Q. We recently attended a mortgage company workshop on "equity maximization" in which they touted putting the equity in your home to work earning income and building wealth. They recommended refinancing to an interest-only loan and investing your equity plus the difference due to your lower mortgage payments in an insurance instrument plus side accounts.

The interest-only loan tax deductions would help offset taxable 401(k) withdrawals. Another key element was using a death benefit insurance policy as a primary investment device that would encompass "side funds." They stated that even taxable IRA accounts could be legally rolled over, in time, to these side funds. These funds would then become non-taxable accounts from which you could "borrow" funds monthly for living expenses, etc.   You would never have to pay taxes, they said, on the principal or earnings.

What are your thoughts on this concept? According to its advocates this is one of the ways the wealthy stay ahead of the rest of us.

Do you know of any legal way to transfer funds out of taxable IRA/401(K) accounts into non-taxable accounts without paying taxes--- such as this insurance instrument they are advocating?

---D.E., by email from Missouri City, TX

  

A. Workshops like the one you attended are happening all around the country. Those who give them attend marketing seminars and join a group devoted to getting people to use their home equity to buy equity index life insurance policies. I wrote about the idea and its flaws last year. (See URLs below) Recently, I attended a seminar like the one you attended.

There are several flaws in the idea. While it could, in theory, work it is very likely that execution costs (i.e. sales commissions and life insurance costs) would severely limit or actually destroy the projected benefits.

One starting flaw is the marketer's bold statement that your home equity earns nothing. This isn't true. If you own a house mortgage-free it has a return.   The return on your equity is equal to the non-taxable value of the shelter it provides (remember, without it you would have to rent) plus the annual appreciation in value. Lately, that has been a pretty nice return. The goal of the marketers is to transfer the massive home appreciation of the last decade to commissioned financial products.

Owning a house with a mortgage is like owning a stock purchased on margin. The life insurance marketers don't discuss owning your house on margin but that is what they are advocating.

The return on your house on margin will be equal to your service return and appreciation (the house doesn't know that you've borrowed against it) plus or minus the difference between what you earn on your side investments less what you pay in interest on the mortgage.

Basically, you are gambling that your investment in life insurance products will earn more than the cost of the interest-only mortgage. For that to work, the return on the equity index life insurance policy--- net of sales commissions and life insurance costs--- must exceed the cost of mortgage borrowing.

This is unlikely for two reasons.

•  First, insurance companies are lenders in disguise. They take in premiums in the hope of lending it out at higher rate of interest than they pay on it. It is unlikely they would design a product whose cost of funds (your cash value) would be higher than the interest rate on low risk mortgages.

•  Second, equity index products don't provide full stock market returns. They provide either a capped annual  appreciation or a percentage of annual appreciation. The index does not include dividends. It is unlikely that annual appreciation in the next 20 years will match annual appreciation in the last 20 years.

Success with this idea is based on a long series of "if-then" statements. It ignores the risk of owning your house with a virtual margin account.

If you borrow at a low and stable interest rate,

If the interest you pay is tax deductible because it exceeds the standard deduction,   If you have a relatively high tax bracket,

If the sales commissions are not destructively high,

If the life insurance costs that are subtracted from your return aren't too high, and   If the equity index performs as it has in the past or better,

Then it might be a reasonable thing to do.

  The sales force that makes its living from mortgage and insurance commissions blows off such concerns. Consumers shouldn't--- their home equity is the sales forces' commission income.

  Alas, I've never encountered a serious financial planner who knows how to avoid taxes on qualified accounts.

  On the web:

Sunday, September 4, 2005: What's missing is reality

Tuesday, September 6, 2005: If you follow author's advice, you could lose a bundle.

Missed Fortune Team

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