We’ve had a great summer here in the Boston area. But the relentless fires, storms and weather extremes across the rest of the country should have us taking stock of our own vulnerabilities. The insurance industry has already come to its own conclusions: the future is looking expensive.Read More
I meant to get this post out on Thursday, when we were all feeling very focused about the work week. Or at least early this morning before you realized that it's now Friday. Because, really, I can't think of a more un-Friday-like topic than life insurance. But it's been a busy week, so here we are planning for death on Friday afternoon. You can leave work early and grab a drink or a tub of ice cream afterward. I promise.
Under the circumstances, let's just straight to the point. If you actually need life insurance, there are two basic categories to think about. About 98% of you will want the first type.
Term Life Is Where It's At
Term Life has been the choice of the masses since insurance salesmen started wearing gabardine suits. It's cheap, and it works. You pay your premiums (monthly or annually), and if you kick off before the term of the insurance contract is out your beneficiary gets the money. The biggest pitfall here is in not doing your shopping. Insurance companies come in various levels of financial stability (it doesn't work if the company dies before you do), and they choose their ratings differently. To get the best deal, find someone who works with an independent broker to shop for you, or look for an online service that does the same.
There is one more catch—you should know how much insurance you actually want and how long you need the policy to last before you choose your policy. That means you should always know what "gap" in your financial plan you are trying cover.
Permanent (Whole) Life For The Other 2%
I have never sold insurance (too lazy to fill out the paperwork), so before writing this post I asked my partner how often he has sold permanent life insurance policies to people over the past 15 years. He figures it's two or three times. You can probably guess the big advantage of permanent policies from the name—you buy the policy and it lasts your entire life so long as you pay the premiums. The insurance company generally builds in a sort of mini-investment account to these policies to help pay for the premiums and to serve as an add-on benefit of the policy. Most insurance sales people put a lot of the focus on that component.
The catch here is that these policies are more expensive—usually a lot more expensive. And there have been cases where the returns from the attached investment account did not cover the premiums. Policy holders that are counting on that automatic premium payment need to be careful that policy does not lapse, undoing all of their investment.
So who should look at permanent life insurance? We see these used most often during estate tax planning, where it's not so much about covering a financial gap as making sure there is a lovely inheritance. So if you are working with an estate attorney, you might discuss it with her. And some people just kind of like the idea of having a policy that lasts their entire lives.
For the vast majority of us, though, the best financial choice is to get term insurance and in just the amount and term needed. You can use the money you saved from those permanent life premiums anyway you want—a strong investment account, a gift for you heirs while you are still around, or just a fund for ice cream purchases. Because no financial plan will stave off mortality, but at least you can enjoy your Fridays while you've got them.
Some Terms To Know
Participating: A “participating” plan pays dividends depending on the company’s returns; these can be used to pay premiums, taken in cash or left in the invested portion of the policy.
Premium payments: premium payments can be “level” (stay the same throughout the policy), “limited” (higher but for a limited period), “single” (just one, large payment), or “adjustable” (the company reserves the right to increase or decrease premium payments).
Variable: In a variable policy, both the value of your investments and the death benefit will vary according to the how well the investments in the account perform. Traditional variable policies will guarantee you a minimum death benefit as long as premiums are paid.
Universal: A universal policy allows you and the company to move money around amongst the premiums due, death benefit amount and investment account depending on investment returns and premium adjustments. Universal life is flexible but risky unless carefully managed—you can find your policy lapsed if not enough of your money is going to premiums.
Surrender Charges: the fee for cancelling your policy and withdrawing your cash balance.
We have a client at the firm who has been planning for years to retire to Costa Rica. Another client has moved to Mexico where she enjoys the fruits of her labor from a little house surrounded by, well, fruit. As the snow piles up every February here in Boston, the whole idea of escaping to another life sounds more appealing. Even those of us who can't imagine not having some sort of work during retirement are tempted by the idea of retiring to a whole new adventure. And in some cases, moving to another part of the world promises a better standard of living. So what are the practicalities of a retirement outside your home country?
Retiring abroad almost always means having financial transactions going on in two countries. Fortunately, our global banking systems have made this significantly easier than it once was. Like most immigrants/expats, you will want to do some careful planning with your cash flow. Start by keeping a U.S. bank account open to receive your social security checks (in most cases, you are still eligible while living abroad), pension checks or any other income. The same account can automatically pay any expenses you have left in U.S. dollars—these might be related to insurance policies, properties you own in the U.S., cash support for family still in the states, or just having your favorite U.S. peanut butter shipped over once a month.
Keeping all of that income and expense in the same (U.S.) currency saves you the added expense of currency exchange—and that can be a big savings. On the other side of the financial border, figure out what your monthly budget will be in your adopted country and have that automatically deposited in a local account once a month (but be sure to account, again, for the exchange rate and any bank fees).
Speaking of your monthly expenses, expect the unexpected in your new life. On one of our family's first trips to Singapore, we plunked ourselves down for lunch at a cafe designed for tourists on the island of Pulau Ubin. After giving three rambunctious children and four hungry, tired adults license to order anything and everything they wanted, we ended up with two tables overflowing with food and specialty drinks...all for a tab of about $14 bucks.
On the other hand, owning a little tin can of a car in Singapore will cost you a small kingdom. My point? Look carefully at what is and isn't expensive in your new home. Your housing or groceries might be ridiculously cheap compared to what you had at home, but your utility bills or transportation might be higher than you ever dreamed possible. And as an aside, don't expect to find cheap food in Singapore anymore—inflation can happen anywhere.
This one has been a big factor for U.S. citizens. In fact, our astronomical insurance premiums and health care costs in this country have made it almost inevitable that Americans save money on health care by going just about anywhere else in the world (why this hasn't been a red flag for us, I don't know). And the quality of health care in other countries hasn't been much of a compromise either. But you do need to know what the arrangements are in your new country before you move. Keep in mind that Medicare will not cover you abroad.
Some nations let immigrants participate in the national health system; others offer private health alternatives (often still cheaper than what we have here). Make sure you look into eligibility requirements and take into account your particular health care needs when choosing where in the country you will live; as is the case here, cities often offer more sophisticated care. And if you still need more coverage, look into international health insurance, which will cover you just about anywhere in the world (with the frequent exception of—you guessed it—the U.S.).
Surely this is the least appealing part of retiring abroad! If you are a U.S. Citizen, you will almost certainly need to keep filing a U.S. tax return, even if you don't owe anything. And you will have local taxes to think about. If your new home country has a tax treaty with the U.S., you might be able to avoid paying income taxes in both countries simultaneously. But there are all sorts of taxes to think about. For those in retirement who are buying property in their adopted nation, estate taxes are likely to be a concern. And if you have more than $10,000 during the year in almost any sort of account abroad, including an insurance policy, make sure to file an FBAR (Report of Foreign Bank and Financial Accounts). Even if you were one of those people comfortable doing her own tax returns and estate planning before, taking on the taxes and procedures of two national treasuries will probably require some professional help.
An Extra Seat At The Table
Ready to start planning your second life as an immigrant to some charming foreign nation? Research thoroughly, plan carefully and most of all, be flexible. And one more thing, make sure there's extra seat at the table for friends and family visiting from back home. After all, it gets pretty cold here in February.
The Secretary of State's Bureau of Consular Affairs has a web page to guide you through the basics of planning a retirement abroad.
My clients might well be surprised to see this post—I spend a lot of time railing about the over-selling of annuities and the hefty commissions that go to the advisors who sell them. But the annuity has a long, respectable history and can actually be a good financial tool for the right situation. So what is that situation?
First, it helps to know how annuities work. They aren't quite as dreary as they sound. Way back in the 17th and 18th centuries, annuities were a great way for a very wealthy person to fund the retirement of a widow, an artist or a beloved servant. For that matter, they were one of the original prizes in government lotteries. Essentially, an annuity is a contract that gives the beneficiary the right to receive a certain sum of money every month or every year for the remainder of his or her life. Sounds great, right?
There is a little more to it, though. These days, annuities are insurance products. Like any insurance policy, the insurance company has used statistics about people's life spans to predict how much they need to charge you (and how much they could pay to the beneficiary) in order for the insurer to make a profit on the deal. So, for instance, Wholesome Life Insurers, Inc. are happy to sell you an annuity that costs $100,000 up front and pays $20,000 per year to your Aunt Betty for $100,000 if they think she'll drop dead after the second year of payouts.
And there are necessary costs. In addition to paying the people who sell you the annuities, the insurance company needs to pay people to file the required reports, process the applications, run the office, etc... That isn't all, though. In point of fact, your insurance company is hoping to make most of their profit by investing your initial $100,000 until it needs to be paid out. For that, of course, they need to pay investment managers. All of these costs are built into how much the annuity costs you.
So why not just invest the $100,000 yourself and skip the other costs? This is the question at the heart of the matter when it comes to annuities. In most cases, it is cheaper to fund your own (or your Aunt Betty's) annuity. But relying on your $100,000 investment to grown enough that it can pay you back the money you need in retirement is a gamble—a gamble on the investments and a gamble on your lifespan not going longer than planned.
In the Bloomberg article with which I started this series, David Little, Director of the Retirement Income Planning Program at the American College of Financial Services, chose to take care of most of his own investing, trusting that he would do better than the relatively high fees and low returns that an insurer would get. But he also purchased an annuity as a supplement to the investments. The annuity offers him a baseline amount that he will get every month during retirement to prop up his social security benefits in case the investments disappoint or in case he lives to, well, 103.
As Little's plan suggests, annuities make sense in those instances when security matters to you much more than cost. Whether it's being able to insure a comfortable living for your Aunt Betty, or locking in a baseline for yourself, annuities are about covering a basic need—often psychologically as much as financially.
Just one last note on annuities—there is no such thing as a "guaranteed" investment. Make sure you feel as confident about the insurance company you buy from as you do about your choice to buy. If you want to learn more about the types of annuities out there, check out the SEC's online guide to annuities.