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IRA Estate Planning Strategies In Light of the SECURE Act

On December 20, 2019, the Setting Every Community Up for Retirement Enhancement Act of 2019 (the “SECURE Act”) was signed into law as part of the government’s Further Consolidated Appropriations Act of 2020. As the law’s name implies, the SECURE Act sets forth reforms to existing rules that impact retirement plans. In a partial summary, the SECURE Act promulgates the following changes to retirement plans (particularly IRAs) as follows:

– RMDs start age increased to 72 – The age at which required minimum distributions (“RMDs”) begin changed from 70½ to 72;

– No Age Limit on IRA Contributions – Contributions to traditional IRAs can now occur after the age of 70½ to match the unlimited age limit on ROTH contributions;

– Qualified Charitable Contributions (“QCD”) are offset by post-70½ Tax-Deductible IRA contributions – Without getting into the minutiae of calculations, QCDs are allowed to be made at 70 ½ instead of 72 with one caveat – the contributions no longer avoid tax recognition to the extent of cumulative post-70½ made by the taxpayer; and

– Death of the “Stretch IRA” – Prior to the SECURE Act, IRA beneficiaries were allowed, if they chose, to “stretch” RMDs from inherited IRAs over their respective lifetimes. Under the new rules per the SECURE Act, with certain exceptions, the stretch provision is now replaced with a 10-year window for completely distributing the contents of the account.

(Note: There are many more provisions of the SECURE Act that reform retirement plans and the way that they are governed and operated. For the purposes of this article, we are focusing on the provisions of the law that have significant estate planning implications. Please consult the law at https://www.congress.gov/bill/116th-congress/house-bill/1994 for more information.)

With the changes to the stretch provisions for traditional IRAs, a valued strategy that many families relied upon as part of their estate plans was essentially erased with the stroke of President Trump’s pen. Having the rug pulled out from under them seems to be apropo in this instance.

In light of the law change, many clients are now wondering what actions should be taken to ensure that the estate plans that they developed prior to the SECURE Act, are still effective. With a focus on Inherited IRAs and the dissolution of the stretch provision, we focus on the following strategies as potential estate planning strategies for revising their estate plans in the wake of the SECURE Act:

  1. Accelerating ROTH conversions and utilizing a testamentary trust to create your own inherited “stretch” IRA;
  2. Make testamentary transfers to a charitable remainder trust (“CRT”);
  3. Utilize Multi-beneficiary Trusts;
  4. Utilizing Life Insurance as an alternative to planning for passing down an IRA; and
  5. Do nothing and revise your estate plan within the framework of the new IRA rules.

The “Death of the Stretch” – A Brief Summary

Pre-SECURE Act

IRA owners are allowed to name beneficiaries for their accounts. This can be anyone – a spouse (or ex-spouse), children, parents, siblings, grandparents, friends, etc. IRA owners can also name entities as beneficiaries to their accounts too, such as charitable organizations, alma maters, houses of worship, etc. Lastly, IRA owners can name entities they create, such as a trust for the benefit of a loved one, like children or siblings. Upon death, the beneficiary has the following options available when deciding what to do with the inheritance:

– Rename the IRA as their own (this option is only available to spouses)

– Take a lump-sum distribution

– Empty the account contents within 5 yrs of the year of death

– Open a new IRA account titled in both the name of the deceased IRA owner and the beneficiary (an “Inherited IRA”) and defer taking distributions by only taking RMDs based on the life expectancy of the aforementioned beneficiary (assuming that the beneficiary is younger than the deceased IRA owner, otherwise the RMDs would be based on the deceased IRA owner). This is referred to as “stretching the IRA”.

Effects of the SECURE Act

The SECURE act changed the IRA rules by allowing the same options for taking ownership of an Inherited IRA, with the exception that:

– The timeline for emptying accounts is now 10 years instead of 5 (the “10-year rule”); and

– With respect to stretching the IRA, only certain “eligible designated beneficiaries” are allowed to stretch payments over their respective lives, which include:

Spouses

Minor Children (only until such minor reaches the age of majority, after which such minor children become “Designated Beneficiaries”, as defined below)

Beneficiaries that are not more than 10 years younger than the deceased

Disabled Persons (per Code Section 72(m)(7) 

Chronically Ill Persons (per Code Section 7702B(c)(2)

Certain Trusts  for the benefit of Eligible Designated Beneficiaries

– “Designated Beneficiaries” cannot stretch the IRA and must adhere to the 10-year rule:

Non-Spouse Beneficiaries

Certain Trusts established for the benefit of Designated Beneficiaries

Prior to the SECURE Act, many estate plans could simply rely on the IRA stretch provision as a means to allow such assets to grow while minimizing the tax impacts of the inheritance. In addition, certain vehicles such as conduit trusts were instrumental in bequeathing assets while establishing a spendthrift to help protect beneficiaries preserve the windfalls that they inherited.

With the rule changes, primarily with the modification of IRA stretch rules, clients are now concerned about the efficacy of their previously established plans, and need education, guidance, and assistance in making sure their plans are adjusted accordingly. In addition, with a strong government mandate to raise income with a view towards taxing the projected massive transfer of wealth  (estimated at $68 trillion over the next 25-30 years), smart estate planning will be key to ensure that future generations don’t lose significant wealth to potential higher tax bills.

Estate Planning Strategies

Accelerating ROTH conversions

One strategy that can be utilized that can be utilized to mitigate the adverse effects of SECURE Act Inherited IRA changes is to begin converting such traditional IRA holdings into a ROTH IRA and bequeath it outright, or name an accumulation testamentary trust as the beneficiary of the ROTH (for the benefit of the Designated Beneficiary), and through such trust, dictate tax-free distributions per the deceased owner’s wishes. The IRA owner can use the IRS life expectancy tables to create their own stretch IRA for the trust beneficiary (or beneficiaries, if applicable).

Charitable Remainder Trusts (CRT)

Another strategy for consideration involves the tax free, lump-sum distribution of Inherited IRA into an irrevocable CRT that names Designated Beneficiaries as income beneficiaries and a charitable organization as the remainder beneficiary. Conceptually, the CRT will make distributions to the beneficiaries of an IRA for up to 20 years (or the life of the beneficiary, whichever is shorter) with the remainder going to the charity named as the remainderman. There are complexities in structuring the CRT and maintaining its IRS compliance (i.e., the 10% remainder test) as well as potential drawbacks  such as (1) distributions being limited to income (principal distributions not permitted) and (2) the disinheritance of successor beneficiaries due to the mandatory payment of the trust assets to the charity upon the death of the beneficiary.

Mutli-beneficiary Trusts

Multi-beneficiary trusts can be utilized to allow Designated Beneficiaries potentially benefit from Inherited IRAs bequeathed to both them and am Eligible Designated Beneficiary, such as a Disabled or Chronically Ill Person. The structures could be in the form of (a) a bifurcated trust, where the conduit trust (and stretch portion) pays out to the Eligible Designated Beneficiary, and the accumulation trust pays out to the Designated Beneficiary under the 10-yr rule, or (b) a sequential trust, where payments are made first to the Eligible Designated Beneficiary under the stretch provisions, and then to the Designated Beneficiary under the 10-yr rule upon the death of the first beneficiary.  For example, let’s say Michael is a Chronically Ill 50 year old with a life expectancy of 15 years. His sister, Janet is 45 and is in good health. Both Michael and Janet inherit their father’s IRA of $1 million. As Michael meets the definition of an Eligible Designated Beneficiary, the IRA can name the multi-beneficiary trust for the benefit of Michael as the beneficiary and pay funds out under the stretch provision. Janet, the Designated Beneficiary can be named as a successor beneficiary to the trust, and upon Michael’s death receive payments under the 10-yr rule.

Life Insurance

Generally, life insurance can be used to act as an hedge against the adverse effects of the SECURE Act. By taking distributions and using part of those proceeds to pay life insurance premiums on permanent life insurance (which can be housed in an irrevocable life insurance trust, or “ILIT”) with a face amount that covers at a minimum the account size set aside for bequeathment, the IRA owner can not only gain peace of mind with the fact that the asset won’t fluctuate in value, he or she will also be pleased that such an asset is being passed on to heirs without the burden of taxes.

Keeping the Status Quo

In some situations, things might be just fine with the new rules in place. The 10 yr rule might work as an alternative to the stretch provision of the IRA, and certain alternative planning may work for clients. This due to the fact that (a) many IRA beneficiaries do not stretch their inherited funds, (b) for those that do stretch their IRAs, many exhaust their accounts within 10 years anyway, and (c) given, the size of the account, taxes, and expenses of certain strategies, the status quo is considered to be the path of least resistance.

Regardless of the strategy chosen, it makes sense to sit down with competent, licensed, and credentialed professionals to ensure that your plan contemplates all relevant variables to ensure that the strategy makes sense in light of the client’s financial goals, wishes, and financial situation.

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Want to Succeed in College? Follow these rules.

Hi there. Thanks so much for visiting my blog and Welcome if this is your first visit. I have been busy writing articles and working on deliverables. As we are in the midst of high school students graduating from school and matriculating to college, here were some thoughts on how to survive college for new and returning students.

– School is Work: Treat it with the seriousness and respect it deserves. Be on time. Be prepared. Do your readings and homework BEFORE class. Prepare questions and discussion topics either for the class or for office hours with the professor.

– Schedule your time: Develop a schedule for everything – class time, studying/study groups/projects, work/internships, eating, working out/sports, socializing, trips, time with significant other/family/friends/etc. Understand that the schedule will need to be adjusted constantly, but the important goal is to STAY IN CONTROL and KEEP TRACK OF YOUR TIME.

– The less free time you have, the better. Get a job or internship, volunteer, get involved in clubs at school, take up intramural sports, whatever. Fill your time up with productive and beneficial activities that will help you stay focused.

– If you control your schedule, try to take the harder courses in the Fall semester. It’s a shorter semester, you’re fresher and focused heading into the fall and you can move easier courses to the Spring (which is longer, and rife with distraction once the beautiful spring weather hits late in the semester).

– ALWAYS REQUEST A SAMPLE SYLLABUS FROM YOUR PROFESSORS AT THE BEGINNING OF THE SEMESTER. Be real with yourself… Can you read 100-200 pages a week, write 2-3 5-page papers, do 3 problem sets, and attend a lab a week over 14 weeks (Fall semester) and expect to get good grades? If not, you need to be real, drop a class, and get something that you can handle. I am not suggesting that you take cake classes. I am merely suggesting that you design your course load in a way that gives you a decent chance of doing well.

– Required Resources: Get very acquainted with your libraries and make sure that you have (1) Elements of Style by E.B.White and William Strunk, Jr. and (2) The Bedford Guide for College Writers. You will have to write a lot of papers during your years in college. You better learn how to properly write papers, cite sources, and conduct research. And no, I don’t mean using GOOGLE…

– Plan your partying accordingly. I was never a big Thursday night party person, but I used to hit the Sound Factory Bar in NYC on Wednesday nights. Therefore, I made sure that I had no classes on Thursday morning. I’m just saying, partying and having fun is a good way to maintain balance during a hectic semester, but you need to keep your eyes on the prize. I had a “pay to play” policy where I would allow myself out to have fun only if I did a certain level of work. If I didn’t, it was “Sorry, Charlie”. That discipline helped me tremendously through college.

– Manage Your friends: I let many of my friends that did not go to college know that I had to hang out with them after the semester was over. It wasn’t their fault, but they were distractions and they could not understand what it is that I was going through, so I had to keep them at a distance. Real friends understood and were supportive; fake ones revealed their true selves as haters and it was a great lesson learned on my journey.

– Less is more: Studies say that the human brain can only obtain, process, and retain information effectively in 15-minute increments. Therefore, there are doubts regarding the effectiveness of all-day study sessions, etc. I believe that it is better to study for 1 hour a day over 5 days than to try to study for five hours one day. Also, it is better to switch topics as you study to keep your mind fresh and effective. And relax on the caffeine. Exercise awakens the brain more effectively than coffee or some energy drink.

– Consistency is key: Like a wellness/fitness program, the effectiveness of your studying can be greatly enhanced by being consistent with respect to the time, place and people that you study with. Also, be careful with study groups. They should be small, and comprise only of individuals serious about doing well in your courses. Participate in such groups if and only if they are beneficial to you.

– Focus on Liberal Arts: So many young adults nowadays can’t write, have suspect math and logic skills, don’t understand politics, economics, statistics, and science, and are not familiar with classic art, music, and literary treasures. Specialization in education is essentially developing adults who cannot function as dynamic, multi-faceted members of society. I would encourage young minds to embrace the liberal arts and strive to have a strong foundation to build upon.

– Not sure what it is that you want to do? Consider Community College. Seriously, these schools are too expensive to be walking around without a clue of what you would like to do. If you’re unsure, defer admission to a school, get a job, register for a few community college classes, and take your time figuring it out.

Best of Luck! Stay safe and stay focused. See you next time.

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Building Wealth on a “Foundation of Protection”

Do you have a solid foundation upon which you can build wealth?

The other day, I received a call from a young 40-something client about retirement planning. “I have two little ones and my wife and I want to make sure that we are doing what we’re supposed to do in getting ready for retirement.” The client also expressed a desire to invest ~$6,000/yr towards college savings via 529 accounts ($250 per month, per child).

While this all sounded respectable and fair, I stopped him in his tracks and said “(Client), I am so happy that you’re being proactive in reaching out to me to discuss and address these issues, but I think we need to step back for a second. We need to look at the foundation upon which you’re looking to build.”

I could tell that my client was puzzled. He proceeded to ask me what I meant. I explained that as an advisor, I strive to develop plans with the strongest chance of succeeding. I am not interested in laying out colorful pages full of rosy assumptions, pretty graphs and a product push on the back-end. I am a professional that breaks down your goal as you communicated it to me, designs a plan to achieve that goal, identifies the risks that can throw a monkey-wrench in that plan, and finally presents solutions that eliminate or mitigate those aforementioned risks. “If we have a plan that ignores risk, we don’t have a plan. We have a pretty looking wish list.”

To develop this foundation of protection, I proceeded to describe to the client a foundation on a home. It has a simple, Pyramid-like shape with protection at the base. These are the four areas of your life that need protection – (1) health, (2) financial, (3) personal property and (4) wealth.

Health – To protect your health, you need health insurance and adequate reserves to handle extreme medical emergencies such as max out-of pocket deductibles and co-insurance. Having those funds in liquid cash, in a Health Savings Account are ways to manage this risk. Insurers like AFLAC also have special products to mitigate this risk for middle to low income earners that find it challenging to accumulate such funds.

Financial – Protecting your financial situation is a multi-faceted strategy. At the base of the plan, one should secure adequate Disability insurance. This coverage “protects the paycheck” and insures that you have the funds needed to meet financial obligations in the event that you can’t earn an income due to accident, illness or affliction. Next, would be adequate life insurance. Having a plan for your family is useless if you die and the resources needed to support surviving family is not there. Insurance is the best way to leverage relative lower dollars to generate a legacy for years to come. Building up an emergency fund and paring down debt are also methods of insuring that a savings/investment plan has a maximum chance of success.

Personal Property – Most of these items are required to be protected – auto insurance, homeowners’ insurance, apartment insurance, umbrella coverage, etc. it’s funny how the powers that be (banks, landlords, auto finance companies) make it required for you to protect their things, but we fail to require ourselves to protect our own valued assets.

Wealth – Strategies like proper asset allocations, utilization of protection-focused instruments like annuities and structured products are all ways to help minimize risks to retirement portfolios. In addition, forward-looking asset protecting vehicles like Long-Term Care help retires keep their assets from being decimated by custodial needs that may arise later in life.

While all of these issues may not be applicable to my client in the present sense, discussing these issues help clients see the big picture and plan accordingly. We identified (1) that his emergency fund only covered two months of expenses, (2) there were shortfalls in his life insurance and (3) that his long-term disability coverage didn’t cover his annual bonus (which made up nearly 40% of his annual compensation). So the plan right now was to secure the needed supplemental disability and life insurance immediately, cut back spending and build his emergency fund up to be a MINIMUM of three-month’s expenses (the 18-month goal is to build this up to 6 months of income), continue to responsibly manage debt, open two 529 with lower contributions (but reaching out to family and friends to contribute to help build up the account), and finally develop a risk- and time horizon-adjusted asset allocation analysis for the retirement portfolio. By engaging in actions to fortify his financial foundation, we are now both in a better position to work together to build wealth.

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Life Insurance – An Honest & Down-To-Earth Q&A Session – Pt. 2

Now, Where Were We?

Hello there. Thanks so much for reading my blog. As this post is a continuation from last week’s post, if you haven’t had a chance to read it, please take a look at it here. I will now continue my “self-interview” on all things involving life insurance.

We get it. You are a big proponent of having insurance – either in the form of term and/or permanent coverage.  But how much is enough?  How does one determine how much insurance he/she needs?  How much should be in term?  How much should be permanent?

Answering such a question is highly subjective.  I mean, life insurance is such a personal purchase, and it is the most unselfish thing that you can buy for the people you love, that I often struggle with the question regarding “how much is enough” or “how much should I buy”.  That is exactly why I engage clients in planning – so I can listen to them, understand their goals, get a sense of their value system, and try to serve as a guide and resource in helping them find the right balance of protection to meet their needs.  Simply saying “7-10 times salary” doesn’t do the planning process any justice.

How much do you need?

So, in trying to answer this question I often do my best to ascertain answers to the following two financial questions: (1) how much is financially needed immediately upon your death and (2) for the foreseeable future, how much is financially needed to meet the shortfall in financial needs due to your death.  Then you add (1) and (2) together and subtract the sum of: (3) existing life insurance, (4) social security benefits (if any), and (5) any assets that you currently have in place to meet the needs of (1) and/or (2).

Immediate Needs are financial needs/wants that you want to take care of within 12 months of your death.  These items include (1) final burial costs, (2) medical bills, (3) satisfaction of joint debts, (4) fully funding of college fund for children, (5) fully funding of emergency fund for family (i.e., one year of after-tax earnings), (6) optional pay-off of major family debt like a mortgage/student loans of surviving spouse, etc., and (7) funding a “surviving spouse grief fund” (funds adequate to pay for the surviving spouse’s time off from work or change in work, as applicable).

Future needs are a little more complex and oftentimes requires a financial calculator of some sort, but I will try my best to be simple.  In looking at future needs, I take the lost financial resources (salary, retirement savings, asset accumulation, etc.) and compare that to the resources needed under the new plan (one where a financial provider is gone, but there remains to be needed for household maintenance, child care, college planning, retirement planning, etc.).  This often entails multi-stage analyses when dealing with young children (where Social Security can be contemplated), teens and college-age children, and the surviving spouse as a pre-retiree and retiree).  Those needs are then computed into an amount needed now to fund the shortfall, which is the Future Needs component of life insurance.

Next, you add the Immediate and Future Needs to arrive at the Tentative Need.  Finally, you subtract the combination of Social Security your surviving family is expected to receive, existing life insurance, and existing assets (in place for the purposes that the insurance is intended to be used for) from the Tentative Need to arrive at your Insurance Need.  This is not the easiest stuff to come up with.  Thank goodness that there are calculators on the web and trusted professionals out there that can assist you in the process.

In determining what amount should be term coverage vs. permanent coverage.  It’s highly subjective, but I generally recommend that families use the “temporary need for term, ongoing and changing need for permanent” approach.  For instance, let’s say that my total insurance need is $1.5 million, made up of an immediate need of $500,000 and a future need of $1 million.  However, when I drill down deeper into my future need amount, I see that $700,000 is needed to fund financial shortfalls needed only while my daughter is a child up to and through her graduation from college.  After college, there is no longer such a need.  Therefore, in this instance, structure my $1.5 million life need as $1.2 million in 15- or 20-year term, and $300,000 in permanent life coverage.  Also, as term has conversion features, I might buy $1.5 million in 20-yr term and at the end of my childcare need period, convert $300,000 of my aforementioned term insurance into permanent coverage and drop the $1.2 million term coverage.  The point is, that once the need is determined, there are many ways to go about securing it.  No one way works best for everyone.

Lastly, this analysis is representative of how I derive insurance needs with a majority of clients that I service.  It should be said and made clear that everyone’s situation is different.  With that said, it is not my aim to tell you that the approach that I described is the best way that works for you and your family.  There are many different situations – families with children who have disabilities/special needs, breadwinners with generous pensions, or a married couple with no children, but provide for parents/other loved ones, etc.  The list goes on and on, but the point to drive home is that different facts, circumstances, makeup of net worth and makeup of existing coverages impact the calculation and derivation of the amount of insurance needed (if any) as well as the structuring of such coverage (i.e., the term life vs. permanent life, or combination of the two).

Stay Tuned. There’s more to come.

Please come back next week for the final part of this discussion on Life Insurance. I hope that the information shared is helpful to you and those that you love. As always, feel free to contact me via Facebook or Twitter to ask questions or discuss the topic in more detail. Thanks!

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Life Insurance – An Honest & Down-To-Earth Q&A Session – Pt. 1

Happy New Year!

Hello everyone and Happy New Year!

Welcome back to my blog.  On the date of this post, I am dealing with the one-year anniversary of my father’s death (February 5th), mired with a myriad of emotions and nostalgia.  I had a complicated relationship with my father growing up, but as I became a father and have grown in that space, I have come to acknowledge and appreciate him more and more – even though he is no longer here. 

Without getting into too much detail, my father died unexpectedly (he was in relatively normal health for a 75-year-old) and caught my family off-guard.  Luckily, we were able to handle the financial impact and with only my mother and siblings as the surviving immediate family members, there was little to sort out by way of probate/estate.  Yes, we were lucky.

Life Insurance should be a no-brainer, right?

Yes, lucky indeed.  But what about families in different or more complex situations?  How would they deal with the sudden or unexpected death of a loved one who is a significant financial provider to the household?  The easy and almost textbook-like answer is “life insurance”.  It is general and widely accepted knowledge that many low- and middle-class families look to financial products like life insurance to help families “pick up the pieces” in the aftermath of the death (whether unexpected or not) of a loved one, especially one that served as a main income provider to the household.  However, such widely held knowledge and understanding does not translate into life insurance ownership. According to a 2017 Life Insurance Study conducted by LIMRA, the following statistics state the following – and it isn’t that positive.

The 2017 LIMRA Study (source: www.limra.com)

The Study (or other information from LIMRA) cites the following statistics:

  • 85% of families agree that they need life insurance, yet only 62% say that they actually have it.
  • 40% of households that have life insurance don’t believe that they have enough.
  • Although industry experts recommend that individuals have enough life insurance to replace 7-10 years of lost income, the average individual breadwinner, who has on average $168,000 in life insurance, falls well short of this recommended threshold with only enough life coverage to replace 3.4 to 3.5 years of lost income.
  • 34% own group life insurance vs. 32% that own private, individual life policies.
  • 71% of husbands own life insurance, while 63% of wives do.
  • 40% of Americans wish their spouse or partner had more life insurance coverage; 50% of married millenials wish that their spouse had more life insurance.

The Study also provides insight as to why current prospective consumers of life insurance currently do not own it:

  • 83% incorrectly think that the insurance in question in too expensive. For example, for a healthy 30-yr old, consumers estimated the cost of a $250,000 20-yr term policy to be $400/yr when in fact, such a policy only costs $150/yr.
  • This same cohort of consumers also feel that life insurance is not as important as (i.e, is subordinate to) other financial priorities, such as (a) building savings, (b) managing debt, and/or (c) saving for retirement.
  • 4 out of 10 consumers haven’t purchased life insurance not because they don’t want it, they simply don’t know how much they need and what type to buy.
  • 25% incorrectly believe that they do not qualify for life insurance at all (i.e., they believe that the underwriters would reject their case, or make the policy cost prohibitive based on a current or past health condition).
  • 50% of Millenials say that they haven’t purchased life insurance yet because – get this – they haven’t been approached by an agent to help them find the right coverage. (I have no words).

So what does this all mean? When it comes to life insurance,

  • We know that we need it, but fall short of committing resources to getting it (or getting enough of it);
  • We don’t value it properly (we don’t prioritize protecting our families as much as protecting our cars/homes);
  • It’s a lot cheaper than we think;
  • We’re shortchanging our families by having far less than the recommended amounts of coverage;
  • We wish that we owned more of it, or we wish our spouses/partners owned more of it;
  • With the advances of medicine and healthcare, it’s easier than ever to get coverage for current or past health conditions that once made it unattainable or financially out of reach; and
  • We need to deal with competent, professional, and trustworthy financial professionals to ensure that we are making informed decisions in selecting the optimal amount and type of coverage.

The “Real” Q&A on Life Insurance

Now that I have done a quick rundown on the status of life insurance in the typical American household budget, I thought I would change up my typical “chat-style” blog format and discuss life insurance in the form of an interview transcript. In addition, as the title of this entry says, I plan to provide “the real” response on these issues, and not provide “agent-speak” (the type of jargon that you would expect to hear from a life insurance sales agent – and this is not to imply that an agent would tell you something improper).

How important is life insurance to a family’s financial plan?

I firmly believe, that next to disability insurance, life insurance ranks as the #1 financial priority of a household, as no other product has the financial capability of completing  the financial plan (i.e., if you die, the death benefit is paid to fund college, retirement,  pay bills, fund emergency reserves, etc.) if you were to die.

OK.  We get that you’re passionate about life insurance.  Many working Americans already have access to coverage through the group policies that they have at work.  Isn’t that sufficient?

I’ll let you in on a dirty little industry secret – If you’re healthy, privately sourced term life insurance is CHEAPER than the group coverage that you pay for through the job! In order for group coverage to be affordable across the board, the healthy subsidize the unhealthy. Therefore, group coverage charges healthy insurance premium payers more than they otherwise would pay so that the unhealthy can obtain comparable coverage at an affordable rate. So, if you’re unhealthy or have a health condition that would be really expensive to cover, group coverage is a great deal for you. If you’re in reasonable health, you can get a private policy that beats that group coverage price over the life of the policy (group policies typically raise rates over 5-year increments).

As far as considering if group coverage is enough? I would say no simply because (a) there’s a question whether the coverage that you’re buying is portable, or that the coverage can be converted into privately-owned coverage if you leave your employer, and (b) many group plans do not allow employees to secure 7x salary (so the need isn’t being fully addressed by group coverage). Take whatever life coverage that the employer gives you for free (1-2x salary), but if you’re going to pay for any additional life insurance, price it out in the private market first.

What about Additional Death and Dismemberment Insurance (AD&D insurance)?  Do you recommend that consumers buy this coverage?

In a word, NO. Without getting into too much detail, AD&D insurance pays the insured if he/she dies or suffers a severe injury (i.e., loss of limb) as a result of an accident (not of their own doing). It costs a fraction of the cost of term coverage because you have to die or be severely injured by accident in order to be paid a benefit, which is an unlikely event. I don’t like managing risks (i.e., dying) with a product that only pays if you die under certain circumstances.

Let’s explore the Term Insurance vs. Permanent Insurance issue.  Many “financial experts say that you should “buy term and invest the difference”.  What are your  thoughts on the issue?

I have so many thoughts on this issue, but let’s start with the basics.

First of all, term life insurance is just that – life insurance that lasts for a certain “term” (i.e., annual renewable, 10-year, 15-year, 20-year, 25-year, 30-year). The insurance is designed to provide protection against “temporary financial risks”, such as covering a mortgage, funding college education needs for young children, replacing lost income in support of a household that have young children and any other financial risk that lasts for a limited period of time. As the coverage is finite, the cost of insurance is relatively low. Many term policies come are sold with “convertibility features”, which allow all or part of a term policy to be converted into a permanent policy at any time during the term period without the need for additional medical underwriting.

A permanent policy is life insurance that is conceptually permanent in nature (as long as the premiums have been paid). This is coverage that can conceptually last all of the insured’s life. This coverage is typically ideal for those who have a perpetual need for coverage, as there is a school of thought that believes that while needs for insurance change over time, they never really go away. A parent who gets life insurance for the benefit of his/her children may want to keep coverage in place to help provide for grandchildren or leave a bequest to a charitable cause. There are three general forms of permanent life insurance: (1) whole life, (2) universal life, and (3) variable universal life.

Permanent life insurance also has a “built-in savings component” that allows for the accumulation of cash value to grow within the policy. Depending on the type of permanent policy, the growth of the aforementioned cash value is attributed to guaranteed interest rates and possible mutual life dividends (whole life), general interest rates (universal life), and the performance of mutual fund sub-accounts (variable universal life). Due to the perpetual nature of the coverage and the cash value growth component, the cost of permanent insurance is significantly higher than comparable term insurance.

Some proponents are in favor of permanent coverage because they desire to have “something to show for their money” in the event that time comes to pass and the insured doesn’t die. One can access the cash value (potentially tax-free pursuant to Internal Revenue Code Section 7702) for a myriad of purposes, which we will discuss later. Term insurance, while cheaper, is sometimes viewed as a “zero-sum game”, where insurance company takes all of your premiums if you outlive the term of the policy.

Now getting to the “perm vs. term” debate. “Buy term and invest the difference” is, excuse my french, pure BS. Why? Because no one actually does it. I mean, it sounds good in theory and the numbers look nice on a spreadsheet, but it is simply not done in reality. So, where does that leave my thoughts on the issue? I believe that most clients will benefit from a combination of term and permanent life insurance – owning term life insurance to cover temporary life insurance needs (i.e., covering a mortgage, providing protection for young children, etc.) and have some permanent coverage for “ever-changing needs”, or for alternative strategies (which I will discuss in a future post).

To Be Continued

This will conclude Part 1 of our “Real” Life Insurance Discussion. Stay tuned for the discussion next week, where I will discuss the different ways life insurance can be used (and should not be used) as part of a comprehensive financial plan. Thanks again for bearing with me, and feel free to seek me out on Facebook or Twitter to provide comments or feedback. Thanks.

Disclaimer/Disclosure

As I am a licensed life, health, disability, and long-term care insurance agent, I want to once again reiterate that the views that I express are mine alone – not that of any firm that I am affiliated with. In addition, my commentary is for information-sharing purposes only, and should not be considered financial, tax or legal advice. As always, any financial decision should be made with adequate information and, if possible and desired, the assistance of a licensed, competent and professional advisor that is unbiased and holds your financial interests above his or her own.

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A Frank Discussion About College

Hi there everyone.

I have been going through changes.  Since my last post, I experienced the loss of my father, prayed as my mother dealt with a bout of pneumonia that would not go away, and finally, experienced the loss of a dear aunt who in all respects was the glue that kept my maternal family connected over the last 40+ years.  I have spent the time dealing with a roller coaster of emotions and, in full circle fashion, I find myself back here to get back into discussion mode.  I am very sorry about the hiatus and hope that we can pick up on things.  The experiences in question have given me many topics that I want to discuss in upcoming posts.

Now, let’s talk about today’s topic – College, the financial impacts of the decisions being made, and why we need to rethink the way we approach it.

College – A Voyage to Higher Learning or A Rite of Passage? 

As the end of the summer months are past us and the fall is underway, many families have completed an annual rite of passage otherwise known as college move-in.  It is a time of pride, satisfaction, appreciation, and anxiety for what lies ahead – college.   In 2017, 64.5% of US high school graduates matriculated to college, slightly lower from a high of 70.1% in 2009.    As the statistics suggest, college is now identified by many families as the main pathway to a professional career across the US labor market.  For many families, it is believed that in order to get a good paying job, you have to go to and graduate from college.

Being a college graduate myself, I totally agree with this sentiment.  However, time and my experience as a financial advisor has taught me many things about the journey into higher education – (1) it can be an expensive trip (college tuition and fees have increased by 63% between January 2006 and July 2016; college textbook prices increased by 88% and room and board expenses increased by 51%), (2) bad choices can have effects that will haunt you and your kids for years to come (imagine paying student loans for a class that you dropped 10 years ago), and the toughest pill to swallow, (3) college is not for everyone.

With that said, I feel that a post is warranted to have a frank discussion about higher education and the mindset parents need to have when it comes to making smart, educated choices concerning one of the largest investments of your (or your child’s/dependent’s) life.

Let Me Tell You a Story

To illustrate part of the issue, let me start off things with a story.  To protect privacy, I will not reveal the client’s name or sex, the client’s child’s name or sex, or the educational institutions involved. The only thing that I will reveal is that the schools in question are located in New Jersey.

In April of this year, while returning a tax return and records to a client, the client appeared distraught and withdrawn.

“What’s wrong?” I asked, sensing the client’s distress.

“[Child] didn’t get into [School A].”

“So sorry to hear.” was my reply, as I tried my best to be sympathetic.  “How did [child] fare with the other choices?”

“Well, [child] got into [College B], but [child] would have to do a summer program out of pocket just to be able to take regular college courses in the Fall.”

Note: College A is a public university with an estimated annual cost (in-state tuition with room and board) of $26,000.  College B is a private university with an estimated annual cost of $58,000.  Both colleges are lower tier nationally ranked (i.e., ranked 100+) and comparable in college rankings with no distinguishable difference in the quality of education.

As the client is a tax client and not a financial planning/investment advisory client, I could only do my best console the client with encouraging words like “Congrats on the acceptance.” and “I’m sure that once the acceptances come in, you guys will make the best decision.”  However, the advisor and financial counselor in me would have another conversation, and it would touch on the following topics:

A Different Take on Higher Education

In looking at the scenario I presented, along with other issues that I think are pertinent, here are the areas that I want parents and students alike to consider as they make decisions with respect to College:

Choosing a college based emotion is not a good idea – I see it too often.  Parents and their children making a choice in college based on pride – focusing more on the name, the perceived prestige of the school, and the “experience” that the young adult will have vs. the education that he or she will receive.  And colleges are in on the masquerade as well, by spending inordinate amounts of money on amenities rather than on strengthening curriculums with tenured professors, etc.  Remember that college is not “young adult sleepaway camp.”  It is the place that you are investing money to prepare your child for the professional lives that they will embark upon.  The key words are “investment” and “education” here.  While making friends and being in an environment where your child will feel comfortable and thrive are important, the ability to develop core 21st-century workplace skills like public speaking, collaboration, growth mindset, and teamwork is much more critical for long-term success post-college.  Keep your eye on the ball.

Be careful with name brands – Did your child get into Georgetown and MIT?  Which school would you choose?  All logic would point to MIT given its name and eminence.   What about getting into Georgetown and Brown?  Brown is an Ivy League school, so would you choose Brown, right?  Not necessarily.  Studies show that students that get accepted to top schools like Harvard and MIT, but for one reason or another don’t attend (i.e., go to Georgetown or Emory instead), have had similar career success/outcomes relative to those that did go.  So, rejoice that your child got into a top-tier school, but take a hard look at academics, costs, college quality of life, and career prospects when making your ultimate school choice.

There’s nothing wrong with Community College – In the past, I’ve heard jokes about community college.  Chris Rock’s joke that community college “was like a disco with books” come to mind (“Here’s ten dollars.  Let me get my learn on.”).  All jokes aside, with the mounting costs of college and with a cohort of graduating students unsure of what they want to do and whether they will succeed in college right out of high school, enrolling in community college is a relatively inexpensive and prudent way to stick your toe into the deep end of the college/university pool.

It’s not how you start, it’s how you finish –  To add to the value of community college, if a student does well and desires to continue on, most state colleges and universities guarantee acceptance of a quality student (GPA of 3.0 or better) and the credits they earned while in community college.  Imagine getting a Rutgers University degree for nearly half the cost by doing two years in community college, doing well and transferring over.  This is also an ideal approach for families who don’t have the funds for college and prefer to not take loans.  Students can work and take classes, earn credits on their schedule and as they progress, matriculate to a 4-year college and make it work financially.

All kids are not built for college, and that’s ok – In his controversial book, Real Education, Charles Murray has argued that 50% of the students currently in college don’t belong there.  His rationale is based on the historical population that colleges once housed – 20% of graduating seniors nationwide.  The other cohorts historically went to professional school, apprenticeships in certain vocations, factory jobs or marriage and homemaking for young, newly wedded women.  Obviously, those days are gone, and the US economy has moved from a manufacturing one to a service-based one.  However, as Murray argues, archaic school systems have been incomparable in educational development, leading the production of graduates that are not ready for the rigors of college ( see the attached article).  As there are no places for these graduates to go in this economy, colleges have stepped up to take them in.  By admitting students who require more remedial courses before even engaging in college-level courses (more than 50% nationwide), it is argued that these students water down the rigor of college curriculum for those that do belong there (the aforementioned original 20%), and the nation’s education system suffers for it.

What is also lost is that students that otherwise would make excellent mechanics, plumbers, electricians, and construction workers miss the opportunity to develop in this vocation, while current professionals age without competent successors.  In evaluating “no college required” vocations as an option after college, have a heart-to-heart conversation with your children.  See what their passions are.  Many careers can be realized without college (or very little of it).  Exploring such opportunities while taking a community college course or two can be one way to test the waters on such vocations.  The key is to not close your mind to the opportunity.

Important Financial Planning for Families with College-Age Children

Please make sure that you take note of the following financial planning tips when considering college with your young adult children:

  • Wrinkles in the new Tax Law – The Tax Cuts and Jobs Act of 2017 have temporarily changed tax deduction rules to limit home equity borrowing to (a) home acquisition and improvement purposes and (b) the difference between $750,000 and the 1st lien mortgage outstanding.  Therefore, it is important to know that you cannot take out a home equity loan for educational purposes and get a deduction on that interest.  Consult your tax professional on how to deal with grandfathered HELOCs that were taken out or established prior to 12/15/2017.
  • Avoid Private Loans – While many of the private loan companies have designed their products to match the look and feel of federal student loans, many of them lack key provisions that borrowers benefit from, such as deferments, forbearances, forgiveness provisions, and programs like the Public Service Forgiveness Program that only come from federal loans.  Private loans should be a funding source of last resort.
  • Protect yourself from Loan Liabilities – If you find yourself co-signing on a private student loan, consider securing term life insurance on your child to ensure that the insurance pays off the loan in the event that the child dies unexpectedly.  As a future post of mine will discuss, securing permanent coverage for a college student or a new graduate is a sound financial strategy to execute for your children’s benefit.
  • Critical Financial Planning Documents – All Parents that are providing financial assistance to students should ensure that the following financial documents are in place: (a) a Durable Power of Attorney on file both locally and in the state where your child attends school (if the child attends school out of state), and (b) a valid Health Care Proxy (aka power of attorney for health care).  Why?  When your child turns 18, your child is an adult (at least in the eyes of the law) and is afforded certain rights of privacy, namely their financial and healthcare affairs.  These documents allow you to assist your child in the event your child is unable to attend to these matters due to incapacitation.  The Durable Power of Attorney allows you as the financial supporting parent the ability to step in to deal with your child’s financial and school affairs on your child’s behalf.  The “durable” element to the power attorney specifies that this power remains in place in the event that your child is incapacitated (either due to a medical emergency, accident, or illness).  The Health Care Proxy allows the parents to receive your child’s information from health professionals and make medical decisions for your child.  The cost to draw up these agreements range from $300 – $600 and should be in place before your child steps foot on a college campus.

Well, that’s all I have to share for now.  Thank you so much for allowing me to share my post with you.  Please feel free to reach out with questions or suggestions for new topis that you would like more information on in the future.

SAM

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10 Financial Pointers for Young Professionals Coming out (or about to come out) of College

Cut It     

Happy New Year!  I know that I have been busy, but I do come bearing gifts (of wisdom).

Graduating from college is a big deal.  Not just for the education obtained, but for the commitment of focusing oneself for 4-5 years on a goal.   All of those years of taking courses, managing your time, balancing assignments of varying priority, dealing with emergencies, and making it to the finish line.  It’s definitely more than an academic endeavor.  College in many ways shows prospective employers that you are ready to take on the rigors and responsibility that come with real work in the real world.

In my contemplation of graduates, I thought that it would be cool to share a few financial words of wisdom as they prepare to venture out into the real world.  Here are my ten pointers for young professionals coming out of college:

1. Save 25-35% of your net pay. You never had the money before, so you will never miss it.  Start building your war chest of savings now, because it will come in handy later.

2. If you have student loans, use every disposable dime (after saving per #1) to pay it off.  I’m serious.  Get rid of those loans.

3. INVEST money in 1-2 custom-made suits, custom-made shirts, some high-quality shoes, and a nice coat. It will cost some serious money, but if you are on the lookout for deals (i.e., finding a quality tailor, looking out for yearly deals from stores like NORDSTROM, tagging along to a friends and family event at a luxury retailer, etc.), you will be amazed by the money that you can save. There will be times when you need to look like you have a million bucks. Be ready.

4. Start developing a Secondary source of income. Start off with a Stock Dividend Fund, a Municipal Bond or Treasuries. Then, consider investing in an investment or rental property. Invest in a business or restaurant. Whatever. The point is, you will do yourself a favor by growing a source of income that is NOT from your job. Don’t be a slave to a paycheck.

5. Sign Up for Match – As in your 401(k) Match.  Since your income is expected to be relatively low, here’s a retirement savings trick that I would recommend – Contribute to your 401(k)/Roth 401(k) just enough to secure the company’s match (which is free money), stop contributing after that and max out a ROTH IRA. Many employer Retirement Savings Plans have mediocre investment options at best and are full of hidden fees. Having a Roth IRA allows you to build assets that you can control with many cost-effective, high performing investment options.

6. CASH rules EVERYTHING around me (CREAM).  If you can’t pay for it with cash (and I’m not referring to your savings), don’t buy it. Credit is not an extension of your income. It is BORROWED MONEY.  Nothing is sadder than seeing a young adult paying on a credit card balance for clothes that he/she bought a year ago, or for a trip that you took two summers ago. Learn to live your life and pay your bills with cash. You will thank me for it later.

7. Be Pennywise… and I don’t mean that big-headed clown from It.  Live frugally. Notice that I did not say “cheap”. Being frugal is all about being an informed and vigilant consumer. You take the time to shop for the best deal possible, You take the time to research alternatives and options (rummage sales, goodwill stores, etc.). You make informed decisions. You set limits for how much you will spend and you try your best to stay within those limits. You budget and save for big purchases and you set aside funds for splurging. You understand who you are, what your attitude is about money and try to protect yourself from yourself. It takes practice, but you will be thankful that you did this now vs. later.

8. Understand that all things that glitter, isn’t gold. You will have friends that have a new car, bought those $100+ jeans, partied last weekend in VIP at ‘the club’. They’re living this fabulous lifestyle. However, they have no assets, bank account is just above the minimum (if not constantly incurring overdraft fees), and they’re barely making ends meet. This is not a judgement – just an observation. When you’re young, its natural to want to go out and have fun, but you have to be smart. If you need a car, buy a used one with cash (you will be amazed by what you can get for $5-10k). Budget for that fun and don’t get carried away. Leave charge cards at home and pay with cash. If you plan to do it up big, plan for it a month or two in advance and work it into your budget (Note: that you will have to cut back somewhere, so be prepared to paper bag your lunch for a few weeks). The point is, everything has a cost, so be considerate of what frivolous spending can have on your long-term goals.

9. Luxurious Living costs you big time. Thinking about moving to the “hot urban areas” with the brand new apartment complexes? With one bedrooms costing nearly $2,000/month ($24,000/year), you say “what the heck… you only live once, right?” That may be true, but if you were able to find a studio a few miles away at $1.250/mo ($15,000/year), you can save $9,000 year which could go towards, savings, investments or retirement. That same $9,000 saved in that one year could grow to $235,197 in 40 years towards your retirement (assumed the 30-yr return of the S&P 500 of 8.5%).

10. Speak to a professional. You may not necessarily be ready to work with a financial advisor year-round, but it doesn’t hurt to pay a few hundred dollars to meet with an accountant and a fee-only advisor to discuss tax, budgeting and investment strategies for the ensuing 6-12 months. Also, you can utilize tools like Mint.com , Betterment.com, Learnvest.com, if you feel comfortable and savvy enough to navigate through this with a little help.

Well, I hope that this information is useful to you.  Please provide me with feedback via twitter.  I would love to hear from you.  Thanks and watch those pennies!

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