In my 40 years of tax and financial planning, I don’t think I’ve ever seen a client sit in my office and say, “We really need to talk about my insurance.
Although the focus is usually on portfolios, social security and withdrawal strategies, insurance issues also deserve special attention.
With this column, I finish my look at the key decisions facing what I call the “Good Saving Couple”.
As I explained in Part 1 of this series, I define a Good Saver couple as a couple who have worked an entire career, are between the ages of 62 and 66, and are considering retirement. They have a seven-figure 401(k), own a partially paid-for home, have consumer debt consisting solely of auto loans or leases, and no longer have financially dependent children.
In the first column, I looked primarily at investment decisions. In Part 2, we looked at a broader range of do’s and don’ts, including Roth IRAs, tax planning, and when to start taking Social Security.
Here we look at insurance.
Insurance safety nets and an up-to-date estate plan are essential. However, two types of insurance are generally overlooked: supplementary liability insurance (umbrella) and long-term care insurance. Finally, fixed annuities can provide a safety net in the event of unexpected longevity and/or increased expenses.
When I ask clients if they have umbrella insurance, there are only two possible answers: “yes” or “what is it?” I explain umbrella insurance to my clients like this: if someone trips and falls in your home and sues you, they can usually go after your entire net worth. Most insurance, including home and auto insurance, covers up to a maximum of about $500,000. Umbrella insurance can cover from $500,001 up to the limit you specify – recommended to be your net worth. So, umbrella insurance is essential for protecting your assets – and the surprising thing about this cover is that it doesn’t cost much. A few hundred dollars a year can add an important layer of financial security.
Long term care insurance
Long-term care insurance is another important safety net. Many people mistakenly assume that long-term care can be covered by medical or Medicare insurance. This is not the case. Medical insurance and health insurance cover medical costs, not long-term care costs. For example, a person with dementia may need care for years. This would be covered by long term care insurance, not Medicare. At some point, if that person had a broken bone and needed surgery, Medicare would cover those expenses.
More than 50% of adults over 65 will need long-term care. And the biggest problem with long-term care needs is that care could be needed for many years and easily cost $10,000 a month or more. Considering that medical science has extended lifespan without necessarily extending the “quality” of life, long term care can often be needed for much longer than the average long term care statistic of 2.5 years for women and 1.5 years for men. In fact, 13% of people will need long-term care for more than five years.
Statistically, a pool of $250,000 (or affordable home equity) could cover long-term care costs. But what if both spouses need long-term care? What if care is needed for more than five years? Here, we see the real need for insurance: to protect your assets in the event of the unexpected.
Even for those who believe they can self-insure, I recommend long-term care insurance. Why? Because if you are the one who needs care, you may be reluctant to spend the necessary money for fear of leaving your spouse without sufficient resources for the future. If you are the caregiver spouse, you may be reluctant to seek paid help for fear of draining your future resources. Yet, for some reason, I’ve never had a client who was hesitant to spend the insurance money.
Long term care insurance can be expensive. In fact, this is one of the main reasons people choose not to have this coverage. While some elements of this insurance are crucial, there are ways to reduce costs while maintaining the important protection. So what should you be sure to include in long term care insurance and what can you skimp on? Below is a simple table. It is not meant to be exhaustive and be sure to check with your own qualified adviser(s) before making any decisions.
According to Christine Benz, there are two main options for long-term care insurance: stand-alone long-term care insurance policies and “hybrid” life/long-term care or annuity/long-term care products.
While buying long-term care insurance when you’re younger may mean lower annual premiums, you’ll pay those premiums over a longer period of time than if you waited until you were older. Mathematically, the age to purchase long term care insurance is in the mid to late 50s, although the risk of not qualifying is an important consideration. According to Benz, about 20% of applicants between the ages of 50 and 59 are denied coverage, largely due to disqualifying health conditions, while a third of those between the ages of 65 and 69 are denied coverage.
If you don’t want to pay premiums for long-term care coverage that you may never use or if health issues disqualify you, consider hybrid life/long-term care or hybrid annuity/long-term care policies. These policies are gaining popularity because medical screening is often less rigorous than stand-alone policies and there is some “return on investment” even if long-term care is not required.
Do I hate spending money on insurance? Yes. But, in many circumstances, it is a necessary evil.
I’m famous for hating annuities. I say 90% of people who have annuities don’t understand what they bought and/or should never have bought one in the first place. But there is one big exception: fixed or single-premium immediate annuities. I consider these annuities (in addition to home equity) to be an excellent safety net for retirees who are worried about running out of money.
Unlike other investments, assuming a financially secure insurer, an immediate annuity can provide guaranteed income for life, in amounts above typical “safe” withdrawal rates. For example, a 75-year-old single woman could receive $1,240 per month for life from an investment of $200,000. This equates to a drawdown rate of around 7.5% – far more than an investment adviser like me can promise for many years. Think of this type of annuity as another “social security” stream. It’s a monthly income that will be there even if you live longer than your estimated lifespan.
As with any insurance policy or investment, it is important to work with a qualified professional, or two – a licensed insurance broker and a fiduciary financial advisor.
Don’t pay for unnecessary insurance
Once retired or close to retirement, life insurance is usually no longer necessary (unless it is for funeral expenses or inheritance tax). Life insurance is generally purchased to replace the covered person’s ongoing income. By definition, a retired person is no longer working and hopefully has accumulated enough assets to cover living expenses in the future. Unless beneficiaries are looking for a windfall in the event of death, life insurance premiums are no longer required.
Note that some policies may have an accumulated cash value. If so, you have four options:
- Continue coverage as an investment decision, either by continuing to pay premiums or by using cash value to pay premiums for a period of time.
- Counting in politics. To the extent that you receive cash in excess of your base in the policy, you will pay ordinary tax on the gain.
- Borrow against politics. As long as the cash value (or the continued payment of premiums) is sufficient to pay the interest and avoid forfeitures, no tax is due on the amounts borrowed. On the death of the insured, the insurance benefit will repay the loan and any remaining amount will be paid out to the beneficiaries tax-free.
- Sell the policy to a third party. This strategy can work even if there is little or no cash value. To the extent that the proceeds received exceed the tax base, tax will be due on the gain.
Similar to life insurance, disability insurance is not needed during retirement or near retirement. These bounties can be quite expensive, so don’t waste your money!
Retiring is one of the most important decisions of your life. Although you’ve worked and saved for it most of your life, pulling the trigger is a big step forward. Please take note of the suggestions here and most importantly hire a qualified financial advisor. For unbiased, commission-free advice, I recommend a member of the National Association of Personal Financial Advisors. You can find someone near you on the NAPFA website.
Sheryl Rowling, CPA, is head of rebalancing solutions for Morningstar and founder of Rowling & Associates, an investment advisory firm. She is a part-time columnist and consultant on advisor products for Morningstar, and continues to work actively in the consulting space. Morningstar acquired its Total Rebalance Expert software platform in 2015. The opinions expressed in its work are its own and do not necessarily reflect the views of Morningstar or Rowling & Associates LLC.