“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.
