Flight Plan for Retirement

Insurance is such a boring topic, don't you agree?  You rarely hear anyone talk passionately about insurance in the theoretical sense. Occasionally, if someone needs it and cannot get it, or if someone has been the recipient of an insurance settlement, they may speak of it with a bit of passion, but most people would really prefer another topic for polite discussion.  Of course the current discussion about health care has generated a bit of passion, and considering the difficulty that our elected reps are experiencing now in keeping the discussion about health insurance civil, I will confine my discussion to life insurance.  Insurance is really just a drain on one's finances; that is until one really needs it, and then it can be a wonderful, life-altering asset.  All types of insurance are basically arrangements where the buyer of the insurance transfers the risk that something bad may happen to the seller of the insurance.  The logical use of insurance is to insure that which we cannot afford to lose.  I can afford to lose my watch thus I do not have it insured (unless it falls under the protection of my home owner's policy; I'll have to check if I ever lose it.)  I can afford to lose my lawn mower to fire, but I cannot afford to lose my house, so I have my house insured.  When I was a young man, my wife and daughter could ill afford to lose me and my salary, so I had life insurance; that is the way we logically use life insurance.  But how much life insurance does one need?  The answer to that question depends on what one needs to insure.  I want to look at two ways young families typically use life insurance.

Many buyers of life insurance want to insure that their children have the opportunity to attend college if they are no longer around.  College costs continue to rise, and they do present a challenge to young families who may be struggling with other financial  issues.  Last year the average cost to attend a public university in the US was $6,585.  That was 6.4% higher than the prior year.  If we assume that college costs continue to rise at 5% per year, that number becomes $10,726 in ten years.  A college education at a private institution can cost much more, over $25,000 last year.  Thus a family has to plan on having nearly $50,000 on hand to fully finance a four year program at a public university ten years hence.  Of course this assumes that no scholarship or other financial aid monies will be available, and that is not likely to be the case.  Last year over $143 billion dollars of financial aid was available to college students.  Many young families, when assessing where to spend their insurance dollars, may decide that they cannot afford to fully insure college costs, and for many this may be logical.  A logical course may be to allot a portion of their insurance money to college costs and assume that their child will be responsible for a portion as well, especially in light of the amount of financial aid available.  Additionally, a disciplined college savings plan will erode the need for college insurance over time.  So buying life insurance to insure college costs may be a luxury that many cannot afford and may not be required to the degree that some insurance sellers would lead us to believe.

A more important use of life insurance may be to simply replace the income of the insured.  (Long term disability is more of a threat to young families, and disability insurance should also be on their agenda, but that is a discussion for later.)  But again we face the issue of determining just how much insurance will be required.  Many financial pundits use the rule of thumb that says that life insurance should be eight to ten times the amount of the annual salary of the life being insured.  This may be a good starting point, but a more detailed analysis should be pursued.  A number of questions need to be answered before arriving at a logical figure:  Does the surviving spouse have a career and will he/she continue to work?  Will there be child care expenses? How many children are dependent on that income?  Where does the family live and will they continue to live in the current home or apartment?  Are there extended family members available to help?   How many assets are currently available?  How long is the insurance money expected to last?  Can an inheritance be expected at some point in the future?  Etc., etc.  And finally, and most importantly, what will be the spending needs of the surviving family?  An honest, thorough discussion with a really dedicated life insurance agent, one dedicated to serving the needs of his clients, should lead to a logical answer; and that would be an answer that not only fits the needs of the family, but one they can afford.

Every good financial plan begins with a discussion about insurance.  Risks need to be assessed and adequately addressed before the discussion about investments even begins.  Additionally, life insurance should not be viewed as an investment.  Most, if not all, life insurance sold as an investment, makes a lousy investment.  Most young families have no need for whole, or universal life insurance.  Term life insurance has gotten progressivley cheaper over the past few years, and term life insurance provides the most coverage for the fewest dollars, and thus should be the vehicle of choice for most.  Remember, another wonderful characteristic of life insurance is that Uncle Sam does not tax it when the beneficary receives it.  It comes tax free!  Though it is never pleasant to consider one's demise, knowing that one has provided for those dependedent on him/her with sufficient life insurance takes a bit of the sting out of the process.

Fly/Drive Safely

15 September 2009

I remember when I was a child, during the "Golden Era" of television, there was a hit television program called "The Millionaire."  It began its weekly showing in 1955 and continued into 1960.  The premise of the program was that this very rich gentleman, John Beresford Tipton, would choose some deserving person or family and have his representative give them exactly one million dollars; he insisted on remaining anonymous.  This gift would of course change their lives in any number of ways, and that was what the balance of the program would be about.  Some of the recipients would be changed for the better; some for the worse.  In any case they were always changed by such a huge sum of money falling into their laps.  This was before the era of the various lotteries in the United States, so this very seldom happened to anyone.  It was a popular program because those watching the program could fantasize about what they would do if a million dollars suddenly appeared on their balance sheet.  And of course, this fantasy is really what fuels the popularity of all the lotteries today.

When this program began its run 1955, a million dollars represented much more spending power then than it does today.  Assuming an average 3.5% inflation, one would need nearly 7 million dollars today to have the purchasing power of that one million in 1955.  Of course a million dollars is still lot of money, but alas it is not what it used to be.  In fact, though not quite a dime a dozen, millionaires are everywhere in the United States today.  About 9% of all individuals in the US have a net worth of one million dollars.  That works out to be about 3 million individuals.  These are individuals whose assets, minus their primary dwelling and various liabilities, equal or exceed one million dollars.

In that long ago world of the 1960's, if an American couple could amass one million dollars for their retirement, they were set for a retirement on easy street.  They did not have to worry about Social Security, Medicare, property tax increases, or boarding fees for their pets as they traveled the world.  A million dollar nest egg put them firmly in the top one percentile of wealth for all retirees.  Not so today! 

A one million dollar nest egg is still a pretty good start to a satisfactory retirement.  According to numerous financial studies, retirees should be able to withdraw about 4% of their retirement savings per year, and increase that amount by about 3% each succeeding year (to allow their purchasing power to keep up with a 3% inflation rate) without too much worry that they will outlive their savings.  This assumes a 40 year retirement.  Of course no one can foresee the future, and market years like 2008 can reek havoc on retirement savings withdrawal plans.  But assuming that all of those financial studies that produced that 4% withdrawal figure were valid, that means that in year one of retirement, one million dollars would safely produce $40,000.  There are those who could live quite happily on that amount.  They would also live quite frugally in today's United States.  If that couple is lucky enough to also have a pension from an employer, they might be able to live a bit less frugally.  A company sponsored pension is, regrettably, becoming an endangered creature (unless you have one of those government jobs) and many will not be able to count on that.  But there is always Social Security, isn't there?  Yes, there will probably be some type of social security for the retired for the foreseeable future.  It will likely not be as generous as it has been for past retirees, but it is an extremely popular program, and I assume that eventually our elected representatives will "man up," and make the changes required to insure that it survives in some form.  So couple the social security payment with the 4% one withdraws from their million dollar nest egg, and the retirement years begin looking a bit rosier.  If a couple were to have a pension providing $2,000 per month as well as that social security payment kicking in an extra $2,000 along with their million dollar personal savings, retirement begins to look absolutely balmy!  (This is a depiction of the "three-legged stool" for retirement that we all have heard about for years: personal savings, pension, and social security; though a couple of the legs are getting increasingly wobbly.)  Of course the tax man is still going to come around and take his cut, so you really won't be keeping all of that  $88,000.  Nonetheless, that sum can work nicely for many.

The Millionaire has long since gone out of production; you won't even find it in syndication  (but you can find The Andy Griffin Show where Andy, Opie, Barney, and Aunt Bea can still teach you many worthwhile lessons.) It is unlikely that any of us will be the beneficiary of an anonymous rich man who is interested in seeing just what we will do with a million dollars.  It is even less likely that we will hit the Powerball Jackpot and sail off into the sunset.  But many have discovered that with commitment and enthusiasm, they have been able to save enough for a secure retirement.  Most did not reach the supposedly magical level of one million dollars in their retirement accounts, but they saved enough to meet their retirement needs.  Most who accomplished this worked diligently at it; and of course it was difficult at times.  They saved early and often over a lifetime.  They took advantage of the miracle of compound interest.  And the really nice aspect of this is that compound interest is available and works for anyone, given enough time.  They say that the first million is the hardest; I guess that means that it gets easier after that!

Fly/Drive Safely

18 August 2009