Authored by Holly Kylén
The COVID pandemic has really brought so many financial issues to the surface. As a financial advisor we often play the “what-if’s” with our clients to see if they could make it through their toughest times. No one enjoys doing this exercise, but it is so important.
“Predicting the unknown before it happens is impossible but preparing for the unknown is a critical step in building a strong financial house.”
When we help our clients build a financial plan, the foundation of the plan is always protection. A strong plan that incorporates strategies to get you through the worst of times is a sign of a good plan. Once we establish the foundation of protection, we then move on to the other two key building blocks, which are accumulation and spending of wealth through our life cycles and the retirement years. Building the plan in this order is vital to the development of a strong, resilient plan..
Although every facet of a financial plan is important to the effectiveness of the plan as a whole, this blog will focus on the protection phase of the financial plan. It begins by understanding and addressing your solutions to these key questions.
Ask yourself how these 4 questions would affect your financial house.
1. What happens if I become disabled and cannot work?
2, What happens when I die or someone in my family dies?
3. What happens if I outlive my life expectancy, and will my money last?
4. How do I prepare for a worldwide pandemic?
These unknowns can cause you and your family’s financial house to crumble if not properly planned for. So, let’s look at each of these unknowns and learn how to evaluate your risk, prepare and insure them if appropriate.
Pro-Tip: If you are following this financial literacy series, let me emphasize again — it does help if your financial advisors include this education and analysis as part of your plan! Don’t be sold, be educated!
Question 1: What happens if I become disabled and cannot work?
According to statistics shared by the CDC (www.cdc.gov/disabilities), 61 million adults in the United States live with a disability. 26 percent of adults (1 in 4) in the United States have some type of disability.
Your work benefit package may offer a sick pay plan or a disability plan. If they do, bring the detail of your work plan to your advisor and have them evaluate it. A good financial advisor will ensure that their clients are educated on these key factors pertaining to your disability and sick pay plan:
When does it start?
How long does it pay?
How much does it pay?
What is the definition of Disability?
Is the benefit taxable or non-taxable?
Once these questions are answered, we can begin to figure out how a disability would impact you. You may need to create a better emergency savings plan to help fund a waiting period or purchase an individual disability insurance plan, often referred to as “paycheck insurance.”
According to the U.S. Bureau of Labor statistics, short-term disability insurance was available to 40 percent of civilian workers in March 2020, and long-term disability insurance was available to 35 percent. Access to these disability benefits varies by wage group. See more statistics at https://www.bls.gov/opub/ted/2020/short-term-and-long-term-disability-insurance-for-civilian-workers-in-2020.htm
Common Mistakes and Misconceptions Regarding Disability
Becoming Disabled: The most common mistake made in understanding the impact of a disability is that people often think of workers’ workers compensation when they think of disability. Remember, workman’s comp is about being hurt on the job. If you suffer an accident or illness outside of your work, then you need to evaluate your benefit package at your workplace and see if your employer offers any coverage outside of workman’s compensation.
Secondly, don’t assume you are covered by your employer! You also shouldn’t assume our government system SSDI will take care of you! Know what you have and how it works. If you find yourself saying “I think I have…”, that is a sign you need to do your homework. You must be able to say, “I know I have…, and this is how it works.”
Another common mistake is thinking, “I can always apply for Social Security Disability Insurance”. Yes, you can apply, but it is very hard to get approval. And when you read the definition of disability to qualify, you see why. In addition, even if you do qualify, it takes time to receive the benefits; you’ll want to have an emergency reserve ready to cover you until the benefit starts.
The basic definition of disability for Social Security Disability coverage is: A disability is the inability to do any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months.
Visit https://www.ssa.gov/disability/professionals/bluebook/general-info.htm for more information on the ins and outs of qualifying for this government program.
Long Term and Home Health Care
The other form of a “disability” is needing long term care or home health care aid for Activities of Daily Living assistance. These are called ADL’s, which are personal hygiene or grooming, dressing, toileting, transferring or ambulating, and eating. These basic care needs are not covered by medical insurance and require you to have enough savings to self- insure, or you will need to purchase a Long-Term Care Insurance Policy. There are 4 main ways to insure Long-term Care and Home Care Needs.
1. Self-Insure: Pay out of your pocket for care needed at home or in an institution.
2. Traditional Long-Term Insurance: Purchase a daily benefit amount for a number of years. You will choose a waiting period to start coverage. You must qualify medically and cognitively for this coverage, and ongoing lifetime premiums must be paid on time or coverage will lapse.
3. Life Insurance with a Long-Term Care Rider: These policies can offer a benefit for home health and/or Long-Term Care, pay a death benefit and usually offer a refund if canceled based on contract terms. The amount is dependent on your age at issue and amount of premium you want to commit to. The premium is a single payment or over a 5 to 10 year period. It usually takes $50,000 or $10,000 per year to purchase this type of coverage. It’s important to remember that, as with traditional coverage, you must qualify for these plans.
4. Fixed Annuity with a Long-Term Care Rider: These insurance products allow you to invest a sum of money, then plus that sum of money up for purposes of paying for long term care or home health care. The policy will pay a fixed rate of return on the investment, and all or part of that rate of return will be deducted to pay for the Long-Term Care Rider. You will answer a series of medical questions and may have a phone interview to determine your dollar availability for care. Here’s an example. You invest 50,000 and may qualify for two or three times that amount if care is needed over a select period of years. These policies are great for people with extra cash on the side not earmarked for retirement or other emergencies.
This is just a very brief definition of the types of Long-Term / Home Health Care coverage you will want to evaluate in addition to disability coverage. You may also want to ask your employer if a payroll deduction for a long-term care policy is available. Many larger employers are adding this benefit.
Question # 2: What happens when I die or someone in my family dies?
This is not a favorite conversation topic, and it’s often pushed to the side because it feels like you are “just being sold life insurance”. For you to not be “sold” on something that’s unnecessary or excessive, you need to understand how to analyze the need and decide if you can self-insure or if it would be better to cover the need through life insurance. And, yes, it is a choice.. Life insurance is not about protecting you, it’s about protecting those you love. You decide what level of coverage you want. The only mistake you can make here is not analyzing your needs; you should make this decision only after you examine the facts.
These questions form the foundation of understanding the cost to your family or loved ones if you or someone in your family dies.
1. How much will the funeral cost?
2. What will inheritance taxes and probate taxes cost?
3. Does anyone need a replacement income from the person that has died?
4. If children are involved as the survivors, is daycare cost needed, or are there other education costs?
5. How does the death of this person affect our retirement plan?
6. Is there a surviving dependent parent or grandparent to care for?
7. Is there a special needs person that needs care?
8. How much debt will be left behind?
9. How has my/my family’s cost-of-living changed?
10. What loss of income from social security and pensions are involved?
These 10 questions are the foundation of understanding the need for life insurance. Once we understand the need, our next step is to take an inventory of your personal savings, the life insurance through your employer, and any personal life insurance you may have to cover these needs.
A good financial advisor will guide you through these 10 questions and help you determine the actual cost and financial impact that must be considered in your Life Insurance Needs Analysis. They should use a formula that looks something like this:
Money needed (determined by answers to questions 1-10)
- Cash and life insurance owned
- Life Insurance Need
Money needed (determined by answers to questions 1-10) – Cash and life insurance owned = Life Insurance Need
Now that we have a dollar figure ascribed to the need, it is time to explore how much it will cost to purchase life insurance to cover this need.
There are three main types of Life Insurance: Term, Universal Life and Whole Life. We will not spend a lot of time on the education of these products in this Literacy Series but will dedicate another blog to this topic. But here are some critical takeaways you’ll want to learn today.
Key Facts About Life Insurance
To buy life insurance you must be insurableThis means you will need to answer health questions, the insurance company may request information from your medical providers, and they may check with the MIB (Medical Information Bureau) for information on you. For more information on the MIB go to their website at www.mib.com.
Life insurance becomes more expensive as you age
The sooner you can determine your needs and take out your coverage, the more you will save. As you age, your risks increase, as do the price tags for coverage.
Term insurance is the least expensive option
While this might not be the best solution for everyone, it may be worth considering, especially for short term needs like a 20 year mortgage.
Universal and Whole Life provide cash values in addition to a death benefit
When buying a cash value insurance policy there are many considerations, and the designs of these policies are very specific to how you will use the policy. Slow down and make sure you really understand how the policy works and how you will use the cash value. These policies are also like an investment and should be monitored and reviewed at least annually.
Question #3: What happens if I live too long? Will my money last?
I remember when I started in this financial planning industry in 1986, the general practice in the industry was to build plans based on a life expectancy of 85 to 90. Our hypothetical growth rate was 8%, and withdrawal rates were 6%. Fast forward to 2022, and I now build plans that incorporate a life expectancy of up to 100, with hypothetical growth rates at 5% and a 4.5% withdrawal rate.
The bottom line is, none of us know the future! The statistics we have looked at in this blog shows us that. But when it comes to planning for living too long, you’ll want to plan on the optimistic side of life! When your advisor is building out your retirement plan, ask yourself:
- Do I agree with the age assumption being used for my life expectancy?
- Do I think the growth rate is conservative and that we could do better? I want the best possible chance of success.
- Is the advisor stress testing* the portfolio both on growth and withdrawal of the suggested portfolios, and how are they doing that?
- What portion of my income is guaranteed for a lifetime for me and my spouse?
*What is Stress Testing? This is the definition that Investopedia publishes, and I think it is a good one. “Stress testing is a computer simulation technique used to test the resilience of institutions and investment portfolios against possible future financial situations.” Such testing is customarily used by the financial industry to help gauge investment risk and the adequacy of assets and help evaluate internal processes and controls. In recent years, regulators have also required financial institutions to carry out stress tests to ensure their capital holdings and other assets are adequate.
What is most important about stress testing is, you should know the factors being utilized in the test and agree with the assumptions used to test the portfolio.
Always request from your advisory team a “whatif hypothetical” on the portfolio they are suggesting you buy. Look back and see how this portfolio would have performed in the best and the worst years over 10, 20 and 30 year periods. After all, if you are retiring at 70 and may live to 100, that is 20 years! Also, look closely at the hypothetical illustration and pay attention to the year by year look. How much did the portfolio drop or gain each year? After a drop in value, how long did it take to recover and start growing again? Could you have taken that ride and lived through that drop and not reacted? Most money that is lost in the markets is because of investor reaction and not understanding the long-term strategy of the portfolio, or buying the wrong portfolio based on your risk tolerance. This information equips you with the financial literacy you need to make informed decisions and build a strong plan with your advisor.
Question #4: How do you prepare for a worldwide pandemic?
This is the new question that many of us would have never dreamed we would be talking about. Some of the answers to this question are about what we are talking about in this blog — evaluating, understanding and making sure you’ve got the insurance you need to protect you and your loved ones against unexpected disability or death that may occur.
I think about the 800,000+ thousand plus COVID-related deaths we have experienced in the USA and wonder how many of these families never did this work. How many people are disabled and can’t get back to work, and how many of them had a disability protection plan in place? You don’t want to wait for something to happen and hear yourself say, ”If only I had…” Play this out and plan for it.
The other big takeaway for most Americans through this pandemic is we need to save more. Having a reserve of 3, 6 or 12 months of your cost of living set aside is critical to getting through a pandemic or difficult times when money is needed and not coming in. This involves learning how to manage your cost of living and not spending 100% of what you make.
For young clients who are just starting out in the professional world, and making money, I suggest they use a 60 / 40 method when it comes to budgeting their income and planning their savings, which can look something like this:
10% - Emergency Saving Account
10% - Lifestyle, Vacation and Leisure Spending
20% - Retirement Savings
60% - Your Cost of Living
Each of these accounts are separate and are funded every paycheck. You pay these savings and investment accounts just like a bill. The money in these accounts might be invested in a bank savings account or investment accounts in Mutual funds, depending on the risk you can tolerate and the timeframe of needing the money. Investment strategies can vary according to your circumstances and the purpose of the savings.
By following this 40 / 60 method, you will be more likely to spend consciously and from the account that was meant for that spending. This approach can help keep you from dipping” into the wrong account or spending money you don’t have.
Check out our next literacy series on the accumulation and spending years where I will discuss the Savvy Saver Program.
I hope this has given you a roadmap and some confidence to start having the talk with your family, your spouse, and your advisory team about your protection needs. Please, remember all these insurance products — Disability, Life, and Long-Term Care — are definition driven and need to be designed to fit your needs. They are not “one size fits all” products. So, slow down and find the advisor team that is dedicated to do the work with you.
Since 1986, Holly Kylén has developed sound retirement and pension plans for individuals and companies. With experience in Life, Accident, and Health Insurance as well as creating effective financial planning strategies, she understands that your life goals have financial realities. Her passion is to help you succeed in reaching your goals while becoming more educated along the way. Holly holds FINRA Series 7, 63 and 65 registrations and has completed the Life Underwriter Training Counsel Fellowship.
The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before implementing a strategy involving life insurance, it would be prudent to make sure that you are insurable by having the policy approved. As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges. In addition, if a policy is surrendered prematurely, there may be surrender charges and income tax implications.
The opinions contained in this material are those of the author, and not a recommendation or solicitation to buy or sell investment products. This information is from sources believed to be reliable, but Cetera Advisor Networks LLC cannot guarantee or represent that it is accurate or complete.