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Demystifying Life Insurance

Life Insurance is not as mystical as it may seem. When you strip away all of the riders you are left with one of four types of policies. These policies are annual renewable term, whole life, universal, and variable universal. These differ in cost and risk and it is important to know what you are looking for.

 

Annual Renewable Term Insurance is pure insurance. It is a pay as you go type of policy with costs increasing every year. This type of policy is good for a young family, because it allows one to buy a larger policy than a whole life when you have a greater need for coverage and you are still healthy. This would cover such things as your mortgage and children’s education in years where sufficient income is not available to pay for a whole life policy.

 

Whole Life Insurance is permanent insurance. In other words if you pay your premium you will always have coverage. This type of policy is good for middle aged individuals who have a health issue or want to have burial costs covered. Partners in business can buy whole life policies on each other. After the death of one of the partners, the remaining partner would be able to use this insurance to buy the remainder of the company from the deceased’s estate. The premium on this type of insurance remains the same. A percentage of this premium is put towards its cash value and the rest is put towards the insurance itself. Over time the amount towards its cash value declines and the cost for insurance increased. This is due to the well known fact that getting older puts you at greater risk to shuffle off this mortal coil, kick the bucket, or join the choir invisible. But even as you age the premium doesn’t change.

 

Universal Life Insurance is a combination of cash value and term insurance. This allows you to contribute at a minimum the cost of insurance and additionally as much cash value as you want to with some coverage limits. You can’t contribute more than a certain percentage of the policies worth in cash value. This allows you to have a greater amount of term, and later in life contribute to cash value as you are able to. Unlike a Whole Life policy the premium is not guaranteed to stay the same. Just as with a Term policy you are subject to any price hikes the 

insurance company puts in place. This would be a great policy for those who want to hedge their bet, get an affordable insurance premium, and still be able to build cash value as their income increases.

 

Variable Universal Life Insurance is similar Universal except that you are responsible for the investment of your cash value. You are given a selection of pseudo mutual funds to invest in. These funds may be stock, bond, or international funds allowing your cash value to participate in the returns or losses of their respective markets. If you or your financial planner (for example Charles T. Shearman CFP of Prospero Financial) is market savvy, this may be the appropriate insurance policy for you.

 

These are the basis for all life insurance policies. Make sure to carefully examine any policy you are thinking about purchasing. Riders can substantially modify the look of the policy, but the underlying policy is one of these four. Understanding what your policy can do for you or your estate is very important, both when choosing, and when cashing it in.

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Different Types of Trusts

Different Types of Trusts

When establishing your estate plan, trusts can serve as a way to put your intent into the estate plan even after your death. The trust is funded from the estate. In an estate, property passes by ownership first where jointly owned assets are passed to the joint owner, contracts with a named beneficiary are second (i.e. IRAs, Insurance Policies), and lastly only what is left over flows through your will. Many people establish elaborate trusts only to have them unfunded at their death because they have everything titled jointly with their spouse.

Testamentary Trusts 

The most common trust is a Testamentary Trust. This trust is drafted as a part of your will and is funded at the time of your death. This is the next step up from having only a simple will. While this is a perfectly acceptable form of trust, this lacks several of the advantages which Living Trusts provide.

 Living Trusts or Inter-Vivos Trusts

These are the next step in the sophistication of your estate plan. This form of trust can be funded during your lifetime or upon your death. A living trust can be the beneficiary to contractual assets. In addition, the will would divide your assets into two baskets; personal property and invest property.  This means that all of the personal property are disposed of through the will and the remainder are investment assets which are transferred into the trust.

 Irrevocable Insurance Trusts

These are drafted in addition to or in place of the two other trusts. This trust is named the owner and beneficiary of your insurance policies. Since they are irrevocable they are not included in your estate at your death.  A neat trick is to make it the owner of a term policy. That way if you later decide that you don’t want the trust, if you are insurable, then you simply don’t fund the policy and it defaults thus rendering your trust irrelevant.

 Items of Note

With any of these trusts the terms are open to your intent. Regarding distribution, you can distribute income and principle as you see fit.  You will probably want to make the terms of all your trusts similar if not identical. Children with special needs require specific care to be drafted within the trust so as not to disrupt their disability services.

 

This is an oversimplification of the trust law and you should consult your attorney before establishing your estate plan.

Buy Smart

    I have always had medical professionals as clients. One thing this has taught me is that being smart enough to pass med school doesn’t necessarily translate into financial intelligence. Doctors, as well as any professionals who have a steadily increasing salary at the start of their careers, can often make purchases that hurt their cash flow down the road once their income plateaus. This makes it all the more important to develop an emergency or “slush” fund early in your career no matter what your occupation. Then later in life, once your rainy day money has grown, the finer things are less of a strain on your bank account. The two main purchases that can set an individual up for financial distress are expensive cars and big houses. Making the right buys can lead to a life of comfort, if done correctly.

 

Fancy Cars 

 

When individuals jump up into the six figure income bracket one of the first things they want to do is buy an expensive new car. What they fail to realize is that when they drive their so called “investment” off the lot, it loses thousands in value immediately. Their new car will then continue to lose value until the wheels fall off. But Chuck, “How am I supposed to show off my financial superiority while I’m on the go?” It’s  simple. Buy used. Say you think you would look nice in a Mercedes-Benz SLK350. You’ve worked hard to bring in the money and its time to reward yourself. A new SLK350 costs over $55,000. A used last year model costs $36,000. Paying an extra nineteen grand for that “new car” smell seems quite ridiculous. Any other investment that declined in value by 35% its first year would make you furious. Even for individuals with more modest tastes, a Honda Civic loses four thousand in its first year off the lot which is still a 20% decrease. Do yourself a favor and let someone else be the sucker who has to unload their bad investment in a year’s time.

 

Living Large 

 

The other mistake many make is purchasing a house that is too big early in their careers. If your job is putting fat stacks in your slacks the worst thing you can do is tie yourself down to a house that will pull cash out of your pocket for the next fifteen to thirty years. We at Prospero Financial always push to develop a solid emergency account before purchasing an expensive home. Buying a less expensive home allows you to build that emergency fund faster.  You will then be able to make a larger down payment on your next home. This will give you more equity to build on. You will need 20% equity in the property in order to avoid private mortgage insurance and decrease your mortgage payment.

 As unpredictable as the housing market is, you want to make sure that your house and property are sellable when the time comes. Choosing your neighborhood wisely can make a huge difference in the future. Picking the right house in that neighborhood can be just as important. The most expensive house in a neighborhood will be the hardest to sell. When prices in housing go up your palace might increase in value, but a home is worth nothing if there’s no one to buy it. The cheapest house in the neighborhood can be just as tough. Look for a home that is in the upper middle price range for the neighborhood you are moving into and you will have made a safe choice if you ever need to liquidate the property. Lastly, when  it comes time to sell a house, you need to leave yourself at least six months time to keep from leaving money on the table. Selling a home can be profitable, as long as you make smart decisions along the way.

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