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Three Steps to an Iron-Clad Protection Plan

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“No one knows the day or the hour…”

Unfortunately, that phrase is so true.  We here in the O.G. house, along with the whole FFA crew, join those across the world in thinking about (dare I say ‘praying for’) those impacted by the terrorism in Boston, the terrible storms in the Midwest, and the explosion in Texas.  The phrase “when it rains, it pours” comes to mind.

These recent events have encouraged me–nay, they’ve compelled me, to write another bit about protection planning.  There are three crucial pieces to a well-designed protection plan and collectively, they are the single most important part of your overall financial plan.  I don’t care what funds you use, what your company 401(k) match is, or even how many pre-IPO shares of Google you own – without an adequate protection plan in place, you have nothing.

Are you worried about your protection strategy? Here are three steps to an iron-clad protection plan.

 

Step 1:  Forget the 6 months notion – head right to 12 months of cash

 

Many financial professionals suggest three to six months worth of expenses in a cash reserve position.  That’s baloney.  If you were sick or injured, would you want to be counting backwards from 90 until you run out of money?  I didn’t think so.  Skip three months and six and head right to 12 months of lifestyle-sustaining cash reserve, especially if you work for yourself or in an unstable industry…and what industry ISN’T unstable these days?  This will take some work to figure out, because it’s not just your annual salary, but rather what you need to sustain your lifestyle for the next 12 months.  We’ve discussed saving in a Roth IRA as a dual-purpose account HERE if that suits you better.

Why do you need so much in cash?

First of all, what exactly is “so much” anyway?  Obviously, “so much” is a relative and personal term – I have one client who “only” has $90,000 in his savings.  That’s on top of the “nearly empty” checking account with $55,000 in it.  Oh, and he spends $60,000 a year  – 100% covered by his pension.  Cash is king.  It allows you to negotiate (doctors have different “cash” prices – as do other businesses) and is easily accessible.  The last thing you want in an emergency is to be floating credit card balances while your insurance company decides how and when they’re going to pay.  Get emergency cash now.  Make a plan and do it.

 

Step 2:  Buy disability insurance beyond what your company provides

 

This is an increased cost, no doubt, but who among us could live on less than 50% of your current income?  I know things around here would get a little tight, for sure!  Remember what I said a few minutes ago about “lifestyle-sustaining” income?  If something tragic happens, should that mean that your kids can’t play soccer anymore?  What about dance class?  If you’re no longer able to work for the rest of your life, do you think you should continue to build up a retirement nest-egg?  Disability coverage only usually pays until age 65!  Then what will you do?

It’s usually best to find your own outside coverage in addition to what your employer provides.  Group coverage will be 100% taxable when you receive it.  Coverage paid for entirely by you is 100% tax-free.

Take this example:

Let’s say you make $80,000 a year as an electrical engineer.  You have group disability of 60% that kicks in after you’ve exhausted all your vacation and sick time.  Sixty-percent of $80,000 is $48,000, right?  Now, let’s subtract 25% for taxes, so that leaves you with $36,000, or roughly $3,000 a month.  You were making $5,000 a month after tax.  Can you today cut two grand out of your household budget?  No?  I didn’t think so.  Everyone’s cost may be different, but let’s say a disability policy that pays you $2,000/mo DI costs $150/mo.  That’s $1,800 a year…is it worth it?  Let’s put it another way:  Your boss says, “Hey Jimmy, we’re going to cut your salary from $80,000 to $78,200 from now on, but if you even get sick or can’t work ‘cause you’re too hurt, you’ll get all your pay until you retire.”  What would you think? I think you’d take that plan.

Go, right now, do not pass go, do not collect $200, go now and acquire an disability application.  Fill said application out and send in the first month’s premium.  Do it now.

 

Step 3:  Buy a gazillion dollars of life insurance.

 

I won’t spend a ton of time on this – we’ve discussed this many times before….but whatever you think you need for life insurance, double it…then double it again.  Too many people buy only a minimal amount of life insurance. If people rely on you for money now or in the near future, go online to a life insurance wholesale shop (if you can’t think of any, in the US, google “buy life insurance”…there are a lot of interesting blogs about life insurance. If you are based in UK, then I recommend reading this blog for latest news and updates related to life insurance.) and purchase a policy.  Twenty or thirty years should do it and the policy had better have lots of zeros (at least 6) and a number bigger than 1 at the beginning.  Does that sound like too much coverage? If you ask any financial planner who’s had a client die–who’s had the unfortunate task of delivering a life insurance check to a widow or survivor–they all know that the survivor nearly always says the same thing: “Is that it?  How am I supposed to make it on that?”

If you want to get technical, read this to figure out how much you’ll need.

I hate that these evil and terribly tragic things happen.  I, in no way shape or form, can justify them or even begin to make sense of them.  In the days and weeks ahead, we’ll hear from the culprits and it still won’t make sense.  What I do know is this:  We cannot ever predict the future.  We can only have a plan on the shelf to execute once tomorrow is here.

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Long Term Care Planning: What Would You Do?

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Be the bigger adult and address the hard problems with people you love before you’re forced to make tough decisions down the road.

My father in law was a smart, active man. An engineer who built houses on the side for fun and profit, he ran nearly every day and lived on healthy foods. He was that guy who everyone knew when you went out to lunch. He had an easy smile and a nearly easier laugh.

I was lucky that a guy this smart would come to his daughter’s son for financial advice. In some ways (like most of my clients) he didn’t need it. He was at the top of his game in most aspects. He just had one big gaping hole in his plan: he didn’t want to talk about illness or mortality.

One problem I saw in most financial plans, including my father in law’s, was that although they did a fine job of picking investments that they knew, their plans generally had no escape valves. Some people only invested in stocks,. Others owned only real estate. Some had all their money in the 401k plan at work and wanted to retire at 50.

My father in law’s problem? He was so insurance-adverse that he’d decided to do nothing.

 

Disturbing Long Term Care Stats

 

The threat of a catastrophic illness is real. While the threat of a fire burning your home is 1 in 1,200 and the risk of an automobile accident is 1 in 240, the chance you’ll need some sort of long term care help is 1 in 5. Those ain’t good odds.

So, as I did with every client, my job was to talk about it. Did I like this talk? Absolutely not. It was my least favorite meeting. But I had a job to do. What action they took was up to them.

When you talk about long term care, talk about the three options available:

 

Long Term Care Strategy: Your Three Choices

 

Assume the risk. This option is best for people with nothing to lose or for people with enough money that they can “self insure.” Much like most life insurance uses, long term care protects assets you can’t afford to lose.

What’s interesting about long term care is the way many of my wealthiest clients saw the products. Based on past comments here on the blog, many of my readers are like me: they want as little insurance as possible. That’s smart for people who are struggling to reach the “finish line” on financial independence. But when financial independence is assured, I met many wealthy individuals who could afford to self insure who decided not to because the cost in assets was potentially so great. In short: the premium payments on an insurance policy is so small that they’d rather insure the risk.

 

Hand the risk to an insurance company. Regardless of what I said earlier about wealthy individuals, this is a tough pill to swallow. The reason my father in law didn’t want to talk about long term care? It’s uber-expensive. The funny thing is….the reason it’s expensive is why you need it: actuaries for the insurance companies price policies higher when they think the product will be used. LTC is expensive because they think you’re going to need it.

 

Here’s a creative strategy that worked for a few people: I had some clients that weren’t worried about outliving assets, but who did want to make sure they still had a legacy for their family. Instead of buying a long term care policy they purchased an immediate annuity. The money from the annuity purchased long term care and an insurance policy in the amount of the annuity. While the person lived the annuity paid the insurance cost and when they died the insurance policy replaced the money that was spent.

 

Take some of the risk and hand some of the risk to an insurance company. In this scenario, you play the statistics. The average person will need long term care for 2 and a half years, so buy a policy that covers just longer than that. Sure, it doesn’t cover the horror stories of long, long term care, but you’ll cover the likely amount of time. Raise the deductible so that you pay for anything short term out of pocket. Moves like these can decrease the cost of insurance so that you can still focus on your goals while not worrying about the “what if’s” associated with long term care.

 

How it turned out for us:

 

My mother in law was very worried about the threat of long term care, but my father in law decided to assume the risk, even though they weren’t wealthy. His family had a history of Parkinson’s disease. Sadly, it struck him, too. Because they didn’t have enough money to afford long term care, my mother in law ended up caring for him. He fell a lot. She couldn’t help him up so she’d have to call an ambulance. He became harder and harder to take care of. In some ways it was lucky that he fell and hit his head while insisting that he walk the dog. He passed away before the big bills would have happened. However, the toll on my mother in law, seven months after his death, is noticeable.

 

What you should do: If you have anyone over age 50 in your family, talk to them about catastrophic illness. If you talk about your options early, you’ll never have to worry about the topic again.

Have you had to have this hard talk with a friend or relative? How did it turn out? What would you advice people to say or avoid?

Life Insurance: Why People Choose the Wrong Amount

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Today I read another “rule of thumb” about how much life insurance coverage we should choose. Please…I’m running out of hair to pull out.

Life insurance, for most people, exists for one reason: to create an asset base that you don’t yet have which will allow those loved ones you leave behind to live comfortably after you’re gone.

If you accept my definition of why life insurance exists, ask yourself this:

How the heck does anyone with a rule of thumb know the answer these questions:

 

What size asset base does your family will need?

What does “comfortable” mean to you (and those you leave)?

How long until they retire/go to college/need the cash?

What does your asset base look like now?

You can see why “rules of thumb” make me want to vomit. They’re not just idiotic…they’ll cost you either thousands of dollars in wasted insurance OR you’ll leave your loved ones with less than they need.

Stay away from rules of thumb.

In the “big boy world” where we don’t rely on the diapers that are “rules of thumb,” we do something that really ain’t that hard. We do the freikin’ math.

There are two computations you’ll need to do. First, you’ll need a capital needs analysis. Second, you’ll need to figure out human life value.

 

Capital Needs Analysis

 

Don’t be fooled by the name. All you’re doing is figuring out the bottom line “need” that your family should cover with insurance to survive without you.

 

1)   Take out your current budget (don’t stumble on this one!)

2)   Refigure the numbers without you. How big is the budget now?

3)   Figure out how much your family will need for goals. What do they need to save for retirement, college, etc?

 

An aside: If you’re married, don’t be an ass and assume your spouse is going to get re-hitched when you pass away. When I was an advisor, I had some dumbs$%!s tell me that, and I about laughed them out of my office. I don’t care if your spouse gets married after you die. I just don’t want her sitting at a singles bar waiting to slow dance with the guy in the Babylon 5 tee-shirt because it’s in the flippin’ plan. Be a grown up and take care of your spouse.

 

4)   Check the budget against the goals. Is there enough to save AND reach the retirement/education/savings goals. If not, track the shortage and add inflation each year.

5)   Backtrack all the shortages (if any) to a sum today that would meet the need.

6)   Subtract from any shortage the amount you already have saved and a reasonable cash amount for the stuff your family will sell.

7)   Boom. Any shortage left? If so, you’ve just figured out how much (if any) life insurance is your bottom line “need.”

 

Why Capital Needs Analyses Are Awesome

 

A capital needs analysis is great because it gives you a bottom line number based on your own goals. No rule of thumb, no “buying what some life insurance agent told me to get.” You have an actual number.

 

Why Capital Needs Analyses Stink

 

Go back to my six points. ALL of these numbers are blowing in the wind. The second you look at “what your family needs to retire without you,” you’re betting on inflation, rates of return on investments, and future behavior of your loved ones. Can you predict any of this? To a degree, yes. However, you and I both know this number will be wrong.

 

That’s why we don’t stop there. We also perform a Human Life Value Analysis

 

What Is a Human Life Value Analysis?

 

Human life analysis looks at the amount you’re worth, in terms of “bringin’ home the bacon” if you were to die tomorrow. Have you ever seen those wrongful death lawsuits where a family is awarded millions of dollars? The big fight between the family and the insurance company isn’t just guilty/not guilty. It’s actually about how smart the deceased was about managing their own money.

In human life value you assume that a person would continue to earn money if they were to still live a normal life through retirement. You also assume they’d retire at a reasonable age, which usually is 65. Then you assume that the deceased would receive reasonable raises.

All that human life value represents is the sum that you’d earn throughout your life, present valued to a single pot of money today. In short: how big a pot of money today would make up for the family’s loss of your income.

 

Another aside: families and insurance companies often switch sides during a human life value argument in court. The family, hoping for a bigger pot of money, pretends they’re a bunch of morons who don’t know investments. Why? An investment savvy family might receive a smaller award because the assumed return on this money will make up the difference.  The insurance company argues that the family is incredibly savvy, so that they can award a smaller check  (because the family will be able to make up the difference in funds through investment returns).

Human life value numbers, as you can imagine, are huge (even if you are investment savvy and assume you’ll earn 8% on your pot of money).

 

How Much Life Insurance Should I Buy?

 

Now you have two numbers. The capital needs analysis produced a number that is small and “blows in the wind” because of the big number of perilous assumptions. The human life value number is usually a larger number, but assumes you’ll need the deceased’s full paycheck to continue living. That’s improbable.

 

The Field Goal

 

I used to perform these two calculations for my client and told them that now they needed to kick a field goal. If you’re not familiar with football, a field goal is a kick between two upright poles. Your correct amount of insurance is somewhere between these two number “poles.” From here on out, it’s more art than science. How do you feel about your need?

Generally, people chose a number closer to the capital needs analysis. Low end. That’s what I did. However, I had clients who wanted to be midway between the numbers and one family who only felt comfortable at the human life value number.  There is no right answer here. My clients who chose the smallest possible number would have been unhappy with more insurance. The ones who chose the full human life value would have had trouble sleeping at night with less. Just realize…insurance isn’t free, so whatever you choose, realize that it’ll affect either the budget today or the amount your family receives if you predecease them.

Life Insurance: It’s Not Just for Breakfast Anymore

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I wouldn’t call Life Insurance an “underrated” financial tool, but I would call it misundastood (to quote P!nk). When I first got into the biz of financial planning, I’d heard heaps of rules about life insurance: how much you should buy, what type you should have, and most importantly: Who To Avoid When Buying Life Insurance.

Specifically, I heard this: avoid life insurance salesmen.

To many people, the above phrase translates to: avoid anyone with a clue about how insurance works because you don’t know who to trust.

Imagine my surprise when I began studying life insurance during my quest to become a licensed advisor. There were tons of policy types AND uses for term, universal and whole life insurance policies. I was amazed at how versatile a weapon both term and whole life insurance could be: among a gazillion other things, you could use it to cover income streams, save for your kid’s college or protect an estate.

 

3 Cases of Mistaken Identity With Life Insurance

 

Here are some of my favorite misconceptions.

1) The only good policy type is term life insurance. If term is the only good one, why do universal and whole life insurance even exist? Are there that many rip off artists out there to support these huge insurance companies? I doubt it. Here’s another theory:

While I’ll wholeheartedly agree that the other types (whole life and universal) are grossly oversold by people who aren’t paying attention to their client’s best interest, these products were each created for some good reasons.

Whole life insurance, for example…how great is this: you pay your premium and you know it’ll be there FOREVER. No worrying about whether you’ll still need it when your term runs out.

…and how about universal life? It lasts forever, but you can change the death benefit to match your lifestyle. Check this out:

 

Uncle Joe’s Universal Life Story

 

Sally, our horse racing fan from the last story, has three boys: Larry, Curly and Morris (she nicknames him, surprisingly, “Moe” for short). As each boy leaves the house at 18 to become a real-life superhero, Sally now needs less insurance and lays off the vodka a little more. She calls her insurance company and sinks the death benefit down to reflect her new need. Now she can pay less money each week OR have more of her premium go into the cash value (money inside the policy) so that she can stop paying for the policy early and enjoy more retirement dollars without a life insurance payment. That’ll give her more money for the ponies. Win!

Cool, huh? I can hear the detractors beating on my door, pitchforks in hand. “You’re going to pay through the nose for those universal and whole life insurance benefits.” Duh. Let’s see a show of hands of people who think insurance companies give stuff away for free. Anyone? Here’s a little secret: any time insurance companies agree to sell you a guarantee you’re gonna pay for it.

2) You only need Life Insurance to cover income needs. Whole, Universal, and Term Life insurances are valuable tools for a variety of reasons:

Burial costs: If your money is in places that are locked up you might not be able to cover some of the costs quickly. Life insurance money can often be ready within a matter of a few days.

Liquidity: Some of those locked up places, like rental homes, aren’t liquid immediately. Life insurance can buy flexibility.

Business concerns: How many spouses of business owners are qualified to run the biz after the owner dies? In most cases, they aren’t. With the proper legal documents and a life insurance policy, the spouse is bought out and a capable underling, associate or competitor takes over the business. (term life insurance isn’t appropriate for this)

Estate needs: For large estates, there may be estate taxes due. These can be higher than 50% of the value of the estate. Ouch! Life insurance is an inexpensive way to cover these costs. (term life insurance isn’t appropriate for this)

3) Buy life insurance when you’re young and don’t need it because it’s cheap. Huh? Lets say there’s a special on Spam and it’s only $.05 per can. Are you going to buy 100 of them? No. Why not? Because you don’t need them. Apply that same principle to life insurance, whether it’s permanent or term life insurance . While there are a myriad of reasons why you might need insurance, don’t get caught in the “it’s cheap” trap.

 

OG and I want to thank Jeff Rose from Good Financial Cents for organizing today’s Life Insurance Movement. You can learn more about the movement on our latest 2 Guys & Your Money podcast episode, #007.

How Much Wood Could a Woodchuck Chuck?

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Anyone know the answer to that?  As we all know, that all depends, right?  No, it doesn’t depend on whether or not the woodchuck could chuck wood, but rather whether he was healthy enough to do so.  So my question to you, dear reader is this: If, God forbid, you weren’t able to get up and go to work tomorrow because you were too sick or hurt…how much chucking would you get done?

We’ve all seen the quacking Aflac commercials, I know I’ve laughed at most of them.  But when was the last time you actually thought about the implications of what that magical duck was saying?  Here’s a little exercise I go through with all my clients – you can play along at home.  Assume the following:

  • You’re an average white-collar worker making $60,000 per year and you get a $10,000 per year bonus
  • You have a nice ‘n comfy group disability policy that pays 60% of your base salary if you’re too sick or hurt to work
  • You’d really like to retire – and your family is counting on you being able to work so that you can save to reach that (or any other) goal

Here’s how I go through this little exercise – it kinda drives the point home:

Mr. Client.  Play along with me a second.  Let’s assume you head into work in the morning and your boss says, “Jim, you’re a wonderful employee, but we have to let you go.  Pack up your desk.”  Just like that you’re unemployed.  Since it’s only 11:30 A.M., you decide to head out to get something to eat before heading home to break the news to your lovely wife.  What’s your favorite fast-food restaurant?

McDonalds.

Excellent.  So, you’re at McDonalds and you see they’re hiring.  A nice little help-wanted sign stares you right in the face.  So, since you’re now jobless, you ask the manager for an interview.  After a short period of time he says, “Jim, you’re super awesome and we’d love you on the team.  We can’t pay a whole lot, but we’d be happy to pay you $60,000 per year.”

Figuring you’re in some kind of third dimension you run across the street to your 2nd favorite restaurant…which is…

Wendy’s.

Right, Wendy’s.  A quick chat with the manager and he wants you there too!  This is your lucky day!  He says, “Jim, we’d love you on our team, too.  We can’t pay a lot, but we can pay $58,000.”

Which job do you take?

McDonald’s right?  (all other things being equal)

So, before you sign your professional McDonald’s contract you ask the sixty-four thousand dollar question:

“What happens if I get sick or hurt and unable to work for an extended period of time?”

“Great question Jim.  We can’t pay you a lot of money – but we can pay you $30,000.”

Armed with this info, you dash over to Wendy’s.  You ask the same question.  The Wendy’s manager says, “Great question Jim.  We can’t pay a lot, but we can pay you $48,000.”

Now what?

If you’re like most clients, looking at this issue in the big picture helps solidify it.  It generally makes a lot of sense to forfeit a small amount of income today in exchange for guaranteed income forever.  There are hundreds of bells-and-whistles that make disability insurances different between companies, but suffice it to say, your group coverage isn’t good enough.  Generally speaking, group policies:

  1. Are considered taxable income when you receive the benefits
  2. Are canceled as soon as you leave employment
  3. Only cover base salary
  4. Require you to visit “company” doctors

I’m not saying group policies are bad – they’re not.  What they are, however, are incomplete.  Consider adding an individual disability policy to supplement your group disability policy.  When you own an individually purchased contract:

  1. The benefits are tax free
  2. Are guaranteed renewable through age 65 (or 67 depending on the company)
  3. Can cover all your income – including bonuses and retirement plan matching
  4. You can use your own doctor for reviews

Disability insurance policies are like car and home owner’s policies.  The premiums suck until you need to collect.  And trust me, you’re not going to be on your death bed saying “What the heck.  I paid $800 per year for 65 years and never had a house fire.”  Instead, you’ll say, “Boy was I lucky.”  Disability is the same way.  Go check out a couple companies and get some quotes.  My bet is you’re talking about less than $100 per month.  Not chump change, I know.  But the price is so much less than the risk.  Go get it done.

It’s all about chucking that wood.

Tennessee Family Expected Insurance For Nothing – Boner of the Week!

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The Boner of the Week! is awarded every Monday to the most outrageous event, quote or story I read about this week.

Usually I discuss outlandish or erroneous quotes in the Boner of the Week! segment. This time, let’s tackle an event.

home after fire According to this story, a Tennessee family living in a rural area without fire protection didn’t pay a $75 annual fee to a nearby city to receive services. When their home went up in flames, firefighters stood by and watched the couple’s home burn to the ground.

At first glance, this appears to be a fire department and government politics problem. “On further review,” to quote the highbrow program Monday Night Football, I believe the Boner of Week! occurred when the family opted not to pay–what now appears to have been—a pretty important ‘insurance” bill before their house fire occurred.

Here’s my rationale:

1) They don’t live inside the city in question and.

2) Homeowners inside the city boundaries pay taxes for fire protection. Those outside are asked to pay a small fee to receive house fire support.

3) The family opted not to pay the fee, in essence declining the city’s coverage plan.

Don’t think I’m heartless. We’re experiencing a similar situation personally. Nearly ten years ago my in-laws met with me to discuss long term care insurance. My father in law, a smart man who’s always been a good friend, was vehemently opposed to it.

He said, “I’m not paying for that overpriced insurance. It’s a rip-off.”

Yesterday wife returned from Detroit, where she was helping my mother in law decide on options for home health care, because he’s suffered a major stroke. My mother in law is meeting with elder law attorneys, looking for ways to cut down on costs while keeping his quality of life high.

There aren’t many options now, because they made a critical decision back then to decline coverage.

It’s fair to assume that my in-laws will now spend about $70,000 per year (or more) of their own money on his care. Just like this family declined fire protection, had they purchased a long term care policy ten years ago, the break-even point on buying “that overpriced insurance” would have been only several months into the nursing home stay.

They chose to self insure. Now they’re faced with the consequences.

So is the Tennessee family that decided to opt out of fire “insurance.” They had a house fire and no fire protection coverage.

Maybe there are larger societal implications here. Maybe not. Maybe it’s that we live in a time when everyone seems to want someone else to take care of us. I believe this event is simply another wake up call: nobody cares about your situation more than YOU. Take care of yourself. Make your choice and live with the consequences.

What steps should you take to prevent making poor insurance coverage decisions?

1) Examine the probability of an event, such as a long term care situation or house fire.

2) Evaluate the cost to cover the probability

3) Decide whether it should be insured, or if you can handle it yourself.

In this case, seventy-five bucks might have saved a ton of personal property from this house fire. Often people will forego insurance because they don’t have the funds to pay the premium. Insurance is created specifically for times when funds are short. If there’s enough money to cover the unlikely need for fire protection and you follow some fire prevention safety tips, maybe it makes sense to avoid the fee.

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Life Insurance: What’s the Right Type of Life Insurance?

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I’m not a big television watcher, so I’m sorry to say that I don’t see much Dancing with the Stars. I know, you had such high hopes for me. My wife watches the show, so sometimes when I’m playing around on “the Twitter” I’ll sit with her on the sofa. On more than one occasion, I’ve half-witnessed a total breakdown by the “star” because the workouts were too hard. What’s interesting is that these “stars” end up achieving nothing on the show while the harder working pairs continue on. Even if they don’t win, those stars that worked hard talk about how rewarding it was to learn something new.

That’s what we’re going to do today: throw out rules of thumb and learn how insurance works. I am totally an analogy ninja.

He did so well last time, The Other Guy is back to write another scintillating post on insurance. If you missed his last one, you may want to start here: Find the Right Amount of Life Insurance in 10 Minutes.

Everyone wants to use rules of thumb, or “what I heard from my friend” to decide which insurance is best. Why throw a dart when it’s nearly as easy and far more profitable to just do the homework?

I hear experts tell us to always buy term insurance. Or they moan that universal life coverage is a rip-off. I agree that there is one type of insurance that’s best for everyone, but:

The best type depends on what you’re going to use the coverage for and how long you’ll need it.

Decisions …so before you believe someone telling you that one type of insurance is better than another, minions, know the available types and how they work! Last week I shared a quick formula to determine how much coverage you’ll need. Let’s use another quick method to understand your choices when it comes to life insurance.

Just as a carpenter needs to know the difference between a hammer and a drill, you’ll need to know all the types of insurance to pick the best kind. Don’t worry, I’ll keep it entertaining.

Term Insurance is probably that most well known type of coverage. Because it’s stripped down coverage, it’s often the only type available in workplace plans. Term insurance is nearly as easy to understand as first grade math: you pay for a specific amount of insurance which covers a set amout of time, called a ‘term’.

Helpful example: Barry Manilow purchases a $250,000 10-year term policy. If he dies during the term, Mandy, his beneficiary would receive $250,000 tax free simoleons. If Barry expires one minute after the term ends, the insurance company owes Mandy nothing.

Whole Life Insurance is equally well known. These plans began decades ago as an alternative to term coverage mainly because the coverage lasts…wait for it…your whole life. Awesome, huh? I know. Marketing and naming wizards, those insurance companies. Most whole life policies contain a “cash value” component that can be cashed in by the owner. Whole life policies require payment for their…drum roll please…whole life, unless you buy a policy that can be “paid up” early. Generally speaking, whole life = coverage for your whole life and premiums for your whole life.

What’s awesome about whole life insurance? Guarantees! If you continue to pay the premium to the insurance company and keep your account in good standing, it’s guaranteed to last. The cash value grows at a guaranteed rate, so you don’t need to worry about interest rate fluctuation much. It’s a wonderful policy type for the super-nervous people of the world.

Universal Life Insurance is a variation on whole life – at some point insurance people said, “Wouldn’t it be cool if the payments to the policy and death benefit could be partially flexible?” Maybe they didn’t ask that exact question, but it makes the point. People who own this insurance pay extra (just like with whole life coverage) to add money to a cash value portion of the policy.

Once enough cash value accumulates, you can sit back and let the cash cover the costs instead of paying more money from your wallet. Many policies allow you to raise or lower the amount of coverage without having to purchase another one.

What’s another key difference between universal life and whole life insurance? Okay, I’ll tell you: universal policy interest rates on cash often float with interest rates. Awesome during 1980 when CDs were paying over 10 percent. Now, though, with the value of savings through the floor, universal policy rates are Coyote Ugly. And no, that’s not code for awesome, like the model-bar.

Variable Universal Life is the newest of the 4 major types. Those crazy insurance companies were getting smoked because the average saver decided to invest money into the financial markets. Marketing people said, pulling their hair out, “what will we do to keep business coming in?” Once again, the phrasing is off, but VUL policies (as they’re known in insurance lingo) were a reaction to the widespread use of mutual funds and other investment tools.

Initially developed in the late 70’s and early 80’s, these types of contracts allow for investment in various stock/bond accounts (similar to mutual funds, but not the same). The major draw of VUL? Flexibility of investments became the name of the game – and the opportunity to have market-like returns right inside your very own life insurance policy. In the go-go 1990’s, this was awesome. Since then, many investors have had middling returns and unpredictable results.

Which is best for the salesman?

In the interest of fair disclosure, I’m going to let you in on a little secret. Life insurance is a BIG commission check…I mean GIGANTIC. You wouldn’t believe how much. Let me give you an example: If you’re a 40-year old man buying a term policy that costs $100/mo; your insurance sales person gets around $850-$900 cash for the first year of your premium payments. Yes, you read that right, you basically pay a year’s worth of premiums to cover the commission amount. I don’t mean to infer that this is bad…it’s just how things operate.

Just thought you’d like to know.

Whole Life, Universal Life, and Variable Universal Life are even bigger payers. I remember receiving a check for over $25,000 for a single $400,000 Variable policy I sold early in my career. I also remember a $70,000 commission check for a $2 million policy. Big money.

My goal isn’t to make you angry. It’s to help you know the broker’s game.

…which brings brings us to the “One Question You Should Ask Before You Buy Anything”:

“Mr. Broker, how much money are you going to make if I buy this insurance?”

I was never ashamed to admit to my clients how much money I’d earn…a good advisor has no reason to be deceptive. But, if he hems and haws…maybe this “complex insurance investment strategy” that sounded pretty cool benefits him more than you. In my opinion, the actual commission is irrelevant – it could be $2 or $20,000, I don’t care – it’s how he answers the question.

All Insurance Types Cost The Same

Sometimes insurance agents will mention that permanent policies, such as universal or whole life, are less expensive than term insurance. I’ll lay it out and let you decide:

Sure, like some margarines are saltier than others, some carriers offer better premiums for smokers, race-car drivers, or 45-year olds. That’s true. However, insurance ‘costs’ among competitors are far closer than you’d initially imagine.

In the above example you’ll see the differences between permanent and term. Notice additional fees (in the right chart, 5 percent is deducted as an additional charge—this fee can be higher or lower depending on the carrier).

Here’s how all insurance costs are similar:

Insurance is sold in $1,000 increments. Imagine pulling up to the insurance store drive thru and ordering 500 $1,000 units of insurance. The cashier calculates the cost based on two factors: your age and the number of $1,000 units you’re purchasing. I hate to disclose this secret: actuarially you’re more likely to die every year you age.

With permanent life insurance, your “cash value” grows over time, reducing the amount of life insurance you buy from the insurance company – which makes it seem like you’re paying less for coverage.

A second handy example: if Jeff Gordon races to buy $500,000 of coverage and he stuffs $50,000 of cash into the policy – his beneficiary would receive $450,000 of insurance and $50,000 OF JEFF’S OWN MONEY to total $500,000.

Permanent life insurance is only cheaper because you’re paying extra into cash when you’re young, which lowers the amount you’re buying later on when it’s expensive.

Whole life, UL and VUL insurances in many ways are forced savings accounts added to life insurance.

Which Should You Buy?

So…which one is best? Well, that’s a loaded question – but here’s what I think. Start by determining how long you’ll need coverage. For the vast majority of savers, maxing out a Roth IRA and 401(k) plan and buying term insurance is the right answer. If you have a long term need and have a maxed out Roth IRA, 401(k) and you still have money left over…well then maybe a permanent policy may be a better choice.

For this reason, using term insurance for succession planning needs at work or estate liquidity needs to cover estate taxes usually ends in disaster. These policies need to be in-force when you die, so permanent insurance works best.

If you’re a worrier about outliving your insurance and want forced savings, whole life, UL and VUL aren’t the enemy. I’ve had clients purchase permanent insurance only because they wanted security and were comfortable paying a lot of money for it. These policies work, but for a cost.

Because most families need life insurance for a fixed amount of time and have other ways to save money, term is often the best choice.

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Find the Right Life Insurance Amount in 10 Minutes

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Another note from AverageJoe’s Thanksgiving visit to the in-laws:

Dear blog diary,

I’ve just trounced my mother-in-law at Scrabble again. It was absolute luck that the triple word score was open for my play of “austerity.” Of course, I had to hide a U and Y in my sleeve to place a nine-letter score. Luckily, we’ve both had enough “holiday cheer” that she didn’t notice. I know that to be a good son-in-law I should let her win, but not until I get a chance to play the word “bailout.”

Between all this winning and making Rice Krispies Turkey Pop Treats, I totally can’t be bothered to post anything today. Instead, I’ve opened the basement and let out The Other Guy, so named because he’s still a practicing financial advisor and doesn’t understand that being associated with me would totally be good for business. Whatever.

We’ll have a special piece tomorrow, but will completely understand if you don’t have time to read it. Safe travels, everyone!

Now, on to the Other Guy:

 

 

A couple of weeks ago, after being sick for about 10 days, I finally went to the doctor. Apparently, I have ‘walking pneumonia.’ I told the doctor that I don’t do any physical exercise, including walking, so I couldn’t possibly have “walking” anything.

In any event, I didn’t feel well. I began to contemplate my own mortality and then an idea popped in my mind: let’s spend a couple of days talking about life insurance! It’s obviously everyone’s favorite topic…and as a financial advisor who doesn’t like to be sold some insurance, I make the perfect teacher. As AverageJoe did with the “evaluate a mutual fund in 10 minutes” post, I’m going to break it down nice and easy for ya’.

Here goes:

Before anything, let’s not waste time evaluating coverages if we don’t have to. All too often, insurance sales professionals and financial advisors will just make the assumption that you need it and proceed to sell it to you. Here’s an easy way to determine if you need life insurance at all:

Questions to ask:

Does anyone rely on you for financial support, either right this moment or if you got hit by lightning?

If you’re single and/or have no dependents, there’s almost a zero point zero percent chance that you need life insurance. I might be convinced that a small group policy so that someone can bury you is adequate. If you have charitable intentions, there are insurance strategies that work really well….but that’s all. Nothing more.

Don’t let an insurance salesman tell you otherwise.

For those of you who have people relying on you for financial support here’s an easy way to calculate how much you need. Is this the best way? Nope. However, once we walk through these steps you’ll be on your way to making a good insurance decision.

Every life insurance discussion contains assumptions. You’ll need to make some to decide what amount is right for you. At the least, you’ll need to know where assumptions have been made, so you’re able to change directions if you need to.

Here are a few assumptions:

If married, I usually assume with clients that they’ll want the mortgage paid off when they die. Even if both spouses have a full time job and can still afford the house, I’ve seen too many people “go off the deep end” when their spouse dies to determine whether everything will remain stable at work and home. I can understand leaving this out, but at the least I’d evaluate your insurance cost with and without this cost before deciding to drop it.

You may find the additional cost is worth the pain.

If you have children, I assume you’ll want them to go to college, and you’ll want it paid for . Maybe not Harvard or Yale, but you want them to have some level of in-state public university education. Since college costs increase 8-10 percent per year on average, this is one of the most expensive budget items a family can face.

Let’s have the discussion here that we’ll have in client meetings: Maybe you paid for your own college expenses. Evaluate your children and savings and not your personal situation when you went to school. With costs rising quickly, do you want them to have this burden?

Here’s how much life insurance you’ll need…plus or minus the assumptions above plus a few more below.

Add together all of your debts, including your mortgage: $__________________

I’ve done the math on an average in-state tuition in the chart below. Add in these costs: $__________________

Next, we’re going to give your family basic income to live on. Here are where we need to make some large assumptions. Take your annual post tax (take home) income and multiply by 80%. This assumes that your family will live on 80 percent of your current salary if you’ve died. There are better ways to do this. Instead, determine what percent your family would need in the event of your death and use that percentage.

Divide this amount by .05. This means that you’ll need to peel off 5 percent to live on. This single number creates (again) huge assumptions. The biggest? It’s that you’ll continue to live on this income stream even as inflation skyrockets. Once again, we’re trying to get in the ballpark, so if you’re trying to do this the “quick and dirty” way, we’ll be close, but there are better ways.

Place your answer here: $__________________

Add up these 3 lines, that’s how much you need.
$__________________

Now, often, I’ve seen insurance salespeople stop at this point. Not good. Remember, you have some current savings! The goal of insurance in most situations is to replace income that you don’t yet have.

Subtract the amount of money you already have saved from the final number.

$__________________
Buy the difference.

Education Chart

Age$ needed todayAge$ needed today
0$78,855.8711$64,200.32
1$77,395.5712$63,011.43
2$75,962.3213$61,844.55
3$74,555.6114$60,699.28
4$73,174.9515$59,575.22
5$71,819.8616$58,471.98
6$70,489.8617$57,389.16
7$69,184.5018$56,326.40
8$67,903.3019$34,071.75
9$66,645.8320$23,139.91
10$65,411.6521$11,792.45

Later, we’ll have a discussion on the various types of insurance you should consider and the #1 question you should ask before you buy anything from any insurance sales person.

As always, this exercise is more about understanding the variables that go into making a good decision as much as it is about the final product. Plug in your own unique situation and evaluate many types of coverage thoroughly before buying life insurance.

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There’s Something Wrong With The Car

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There are good days and then there are bad days. Neither of those descriptions fit last Saturday morning.

I woke up to my son running in the door.

Nick: Dad, there’s something wrong with the car. You have to come outside.

me: Where did Kim Kardashian run off to?

Nick: Dad, wake up. Come outside.

me: What time is it?

Nick: 7 o’clock. Come outside. There’s something wrong with the car.

me: (suddenly realizing Kim isn’t coming back, I’m not drunk in a Beverly Hills swimming pool and I’m a happily married parent of twin 16 year olds) What’s wrong with the car?

Nick: Just come outside

Cheryl: Go, Joe

me: (I’m thinking to myself: why don’t you go?) I’m saying out loud: Okay

(18 years! Why do you ask?)

Cheryl (to Nick): What’s wrong with the car, honey.

Nick: I hit a mailbox.

me: Okay. (out of bed, throw on jeans and a tee-shirt, follow Nick outside)

I shouldn’t interrupt the story here, but it’s time for a little op/ed piece.

Who the F$%# decided that mailboxes should go in brick structures? My mailbox looks like this:

Our Mailbox

Awesome dent in the side, huh? I was going to actually change this mailbox until some kids late at night kept driving down our street with a kid out the car window slamming a baseball bat into everyone’s property. Where before, I saw a rotten looking mailbox, now I saw less cost when it’s finally destroyed.

So, back to our story…..

I’m following Nick through the house, expecting to see my mailbox on its side, with maybe a little dent in the car fender. My son has been driving for six weeks. We’ll have a talk about it and he’ll go to his swim meet. We’ll laugh about it when he’s 35 years old.

Heading up the stairs, I realize that many of my neighbor’s mailboxes look like this:

random neighborhood mailbox

Holy brick-house, Batman! The front end of the car might be crumpled around that thing. Now I’m worried. By the time we hit the front door my pace is almost as fast as a cop headed for Dunkin’ Donuts.

me: Whose mailbox did you hit?

Nick: Huh? (he’s 16. I omitted most of the 16-isms for brevity, but had to leave one “huh?” in here.)

me: Whose mailbox?

Nick: Bill’s

me: Oh sh$#.

Bill lives across the street and has a mailbox similar to the one above. The front of our Saturn Aura is probably crushed in. Being a Saturn, it’s a collector’s item (that’s a joke, by the way. Some are apparent, others I’ll point out as we go.).

me: How did it happen?

Nick: I was trying to change a CD.

me: Nick! Don’t try to change a CD while driving. Keep your hands on the wheel. (I think I’m giving good parenting advice here, but I’m not. It turns out that my daughter–remember I said I had two driving? My insurance company remembers….and giggles out loud.–My daughter had a GLEE CD playing LOUD. I know because, when I turned on the car, it was still playing. My poor son. A Glee CD. The Horror.  Forget the mailbox, I would have hit Bill’s house hard enough to end it all.)

Here’s what I see. Remember that as a recovering advisor for 200 families, it’s difficult to amaze me. I’ve pretty much seen it all.

Except this:

Wheelie!

We call it “Wheelie!” or “Full-Sized Car Statue on an attractive brick base.”

My car is on two wheels (the left two if we want to be technical about it), and is TETTERING ON THE TOP OF my neighbor’s brick mailbox).

me: How the hell did you get the car all the way on top of it?

Nick: I don’t know.

Me: What did you tell me inside? Something’s wrong with the car?

Nick: Yeah.

Me: Understated. In social circles, that’s classy.

It took TWO wreckers to get the mailbox out from under the car. One to pick up the front end and another to drag out the mailbox.

Do you know that whole thing about people getting their 15 minutes of fame? The wrecker drivers all took pictures with their cameras “for the record.” I’m sure my car claimed its 15 minutes and more that night. You may have already seen this picture on Facebook.

So, in closing: please read my blog. Click on every advertising link. Next week I’ll have advice on how to deal with your car insurance company, and how to write big $%#!ing checks without shaking (much).