insider trading law involves the fact that insider trading – again, we’re grossly oversimplifying, there are a number of-
Thomas: Sorry, I was just trying to make a quick [Laughs]
Andrew: No, that’s great! But, hey, we’re going down-
Phil: No, it’s good fun!
Thomas: But it’s an interesting question-
Andrew: Hey, we’re on a rabbit trail and by god we’re finding the rabbit at the end of this!
Thomas: Let’s do it! Let’s get that rabbit.
Andrew: Uh, requires specific intent. So this case, I’m just summarizing the facts, but it was I wanna say a basketball game, could’ve been a title fight, but you know, classic – I think this is from the 1980s, so sort of classic, you’ve got a guy sitting in the front row and sitting behind him are two go-go 80s guys, fresh out of the casting of Wall Street, and they’re loudly bragging to each other about their various wall street acquisitions and the one guy’s like “yeah, man, and I’ve been working so long and just you wait until Amalgamated Consolidated Industries is acquired tomorrow, dude my holdings are gonna triple!”
Andrew: And the dude in the front row, dutifully took notes.
Thomas: Got on his giant phone.
Thomas: I don’t know what it would be back then.
Andrew: And the next morning called his broker and was like “hey, can you buy Amalgamated Consolidated whatever?” and did and it was super easy.
Thomas: Can I?
Andrew: And again, back then you looked at all of a sudden, even the Commodore 64s that were used to track transactions back then, all of a sudden if you have a guy who’s buying 100 shares at a time and holding them, all of a sudden buys 310,000 shares of Consolidated Holdings five seconds before a merger is announced, that tripped red flags even in 1987.
Andrew: So he was arrested on insider trading and conviction overturned. The appellate court said no, overhearing people bragging about the law about potential acquisitions is not insider trading.
Thomas: But just to be clear, if Trump went and told his buddies though-
Andrew: Yeah, yeah, yeah.
Thomas: That’s at least, we should impeach him, right?
Thomas: For that, specifically.
Andrew: For lots of things, but yes.
Phil: I’ve seen some conservative friends freaking out about Nancy Pelosi having personalized pens that she used for the signing ceremony.
Phil: And I would have to agree that that’s bad form, that she should not have done that, but honestly if you’re worried about those pens and not the underlying constitutional violations you have a problem.
Andrew: Amen, brother! [Laughs]
Thomas: Wow. So let’s get back to our topic at hand.
Phil: What was our topic? Oh yeah, the SECURE Act! The cleverly titled SECURE Act. So anyway, I’ve read a lot of articles, advisor reviews, and for the most part a lot of this is meh. It’s little stuff that doesn’t have a big difference, and I can go through some of the highlights if you’d like.
Andrew: Yeah, please do.
Thomas: Yeah, please.
Phil: There’s a couple of incentives for small companies to create a 401(k) or a 403(b) plan so their employees can save money.
Andrew: Ooh, can I just interrupt for just a second? I get to play Thomas in this, which is great.
Phil: Of course!
Andrew: I think everybody knows what a 401(k) is, what’s a 403(b) and what are the differences?
Phil: A 403(b), from all practical aspects as an end user it’s the same thing but a 403(b) is often organized, initiated by company that is either a government agency, a charity, a hospital, a church. It’s also called a TSA, a Tax Sheltered Annuity, and it’s one of the rare cases that the word annuity shouldn’t scare the shit out of you.
Phil: But, yeah, TSA 403(b) is for our practical purposes essentially equivalent to a 401(k).
Andrew: Okay, so go back. Sorry, I just, uh, had to do that.
Phil: Yup, yup! So some small companies don’t wanna set up a 401(k) because there are requirements, regulations, filing things, and there’s fees and expenses that you have to pay for that, but that usually amounts to a couple of thousands of dollars. Like two or three or four thousand. Part of the things in this is it has incentives, $500, a couple thousand dollars maybe, for a small company to encourage them via tax breaks, tax credits, to set up a plan that maybe they weren’t going to. So that’s nice, I’m all for it.
Another small thing is that a lot of companies will set people now to auto-enroll, usually at three or four or five percent of your savings and you can opt out of that, whereas a generation ago there was no automatic opt-in and you had to fill out the paperwork to sign up.
Phil: What happened was a large number of people don’t understand money, they don’t understand a 401(k) or a 403(b), and until they do they don’t feel comfortable putting their money in and they never end up saving any money, so the auto opt in function is good and now it’s changed where the maximum it could go up to before was 10% and now it’s 15%. So they might start you at 5% and then increase one or two percent every year. I think that’s nice, people still have the ability to opt out.
The one thing I think in this sphere with small companies that may be a surprise game changer, and I don’t know ‘cuz like I said I didn’t read the exact language in this particular part – is that small companies that are completely unrelated, different industries, different States, different parts of the country, combined together to share and efficiently manage and hopefully get a better product. They can put together a joint 401(k) that goes across multiple companies.
Phil: Now I don’t know the exact rules or how many companies can do this, but it could theoretically create the situation where a company creates a 401(k) and somehow finds a way to make more money by running the 401(k) than their main business and they end up getting hundreds if not thousands of different companies involved in this, and they could become a heavyweight within the financial world by running third-party, basically, 401(k)s for companies all across the United States.
Andrew: And drill down – I’m gonna talk about the specific provision in a minute, but drill down a little bit on the potential financial incentives there.
Phil: Well the financial incentives, for example – I can’t remember which one of the late night comedy shows did a segment where if you’re a very small company and you go to one of the big players in the financial services industry like Schwab, Fidelity, Vanguard, and you say hey, I’ve got five employees and we wanna start this 401(k) and everyone’s gonna start at zero but I want you to set up all the paperwork and do all this, they say no, you have to have a certain minimum whether it’s a million, five million, ten million.
As the size of the portfolio gets bigger you get bigger discounts, you get lower fees, lower expenses, lower operating expenses. They might even do a federal filing for you for free because they want your $10 million account, even if it’s 20 or 50 or 100 employees. But a small company with 10 or 15 – actually the more employees probably the harder it is to start. People add money, you’ve gotta track all that, people take money out. There’s reasons and ways and qualifications where they can take money out for different reasons and you have to track that, maintain all that. Those people move, you’ve gotta change the addresses, and it can be very tedious and expensive accounting if there’s practically no money there.
So a really small company might end up with – okay, on my show I might mention the name, on your show I don’t wanna do that. Some small company that specializes in providing 401(k)s to really small companies but the expenses are gonna be borne by the employees, so the investment products that you have available to you are at minimum subpar and maybe just downright horrible because they’re not doing it for free and they’ve gotta make money from somewhere, they’re gonna take it from you, the individual investor/employee.
Andrew: And are there any restrictions on how large those fees can be that they can pass on? Or is it just every provider for themselves?
Phil: There’s different fees. As an example, a front end load where when you invest money they can charge you what’s called a load in the front. They can also do continuous or backend but usually something like this will do a frontend. That is limited to 8.5%.
Andrew: That still seems high! [Laughs]
Phil: Well, I mean, if you think that 1% give or take is too much to pay for advice, paying 8.5% is obviously a lot higher. It’s not just 8.5% on the first batch that you put in, if you are continuously adding money every time you add new money, 8.5% of it comes right off the top. So you could have that.
Phil: As far as the expense ratio, I am not aware of a maximum legal limit that that could be. A lot of index funds have expense ratios around 0.1% or less, whereas a managed fund might be 1.0% or 2% or even 3%, so you could lose 8% up front and then 1, 2 or 3% more every year. So all those expenses and other expenses may be like $25 to trade, if you wanna close the account $100 fee, and you get all these little things that, if you’re talking about a portfolio of $500,000, $100 is annoying as a fee. But if you’re talking about a $400 account, a $100 fee to close it is a really big deal to that individual investor.
Phil: So instead of all these companies having subpar 401(k)s, dozens if not limited hundreds, maybe even thousands of companies can come together and participate in one ginormous 401(k) which in a weird way may be a step towards what I think is inevitable, that the employers really shouldn’t be involved in your retirement planning. This could create a way for a 401(k) to become standing on its own rights and then maybe it has sales people that go to all the companies and say “just agree to sign up to our 401(k) and you don’t have to worry about it.”
I dunno how that’ll play out, but that could be the dark horse, that’s the black swan of the whole thing that maybe that changes the entire system, but I dunno yet.
Andrew: Yeah, that’s really interesting. I’m just gonna flag, if you are – [Laughing] and believe me we have listeners who, like me, are delving into the specifics of the text – look for, these are the aggregation provisions, so if you just do a CTRL+F for “aggregated” you will see the specific, I’m not gonna read them all out-
Phil: Yeah yeah.
Andrew: -because that’ll bore Phil to tears. Thomas is used to it.
Andrew: If it was only him on here we would, yeah.
Phil: That’s why you have a third-party editor!
Andrew: [Laughs] Oh yeah.
Phil: Other things that are real practical to individual people-
Phil: If you have an IRA, previously, before 12/31 of ’19 when you turned the age of 70 and 1/2, or more specifically the year in which you turn 70 and 1/2 (which is stupid to have a half) but in that year you would have to start taking out what’s called “required minimum distribution” (RMD’s). They changed that from 70 and 1/2 to 72. So they’ve technically added a year and half but what it means is some people will get one year, some people will get two extra years because of when your birthday falls.
That’s nice if you don’t need the money, but people that don’t need the money are a select few that have money and assets other places so they get to defer taxation for another year or two. It’s a nice little perk, not a real big deal but nice for people with nice portfolios.
Another change which is one of those things that’s nice in theory. They’ve expanded who can join into a 401(k) even if they’re part time.
Andrew: Yeah, I was gonna ask you about this, so yeah, please do.
Phil: Well the previous rule was if you had more than 1,000 hours, I think it was 3 years, but now it’s a total of 1,000 hours or 3 years of 500 hours, that’s nice that more people can participate, but if you have job where you’re only working 500-800 hours a year you don’t have enough money to save in a 401(k).
Andrew: Yeah, that’s a really good point.
Phil: Yeah, it’s a nice bone to throw at somebody and say hey, you can save money poor person, I changed this plan. Well it would’ve been a whole lot nicer if you increased minimum wage.
Phil: Kay, we could go on. Here’s another thing that could be a real big problem, and I do expect this to be a problem, is that 401(k) plans are gonna have more flexibility allowing in alternate investments including annuities inside of a 401(k). This may create a lot of attention from the insurance industry where they will now want to go out and very, very aggressively sell their 401(k) plans to companies.
So you will have people that maybe have spent 5, 10, 20 years and they’re professional sales people, calling on people who have a job in the HR department. Who is more skilled and adept in understanding how this works? You might have someone who just loves helping other people out and has a job in HR because they like doing that, across the table from someone who’s a trained lifetime professional, high pressure salesperson. I worry about that.
Andrew: Yeah, and I want you to drill down on that a little bit. My perception as an outsider to your profession, but as somebody who interacts with a lot of people in your profession, is that folks who are selling annuities tend to be the highest pressure salesman [Laughs] in the industry. That’s my observation, what do you think about that as an observation?
Phil: I absolutely agree and it may come down to the fact that annuities aren’t bought, they’re sold. That’s the catchphrase in the industry. Very, very rarely does someone just sitting around and looking at their portfolio and they think to themselves, well gosh darn it, the one thing I need is an annuity, and then they go out-
Thomas: Do you mind just defining annuity for people listening?
Phil: Ah! Okay, so the first caveat I have to do is the word annuity can be used in multiple different ways and I’m gonna briefly cover two of them and then not talk about them anymore. The first is the tax-shelter annuity, a 403(b), equivalent to a 401(k). We touched on that earlier. So that use of the word “annuity” is okay. The next one is when you’re going to retire from your job of 10, or 20, or 30 years and they wanna offer you a lump sum of cash or an annuity payment, that may or may not be good for you but you can do some math on it, or I can help you do math on that. Again, it’s not necessarily bad.
Andrew: And that’s because – let me just jump in. I use that vehicle in commercial settlements all the time, right?
Phil: Right, right.
Andrew: When somebody will say hey, I was wrongfully terminated and what they are entitled to or what we settle on is fine, you’re gonna get $100,000 a year for the next 20 years and you can go to a financial institution and pay a lump sum of money and that’s a simple NPV, Net Present Value, calculation you can stick into Excel and say okay, well, we know the time value of money is higher in the present than in the future, so $100,000 for 20 years is not worth $2 million, it’s worth something less than that.
Phil: Absolutely right.
Andrew: And again, super easy calculation. So those two seem fine.
Phil: And in that case it can be a huge advantage to the person paying the settlement because they get to stretch it out over time, and it can also be a huge benefit for the person receiving the money-
Thomas: For tax purposes.
Phil: -because if you take someone who has no idea how to handle $10,000, or their $3,000 pay check, they don’t understand how to handle $2 million and it will disappear, so a settlement like that in payouts over time via an annuity, not a problem.
The annuity that we’re gonna talk about now is where someone convinces you to come to their office or they show up at your house and they sell you something that you didn’t know you needed.
Phil: And so you have to be – I don’t know if I wanna say good? Persuasive? Something. You have to have sales skills to succeed at that job and you put money in and they’ll say buzzwords like “I think that when the company finds out how good this annuity is they’re gonna pull it off the market, so you’re gonna want to get into this right now.”
Thomas: Mmmm. Sold, Phil! I’ll buy it! I’ve got fistfuls of money for ya!
Phil: Or they’ll tell you things like “you’re gonna make the vast majority of the money the stock market makes because it’s indexed to the S&P 500, but when the market goes down you won’t lose a dime.” That sounds very sexy that you’re gonna make most of the upside and experience none of the downside, it’s a win-win for you as the investor, and like with anything – I’ve done these on the show where I’ve gone over specific contracts and one of the problems is that every single annuity is unique and you are bound by the 120-page contract you sign.
In the details there’s little caveats and what-ifs that it never really seems to work out exactly like it was sold, and it can take you years to figure that out.
Andrew: Well, I know we’re a little in the weeds but I think this is really, really interesting. Let me kind of steel man the other side.
Andrew: So if I am a person headed towards retirement, which anybody who listens to the show knows that’s never gonna happen! But I’m a person headed towards retirement. The idea of an annuity, that I invest in this vehicle, I buy in, those payments are tax-deferred, and then when I retire I’m going to get lump-sum distributions back to me that are predictable means that okay, well I just need to figure out, what do I need to get so that now I’m earning income when I’m retired? I get that kind of concept, if I’m anticipating the sales pitch that seems like a pretty good program. Go ahead.
Phil: Well the idea of an annuity can be quite good. I’m not opposed to it from a theoretical perspective, I’m opposed to it from a practical, I’ve seen what they do perspective.
Andrew: Yeah, so what happens? Yeah, that’s what I wanted to drill into.
Phil: Yeah, as an example, and I’ll try to keep this tight. Somewhere in one of my 300+ shows is half an hour of the mathematics, but someone calls me up one day and says, “Phil, I’ve got this annuity and last year the market made 14% and I got paid 0.” I’m like, is it a fixed annuity? They go no, it’s variable, it’s tied to the S&P, I’m supposed to make whatever the S&P makes only when the market goes up.
The first thing you should be warned about is if someone tell you you make money when the stock market goes up and you don’t lose money when it goes down, there’s gotta be more to it!
Andrew: [Laughs] It’s not a pyramid, it’s a trapezoid! [Laughing] Yeah, right!
Phil: Yeah, yeah! And so what they had was they had the most you could make in any given year was 12%, the worst you could do is zero. So he’s thinking the market went up 14%, should I not at least get my 12 or some portion of that? Well they had this neat clause where they calculate a number every month on what percentage you should get that month, so if the stock market went up 4% in a month the most you could make in a month is 1%.
Andrew: Oh, I see. So to get to the 12 you had to have 4% growth every month for twelve months?
Phil: No, no, you’d have to have 1% or more of positive, every month.
Andrew: Oh, okay, I see. Got it, got it.
Phil: So it’s capped, it’s not a ratio, it’s not tied to it, it’s just a cap.
Andrew: Got it.
Phil: Now if you have a month where the market goes down, for that month there’s no downside cap.
Andrew: In any given month. So it subtracts-
Phil: In any given month.
Andrew: I get it. So in other words, let me see if I can’t spit this back to you, to make the 12% you’ve gotta have 12 consecutive months with 1% growth or more. To meet up with the “you never lose money,” you have to have 12 consecutive months all loss and then at the end of the year they sort of zero that out-
Phil: But even more tricky-
Thomas: I thought he was saying if it loses a lot then, does that count for the whole year or no?
Phil: Let me give you the example, in this year that we’re talking about. 10 months were up 1% or more, so he had +10.
Phil: So the max is 12, he’s gonna get 10, but two of the months one went down 8, one went down 10% a net month, so the total loss was 18.
Phil: So he’s got positive 10 points, minus 18 points, the net is negative 8 but they guarantee you not to lose money so they give you zero.
Andrew: This sounds like a carnival game, right? [Laughs]
Thomas: It does!
Andrew: With the milk bottles, or, you know!
Phil: And it’s the thing that part of me, I’m impressed because this is so clever! So insidiously brilliant that you’re not gonna make money, but it’s sold and the person selling it may not actually know what they’re selling. In some cases I have found salespeople that do a better job when they don’t actually know the details because it doesn’t [Clownhorn] matter. They’re not paid to be experts on how annuities work, they’re paid to be experts in selling [Clownhorn] annuities.
Thomas: Salespeople? Yeah.
Phil: So they’re paid to sell, not to know.
Thomas: So with that in mind, what was the part of the Act? Just to refresh us.
Phil: Yeah, yeah.
Thomas: So you were saying this open ups and opportunity for…?
Phil: So previously-
Thomas: Go ahead.
Phil: -the employer assumed the responsibility as a fiduciary to make sure all investments were in the employees best interest. Most employers took that as meaning mutual funds are the way to go, we’re not gonna get creative because we can be held personally, or as a company as a whole, liable if this shit implodes and somebody makes no money, so they’re not gonna go anywhere creative, they’re gonna stick to really boring stuff.
Andrew: And let me jump in with that. I’m asking this as an open ended question. In my experience, which includes switching jobs a couple of times and representing a whole bunch of clients, I have never seen an employer 501(k) program that includes annuities. I’ve literally never, ever seen it.
Phil: Yeah. You said 501(k)? I’m assuming you meant 401(k)?
Andrew: [Laughs] Thanks! Usually-
Thomas: 501CK3, 3-P-O.
Andrew: Usually I get to correct Thomas, that’s fair – we’re good! [Laughs] I meant 401(k)s and I was confusing that with 501(c)(3)s which I’m used to.
Thomas: Sure, yeah, usually you’re the one doing the correcting!
Andrew: I know! And I don’t like it at all! This needs to stop!
Thomas: Mr. Hookers and Flapjacks, is what I was getting to before you rudely interrupted me!
Andrew: Phil is never coming back on the show!
Phil: Never coming back! And it can happen, but there’s trends that I see in the industry. One is that everyone had three or four or five funds you could choose from 20 years ago.
Phil: And then it became 12, and 15, and 20 and then index funds became popular and you had index funds. Then target-date funds became the default, where when you are auto-enrolled the company, to protect itself even more, would push that management of what you own versus stocks, versus bonds, versus international, different types of stocks, different types of bonds, they would assign you automatically to the target-date fund that matched your age and then Vanguard or Fidelity or Schwab, they were the one managing your account, not the employer.
Phil: Not the employee, but the experts. Yeah, so those companies wanna be safe and conservative and not get sued by trying to provide some perk to the employees that they’re kind of obligated to provide because everyone else does. But now, now they’re specifically – the employer – is specifically off the hook, they will not be held responsible as the fiduciary of the 401(k) plan, they can abdicate that responsibility to an outside company like an insurance company, and the insurance company can come in and say yes, these annuities are good for the employees, you can trust us.
Andrew: And so it’s your understanding of the SECURE Act that it eliminates the fiduciary duty requirement?
Phil: Well, no, it eliminates the fiduciary requirement from the employer.
Andrew: Right, right.
Phil: It is pushed to the insurance company, and I don’t trust ‘em. I think they’re gonna get tempted, some of them, to sell and promote to companies that don’t know any better and they’ll come in and they’ll say look, you guys pay $5,000 a year for this 401(k), that’s a lot of profit to the family that owns this. We’ll absorb all that, we’ll cover all those costs, and we’ll sell everybody annuities and whether they make 2, or 3, or 5% a year, the employer may not care, may not know, may not even know how to care. They don’t understand it, it’s very complicated [Clownhorn], but again that high pressure salesperson comes in and convinces you they’re gonna make your life better.
Andrew: Well and to put a cap on that, that explains. This is on page 1608 for my listeners who are following along and reading the bill.
Thomas: Yeah I’ve printed it out. Hold on, just got a really big binder.
Phil: And so that’s something the insurance industry must have pushed for, must have lobbied for, must have paid a lot of campaign funds for. It can totally change the dynamics of how those services are provided, and I have every expectation in the next few years that a lot of people will be calling me going, “uh, I had my account being held at Vanguard, at Schwab, at Fidelty and now I’ve got this insurance company that I don’t know.
By the way, one of the tricks that you may or may not know. If you have an annuity, an insurance company goes broke, you might not ever get a dime out of it.
Andrew: Well and the provision – I did not know that, and I wanna explore that. I was also gonna add, as far as I can tell it’s even slightly worse than you suggest? Because the provision to which I was alluding is a limitation on liability provision, which says this: “No plan fiduciary shall have any liability under this title solely by reason of the provision of lifetime income stream equivalents” that is, annuities, “which are derived in accordance with the assumptions and rules described in this section and which include the explanations contained in the model lifetime income disclosure described in” also in this subsection.
Andrew: “This clause shall apply without regard to whether the provisions of such lifetime income stream equivalent is required by” another different section. So I read that as saying not only does the bill encourage the adoption of annuities into the 401(k) stream, but if you follow the model language in the law, which the reason you put model language in the law is so that you can put it in a thirteen-page, four point font disclosure-
Andrew: -and have the client sign it. If you follow that then that seems to imply that your employer signs up and everybody gets auto-enrolled into this annuity program including the 71-year-old who probably has a very different payment income stream headed towards them than the 30-year-old in the office. And that’s bad.
Phil: And of course I’m assuming that they’ll provide a long list of options, not to be confused with the investment vehicle options, but you’ll have a lot of choices. So you might have 10 annuities to choose from, you don’t know which one you wanna pick, it’s all very complicated, so the very friendly representative from the insurance company will sit down with you and give you what is in your best interest, wink wink, nudge nudge, pays the highest commission.
Phil: So the whole thing to me stinks, and the opposite of the free market third party 401(k) programs that don’t exist, but may in the future, this is on the opposite end. Again, if we are assuming that people don’t know what to do with their money, which is why we have the auto-enrollment and the auto-increase-
Phil: This now allows people who know what the [Clownhorn] they’re doing and come in to HR people and individual employees and convince them of something under the guise that they are there for their best interest and make what is probably going to be an unlimited amount of profit.
Andrew: Ooof! To maybe not strain an analogy, but this sort of seems like – a salient analogy would be when we repealed restrictions on pharmaceutical company salespersons [Laughing] dealing with medical professionals in the 1990s.
Phil: Mm-hmm. Yeah.
Andrew: It seems like the same kind of situation that you’re now injecting folks who are self-interested into a process that will have material outcomes. Well this is depressing.
Andrew: This is why we had you on the show because when I initially read, I mean Thomas and I talked about this on Friday’s episode, you heard in the intro section, this was predominantly being agitated on the left side of the spectrum and it seemed like there were a number of useful provisions, in particular the part time employee provision. We could talk about, I mean you already think 529s are a scam, but the ability to take-
Phil: [Laughs] I think they’re suboptimal!
Andrew: [Laughs] But the ability to spend that – so one of the things that the SECURE Act does is you can take up to $10,000 out of your 529 to repay student loans.
Phil: Right. And as a standalone item, that’s great. Matter of fact, I like that much better than the rule that you can take out $5,000 from a qualified retirement plan to pay for an adoption-
Phil: -or other qualified childhood expense, birthing expense.
Andrew: That’s a Ted Cruz provision, but yeah, keep going.
Phil: [Laughing] Well, yeah. One of the problems is that if you allow more and more ways to pull out of your retirement fund earlier, you’re just not gonna have a whole lot in your retirement fund.
The other thing I want to get to, because I don’t know if you planned on us talking for too long so I wanna make sure I get this in. One of the most significant – and this is the one that I have not yet wrapped my head around. You can, of course, listen to the Phil Ferguson show, maybe I’ll figure it out.
Andrew: Oooh, nice plug! That was very slick!
Phil: Thank you, thank you. This is what they’re calling the “stretch provision.” People may or may not know. If you as the parent have a million dollar IRA and you have two children and you leave them each half, or about $500,000 in IRA money, when it goes to the descendants it becomes a beneficiary IRA and that descendant will have to pull out, again, a required minimum distribution based on their life expectancy. So if they receive this $500,000 when they’re 40, if their life expectancy is another 40 years they might have to take out 2.5% of the money, one over 40 for the life expectancy.
So they can take out a very small amount that’s required every year, for the rest of their lives and it’s a really nice way, generation, to hand over money that one person has made and their descendants get that money and they get to defer taxes for decades to come. Absolutely delightfully wonderful thing and a real pain for the government because they’re never getting the taxes on this.
Phil: Or at least they have to wait 30, 40, 50 years. One of the new rules is that money must all come out of there within 10 years. Period.
Andrew: And that’s primarily done as a revenue portion of the bill, right?
Andrew: To offset all of the costs of everything else in terms of the additional deferments that are permitted.
Phil: Well, it’s bad enough when you’re in your 20s or 30s or 40s that you can put money into an IRA and avoid taxes for your entire lifetime, which can be 30, 40, 50 years from when you put the money in there. But then when you give it to your kids and they can do another 20, 30, 40 years, the government’s not getting paid. It’s one of those things that it’s been kicked around as an idea, I can’t believe it survived and made it into the law.
Because another thing that has been kicked around, I normally tell people with a Roth IRA you pay all the taxes up front and you never ever pay taxes again under current law, and people are like “why do you say it like that?” [Laughs] Because it’s only a vote! It’s a vote. At some point they say, oh, you know what? Now everything you’ve made inside of the Roth, which we told you was tax free, is now 15%. They have not done that – just before I scare anybody, they’ve not done that yet.
Thomas: I was gonna say, dammit! I think I have some money in a Roth IRA!
Phil: Yeah! And they went for something that I never though this had a snowball’s chance in hell of passing, but if you give money to your kids, I’m assuming on your death. Your IRA becomes a beneficiary IRA for your descendants, they will have to take out the money within 10 years.
Phil: Or the penalties are huge. Now to tie this to even a more fun thing, if you have a large portfolio you may have created a trust and you may have designated that the IRAs designate the trust as the beneficiary, and so now the trust owns the IRAs. There’s pros and cons with that, I’m not a big fan of it, but you might have chosen to do that.
If that is something that you have set up, if you currently have a trust, you better get to your attorney freakin’ toot sweet and make sure you’re not gonna get [Clownhorn] by this, because what could happen is that IRA goes into the ownership of the trust, and the trust may have a paragraph or a couple sentences that says the Trustee must only give out the required minimum distribution to the beneficiary of the trust.
Andrew: [Sighs] [Laughing] Yeah.
Phil: Under the 10 year provision the required minimum distribution for year one is technically zero, so the Trustee not only could argue but may be obligated to give the descendent, the beneficiary, absolutely nothing otherwise they would be in violation of the law and the trust language, even if it is contrary to what the intent of the language was. Because the intent may have been to spoon feed your kid from the grave because you know they’re a [Clownhorn]-up and if you give ‘em all the money they’re gonna blow it and be worse off than if they never had the money at all, so you only want them to get 2, or 3, or 4% as they age.
So in year one, the technically required distribution is zero. So that person who may have been counting on getting 2 or 3% of the money is now told by the Trustee I’m sorry, the language says I can only give you the RMD, the RMD is technically zero for this year, I cannot give you any money at all. Then on the 10th year they will dispense 100% of the money because the RMD for the 10th year is 100%, so they get nothing for 9 years, on the 10th year they get the entire amount. Money that was intended to provide for them for 20, 30, 40, 50 years, they get nothing for 9, they get 100% in the 10th year and then all hell breaks loose because they don’t know what to do with the money and they blow it.
Phil: It’s not necessarily that this is bad or good, but you could end up with something that’s the exact opposite of what you intended if the language in your trust is not correct. So if you have a trust, you need to pay your attorney to sit down and assure you that it is in compliance with the new rule and regulations of the SECURE Act, not just this but everything else and it will actually do what your intended for it to do.
Andrew: Let’s unpack that a little bit. [Laughs] That’s why you heard me inhale sharply in the middle there. Let’s be super clear, the reason you establish a trust is because you have a child – very often at the time a minor child – and you want to control in some way the distribution to that child because even though we might say okay, well, 18 they become a legal adult. Ah-huh, my son is 17. The idea that [Laughing] I would leave, you know, my entire estate, modest though it is, to my son to do whatever he wants at 18 is … that would not happen.
Andrew: Because, you know, he’s a kid! He’ll still be in High School at the time.
Phil: And it’s not because he’s 17, it’s because he’s a human.
Phil: And most humans don’t really deeply understand money and how it works.
Thomas: Well, and he has a fierce drug habit. I know you don’t know, Andrew’s son, but… No I’m just-
Andrew: [Laughs] Yeah, he met Eli when he was 12 so, you know, it’s…
Phil: It’s a very weird bubble that I live in because all of my clients are the exceptions.
Phil: They are people that have worked very hard, they’ve got a little bit of luck but they’ve worked very hard, they’ve saved a lot, they’ve got this big portfolio, and it has taken them 10, 20, 30 years to absorb this idea that they have a million dollars or two million or five million. So you have generations to try to equip yourself mentally to what that money means, but you hand 3 million to anyone, whether they’re 17 or 42, they cannot conceptually understand how big that is and how small it is when you start spending it, because it just disappears.
Andrew: Well, and for me, and the reason – ‘cuz I’m a lawyer. The reason I inhaled sharply is whenever you have anything that creates an effect that is the opposite of what people intend, that’s where the law runs into problems.
Andrew: And I would add, you didn’t mention this but it remains, putting those two pieces together. The other implication of phasing out the stretch IRA rule, or eliminating, I guess it doesn’t even phase it out.
Phil: It doesn’t phase out, it’s already gone. It’s already gone as of January 1.
Andrew: Thanks! I want it to be even worse!
Andrew: But the other implication of that is you now have, if the trust is the beneficiary of the IRA, you now have a situation where that’s paid out into the trust and that becomes – you lose out the opportunity to continue to grow the money tax free, even if the trust is able to, even if you re-write the trust so that they’re paying appropriately, they don’t get stuck with the zero for 9 years and 100% in year ten-
Andrew: You still have, if I wanted to provide for my son for 30 or 40 years I’m now providing with a substantially less tax deferment than previously.
Phil: And you may or may not know that a trust, theoretically, is designed to dispense the money like we talked about, as one of the reasons one might have a trust. The tax tiers, whether you pay 0 or 10%, or 24, or 28, or 39%, the tax percentages are the same, but the tier sizes are dramatically compressed. I think the number – I actually manage a trust for somebody – is once that trust makes something like $12,000 of earnings they’re in the top tier and they can be paying 30% tax on that, whereas if the money went to your descendant they might pay 10 or 15% tax on that. Or zero, because-
Phil: Because $12,000, you might pay zero tax bracket, but the trust if it holds it by choice or by requirement because the language compels the Trustee to do something that’s stupid, 30% is lost. It’s a very, very big deal, this is a very serious change and I kind of see it as – it’s a weird thing. If you are poor, and it’s awful, no one should be poor, I dunno how we fix it but there’s some ideas that we’re not doing. But if you’re poor this doesn’t affect you, you’re not saving an IRA, you’re not creating a [Clownhorn] trust, you’re not handing your IRA to your kids, it doesn’t affect you.
If you’re really rich, most of your money is not in an IRA, it’s in a taxable account and there’s some really big freakin’ perks when you hand your money to your kids and none of that changes. This affects people in the middle, in the upper middle.
Phil: That have, over their lifetimes saved up some money with the expectation that they can give it to their kids for the rest of their child’s natural life and that’s gone.
Andrew: Well that’s … that’s depressing.
Phil: Yeah, glad I could help.
Andrew: In addition, I mean one of the things I really liked about that is we have some concrete takeaways. If you are a listener and you have a trust, talk to your trust’s lawyer. What else, is there any other sort of practical on the ground takeaway that the average listener ought to think about in light of the SECURE Act’s passage?
Phil: I think the idea that you can delay until 72 to take out money is nice. Not a big deal. You can add money past 70 ½ into a traditional IRA, a nice perk but not a big deal. I think other than this trust and the stretch IRA or the bene-IRA thing, the next big thing for people to worry about – and this affects you, not your descendants – is keep an eye on your 401(k), because there could be some crazy [Clownhorn] wicked [Clownhorn] going on in there, and make sure your employers and your HR department understands how investments work. Good luck with that.
But that is the place where theoretically, unless I’m mistaken (and it happens), you could have several hundred thousand dollars in your 401(k), it switches to a new provider that switches you into loaded funds or an annuity and you could lose 5 or 8% of your money right off the top, money that you’ve already saved over the last years, lose money right off the top and then lose several percent every year afterwards and then maybe get less money when you retire. Keep an eye on that and if your employer allows annuities into your plan, my default is [Clownhorn] no! Unless they can convince you with mathematics that it’s a better idea, and I don’t think they can do that, so good luck with that. Sorry.
Thomas: Alright well, so, not a good bill, it sounds like? [Laughs]
Phil: Well like I said, it’s got a couple of nice little things but there’s a couple of big things that can really, really hurt people.
Thomas: Huh, well there you have it, there’s the break down. Anything else, Andrew?
Andrew: Nope, nope.
Thomas: I think we need to call it to a close?
Andrew: Yeah, we do.
Thomas: Thanks so much, Phil. We’re going to, of course, have you back on for the thrilling conclusion of T3BE, but in the meantime, once again the Phil Ferguson Show is the name of your podcast, right?
Phil: That is correct, the Phil Ferguson Show and of course you can listen to it on any good podcast feed. If you have questions about your portfolio or about anything we’ve covered here or anything else you hear on the show, you may email me, email@example.com, and I can’t believe but I’m compelled to tell you this: Do not send financial information. Do not send your social security number, do not send statements. If we contact, we talk, and then it’s decided that it might be beneficial for you to do so, [Laughing] only then do you send me anything and never send Phil money. That’s the only rule of Polaris club, never send Phil money.
Andrew: I promise-
Thomas: I was just about to! I wanna buy your annuities!
Phil: Yeah, yeah. Exactly.
Thomas: Alright, okay Andrew. It is Top Patron Tuesday, and it’s my turn. No, your turn first!
Andrew: No, it’s my turn. Yeah.
Thomas: It’s your turn first, so why don’t you go ahead!
[Patron Shout Outs]
T3BE – Answer
Thomas: And here we are, finally! For the thrilling conclusion of T3BE, Phil, I am very curious to see-
Phil: Oh my.
Thomas: -if your wild card answer was right. I have no confidence in my answer. What happened here, Andrew?
Phil: My perfect streak is on the line, here.
Andrew: [Laughs] Alright, so this question was: A woman and her sister took a trip to the Caribbean. Are caught smuggling cocaine on the way back, the woman upon being caught says “you know I told my sister there were too many officers at this airport.” They’re tried separately, which, by the way, that’s a total distractor that has nothing to do with how you evaluate the question.
Andrew: They were indicted for conspiracy to import cocaine, that evidence was introduced and then the woman’s lawyer moved for a judgment of acquittal on the grounds of insufficient evidence. So Thomas, you had asked, you said I’m not even sure kind of what the question is testing.
Andrew: The answer is the question is testing the elements of conspiracy.
Andrew: To prove conspiracy you have to prove, is there agreement to commit a crime and then did one person, as part of the conspiracy, commit an overt act in furtherance of the conspiracy.
Thomas: [Sighs] It’s B.
Andrew: Okay? So Thomas, you went with no because the evidence shows that both the woman and her sister agreed to import cocaine. Phil, you went with D, yes because the woman effectively withdrew from the conspiracy when she cooperated by giving a statement. I wanna first say, Phil is wrong. [Laughs]
Phil: Yaay! Oh wait…
Andrew: So here’s the thing, when you are part of a conspiracy you can withdraw from the conspiracy. That is, think about classic money laundering. Let’s think about Superman 3, right? Everybody gets together-
Andrew: It’s the Office Space version. People get together, we’re gonna steal all the half cents from the company, we all agree and only Michael Bolton goes in to actually upload the virus. Doesn’t matter, I’m sitting on the couch, I can be indicted, arrested, and convicted for conspiracy to steal all the half cents even though Michael was the one who actually did the thing. That’s important in conspiracy law because criminal masterminds don’t get their own hands dirty.
But what we also wanna have is, we wanna have the possibility that you get cold feet. That you’re sitting on the couch and everybody’s drinking and you’re like “yeah, we should do, it’s the Superman 3 thing! We should all!” and then the next day you’re like, “oh, holy clownhorn! Michael Bolton is actually gonna go upload this virus, I want no part of that.”
Andrew: So at some point, and I’m not gonna get all the way into the legal aspects, but prior to the completion of the criminal enterprise-
Phil: That’s where you got me!
Andrew: Yeah, you can withdraw.
Phil: They’d already been caught, yeah.
Andrew: Right. But once you’re caught, you can’t be like “no, definitely not!”
Thomas: [Laughs] You know, I feel like I’m gonna officially withdraw from this conspiracy! [Laughs]
Thomas: I had a good time doing this conspiracy, but my time has come! I’m retiring from it!
Andrew: So, attractive distractor. I like the way Phil got there, but no.
Thomas: Hold on, is that another way of saying once a media organization is going to publish a story about you withholding, let’s say money from Ukraine or something like that, and you’re caught, and then you say “no, here’s the money!”
Andrew: It’s almost like that!
Thomas: It’s almost like that doesn’t just get you off scot free?
Andrew: That’s an exceptional analogy. I mean, utterly farfetched-
Thomas: I don’t know why I thought of that example, but uh…
Andrew: -but completely parallel. Now I’m gonna cut through the rest of the answers, we could go through, but Thomas, you got this one right! Yup!
Thomas: Nailed it! Alright! [Laughs]
Phil: Good job!
Andrew: So the difference between – you chose A, because the evidence shows they agreed to import cocaine, and B was yes because it showed that they possessed cocaine.
Andrew: Well just having the coke does not prove that there was a conspiracy to import it.
Thomas: Yeah. [Sighs] Yeah.
Andrew: What the question is, does having it-
Thomas: I meant – earlier when I said I thought it was B I meant C because I was gonna say oh, does it actually show that they both wanted to commit conspiracy or just that they were possessing it? So what’s the difference there?
Phil: Thomas, do you wanna change your answer now?
Thomas: [Laughs] Now that I got it right? Yeah. [Laughs]
Andrew: Here’s the reason for that. The standard for whether there is agreement is that you can prove agreement by circumstantial evidence.
Andrew: You don’t need direct – you don’t need a written piece of paper that says “I agree to do the crime” and we’re all signing and notarizing, we’re all part of the – no, of course! You prove a conspiracy through indirect evidence and having the coke and turning to your sister and being like “see, I told you we were gonna get caught!” is sufficient for a rational jury to go, yeah, obviously.
Andrew: They were-
Thomas: You know, it was a guess but again, it was a guess based on what I know of our country and the drug war!
Andrew: But look, this may be relevant in other contexts. When you are going to prove someone’s state of mind – you don’t have to prove someone’s state of mind with a notarized document that downloads the contents of their head to a piece of paper.
Andrew: A rational jury can look at the facts and go yeah, obviously in this situation. This is not just two sisters who both happened to independently get the same idea to sew coke into their clothes. Yeah, there’s enough here for us to conclude that there was an agreement. So that’s what it was testing.
Andrew: The key part is not the possession but the agreement, and the evidence is sufficient, so great work!
Thomas: I got bad news for you, Phil. You just went from first place in percentage to now you’re below me! [Laughs]
Phil: Oh, wow. Well at least I knew it was the conspiracy, I just didn’t understand the definition, so I was in the ballpark.
Thomas: Yeah, the Bar is a fickle mistress!
Phil: Yeah, you got that right!
Thomas: Ah, it’s tough! Alright thanks so much for playing, though!
Phil: Thank you!
Thomas: And of course, Andrew’s gonna hop in his time machine and tell us who this week’s big winner is, who played along with us and had the best and/or funniest answer!
Andrew: Well Thomas and Phil, a lot of folks played along this week and we had a diversity of answers. I think almost nobody picked D, a lot of people picked A and this week’s winner is Natalie Lips, @Natalie_Lips on Twitter, who writes “#T3BE it’s not D because you can’t withdraw from a conspiracy after you’ve been caught. I agree with Thomas that it’s A because a reasonable jury could infer from the woman’s statement she and her sister were working in concert and were worried about being caught”
That is exactly right, dead on on the reasoning and takes a little swipe at Phil too, so I’ve gotta say, congratulations Natalie on being this week’s winner! Everyone, give Natalie_Lips a follow on Twitter for more fantastic wisdom.
Thomas: Alright that’s our show, thanks again to Phil Ferguson, check out the Phil Ferguson Show if you want more of Phil and his very astute yet clownhorn-filled financial advice. [Laughs] Poor Brian, I’m sure he had a lot of clownhorning to add, but that’s okay. And we will see you for a Rapid Response Friday and I’m sure nothing interesting will happen in the news before then.