The “Safety Net” Principle
by Dan Federman, CFP(r)
If you think about it, financial planning comes down to having a safety net for just about anything you can think of. The purpose of the safety net is to catch you just in case you fall from the high wire on which you thought you could walk.
There are plenty of examples of safety nets in our daily lives:
- A nurse uses gloves when handling a patient to prevent spreading diseases.
- A pilot has an “eject” button (and parachute) if the plane goes down.
- If the electricity goes out, use a back-up generator to avoid interruptions.
- Cars have airbags and seatbelts in case of an accident.
- Hikers carry a first-aid kit, compass, water, snacks, and blankets in case they get lost or injured.
Another way to view the safety net principle is to have a “Plan B” if “Plan A” does not work out. In the world of financial planning, here are some common examples of safety nets:
Emergency cash reserves -If you lose your job and need to pay for basic expenses or unforeseen expenses such as a mechanical problem with your car, you may need to dip into your emergency fund. The importance of having access to cash during times of crisis cannot be overstated.
Retirement Plan - By building up retirement savings in a 401k or IRA, you will not need to depend (as much?) on assistance from the government or relatives when you reach retirement age.
Professional Liability Insurance - more commonly known as Errors and Omissions (“E and O”) insurance, used by lawyers, consultants, accountants, brokers, and other professionals. In the medical world, a doctor clearly would not want to operate without medical malpractice insurance.
Personal Liability Insurance - If something happens to another person on your home property (or as a result of an auto accident), they may pursue you as being liable for damages. A Personal Liability Umbrella policy can provide coverage above and beyond what your home or auto insurance coverage provides.
Life Insurance - is such a critical tool in financial planning (or “safety net” planning). When someone dies, whether he is a parent, spouse, or a business partner, if others depend on him for their livelihood, there needs to be an insurance policy on that breadwinner to replace his/her income in the unthinkable (but inevitable) event of their death.
Disability Insurance - Similar to life insurance, if a key breadwinner gets into an accident and is unable to go back to work, the “safety net principle” suggests that it would be a great idea to have a disability policy to replace a percentage of his or her income to help sustain the dependents’ lifestyles.
Short-term disability Insurance - In the case of short-term disability, it does not even need to be an “accident” as a qualifying event. It can be something as common as “Maternity leave.” Having a baby is considered a qualifying event to claim short-term disability payments.
Long-term care Insurance – If you need nursing home care, and have assets to protect, the “safety net principle” would suggest it is a good idea to have a long-term care policy in place to kick-in in the unthinkable event that you may need nursing home care, assisted living, or home healthcare if you are unable to handle 2 out of the 6 “activities of daily living.”
Spendthrift Trust - Let’s say you have amassed a nice fortune that you would love to pass on to your children. However, you are concerned about your child’s spending habits, in spite of your efforts to teach him or her how to save and build wealth. By meeting with an estate attorney and building a clause into the trust that limits the amount that can be withdrawn at a certain age, also known as a spendthrift clause, you can create a “safety net” to prevent your son or daughter from spending down their inheritance too fast.
Estate Taxes – This is becoming less relevant, but the law could change at any time. Under current law, people with a net worth greater than $10 million can plan their estates to minimize excessive estate taxes that will go to the government instead of their heirs or favorite charities.
Naming a Guardian for your children - If you do not name a guardian for your minor children in your will, the state will take on this responsibility. Also, you may need to name a “financial guardian” or trust if you leave an inheritance to minor children.
Financial Power of Attorney - In the event you are unable to sign your tax returns or other financial documents due to disability, you want to name a power of attorney BEFORE the disability occurs. This means if you don’t have one in place, get started on this today.
Medical Power of Attorney - If your health declines to the state that you can no longer communicate with others, the person named in your medical power of attorney will communicate for you. This communication can be to your doctors and other health care providers.
Investments - Since no one can predict the future, it makes sense to diversify your investments to spread the risk of something going wrong when one particular investment does not work out.
Mortgage - By locking in a 30-year mortgage, especially at today’s low interest rates, you can free up cash flow that can be used toward savings and investments, i.e. YOUR SAFETY NET.
This list is by no means comprehensive. Please feel free to comment on this article and add your own examples of safety nets. By thinking in terms of safety nets, you will be able to sleep better at night knowing that you have a Plan B in the event of a crisis.
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