We are all looking for ways to grow our money and build wealth for our family and for ourselves for the future. In response to these needs, you turn to your financial adviser who will most likely offer you some annuities, bonds, stocks, mutual funds, and rates. What you don’t realize is that you may actually lose money and get back less than you put into it. Hollis Day Jr. brings Mark McKay on the phone, the first ever guest of Sage Money Radio back in July of 2012. They discuss these annuities and possible alternatives. Given the declining GDP, it will certainly be a great time to be familiar with other assets. They talk about this very promising tax investment which you may not usually hear from your typical financial adviser or CPA. They delve on its benefits which can be quite favorable to everyone. Indeed, it’s high time to look at some alternative investments and tax deductions.
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Growing Your Money with Mark McKay
Time goes by fast. I always say time’s a commodity. That comes with your investments too, with your money. How is your money making money? How does your money make money? There are many things to look at than what your typical strip mall financial advisor has to offer? There are many things out there instead of the same old CDs, bonds, annuities, stocks, mutual funds, REITs. There are some great things out there. You have to get educated on those and feel comfortable doing that. I only deal with three strategies. Two of them are tax-related. All we do is follow certain parts of the tax code. Literally, going to the IRS tax code which is 86,000 pages, following them and doing what the ultra-wealthy are doing but doing it on a much smaller scale. I’m not wealthy, much less ultra-wealthy. I’ve been on this show for a few years. By saying that, I’m going to bring a man on the show, a good friend of mine who was the first guest ever of the show back in July of 2012. Mark, welcome to the show.
Hollis, how are things in Baton Rouge? Things are great.
Mark, the show’s been on the air for a few years and you were the first guest on the show. It doesn’t seem like a few years ago, doesn’t it?
It doesn’t. Do you know what we haven’t had in that few years period?
The start of the bear market. You get economic cycles throughout history and depending on how you measure it. The current economic expansion is well overdue for a correction. That’s why we’re seeing so much volatility in the market.
I want to go back and look at the history of the market since my first show and you see what the market’s done the last few years. To our audience in Baton Rouge, Mark’s been on here. Mark comes on out about once a quarter or so. Mark and his wife Marcy have a great radio show. It’s been on the air in Amarillo for a long time. How long have you and Marcy been on Smart Money Radio?
We’ve been on many years. We started our show right before the credit crisis in 2008. It’s been nice being able to communicate with people that otherwise wouldn’t be able to learn about anything other than what the talking heads on CNBC or Fox Business or whoever these financial experts are that are sponsored by the big insurance companies, mutual fund companies and annuity companies. Market volatility and what’s been going on is first and foremost in I’m sure a lot of our audience minds, but ours too. I’ve got people that are contacting me on a regular basis that had no idea how risky their 401(k) portfolios were. The names of the investments sound warm and fuzzy. They all went down 16% and they didn’t realize that they were that aggressive of a stock investor with their retirement savings.Sometimes you just don't realize how tied up your money is. Click To Tweet
I always question maybe because I don’t fully understand because it’s somewhat of a scam. The whole indexing thing. I met with a guy and he was telling me that he went and met with another person. After 30 minutes, the guy was like, “What is this you put me in? It sounds like an annuity.” The guy goes, “It is.” He’s like, “Why don’t you tell me that?” You and I both hound all the time about there are many things more out there than stocks, bonds, mutual funds, annuities, CDs.
One thing, especially in the annuity arena, to be on the lookout for when the markets get this volatile is they will start repackaging these. It’s true about variable annuities and fixed annuities. It’s not so much indexed annuities, which is a fixed annuity. They will package them so that they can promote the guaranteed benefits. What people don’t realize is I’ve sat down with people and they thought, “I’ve got this annuity,” and worst-case scenario it makes 6%. I said, “You don’t understand.” People get upset when I tell them that they’ve lost their money up to many years. The best it’s ever going to do is 2%. It’s not designed to return much better than that. They say it’s got a 6% guaranteed minimum withdrawal bucket or a guaranteed lifetime income rider. This imaginary number on a piece of paper can grow at 6% if you agree to annuitize it over your lifetime. I’m using a generalized example, but I see it over and over again and these people don’t realize how tied up their money, how expensive these products are. They’ll sell it.
They’ll say, “You need to have this income,” and worst-case scenario is the market crashes. Your income account is still going to go up. That’s great but that income account is never something that you can call and say, “Send me a check for $100,000.” They’ll say, “Your value if you do that is $87,000.” People don’t know what they’re buying. That’s one of the reasons that a lot of these annuities have what’s called a free look period. If you’ve gotten into something, it depends on what state you’re in, but you have a window to basically back out of that annuity if you’re not comfortable with it from the time that it’s delivered where you sign a piece of paper saying, “I have received this policy.” You get a free look period. Some states, it’s only three days. I’m not sure what it is in Louisiana, Mississippi or anything. Those types of provisions are there for a reason. It’s because regulators started realizing that people were getting locked into these things and they’re not all bad. There are 400 different types of annuities and in advanced planning.
I’ve got a client that bought one of those income riders, but that’s one case out of a couple of hundred clients I’ve worked with. We turned on that income rider, so it made sense. We ran the math, but it’s a great time to look at old policies sometimes. When interest rates are this low, your policy can be worth more than you think it is if you surrender it. It’s a good time to sit down with an annuity expert or an insurance specialist who we work with. I don’t do a lot of annuity business, but I’ve got some experts that if I need to analyze a policy or design a strategy that involves annuities, I’ve got actuaries, CPAs and lawyers that can help me design the best plan. They can also look at old policies. I get people all the time. They don’t realize what they have or the fact that this, “We’ll participate in the upside of the stock market with none of the dark downside risks.” Those things are capped at 5% or they’ve got strategies that are confusing. You don’t ever understand why it’s not putting more money in your account that it is.
I like the access of the people that we have to look at that. Call me at 202-SAGE. That’s 202-7243. You can send me an email, go to the website SageMoneyRadio.com. On that subject, it’s the phantom money. I didn’t coin that phrase. I heard somebody else talking about it. The phantom bonus. It’s not all because I’ve seen somewhere the money hits the account, but then some it’s down the road. I call it phantom money because it’s not real money, the bonus.
They’re restricted with a legal reserve fixed annuity. They’re restricted as to what they can go invest in. It’s basically treasuries and mortgage-backed securities, things that are yielding 1.5% to 3%. If you think that these guys, these huge insurance companies that are immensely profitable are going to give you a 10% bonus for bringing your money over, yes. How long do you have to keep it there before you see that? One, a lot of those bonuses goes away if you don’t hold it in there a certain period of time. Two, there’s a surrender charge built into it. If you pull out within ten, twelve, fourteen years, there may be a significant adjustment. The adjustment is they take the money from you and they put it in the insurance company’s account.
I had a caller. I sat down with him and he was mad because he was in annuity and he swore that he was never told it was an annuity. Everything he signed, it said annuity. I introduced him to an attorney. I never knew if he even called the guy. About a couple months later, he called me and wanted to sit down with me again. He had already received his check. The attorney sat down with him in Baton Rouge and they wrote it. It’s one of the bigger annuity companies. They wrote a letter saying he had been tricked or whatever. They sent him back the same amount with no penalties or anything, the exact amount. He thought I was a rock star, but all I did was make the introduction to the attorney and he wrote this great letter.
Have you seen any of the Dateline pieces? It’s like the Chris Hansen guy that sets people up with the predator stuff, but he did the same thing with annuity salesmen. It showed some of the misrepresentation and not all of these things are bad.
I’ve seen one that’s okay but some of these are the way they’re sold. It’s the person selling them.
The people selling them do not understand. I used to cover a big part of the state of Texas funding trust. We’d go and check people’s beneficiaries and things. I’d see these policies and there were some old policies. These are now illegal in Texas. I don’t know if they are in other states. There was no way to get out without annuitizing it. Let’s say you’ve got $100,000 there and they said, “If we cut you a check, it’s $90,000. Do you want the $100,000? You have to take it over ten years,” but they barely give you any interest crediting over that. All the money’s in that annuitization phase. They’re getting all your money back anyway. It’s all clever the way they’ve designed it because a lot of people do think that they’ve got guarantees and there are some guarantees. They’re not even all return a premium. You can lose money and get back less than you put into it with some of these guaranteed annuities, especially if you’re paying for that phantom money, these income buckets.
In order to pay for this guaranteed fictitious number on a piece of paper to go up, you’re pulling it out of the real account. They’ve rigged it so much in their favor. What they do is they say, “You’ve got $100,000. You pay 1%. We’ll guarantee that that’ll grow at 2% a year.” They keep growing that number on a piece of paper. They charge the 1% on that growing number so the $1,000 over time is more than $1,000 that you’re paying for that. They’re paying that $1,000 that’s growing out of your real money. It’d be like you’ve got your bank account over here that’s real. You need to know what you’re getting and you need a second opinion. These things are complicated.
It didn’t cost anything to run through the report that we do.
There are some fixed rate ones that are like CDs out there that you still need to have a second opinion and look at them. A lot of these are being sold as a way to participate in the upside of the stock market without the downside risk. I was the third person in the state of Texas to sell an index annuity back in 1997. We had to get on a waiting list while the product got approved. If the NASDAQ went up 25%, it gave you 25%. Guess what was a good place to be in 1997, ‘98, ‘99? Some of these index annuities were returning triple digit. Guess who didn’t like that? The insurance companies. They designed this product and then got caught. They started tweaking it and they’re like, “We’ve got a cap. We’ve got a month-to-month, point-to-point dollar cost averaging. If you see ten different ways to what they call crediting strategies, how they apply the interest. Why are they making it complicated? I had never in my entire life seen a daily average of the Dow Jones, which seriously waters down the returns except in rare circumstances. The only reason they put these different types of strategies in there is so that you think you’ve got more upside than you do.
I know all annuities aren’t bad. They’re sold the wrong way. If you have a good advisor that truly explains it to you and that knows you’re going to lock your money up for fourteen years, ten years, seven years, it’s all about knowing. The same thing that we talk about what we do, being educated and fully aware.
Some of the advantages of annuities and there are some anomalies in Texas and Florida that make them more attractive. Some of the planning strategies that I’ve looked at over the past several years that involve annuities don’t work in other states. Make sure that you know what you’re going into. One thing I do want to touch on is the signs of an upcoming recession and bear market. They’re everywhere from a technical standpoint with the stock market. One thing I didn’t consider is that this government slowdown is going to accelerate the rate at which GDP is declining. We’re about several years into a business cycle. We had declining GDP, which means the amount of goods the country is producing is slowing down. It looks a lot like 2001, 2002.The money in your investment plan is called phantom money because it's not real money. Click To Tweet
This is a great time to familiarize yourself with other assets. We have a lot of our accredited investors doing collateralized business loans, getting attractive rates of return. We have clients that are purchasing precious metals or real estate inside their retirement accounts. It’s a good time to sit down with someone that has not been trained in that cookie cutter, “You need a 60% blend of high growth yield.” You look at them and 70% of the stocks are the same in every one of those funds. They’ve all got Apple, Microsoft, GE, Boeing and Caterpillar. Most people’s portfolios are much riskier than they would be comfortable with or that is appropriate for somebody in their situation.
Those target date mutual funds get them on ours too.
Look up the target date mutual funds and analyze. Figure out what the total expenses were. That’s what you’re seeing. You get over 2% in fees inside some of these 401(k)s. You’re not going to make a good rate of return over time.
I met Mark several years ago. Mark and his wife Marcy told me they thought I was a weirdo at first because I was talking to them about a radio show and starting to wind down here in Baton Rouge. He was a big factor or the reason that I have Sage Money Radio on. I’m thankful for our friendship, Mark. He’s a great mentor of mine.
I’ve been thinking about how nice it is during times of market volatility when you’re looking at a piece of paper that’s saying, “I lost 14% of my 401(k) in the month of December. On the other side, you open the mail and it’s a check. That check comes and you get that 8% whether the market goes up, whether there’s a tariff or Congress has shut down or whatever. Earning starts slowing down GDP, the recession that is overdue hits. There are ways to spread your assets around in alternative investments that can provide you with different types of income and different types of growth. That makes the rocky times in any given sector, like the stock market, or even the economy in general. It makes it a lot smoother for people who are truly diversified.
No matter where you live in the country, you can partake in certain parts of the tax code. I’m a numbers geek. If I could go back and do things over again, I probably would be an attorney and be a tax attorney because I like looking at certain things. One of the parts of the tax code that Mark and I like and we like talking about is IRS section 469(c)(3).
The greatest tax advantage investment I have ever seen.
That’s a passive activity loss rule. We’re talking about how to get a deduction.
I can’t give tax advice. I’m talking about how I use it and anecdotal. You can take a straight line deduction. I’ve worked with some high-end CPAs over the years and we’ve put together strategies designed around tax savings. We used to have a strategy called pigs and towels, but you needed a passive gain to offset the passive loss. With properly structured oil and gas equity investments, you don’t have to have a gain to offset it. If you know that you’ve got $200,000 of taxable income, you can deduct. I don’t go too deep into the way they structure them. I know it sounds risky, but there are ways that these had been put together. They can spread out the risk or minimize the risk.
The technology now with some of the shale recovery and the fracking allows you to turn a profit much lower volumes and much lower oil prices than in the past. It’s not appropriate for everyone. If you’re looking at a big tax bill, this is a great time to do some planning. I know a lot of people are taking advantage of the tax code changes to do a Roth conversion. With a few people in the higher end tax bracket, they had to worry about the alternative tax in the past when they do that. They don’t anymore. One of the ways that we’ve structured this is we will have people that do a large Roth conversion. With their money outside of their retirement accounts, they’re going into oil and gas position. They get that huge tax break, which offsets the tax bill created by the Roth conversion.
They can get access to the website and educate themselves on it. Mark, I sat down with somebody. They called on the radio show and they’re like, “What is this tax deduction?” I told them how I do it and they said, “How come I don’t know about this? How come my CPA hasn’t told me this?” I was like, “I don’t know. You need to ask your CPA that.” I think most CPAs, their job is to file the return and not necessarily go dig up great ways to get a tax deduction. We always say we don’t do this just for the tax deduction. It’s extra. It comes along for the ride.
Most CPAs are motivated by a fear of regret, not by the opportunity of growth. Your average CPA is not going to go out and familiarize themselves with high net worth tax saving strategies unless that’s what their practice focus is on. There are a few out there, but the average guy that is filing your taxes is probably not giving you tax planning strategy advice. It’s not the way that the average accounting firm is set up. There are some high-end tax planning attorneys that do it all the time. They were getting these tax benefits for their high net worth investors.
Another tax code IRS Section 263(c), 59(e), which is the intangible drilling cost. The IDCs, that’s what I look forward to. That’s what I’ll be looking forward to in another few months or so for my 2018 taxes.
My first investment and I’ll be a little bit indiscreet here, but I put $40,000 into a project. It was a two-well package. The first well came in pretty solid. The second one took a little developing, but it was making money. The price of oil started going down and the revenue went down, but I remember sitting at the computer looking at my taxes. I saw what my adjusted gross income is and I started having an anxiety attack because I was thinking, “I have not done enough estimated payments.” My wife goes, “Remember, we’ve got that deduction for the oil and gas investment.” A $40,000 investment got me $32,000 intangible drilling cost deduction. On that year, it saved me $8,000 taxes right there. I’m still receiving checks from that particular project.
Plus, the first 15% of income into perpetuity of the wells is tax-free.
It works out especially with some of the more recent changes that a lot of people can take a deduction almost equivalent to the amount of the entire investment. Didn’t you say that you had a CPA that participated himself at a project and he analyzed the returns?
Yes, and he also reinvested that money. He’s a local guy here. He teaches economics and finance. He’s a CPA by trade. He used to have his own practice and he’s a teacher now, he’s sharp with numbers. He called me and we sold that last project. He called me in less than ten minutes of the email going out. I think 52.68 was his number. I said, “Chris, how are you?” He goes, “Once you factor in the return on the basis,” which was 20%. He goes, “Once you factor in the monthly income and the deduction,” his retirement was 52.68 in nineteen months.
That’s the problem with that type of investment is you’ve got benefits coming from many different places. You have to be a CPA to understand how good it is.Most CPAs' job is to file the return, not necessarily go dig up a great way to get a tax deduction. Click To Tweet
Our typical deal, nineteen months is not normal. Usually, three to five years is the goal. This one was nineteen months for him. He goes, “I’m going to roll it over to the next project.” I said, “Chris, I don’t think you can get the deduction again.” He goes, “You can,” and then he quoted the tax code. He goes, “I looked it up. I can.” I remember calling our CEO going, “Is this right?” He goes, “He’s right.”
As long as you’re not doing a 1031 exchange or some deal, the two transactions are a little bit separate. That’s the thing you question and it’s better to do that ahead of time and make sure. It’s like the annuities when people are out there and they go, “This and that,” but they didn’t bother to do the legwork and double check and make sure that what they’re saying is true. I don’t want to go back to the annuities too much, but that is why many people are stuck in these bad annuities.
This particular guy, he has funds in the fixed interest rate and the oil wells as well. He has some fixed money coming in that he knows that he can rely on every month. He has the wells. Number one, we can hit oil. Number two, the price of oil per barrel. Number three, barrels per day. That monthly check is going to fluctuate some, but he has it coming in and he loves it. He’s introduced me to somebody else.
Last time you and I saw each other in person, we got cornered by a CPA who runs a big firm and has been in the industry for 30-plus years. He was giddy with some of the changes in the tax code that made it even more appealing. He was excited because he was learning some things that this investment and this tax strategy were even better than he realized. This was an established accountant. If you’re concerned about sending too much to Washington, sit down with some people. We work with some of the best boutique planning experts in this country whether it is tax planning, asset protection, insurance planning for businesses and things. If you’re not sure whether something is a fit for Hollis’s practice, call and ask him. It’s easy.
It’s all about education and learning what else is out there besides your traditional stocks, bonds, REITs, mutual funds, CDs. There’s more to it out there than what’s flowing through Wall Street. It’s about education.
A lot of the strategies that we will employ or our colleagues use is like with the land bank where your clients got that fixed interest rate. These are secured business loans. There are assets. In this particular case, it’s real estate or leases. There are assets backing the instruments. It’s a great time to look in. A lot of these strategies were reserved for people in the know or the true high net worth individuals. With some of the tax code changes over the past several years, we’re starting to be able to see these alternatives available to more and more people. A lot of things are available inside your retirement accounts that you did not know.
We work with a custodian that allows for some of that stuff. Neither one of us are CPAs and we don’t give tax advice. With the new tax code, the new tax laws, every project is different. The potential opportunity there is to make a contribution into an oil well package and then to deduct potentially up to 100%. It used to be 85%, but the current administration changed a couple of things, tweaked little things. That’s what he was giddy about and that’s what you and I were learning about.
You used to have to spread some of the tax benefits over a five-year period and they allow you to take that all in the first year, which along with the intangible drilling costs. I don’t pay too close attention to the details once you start talking about the other tax benefits because the intangible drilling cost benefit is huge. The other tax benefits are lagniappes. That’s intangible drilling cost because I can see right there how much it saved me. That $40,000 investment had a $32,000 intangible drilling cost deduction. That means if my adjusted gross income was $100,000, it was now $68,000. It’s pretty simple to see the benefits. That can put you in a lower tax bracket, but it automatically reduces by thousands of dollars the amount of taxes you pay.
Most people that I know like me use the deduction ASAP. If there’s another thing going on in your life, another one of the rules is you can carry it forward a couple of years if you don’t need it that particular year. There are many advantages. It’s about education and learning the rules.
We talked about the land bank, the fixed interest strategies that are out there. Some of these strategies are real estate, but if you’ve got some fixed income that is coming in that mailbox money but it’s taxable. You can tear that and Hollis and I have put together some strategies for some individuals that you can basically show how to negate the taxes on that interest. If you go out and you get a one-year secured business loan and it’s paying 8%, that’s great. Say you’ve got $1 million, that’s $80,000 of taxable interest. You could put a couple of hundred thousand dollars in an oil and gas project, doesn’t have to be big numbers. That would get you $170,000 intangible drilling cost reduction or $140,000. Your income on the other side, those taxes aren’t affecting you nearly as much. They’re some strategies that once you see them make a lot of sense and they’re not that complicated. You’re not going to think of them and they’re not going to talk about them on CNBC because Hollis and I are not out there sponsoring Masters Skins games or golf tournaments or building 60-story buildings in Manhattan.
Mark, thank you for being on the show as a guest. Any last words of wisdom for our audience here in Baton Rouge?
I urge everyone to try and remember what it felt like in 2008 when the market started crashing. Every morning as you turn on the TV and you knew the markets were going to be down 3% to 5%. You kept thinking, “If I can only get a couple up days in a row, I’m going to sell it. I’ll never do this again.” You got a taste of that but given where the national debt is the way the GDP is going, there are many political black swan events out there. Anything could shock this market at any time. Don’t get caught off guard. Sit down. Find some ways to truly diversify your assets. Look at some alternative investments. Look at the mailbox. Tax deductions work well in every economy.
Thank you so much. Go to the website SageMoneyRadio.com. You can send me an email from there. Mark McKay from Amarillo, Texas. Mark, I appreciate it. Thanks for your time.
Everybody, take care.
About Mark McKay
Mark McKay is an Amarillo native with over 25 years experience as a financial advisor. After getting his start with a major wirehouse in Austin, Mark moved back to Amarillo to start the investment department for the largest privately owned bank in the country. In 2000, Mark started his own financial planning practice and began to specialize in working with alternative investments and safe money solutions. Mark focuses on non-correlated investments that provide exceptional safety with superior returns, as well as the best tax advantages available today.