Life insurance can be a confusing topic. There are many different flavors and choosing the right coverage for your needs and budget can be difficult. Throw in the fact that life insurance agents goal of collecting a commission check may be at odds with your goal of obtaining the best protection for the lowest price and you have a recipe for disaster.
Let’s start by getting to know some of the basic flavors of life insurance available to you. While this is not a complete guide to all the life insurance options available nor does this explain all the nuances of each policy type, it is useful as a primer to get you started.
Term Life Insurance
Term insurance is the most basic and the least expensive type of life insurance policy available. Term insurance is pure protection. You give the insurance company a premium and the commit to paying your beneficiaries a death benefit if you die during the policy’s term. Once the term has expired you no longer have life insurance protection and the insurance company no longer has an obligation to pay.
One-year non-renewable term insurance is the absolute cheapest type of policy you can buy, but that is rarely the type of policy you will need.
Usually you need protection for longer than a year, so insurance companies came up with multi year guaranteed renewable term policies to meet that need. You can often find 5 year to 20 year guaranteed renewable coverage that can be used to customize coverage for just about any situation. Because the policies cover multiple years and have guaranteed renewability, premiums are a bit higher. You can also add level premium guarantees to the coverage, so you know what your premiums will be for the entire term of the contract. Level premiums mean there is a bit more risk for the insurance company which gets passed along to you the consumer in the form of higher premiums.
Many young families can use term insurance to protect against premature death and until they have accumulated enough capital to no longer need as much protection. For instance, new parents might purchase enough coverage to protect against the loss of wages if one spouse dies and provide funds for childcare and education until their children graduate from college with a fifteen or twenty-year level premium term policy. After that term expires their need for insurance may well be much lower and they can follow it up with a ten-year level premium policy to provide protection until retirement when they will likely not need any life insurance coverage.
Whole Life Insurance
Whole life coverage as the name implies will last your entire life. The insurance company issues you a policy with a premium based on your age when the policy is issued. The premium you pay is calculated to cover the cost of term coverage for you, pay the agent, and have some money left over to go into a savings account inside the policy. Usually there is a stated interest rate that your excess premiums earn inside the insurance policy. As you continue to make premium payments, you gradually build up enough money inside the policy to either increase the policy’s death benefit or to stop making premium payments altogether.
Whole life coverage is usually the most expensive flavor of life insurance you can buy. There was an old adage that said buy term and invest the savings yourself for a better long-term outcome but having worked with many clients who are terrible savers, I do recognize the place for whole life insurance policies in many family’s insurance portfolio. Perhaps it is used as a foundation that you build term coverage on to meet all your needs for all your life.
Universal Life Insurance
Universal insurance works like whole life but rather than earning a guaranteed rate, the excess premiums are credited with an interest rate that floats with market rates. These policies were popular when interest rates were high. As interest rates came down over the past two decades many of these policies collapsed as the interest rate assumptions made when they were issued failed to materialize leaving the owners with much higher than anticipated premiums or reduced or even eliminated death benefits.
Variable Universal Life
Okay, take a universal insurance policy and make the savings account inside the policy a high priced mutual fund and what you end up with is variable universal life. If the mutual funds you own inside the policy earn enough net of fees, your premiums vanish or your death benefit increases. If you can find a variable universal policy with low expenses this is a good idea, but determining all the fees being charges to your account can be very challenging.
In the end life insurance is often a must for building a solid foundation for your family's financial plan. Life insurance is the one product that can create wealth where none existed before. Life insurance provides the cash your family will need to replace the earnings or human capital of a loved one. Life insurance is a valuable tool for providing protection for your family, but it is almost never a good tool for investing. If your agent talks about the investment properties of a life insurance product you should see this as a red flag and seek out a second opinion.
“Sell in May, then Go Away” used to be a common theme in the investment world.
This referred to the idea that traders would be occupied during summer months vacationing and enjoying the warm weather and are not as easily available to watch markets and make educated trades. This would in turn reduce liquidity in the markets and exacerbate any volatility which caused a lot of stress on traders during the summer months.
Today, that explanation just doesn’t add up with access to markets, data, and trades quite literally at the palm of our hands. You will find it very hard to really “Go Away”.
Whether you go away or not the ”Sell in May” strategy actually works, and they have data to back it up. It seems that seasonality is a real thing, and something to be looked at. If you’re a DIYer this may be something to look in to- it shows a strong success rate and you even get to take the summer off!
Spring is the time of year when all the potholes created by the freeze/thaw cycles of winter become all too obvious. You can damage your car, your tires, and your rims if you are not careful. We all have to slowdown to avoid these cavernous craters on our roadways and we complain to our local officials about fixing them on the roads we travel the most often.
Your investment portfolio can be like that also. Stocks fall in value creating imbalances or potholes in our holdings. Not all stocks rise at the same rate, so you could have some underperformers that you should be adding to or selling. Or maybe you sold something at a profit, but you haven’t reinvested the proceeds. Maybe you sold something that wasn’t working in your portfolio or even worse, maybe you need to sell something in your portfolio that isn’t working.
Maybe your pothole isn’t an investment at all. Maybe your pothole is a lack of a long-term plan or the need for a consistent strategy. Your pothole could be that life insurance you have been meaning to buy since your second child was born, or the debt you have let accumulate on a credit card since the holidays. Maybe your pothole is the will or power of attorney you have been meaning to establish for the past four years.
Whatever the case you need to periodically look at filling in the potholes in your financial life. The work crews you pass everyday on your way to the office can serve as a reminder that your financial life needs maintenance and care if it is to provide you a smooth and comfortable ride on your journey. Patch your potholes – today is as good a time as any.
The popular press is fond of pointing out how old the bull market for stocks is. After bottoming in 2009 we have seen stocks march upward for for nearly a decade. Many of today’s younger investors, say those in their thirties, have seen the stock market fall, but never felt the pain in their own portfolio.
Yet for another class of investor, those who have invested in bonds, the bull market run has been even longer. Going back to the days of President Jimmy Carter in 1981, bond yields have fallen, year after year. Because bond prices move inversely to interest rates, bond prices have been rising for the last 36 years. That means someone who entered the workforce in the early eighties, bond prices have always gone up.
For some perspective the Certified Financial Planner Board of Standards was formed in 1985. As a group, CFP® practitioners have never experienced a true bear market in fixed income securities. Although the credit freeze that coincided with the great recession bear market for stocks, had a short, sharp panic in the fixed income markets; a long drawn out bear market for fixed income has been an experience the profession will for the most part find alien.
The closest thing to the pain of a bear market in bonds experienced by this group was the 2004 to 2006 Chinese water torture of the Greenspan/Bernanke Fed. During the thirteen months that spanned June of 2005 to July of 2006, the Federal Reserve raised rates 25 basis points every time they met. Although the aggregate bond index only fell in price by about 5%, the constant barrage of interest rate increases was hard to live through.
That pain was nothing compared to the Burns/Miller/Volker era where we saw the Fed raise rates from 4.75% in November of 1976 to the 20% Fed Funds rate of May 1981. That was the last true bear market for fixed income products in the United States. Although your grandfather might wistfully talk about getting 18% on his CDs, the path that led to those astronomical rates was littered with bond investors who saw the value of longer term bonds fall by 50% or more.
When I hear today’s press ask what will happen if the 10-year Treasury bond breaches 4% I am astonished. It is not a question of if, but a question of when.
If we can avoid creating a trade war with the rest of the world, there are some very expansive monetary policies recently enacted by congress and the Trump administration investors can benefit from. The tax overhaul will provide a good measure of impetus to the economy, and the budget bill recently signed into law gets us away from the restrictive spending of the sequestration agreement and into a more expansive government spending era.
Yet, the Federal Reserve must walk a fine line between economic growth and containing inflation. GDP growth has entered a more normal territory.
Inflation, while still subdued, has shown signs of rebounding. The uptick in inflation is related to a small increase in wage growth, which is in turn related to the continued implosion of our unemployment rate. You also will note a similar uptick in mortgage rates.
As investors search for yield in a low rate world, we have seen a compression in the interest rate spreads between high quality bonds and low quality (junk) bonds. With rates as low as they are today and with the economy growing it is inevitable that interest rates will rise. The end of the 36-year bond bull market is likely upon us.
A flattish yield curve where the difference in a two-year treasury and a ten-year treasury is a mere 52 basis points, puts bond investors in a peculiar spot where an interest rate increase of just 1% could potentially wipe out three to five years of interest income.
The take away from all this is bonds are a minefield for investors today. A small misstep can be very costly and the rewards for investment are very small. Many advisors are ill-prepared for a world of falling bond prices.
Unless you or your advisor are true experts with fixed income investments, your best option in today's environment is to keep your maturities very short. That means you should be selling any bonds or bond mutual funds that have long durations. You should direct those allocations to short term treasuries, certificates of deposit, and bonds in the 1 to 3 year maturity range. Hopefully you will ladder those investments so you have new money available to invest at progressively higher rates throughout this interest rate cycle.
For those of you who need to squeeze every last drop of return out of your fixed income investments, I recommend you read an article I had selected for publication in the "Journal of Financial Planning" in July of 2011. In this article I explain how thinking about the life of a bond as it moves toward maturity can produce positive returns even when interest rates are moving up.
The recent income tax revamp has made income tax planning early in the year a must for many self-employed professionals. The ability to take a 20% deduction of business income, available for single filers with income below $157,500 and married filers with income below $315,000, is too good to pass up. Filers with taxable income at these levels will be in the 24% marginal tax bracket, so being able to qualify for the business income deduction is worth thousands, particularly when proper tax planning can prevent many from reaching the next 32% bracket. There are a number of ways to game your reported income, allowing many filers with reportable income well above these limits to qualify for the 20% exclusion.
First, the exclusion counts toward reducing your income below the phaseout thresholds. A married couple with employment income of $175,000 and a like amount received as business income would see their total income of $350,000 reduced by 20% of the business income or $35,000 allowing them to remain within the proscribed income limits.
Contributions made to an Health Savings Accounts will also reduce your taxable income. For 2018 single filers can deduct up to $3,450 and couples up to $6,900.
A real biggie for high earners looking to qualify for the 20% exclusion is retirement plan contributions. Money contributed to your qualified retirement plans can make a huge difference. For 2018 those under age 50 can contribute $18,500 to a 401k and those 50 and above can contribute up to $24,500. Presumably as a business owner you can also be sure to offer a generous match. Matching contributions are a deductible business expense that benefits you the owner directly yet reduces your reported profits and thus your total income for purposes of qualifying for the 20% deduction. And for very high earners, adding a defined benefit plan to your existing defined contribution plan might be a smart move, depending on the demographics and size of your workforce.
Don’t overlook simple things like using tax free municipal bonds for your savings versus taxable bonds and CDs.
Going beyond the basics, some business owners could benefit from reimagining their business ownership. Suppose you are a professional who owns your place of business. Setting up a separate company to own the real estate could be a smart move. You lease the building back from the owner at a fair market rate creating business income that is not subject to the target income limits.
Busy professionals have little time to devote to income tax planning and their CPAs are busy during tax season, but the difference between qualifying for the deduction and not qualifying could hinge on how soon you begin a given strategy.
It has been a long time since we have seen the stock market exhibit this much volatility. Corrections are a normal and healthy part of investing. Corrections weed out the speculators and hot money. For a clearer view of what is happening, we offer a few charts with longer term views.
Carrying mortgage debt can be a contentious subject among financial planners. Some look at the leverage as an opportunity to build net worth. Others see mortgage debt as merely a necessary evil. Often clients believe the mortgage interest deduction is valuable, but with the new income tax rules effective January 1, the deduction is limited for some and worth less for others.
So when should you try to be mortgage free?
Certainly, by the time you plan to retire. I have given this advice to everyone who has the means to do so, and to a person, they have always commented that it was the best advice they ever received. The reason has little to do with money, but everything to do with peace of mind. Not having the expense of a mortgage often reduces your need for significant cash flows. Being mortgage free also means that if push comes to shove, how much does it really take to live each month? Your basic expenses are then whittled down to food, energy, medical, and insurance expenses.
Retirement is also the point in your life where growing your net worth takes a back seat to generating income. I explain to clients that the easiest and safest way to earn 4% on your money is to avoid paying 4% for your money. Paying off a mortgage can be compared to purchasing a bond with a yield equal to your mortgage interest rate.
I like to illustrate the value of paying off your mortgage in a very simple way. Below is a chart of the annual payments for a $250,000 mortgage at 4% interest. We can ignore escrow amounts, because that covers expenses that will continue regardless of whether or not you pay off the mortgage debt.
Cash flow expense is simply the mortgage payments for the year divided by the payoff amount, or if you had the cash available to pay off the mortgage how much cash flow that money would have to produce to cover your mortgage payment.
You can see in this example that by year 15 the amount of money needed to pay off your mortgage would need to produce returns close to the historical equity market rates to be an even trade-off. By year 20 of a 30-year mortgage, or around the time many people are reaching retirement, the return on cash needed to make your mortgage payments has reached double digits.
If you were retiring at that point and had $117,886 available in a taxable account I would encourage you to use that money to pay off your mortgage. With a cash on cash return of over 12% the odds of earning a higher return on that money is slim, and it gives you an extra ten years of a less stressful retirement.
I once had a planning client come to me complaining that low CD rates were cutting into their lifestyle. The client felt they needed more income, but they were very risk averse. For them using the $100,000 to pay off their mortgage saved them from having $9,000 in annual expenses and did so without exposing them to any investment risk at all.
Every situation is a bit different, but you should challenge your assumption that carrying mortgage debt in always a good strategy.
The tax plan passed at the end of 2017 has a bonus for parents whose children attend private elementary and high schools. You can now use funds from a 529 savings plan to pay for these expenses. In South Carolina and other states that allow a tax deduction for 529 plan contributions, this change can mean significant savings on your state income taxes.
For example, the Charleston, SC both Porter-Gaud and Ashley Hall have high school tuition that exceeds $23,000 per year. By using the SC Future Scholar program as the funding vehicle for this tuition, families can save between $1,150 and $1,610 on their state income taxes.
To take advantage of this income tax break, simply open a Future Scholar 529 plan and fund the plan with the money you will be sending to the private school anyway. Then, request the plan send the money to the students account at the school of your choice. By using the 529 plan as a middle man in the transaction you will save yourself 5% to 7% on your annual tuition expenses by lowing your state income tax liability for the year you make the contribution.
It is also important to understand any sales charges associated with your 529 plan investments. In South Carolina you can open a 529 plan directly with the sponsor and avoid sales charges and loads. If you go through a broker your savings could be negated by the additional expenses. Another good reason to work with a fee-only financial advisor.
While there are no limits to the amount you can contribute each year to a 529 plan, you should understand that contributions are considered gifts. Contributing more than $14,000 per parent per year can be complicated but there are strategies to contribute much more in a single year and stretch the tax benefits of doing so.
You should also understand how using this tax saving strategy will impact your savings goals for post high school education. College expenses will still need to be planned for and funded, so have a plan in place to address both education funding needs. Talk to your tax professional or financial advisor about not only maximizing the tax advantages of a 529 plan for college- but for private elementary and high school as well.
Even the most independent among us, if fortunate to live long enough, may experience a decline in mobility or health that can strip away our independence and diminish the quality of our lives. Great advances in medicine have extended our average life expectancy to a record high of 78.7 years. Living longer means more years spent in the struggles that accompany old age. Add to that the increase in geographic mobility of our families and the result is millions of seniors left behind, hungry and alone.
Meals on Wheels has been guided by a single goal since the first known U.S. delivery by a small group of Philadelphia citizens in 1954 – to support our senior neighbors to extend their independence and health as they age. What started as a compassionate idea has grown into one of the largest and most effective social movements in America, currently helping nearly 2.4 million seniors annually in virtually every community in the country.
You can help today!
At this time of year, when we all gather with our families to share the love of the holiday season, we want to take some time to help those who are less fortunate. Yes, our stockings are hung, but there are those who have no stockings and those who have no place to hang a stocking, or are simply too sick to hang a stocking. This is the first of twelve pleas for your support to make this holiday a better time for all. A plea to do your part in bringing "Peace on Earth and goodwill to man"
I begin with the American Red Cross because in time of disaster they are often the very first on the scene. Let me share some of the ways the Red Cross makes a difference in the lives of those in need.
Wherever the is need you will find the Red Cross. Ninety percent of Red Cross workers are volunteers. An average of 91 cents of every dollar the American Red Cross spends is invested in humanitarian services and programs.
Please join me in making a donation to help support the mission of this charity. And please share this with your friends and neighbors. #12DaysofChristmasCharityChallenge