Buying Life Insurance: What Kind and How Much?

Posted by dfederman on Feb 21, 2012 in Investor Education | 0 comments

Description

Finding the middle ground between being “insurance poor” and unprotected requires assessing real needs and choosing products that are affordable. This article introduces different types of insurance products and the role that they can play in a personal financial plan.

Synopsis:

Death is one of things that no one likes to talk about. Yet, protecting loved ones from the financial consequences of death is one step you can take to gain peace of mind for you and your loved ones. And this is where life insurance enters the picture.

If you have a family or spouse who depend on you for financial support, or if you work at home providing your family with such services as child care, cooking, and cleaning, then you need life insurance. Older couples also may need life insurance to protect a surviving spouse against the possibility of the couple’s retirement savings being depleted by unexpected medical expenses. And individuals with substantial assets may need life insurance to help reduce the effects of estate taxes or to transfer wealth to future generations.

Determining what type of insurance depends on your goals, while deciding on an appropriate amount of coverage requires an assessment of your needs. Some approaches use a formula based on your income, while others factor in future liabilities, such as mortgage debt, college expenses, and estate taxes. The bottom line is quite simple: Don’t go it alone. Enlist the services of a qualified life insurance professional to help you determine the type and scope of coverage that best suits your financial objectives.

Key Points

• Types of Insurance
• Key Terms and Definitions
• How Much Insurance Do I Need?
• Other Types of Life Insurance
• Conclusion
• Points to Remember

Conventional wisdom says that life insurance is sold, not purchased. In other words, some people are reluctant to discuss the importance of owning life insurance, and others are simply unaware of the need to have life insurance. Although many large companies provide life insurance as part of their benefits package, this coverage may be insufficient.

Who needs life insurance? If there are individuals who depend on you for financial support, or if you work at home providing your family with such services as child care, cooking, and cleaning, you need life insurance. Older couples also may need life insurance to protect a surviving spouse against the possibility of the couple’s retirement savings being depleted by unexpected medical expenses. And individuals with substantial assets may need life insurance to help reduce the effects of estate taxes or to transfer wealth to future generations.

Types of Insurance

Term insurance is the most basic, and generally least expensive, form of life insurance for people under age 50. A term policy is written for a specific period of time, typically 1 to 10 years, and may be renewable at the end of each term. Also, the premiums increase at the end of each term and can become prohibitively expensive for older individuals. A level term policy locks in the annual premium for periods of up to 30 years.

Declining Balance Term insurance, a variation on this theme, is often used as mortgage insurance since it can be written to match the amortization of your mortgage principal. While the premium stays constant over the term, the face value steadily declines. Once the mortgage is paid off, the insurance is no longer needed and the policy expires. Unlike many other policies, term insurance has no cash value. In this sense, it is “pure” insurance without any investment options. Benefits are paid only if you die during the policy’s term. After the term ends, your coverage expires unless you choose to renew the policy. When buying term insurance, you might look for a policy that is renewable up to age 70 and convertible to permanent insurance without a medical exam.

Whole Life combines permanent protection with a savings component. As long as you continue to pay the premiums, you are able to lock in coverage at a level premium rate. Part of that premium accrues as cash value. As the policy gains value, you may be able to borrow up to 90% of your policy’s cash value tax-free, although loans reduce the policy’s death benefit and cash value, and may trigger a taxable event if the policy lapses.

Universal Life is similar to whole life with the added benefit of potentially higher earnings on the savings component. Universal life policies are also highly flexible in regard to premiums and face value. Premiums can be increased, decreased or deferred, and cash values can be withdrawn. You may also have the option to change face values. Universal life policies typically offer a guaranteed return on cash value. You’ll receive an annual statement that details cash value, total protection, earnings, and fees.

Drawbacks to this type of insurance include higher fees and interest rate sensitivity. Universal policies include up-front fees as well as ongoing administrative fees totaling as high as 5% to 7% of your premiums. You may also find your premiums increasing when interest rates decline.

Variable Life generally offers fixed premiums and control over your policy’s cash value. Your cash value is invested in your choice of stock, bond, or money market funding options.¹ Cash values and death benefits can rise and fall based on the performance of your investment choices. Although death benefits usually have a floor, there is no guarantee on cash values. Fees for these policies may be higher than for universal life, and investment options can be volatile. On the plus side, capital gains and other investment earnings accrue tax deferred as long as the funds remain invested in the insurance contract.

Universal Variable Life insurance is the most aggressive type of policy. Like variable life, you can choose from a variety of investment options. However, there are no guarantees on universal variable policies beyond the original face value death benefit. These policies are probably best suited to affluent buyers who can afford the risks involved.

How Much Insurance Do I Need?

A popular approach to buying insurance is based on income replacement. In this approach, a formula of between five and ten times your annual salary is often used to calculate how much coverage you need. Another approach is to purchase insurance based on your individual needs and preferences. The first step is to determine your unique income replacement needs.

Currently, a large portion of your income goes to taxes (insurance benefits are generally income tax free) and to support your own lifestyle. Start off by determining your net earnings after taxes. Then add up all your personal expenses such as housing, health care, food, clothing, transportation expenses, etc. This represents the amount that your insurance will need to replace. You’ll want a death benefit amount which, when invested, will provide income annually to cover this amount. Then, you should add to that the amounts needed to fund one-time expenses such as college tuition for your children or paying down mortgage or debt.

Income replacement for nonworking spouses is an important and often overlooked insurance need. Coverage should provide for your costs for day care, housekeeping, or nursing care. Add to this any net earnings from part-time employment.

Finally, estimate your own “final expenses” such as estate taxes, uninsured medical costs, and funeral costs.

Other Types of Life Insurance

Survivorship life insurance (also referred to as last-to-die or second-to-die) is a unique type of contract that insures the lives of two people. It pays a death benefit upon the death of the second insured. Therefore, it is typically less expensive than two individual policies. Survivorship life is often used for estate planning, where it may be possible to potentially leverage today’s dollars — via insurance premiums — into a potentially significant death benefit that can be used to fund estate taxes, create wealth for future generations, or benefit a charity. These policies may be available if one insured is medically “uninsurable.”

First-to-die life insurance insures the life of at least two people and pays a benefit upon the death of the first insured. This policy is useful for covering a mortgage or other large debt obligation where there is more than one debtor. In addition, it can be an ideal tool for funding a buy-sell agreement within a closely held business.

Conclusion

Life insurance is an important component of a sound financial plan. Buying insurance involves asking a variety of personal lifestyle and financial questions. If you are not already working with an insurance professional, you may want to consider the advice of a fee-for-service financial planner who can offer you an objective review of your insurance options. When you decide on what you want, there are many insurance companies to choose from. Consult your library or an independent insurance professional for companies with the highest ratings from the four ratings agencies: AM Best, Duff Phelps, Standard & Poor’s, and Moody’s.

Points to Remember

1. Term insurance is basic, inexpensive coverage that does not accumulate cash value. Policies with very long terms offer stable premiums, but policies that require periodic renewal feature premiums that may increase over time to maintain coverage.
2. Consider a term policy that is renewable and convertible to whole life should your needs change.
3. Whole life provides level coverage with level premiums. A portion of those premiums goes into tax-deferred savings.
4. Variable life offers control over your investments.
5. Premiums on variable policies are fixed, but face value and the value of your investments can fluctuate.
6. Universal life is highly flexible, but is sensitive to interest rate changes. Universal variable life offers more investment options but fewer guarantees.
7. Insurance needs are based on income replacement and personal preferences.

Source/Disclaimer:

¹An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.

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February 2012 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by Dan Federman, CFP^®, a local member of FPA.

Required Attribution

Because of the possibility of human or mechanical error by McGraw-Hill Financial Communications or its sources, neither McGraw-Hill Financial Communications nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall McGraw-Hill Financial Communications be liable for any indirect, special or consequential damages in connection with subscriber’s or others’ use of the content.
© 2012 McGraw-Hill Financial Communications. All rights reserved.

Spendthrifts: Preserving Your Estate for Your Children

Posted by dfederman on Feb 21, 2012 in Investor Education | 0 comments

Protecting and preserving your estate for your children after your death has become much more challenging in the face of the current economic climate.

With the financial collapse of 2008 and subsequent recession, the perilous nature of the European market, our country’s debt crisis, and the fears of another recession, many people are concerned about the long-term stability of the assets left to their children. Very often, however, market conditions are not the biggest threat to the inheritance you leave to your children; rather, the unpreparedness of your own children to manage their inheritance may pose the biggest threat. According to a recent poll, 75% of heirs felt either completely unprepared or only somewhat prepared to handle the management of their inheritance.

Fortunately, there are several solutions to protect against the diminution of such assets, either through mismanagement or creditor issues. One of the most common solutions to preserving your assets for your children is the creation of a spendthrift trust. A spendthrift trust is a trust that restrains the voluntary and involuntary transfer of a beneficiary’s interest in the trust. Such a trust is often established when the beneficiary cannot effectively manage the beneficiary’s own financial affairs, or, similarly, as an asset protection tool to protect the trust’s assets from the beneficiary’s debt and creditors.

The following are several considerations when using a spendthrift trust:

Trust terms—Most spendthrift trusts are irrevocable, provide discretionary as well as mandatory payout provisions, and may even direct partial or full payments of the trust assets to the beneficiary upon reaching certain age requirements.

The terms of the trust should also explicitly provide spendthrift provisions. For example, the trust should be a spendthrift trust to the maximum extent permitted by law, providing that no interest in the trust shall be subject to a beneficiary’s liabilities or creditor claims, assignment, or anticipation.

The spendthrift trust should also provide protections against the beneficiary’s creditors. For example, if the trustee determines that a beneficiary would not benefit as greatly from any outright distribution of trust income or principal because of the availability of the distribution to the beneficiary’s creditors, the trustee shall instead expend those amounts for the benefit of the beneficiary (i.e., the trustee can directly pay the beneficiary’s bills ? such as rent and medical costs ? instead of giving money to the beneficiary outright which may then be reached by creditors). This direction is intended to enable the trustee to give the beneficiary the maximum possible benefit and enjoyment of all the trust income and principal to which the beneficiary is entitled.

Finally, the spendthrift trust can prevent marital claims against the trust assets in case of the beneficiary’s divorce. This is done by providing that all benefits granted to a beneficiary of the trust shall be the separate property of such beneficiary (as distinguished from marital property, community property, quasi-community property or any other form of property to which such beneficiary’s spouse might have a claim or interest arising out of the marital relationship).

Trustee—One of the most important decisions you must make is who to appoint as trustee of the trust. Often, another family member is asked to serve as the trustee. There are many reasons, however, to consider appointing a corporate trustee (or co-trustee). The corporate trustee—such as a bank or trust company—has experience managing money and can provide valuable guidance. It is also much easier for a corporate trustee to make unbiased decisions, especially when various family dynamics are in play.

Trust Protectors—A growing trend is to also appoint one or more trust protectors, defined as a person or persons who are authorized to direct the action of the trustee. The use of a trust protector can be a valuable tool when you have appointed a corporate trustee of the trust. The addition of a trust protector allows you to appoint a familiar, trustworthy person to oversee the trustee. Depending on your desires, and the applicable state laws, the trust protector may be given the power to (i) modify distribution or administrative provisions; (ii) remove and replace the trustee; (iii) consent to or veto exercises of trustee discretionary powers, such as investments and distributions; (iv) resolve disputes between beneficiaries and the trustee; and (v) terminate the trust.

The attorneys at The Estate Planning & Elder Law Firm can assist clients with their estate, financial, insurance, long-term care, veterans’ benefits, and special needs planning issues.

For a comprehensive review of your financial situation, including estate planning, investments, insurance, taxes, and retirement planning, contact an adviser at Ariba Asset Management 1-800-808-7488.

Should You Contribute to a Non-Deductible IRA?

Posted by dfederman on Feb 17, 2012 in Investor Education | 0 comments

When deciding which type of Individual Retirement Arrangement (IRA) to fund for your retirement savings, the answer may not be as simple as you would like.  As a refresher, the Traditional IRA allows an upfront tax deduction along with tax deferred growth. When you eventually take money out of a Traditional IRA, the distribution is taxed as ordinary income. By contrast, the Roth IRA allows you to place after-tax money into an IRA, and all future growth and withdrawals are tax-free.

If your tax bracket is higher than 15% it makes sense to take advantage of the tax deduction of a Traditional IRA. If your tax bracket is below 15% then a Roth IRA makes sense. However, if your income exceeds certain IRS limits, you may be excluded from contributing to both the Roth IRA and the Traditional IRA.

If you are excluded from these two options, should you contribute to a non-deductible IRA, which is funded on an after-tax basis? In most cases, the answer is no.  The problem with non-deductible IRAs is they give you the “worst of both worlds.” For example, it does not give you a tax deduction like the Traditional IRA, and the earnings cannot be withdrawn tax-free like the Roth IRA.  Furthermore, it is cumbersome from an administrative perspective. To designate contributions as nondeductible, each year you add to or make a withdrawal from the IRA, you must file Form 8606, Nondeductible IRAs with the IRS, and you must hold on to these records until you eventually make withdrawals, which could be 30-40 years. Last but not least, if you fail to file there is a $50 penalty!

So when does it make sense to contribute to a non-deductible IRA? There are two exceptions. If you’re older than 59 1/2 and able to avoid the 10% early withdrawal penalty, then you don’t have to worry about losing access to your money if you need it. As long as you choose investments that will maximize the value of tax deferral, you can use a nondeductible IRA to manage your tax burden. The other exception is if you plan to do a “backdoor roth IRA,” which allows you to contribute to a non-deductible IRA then convert to a Roth IRA. Talk to your tax adviser before attempting this because if you also have a Traditional IRA, you must also convert those assets, creating a taxable event.

Talk to your financial or tax adviser to learn about your options for maximizing retirement savings.

For a review of your investment portfolio and financial plan, talk with your Ariba adviser at 1-800-808-7488.

Looking to Diversify? Mix Growth and Value

Posted by dfederman on Feb 13, 2012 in Investor Education | 0 comments

Description

This article illustrates how diversifying with growth and value funds can be an effective way to balance risk and return within your stock portfolio.

If you’re unsure about the best way to balance risk and return within your stock portfolio, you may want to consider the strategy of combining growth and value funds. Because these funds often do not move in tandem in response to market or economic conditions, you may minimize risk without sacrificing return by owning some of each.

Growth and Value Defined

Growth stocks represent companies that have demonstrated better-than-average gains in earnings and are expected to continue delivering high levels of profitability. While earnings of some companies may be depressed during an economic slowdown, growth companies generally continue to expand their earnings. The primary risk associated with a growth stock is the potential for its price to decline sharply if the company releases negative news that disappoints investors.

Value stocks, in contrast, generally have fallen out of favor in the marketplace and are priced much lower than stocks of similar companies. The lower price may reflect investor reaction to recent company problems, such as disappointing earnings or a lawsuit, which may raise doubts about a company’s long-term prospects. The value group may also include stocks of new companies that have yet to achieve recognition. Value stocks also pose a potential risk — the stock price may not rebound, leaving an investor with limited upside.

An All-Season Portfolio

Mixing growth and value funds within your portfolio allows you to potentially gain as the market moves through different cycles. Although past performance cannot guarantee future results, value stocks, often those of cyclical industries, tend to do well early in an economic recovery; growth stocks, on the other hand, tend to outperform during bull markets, which are normally fueled by falling interest rates and rising company earnings. But the good news is you don’t have to choose — combining growth and value funds may present a prudent strategy for balancing risk and return over the long term.

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January 2012 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by Dan Federman, CFP^®, a local member of FPA.

Required Attribution

Because of the possibility of human or mechanical error by McGraw-Hill Financial Communications or its sources, neither McGraw-Hill Financial Communications nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall McGraw-Hill Financial Communications be liable for any indirect, special or consequential damages in connection with subscriber’s or others’ use of the content.
© 2012 McGraw-Hill Financial Communications. All rights reserved.

CMS Provides First Guidance for Liability Medicare Set-Asides

Posted by dfederman on Feb 10, 2012 in Investor Education | 0 comments

The Centers for Medicare and Medicaid Services (CMS) recently issued its first memorandum directly addressing the use of a Medicare Set Aside (“MSA”) in third-party liability cases.

Previously, the only guidance available to attorneys was that CMS’s interests must be taken into account when settling third-party liability cases. This memorandum provides the first information about how CMS’s interests must be considered.

Under the Medicare Secondary Payer Act, Medicare makes conditional payment for medical expenses for beneficiaries, with the understanding that Medicare will be paid when the beneficiary receives payment from a third-party. Medicare is opposed to any settlement that results in a contrived shift to Medicare of the responsibilities for a claimant’s future medical care. In settling claims, the only guidance that CMS has published to date is that Medicare’s interest must be considered. One solution to the problem of burden shifting and properly considering CMS’s interests is to establish an MSA.

The September 29, 2011, memorandum makes it clear that when a Medicare beneficiary’s treating physician certifies in writing that treatment for the injury related to the personal injury settlement has been completed as of the date of the settlement, and that future medical treatment or services will not be required, then Medicare considers its interests satisfied. Personal injury settlements are defined as liability insurance settlements, judgments, awards, or other payments. The memorandum also makes clear that when such certification occurs, there is no need for the certification or a proposed MSA to be submitted to CMS for its review. CMS also indicates that it will not provide the settling parties with confirmation that Medicare’s interests have been considered.

This CMS memorandum is important and extremely useful not just because of its content, but also because it is an indication that CMS is beginning the process of addressing some of the many questions that exist for parties settling third-party liability cases. We will keep our news readers informed on any additional guidance from CMS in this developing area. The CMS alert can be found at: http://www.cms.gov/COBGeneralInformation/Downloads/FutureMedicals.pdf

There are many considerations that need to be addressed prior to or at the time of a personal injury settlement or judgment. These may include medical insurance, eligibility for medical and non-medical public benefits, income and estate taxes, estate planning, guardianship, conservatorship, structured settlement advice, investment advice, special needs trusts, support or settlement preservation trusts, Medicare set-aside arrangements, and qualified settlement funds.

The Estate Planning & Elder Law Firm can assist clients with their estate, financial, insurance, long-term care, veterans’ benefits, and special needs planning issues.

For a review of your financial plan and investments call Ariba Asset Management at 1-800-808-7488.