When is a multi-level-marketing scheme a pyramid scheme ?

This is definitely a source of confusion for many people, and Multi-Level-Marketing (MLM) schemes tend to be all tainted with the same brush.

Even to otherwise highly educated professionals, exactly when an MLM scheme becomes a pyramid scheme is not trivially obvious.

After looking around and considering the matter at length, I think the best definition comes from an advisory from the Federal Trade Commission (FTC) itself.

To quote,

Much has been made of the personal, or internal, consumption issue in recent years. In fact, the amount of internal consumption in any multi-level compensation business does not determine whether or not the FTC will consider the plan a pyramid scheme. The critical question for the FTC is whether the revenues that primarily support the commissions paid to all participants are generated from purchases of goods and services that are not simply incidental to the purchase of the right to participate in a money-making venture.

It goes on,

A multi-level compensation system funded primarily by such non-incidental revenues does not depend on continual recruitment of new participants, and therefore, does not guarantee financial failure for the majority of participants. In contrast, a multi-level compensation system funded primarily by payments made for the right to participate in the venture is an illegal pyramid scheme.


To repeat, the amount of internal consumption in any multi-level compensation business does not determine whether or not the FTC will consider the plan a pyramid scheme.

For a more in-depth discussion on the differences between a pyramid scheme and legitimate marketing, see this discussion by Debra Valentine.



Effect of provisional income on effective marginal tax rate

According to David McKnight, author of the Power of Zero, the name of the game in retirement is to get yourself into the zero percent tax bracket, as tax rates are likely to rise.  But what if tax rates remain the same ?  Is there a case for getting into the zero percent tax bracket, then ?  In this post, I will argue yes.

Let’s review the effect of provisional income on the percentage of social security subject to tax :

Tax Filing Status Provisional Income Amount of Social Security subject to tax
Single or head of household Less than $25,000 0%
$25,000 – $34,000 50% of the excess provisional income over $25,000
More than $34,000 50% of the excess provisional income over $25,000 + 85% of the excess provisional income over $34,000
Joint filers Less than $32,000 0%
$32,000 – $44,000 50% of the excess provisional income over $32,0000
More than $44,000 50% of the excess provisional income over $32,000 + 85% of the excess provisional income over $44,000

What isn’t immediately obvious is that as your provisional income (from non-social security sources) rise, it triggers a double whammy : firstly your tax rises at the rate that is determined by your taxable income; secondly it triggers additional income from social security that now must be counted as taxable.

This has the effect of increasing the marginal tax rate beyond what your tax bracket might suggest.  I call this the effective marginal tax rate.    Michael Kitces made the some observation.  This is the “tax bubble” he described in his post.  I set out to visualize the bubble, i.e. the increase in the effective marginal tax as provisional income (ex-social security) increases, in the graphs below.


The experiment assumed a social security benefit of $36,000, deduction and exemption of $20,000 and joint filing status.  I varied the source of provisional income (ex social-security) from $10,000 through $65,000.

As can be seen, the effective marginal tax rate is no longer monotonic with increasing income, and shockingly, can reach as high as 54.4% for income in the $30,000 through $48,000 range.  This means for every dollar between $30,000 and $48,000, 45.6 cents is taxed.

Let’s take a look at what the increase in the marginal tax rates look like with different amounts of social security benefits :

At $10,000 of social security benefits :


At $15,000 of social security benefits


At $20,000 of social security benefits :


At $25,000 of social security benefits :


What’s clear is that as the social security benefit increases, the range of provisional income that triggers the hyper inflated marginal tax rate of 54.4% gets wider.

In the examples shown where the sum of deductions and personal exemptions were $20,000, we would want to keep our provisional income (ex social-security) just at or below $18,000, and move other sources of retirement funding to tax-free vehicles funded with after-tax dollars (Roth IRA, LIRP).   If not, the amount you stand to lose in taxes increases with the amount of social security benefits you expect to receive.

Key take-away : even if tax rates remain the same, just by preventing social security from being taxed, one already comes out ahead, as the increase in effective marginal tax rate is avoided.

Indexed Universal Life shines in a sideways market

I was asked by a client recently to compare the returns between two vehicles, a tax-free vehicle with reinvested dividends, and a cap-and-floor strategy adopted by a specific Indexed Universal Life policy.

Illustrations normally show a projected fixed return from the market, instead of actual historical returns.  I have yet to see one anyway.  Illustrations also do not compare returns with an indexed fund strategy using a tax-free vehicle such as a Roth-IRA.  That is what I set out to do.

As an appointed agent, I had access to a particular product provider’s actual cost of insurance, and was able to obtain, year for year, the actual cost-of-insurance and other expenses, for a 6 year old, with a face value of $250,000.

The results are interesting, but not unexpected.  Since the IUL does not include dividends, it is only fair to include them in the buy-and-hold indexed fund strategy.

I used historical dividend yields from multpl.com.  A chart of dividend yields over time shows that yields are on a downward trend.



I compared the performance of the IUL with expenses over selected time-frames of the SP500 (1970-2016) and the Nikkei (1980-2016), and the results are shown below.  Assume that $1,875 is invested annually for fifteen years, and thereafter no further investments are made.  In the IUL case, the $1,875 is the premium paid annually for fifteen years, and no premiums paid thereafter.  This was actually the guided premium for the policy.

Comparison using SP500 historical data


This graph above shows that in a bull-market, the IUL simply cannot capture the upside as well as a tax-free vehicle with reinvested dividends.    The IUL performs roughly on par with a taxable account at the 28% tax rate, where all gains are taxed annually at that rate.  Notable is that during the 40% market drop in 2008, the IUL catches up to the 15% vehicle.

Comparison using Nikkei historical data

For the Nikkei I used an average yield of 1.68%, which was simply the average of the dividend yields over the years 2010 through 2017, at the time of writing.


The graph above shows the performance of the IUL overtaking the indexed fund strategy in 2000 as the floor protection feature of the IUL protects it from plunging as the index suffers three years of consecutive loses of -27%, -23%, -18% in years 2001, 2002 and 2003 respectively.  After the plunge the Nikkei recovers and meanders for awhile, and just arrives back at its 2000 high in 2016.  In the meantime, the IUL is able to make progress and in fact, pull away from the index fund strategies.

Multiple children in college and the Expected Family Contribution

I recently learned something I wasn’t expecting.  It turns out that the computation of the Expected Family Contribution (EFC), while important, isn’t as important as the fact that the sum of the expected contributions in any one year does not materially change if you have more than one child in college at the same time.

Here is a discussion on this. To quote :

For example, twins, triplets and other multiples may qualify for more need-based financial aid than children who do not overlap in college. While it may be too late to implement such a family planning strategy, the impact on eligibility for need-based financial aid may influence the parents’ thinking about whether to allow a child to skip a grade or take a gap year between high school and college.

Now, isn’t that useful to know.

Details : This worksheet computes the EFC for 2015-2016.  On page 9, the Total parents’ contribution from the Adjusted Available Income is divided by the number in college (question #74 on the FAFSA) to arrive at the Parents’ Contribution, which is then added to the Student’s Contribution (from income and assets) to arrive at the EFC.

This really turns logic on its ahead.  In the Asian culture, a widely held assumption is that the cost of putting multiple children through college would, well, scale linearly with the number of children.    Not so here.

Funding Long Term Care without LTCi

With the recent failure of two long term care insurers in the state of Pennsylvania, the state and future of long term care insurance (LTCi) bears studying.  To that end, the National Association of Insurance Commissioners released a report last year titled “The State of Long Term Care Insurance : The Market, Challenges, and Future Innovations”.

Fun fact : did you know that Alzheimer’s is the most expensive disease in America ?  According to Alzheimer’s association, nearly 1 in 5 medicare dollars is spent on a person with Alzheimer’s.

In the absence of LTC insurance, the report sites an novel way of funding LTC using an immediate annuity :

Traditional immediate annuities are priced assuming the annuitant is anti-selecting; in other words, the person is very healthy and expects to live longer than others the same age. For example, let us assume the premium for healthy people buying an annuity at age 82 is 10 times the annual payment they will receive. So, a $120,000 single premium will purchase an annual income stream of $12,000. However, people beginning a stay at a nursing home typically have health conditions which will shorten their life expectancy to, let us assume, 20 months. This makes the purchase of a traditional immediate annuity to protect against longevity uneconomical.

Such a situation is ideal for an underwritten immediate annuity, particularly one aimed at people entering a nursing home. Here, underwriting is counter to what we think of in life and health insurance because the more health conditions people have shortening their life expectancy, the more leverage they have. For example, an underwriter could discern, based on health conditions, a particular person is expected to live approximately 20 months. Allowing for profit margin, the insurer might assume a two-year life expectancy for pricing purposes. In this case, the $120,000 could purchase an annual income stream of $60,000 for the life of the annuitant, which is enough to fill the average income gap during a nursing home stay while the annuitant lives. This could be purchased from just a portion of the average person’s net worth at over age 80—and it would eliminate the fear of outliving assets and the panic which leads to the initiation of Medicaid planning.

As of this writing, there is at least one such product available in the U.S. There are examples of proven success elsewhere. This is the predominant form of LTCI in the U.K., where the traditional product as we know it in the U.S. is not sold. The target market for such a product comprises people entering or currently in care episodes with income shortfalls, but who have enough net worth to fund the income shortfall for an average remaining impaired life expectancy. This is the case for about half of the U.S. population over age 80.

Other solutions :

Other point-of-need funding solutions have emerged for those who did not previously purchase LTCI. There is a budding financial advisory space focusing on these cases, and these advisors do not push a Medicaid solution. The approach of such financial advisors is to first determine whether there is an income shortage for persons who need LTC and, if so, to quantify it. Then they take steps to convert net worth into income streams help fill this gap. The most common ways of doing so are:

Home equity can create income via reverse mortgages.

A life insurance death benefit can be assigned in exchange for a lifetime income payment (life settlements).

A series of loans against a life insurance policy can be taken, but only while principal lasts.

At least one “financial concierge” company has emerged in this market, which receives referrals from nursing home and assisted living facility admissions offices. It acts as an advocate for new entrants in finding ways to finance care, and it can provide bridge loans as solutions are put into place, which can take months in many cases. The company also receives real estate brokerage or referral fees in cases where a home is sold, as well as referral fees for other transition services (such as moving and storage services).

The government, sigh.

I finally found out why my application for an insurance license was sitting at the CDI (California Department of Insurance) for over a month !  It turns out I had submitted my application on the same day I had taken and passed the Life, Accident and Health exam.  At the time of the submission, my passing status wasn’t yet registered in the system, so my application had remained in the ‘wait for exam passing status’ state.

Apparently no one thought to check whether the pending applications already had their corresponding exam requirements met.

Moral of the story : follow up.

On the plus side, the lady I spoke to from the California Dept of Insurance cleared up quickly, and my license was issued in two days.