The Cost of Protection v. the Cost of Non-protection

I was talking to a couple recently about life insurance.  They didn’t think that they could afford to buy any.  Now it’s true that some people simply can’t afford any extra expenses, no matter how small.  But most employed people can afford at least a small life insurance policy, even if it means going out a little less.

For a couple who are both 35 years old and in reasonable heath, they can both get 30-year term policies of $100,000 for a total of roughly $40-45 per month.

How does this compare to the cost of a funeral?  The average cost of a funeral these days is about $6,500.

And believe it or not, that doesn’t even include the price of burial and cemetery fees.  $6,500 divided by $40 comes out to between 13 and 14 years.  In other words, if you’re able but not willing to pay $40 a month for life insurance, you’ll need to save $40 a month for at least 14 years in order to have enough money on hand to pay expenses if you die.  But in reality, it will be more than that–if you want an average funeral.  Even if inflation remains very low all that time (say 2 percent), the average funeral cost will be up to at least $8,500 in 14 years.  So you’ll actually have to save for an additional four years to make up the extra $2,000.

Of course, not too many people actually save for their funeral in advance.  So in other words–the choice is to pay now or pay later.

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Something New

I’ve decided to try something that I haven’t done before.  I’m going to run a promotion.

Anybody who calls me about an appointment during this week will get the opportunity to have all insurance policies of all types reviewed for free.  Sometimes people buy car insurance (for example) and don’t look at it again for years and years, even though their situation may change quite a bit in the meantime.

In addition, while I am not a financial advisor and therefore cannot provide advice on some matters, I will give–if requested–a general overview of things like IRAs and 401Ks.

All of this is free, and carries no obligation whatsoever.  If, at the end of the appointment, you don’t want to take things any further, or buy anything from me, then I will simply walk away and not bother you again.

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Deductibles v. Premiums

A lot of people don’t think much about the effect that a deductible has on the premium.  Life insurance doesn’t have any deductibles, but most other types of insurance do.

For instance, a 30-year-old woman with a $1,000 deductible on her health insurance might have a premium of $236 per month.  If she raised her deductible to $2,500, the premium would drop to $176 a month,  and if she went on up to a $5,000 deductible, her premium would be $142 a month.

Here’s an example with a married couple, both 40 years old, using the same plan as in the first example.  With a $1,000 deductible, their premium would be $581.  Using a $2,500 deductible, their premium would be $428.  And going up to a $5,000 deductible, their premium would drop to $342.

For most reasonably healthy people, it usually makes sense to choose a medium to high deductible.  However, there is a danger that people will just waste the money that they save.  The best way to avoid that is to set up a Heath Savings Account (HSA).  This is a special savings account used to save money for medical bills.

Using the example of the married couple, let’s say that they have had a deductible of $1,000, which they raise to $5,000.  They then save $239 per month.  They set up an HSA and put the whole $239 into it for the next eleven months.  The twelfth month they spend the money on their regular doctor’s visit.  Then they save the $239 for the next eleven months.  At this point, they will have $5,258 in their HSA and thus they have sufficient money on hand to pay their full deductible should one of them become seriously sick or injured.

Or if they both stay healthy for five years, then they will have $13,145 in their HSA.

This relationship between premiums and deductibles is the same for every type of insurance that has deductibles.

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Financial Education, Part 2

A lot of people who retire these days have roughly $75,000.  The reason is because they were told forty years ago that they would need that much to retire.  So that’s what they saved.

Now, today, $75,000 is an absurdly low figure for retirement.  But somebody retiring forty years ago would have had a pretty comfortable retirement on that amount.  The reason why $75,000 was sufficient for retirement then but woefully insufficient today can be summed up in one word:  inflation.

The historical average rate of inflation is about 5%.  This means that prices tend to double about every fifteen years.  So in forty years, prices will double 2.5-3 times.  Call it 3 to make calculation easier.  The 1st doubling will take that $75,000 to $150,000.  The 2nd takes it to $300,000 and the 3rd takes it to $600,000.  So somebody who started their retirement planning forty years ago should have planned to save about $600,000 instead of $75,000.

In the same fashion, somebody who plans to retire thirty or forty years from now should try to save a lot more than the current retirement figure–say 2 or 3 million dollars.

Inflation and interest rates
You can’t simply throw some money into a CD, and expect to end up rich.  About the most you could reasonably expect would be for that money to grow as fast as inflation–and that’s if you choose the longest CDs.  To reliably keep ahead of inflation, you need a longer-term vehicle than CDs.  If you’ve got a high tolerance for risk and volatility, you can simply jump into the stock market and see what happens.  If you’re in the stock market for a long time, you’ll come out ahead, although there will definitely be some roller-coaster moments along the way.

Or–or in addition–you can put some money into an annuity.  Annuities pay higher interest rates than CDs, because they run longer.  Right now, even the longest CDs pay only about 2%.  But annuities are paying 4% or higher.  That may not sound like much, but it’s significantly higher than the current rate of inflation.

Over the medium term, say 7-10 years, an annuity offers safety and a guaranteed return.  Over that length of time, you may or may not make money in the stock market.

Advantage of time
Time is your greatest friend when saving for retirement.  Suppose you receive a $10,000 inheritance when you’re 30.  You find some investment, possibly an annuity, that allows your money to double every ten years.  That’s 7.2%, which is quite easy to achieve when you’re planning for the long term.  When you turn 70, your $10,000 will have grown to $160,000.

Small changes, such as eating out one time less a month, can help a person save money.  Say you save $5,000 over the course of three years.  That averages out to $4.57 per day.  Once you have the $5,000 saved up, you stick it in an annuity or a good mutual fund.  And you repeat that process for fifteen or eighteen years.  You’ll have a significant chunk of your retirement planning done.

These are some of the general ideas and principles that should be taken into account when planning for retirement.  Obviously, not everybody can do all these.  But anything is better than nothing.

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Financial Education, Part 1

Old-school insurance didn’t have anything to do with financial education.  The salesmen just pushed their policies and went on to the next customer.  You can still find a lot of insurance agencies who do things that way.

But those of us who are affiliated with Five Rings Financial approach insurance from a different perspective.  We educate before we sell.  Most people learn little or nothing in school about how money works.  Most of what is taught is geared toward every-day stuff, such as balancing a checkbook.  That’s commendable and desirable, but it doesn’t really touch the basic principles of how money works.

As an example, most people know that compound interest is good, and they may have heard examples of why it’s good, but in many cases they don’t really know how to apply that knowledge to their own lives.

The Rule of 72
Another example is the Rule of 72.  Some people have heard of it, but they don’t really know what it is.  It’s a way of telling how quickly any given sum of money will double.  You divide 72 by whatever interest rate you’re getting, and the answer is the number of years that it will take your money to double.

But one thing that most people don’t realize is that the Rule of 72 works in “reverse,” too.  Suppose you have $1000 in government bonds earning 4%.  Well, 72 divided by 4 comes out to 18 years.  So in 18 years you’ll have $2000.  But suppose you also have $1000 in credit card debt at 18%.  Well, 72 divided by 18 is 4 years.  If they let you go without paying anything, you would owe $2000 in just 4 years.

But say that you wait 18 years before paying anything.  Then you will have $2000 in government bonds, and a little over $11,000 in debt.

This sort of knowledge can make a big difference over the course of a person’s life.  For example, there’s an almost unbelievable amount of money in very low-paying accounts.  The current interest rate on CDs is downright pitiful, and the rate on money market accounts is even worse.  Yet there are trillions of dollars in such accounts.  This article is slightly outdated, but the general trend is still present.

It’s worth noting that at the average rate for money market accounts, it would take a person’s money 175 years to double!

This is a pretty big topic, so I’ve decided to split it into two parts.  The second part should be up next Monday.

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Annuity Basics

A lot of insurance companies sell more than just insurance.  Many life insurance companies also sell annuities.  A lot of people have heard of annuities without really knowing what they are.

In the simplest terms, an annuity is like a CD that’s sold by an insurance company instead of a bank.  Some similarities between the two:

  • For a fixed length of time.
  • Penalty for early withdrawal.
  • Fixed interest rate.

And here are some differences:

  • Annuities typically are for ten years or longer, whereas CDs are usually five years or less.
  • Annuities offer higher–sometimes much higher–interest rates than CDs do.
  • Some annuities offer a bonus.

After a certain length of time, you can start getting money from the annuity.  The insurance company looks at the life expectancy of people your age, and uses that figure to decide on a monthly sum of money.  Once you start receiving that money, you get that same amount of money every month for the rest of your life.

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Reasons for Life Insurance

There are several schools of thought about life insurance.

  • The best thing ever.
  • Good but not necessary.
  • Useful for some people but not others.
  • Take it or leave it.
  • A total rip-off.
  • Don’t know anything about it, and don’t want to know.
  • I might buy it, but then I’d have to think about dying, and I don’t want to do that.

Much of the neutral and negative attitudes about life insurance can be traced to two sources–traditional types of life insurance, and the old stereotype of very aggressive salesmen.

Fifty years ago, about the only type of life insurance sold in this country was traditional whole life.  It was fairly expensive and tended to have quite low death benefits.  Anybody with the ability and self-discipline to consistently save money would likely have been better off without it.

Another factor that has caused negative attitudes about life insurance is traditional term insurance.  Some people look at this model and conclude that you basically get cheated if you outlive the policy.

I know that everybody has individualized reasons for thinking the way they do, but I have talked to people who disliked life insurance simply because they didn’t understand it.  So the purpose of this post is to try to help people understand possible reasons for buying insurance.

Peace of Mind
I sometimes say that I sell “sleep insurance.”  That phrase can refer to things besides life insurance, but it means that you’ve done something or have something that allows you to go to sleep, instead of worrying.  Life insurance gives the assurance that tragedy, however unlikely it may be, will have a silver lining.  Even self-proclaimed psychics don’t claim to predict everything in life, and we never know what might happen.  Some people sleep better when they know that their spouse or children will have the money to do a certain thing after their death.

Plan for Living, not for Dying
The various types of life insurance that build cash value can be very helpful in case of emergency.  I’ve been seeing news articles lately about how many people are borrowing from their 401Ks because they can’t get needed money anywhere else.  But that can be risky business.  If they can’t pay the money back, they’ll likely have to spend money paying penalties to Uncle Sam.  On the other hand, somebody with cash value in their life insurance policy can borrow from that.  Of course there are risks that way too.  It’s not something to be done lightly or carelessly.  But it can be a handy option at times.

If you have a lot of cash value built up, borrowing from it can be done for other reasons.  Here’s a way that tends to appeal to the “forced savings” type of people.  Say you borrow $20,000 from your policy to buy a car.  Naturally, the loan charges interest.  But because it’s from your policy, you are effectively charging yourself interest, and thus in the long run you will wind up with a little more value in your policy than you would have otherwise.

The ability to borrow from cash value is part of the things called “living benefits.”  This means anything and everything that allows you to gain benefit from your life insurance policy while you are alive.  There are things like critical illness riders, which allow you to get an advance on the death benefit in order to pay for a serious illness.

Life insurance has come a long way in the last several years, and insurance companies have gotten quite creative.  So much so, in fact, that they are beginning to see people buy life insurance primarily for the living benefits side.  For some policies, the death benefit is actually beginning to be more or less just a really big bonus.

Tax Advantage
Life insurance can be used as a way to pass money between generations untaxed.  Tax stuff gets complicated, and when someone dies there can be different types of taxes involved.  But this one thing you can take to the bank–a lump-sum life insurance payout is never subject to federal income tax.  In my opinion, that’s one of the best reasons, and certainly one of the least known, for buying life insurance.

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