A Reddit thread about getting sold life insurance when going to a life insurance company for financial planning gets Joe Anderson, CFP® ranting! To make sure Joe’s insurance rant doesn’t apply to you, and to help you avoid buying insurance you don’t need, Paul Lim CFP® educates us on term life insurance, permanent life insurance, long-term care, and annuities: what they are, when you need them, and how they fit into your overall financial plan.
- (01:19) Ranting About Reddit: We Got Sold Insurance We Didn’t Want
- (12:54) Paul Lim, CFP®: Life Insurance
- (22:27) Paul Lim, CFP®: Long Term Care Insurance
- (32:08) Paul Lim, CFP®: Annuities
Today on Your Money, Your Wealth, Joe Anderson, CFP® is in rare form. I showed him a Reddit thread in r/personalfinance about a young couple who got sold life insurance they didn’t want when they went to a life insurance company for financial planning – and Joe started ranting!
“I do not sell life insurance, disability insurance, or any of the above. I think the most important thing that I have is my disability insurance policy. If you’re in your 20s, 30s, and 40s, the biggest asset you have is not $17,000 that you have in your savings account wanting to buy stocks. It’s your ability to earn an income. If you look at a true, rounded-out, financial plan, you have to start there first. ‘Hey, can I get some stocks in a Roth?’ Why are you going to Northwestern Mutual Life Insurance?? Of course, they’re going to start with the protection side first. You know, I’m going to go to a Ford dealership and get pissed off because I didn’t get a Chevy! And I’m going to go on Reddit!” – Joe Anderson, CFP®
Keep listening to make sure Joe’s insurance rant doesn’t apply to you, too. And to help you avoid buying a Ford when you really wanted a Chevy, Paul Lim CFP® joins Big Al to provide some education about term life insurance, permanent life insurance, long-term care, and annuities: what they are, when you need them and how they fit into your overall financial plan. Now, here are Joe Anderson, CFP® and Big Al Clopine, CPA.
01:19 – Ranting About Reddit: We Got Sold Insurance We Didn’t Want
JA: You know what I really want to talk about? I got these e-mail questions, but Andi, our producer here, wanted us to talk about this Reddit stuff. So this is all the rave. So I’m going to spend a couple of seconds to talk about this, because all these financial advisors, they’re all chiming in on this thing, and here’s what this individual went through. It says, “My husband and I are idiots, we’ve been bamboozled by a financial advisor. Ugh, I’m so frustrated, I thought we were doing a good thing for ourselves. But now I think we are trapped. Full backstory.” You want the full backstory?
AC: Sure. I don’t think I have a choice. (laughs)
JA: “So a friend recommended their financial advisor to us. We thought, great. We’ve been meaning to meet with someone for a while. So they set up a phone interview with a financial advisor that works at Northwestern Mutual. So they give them a call. The financial advisor asks a lot of questions, what they were looking for. So the clients or prospective clients, they tell them “we want to set up a retirement for my husband, maybe explore putting their $17,000 in savings into CDs or mutual funds. She asks us questions about when we are seeing ourselves retiring, how aggressive they are, and everything else. So these are young individuals. They don’t have a retirement plan set up. They have $17,000 in savings. So she goes on. “Cut to a week later we are having a phone meeting with this financial advisor from Northwestern Mutual. She e-mails THE PLAN” – and THE PLAN is all in large caps. “It’s many, many pages basically explaining what we have versus what we need and what we need to retire. But she most just talks about how we need more life insurance. Sure, we think, maybe we do need more life insurance. She explained that my husband needs a million dollars in life insurance and I need $500,000.”
She goes, “We both already have $150,000 policy through our work. She also spends a ton of time explaining how we need to have disability insurance. Again, we think maybe we do. So we spend the greater part of an hour and a half talking about life insurance and long-term disability. She briefly mentions how we should be maxing out Roth IRA and we could perhaps start one for my husband. So we hang up with the plans that talk in about a week or so. Over the next week, husband and I realize that we don’t want disability insurance, and we don’t really feel we need more life insurance at this time, but we are OK maxing out Roth IRAs for $450 a month. We also want to explore stocks and bonds and mutual funds, like we initially told her.” So I guess another phone meeting happens where she would talk to us about our updated plan, she e-mails the new plan, we’re on the phone, literally, nothing has changed. “She proceeds to spend the next hour convincing us why we need life insurance, disability insurance. Every time we bring up a reason we don’t feel we need it, she tells us how we are wrong. I still express my disinterest in disability insurance, but we weren’t completely closing the door on life insurance, she kept giving me the guilt trip, ‘what will your kids have if one of you dies?’ But at the end of the conversation, I agree to anything except to roll over my Roth to Northwestern. I had to give her my bank routing information to get the paperwork started.
She also said she was going to be sending me a bunch of stuff to sign in the next few weeks, but it was just to apply for things. She says a small amount might be taken out of my checking but it’s just to make sure that the charges are able to go through when we started moving the money to my Roth. So a week goes by and I see a $30 charge goes through – disability insurance. I told her I didn’t want disability insurance. She still hadn’t addressed our interest in CDs, mutual funds, stocks that we initially came to her for. I decided to call the whole thing off. So it’s been a nightmare trying to cut ties with her.”
I guess she says she’s very adamant that they need life insurance, long-term care and so on, and so she’s really worried about getting her $30 back. So all these advisors are on the bandwagon that she’s getting bamboozled. Oh, these financial advisors are clouding themselves as insurance agents, and oh my gosh, these poor people, and how could she get taken advantage of so badly by this insurance agent. The whole industry is bad! Here are my two cents.
AC: OK. I knew that was coming. (laughs)
JA: First of all, I don’t work for Northwestern Mutual. I do not have an insurance license. I do not sell life insurance, disability insurance, or any of the above. OK. Fair disclosure. Full transparency. However, I think the most important thing that I have is my disability insurance policy. I’m a single person that makes a couple of bucks a year. That’s probably the biggest asset that I own. If you’re in your 20s, 30s, and 40s the biggest asset you have is not $17,000 that you have in your savings account wanting to buy stocks. It’s your ability to earn an income. So I think disability insurance is very prudent. Would you agree? What say you?
AC: Yeah, I would say that’s logical. Yeah.
JA: So if you look at a true, rounded out financial plan you have to start there first. They’ve got small kids. They’re a married couple. They have $150,000 of life insurance. What is that going to cover if one of them dies? I get her point. I don’t know if that’s a hard sell. “You have $150,000, you probably mean a million.” “No way, a million? That’s crazy.” “Well, what if you die? What’s going to happen to your kids?” (laughs) But the truth be told, what would happen to their kids if one person dies? How long is $150,000 going to last that family?
AC: Yeah, probably two, three years.
JA: If that! If she’s recommending a million bucks, I would imagine the husband’s making maybe $70,000 to $150,000 a year. They’re recommending $500,000 for her. I don’t know, she’s probably making anywhere from $50,000 to $100,000, who knows. But it’s not chump change I’m sure what they’re making because they’re interested in financial planning. I guess my point is, I guess you could take anything and then blow it up like this person is just trying to take advantage of them. But I’m not an insurance agent, but I look at this, I don’t see anything disastrous here, and this thing has gone viral like this poor advisor is just going out there taking advantage of this poor couple.
AC: Yeah. And I think though, what happens is, in some cases, we know that there are some insurance products that have high commissions. And of course, that’s the assumption, that the community out here is assuming that this particular policy was a high commission. Now it probably wasn’t, because there’s not that much money available for a policy. So a person like this very likely would need a term policy, because they’re trying to like we talked about, cover a temporary short-term gap, cover an income need. Like, let’s say it was me. If I passed away, and I have two boys, what would Anne have done? Well, you need life insurance to be able to cover that. Now before I got married, who cares? And even if I got married, if my spouse was making a good income maybe I don’t have a huge need for it. But maybe there’s some need for it. If we had kinda increased our lifestyle or bought a more expensive home or something like that and I want my spouse to continue that – and certainly when I was younger, that’s exactly what I did. As soon as I had kids is when it became quite important for me to have a life insurance.
JA: Here’s the problem I think too is let’s say if I’m now interested in saving, getting invested, and things like that. I don’t wanna buy insurance. I get it. But it’s important to start there. That’s the foundation. I want to buy stocks, I’ve got 17 grand, let me buy stocks. I want to start this Roth IRA. I want to start building wealth.” OK. Yes. That comes with this whole process. But if tomorrow, something happens to you, you’re more likely to get disabled and all of a sudden you can’t work. You get sick for a couple of months. I don’t know, then that income is gone? You’ve got to start protecting yourself. I mean it’s just like your car insurance, your home insurance – it’s just a necessary evil.
AC: Well, and I think the way that you try to think about that is, you try to incorporate that into your budget – the insurance payments – so that you still have the $17,000 or most of it. You probably need all of that, every penny, just for an emergency cash fund before you start investing in stocks.
JA: Yeah, you’ve got $17,000 in cash, keep it in cash!
AC: Most advisors, including ourselves, would tell you, work up to three months of expenses in an emergency fund before you spend a lot of time investing. Now the truth is, when you first start out, that’s difficult. And if you’ve got a 401(k) at your employer, and there are matches, you probably want to do a little bit of balance, even though the numbers might be small and everything. But you’re right, you’ve got to make sure, particularly if you’re married, if you have a salary, and if you have kids, if you don’t have life insurance you just not being responsible.
JA: But then you have to look at where you’re going. So they went to Northwestern Mutual LIFE INSURANCE. One of the most probably well-respected life insurance companies in the nation. But it’s a life insurance company!
AC: Yeah, that’s in their name. (laughs) So what do you expect?
JA: “So hey, can I get some stocks in a Roth?” Why are you going to Northwestern Mutual Life Insurance?? Of course, they’re going to start with the protection side first, that’s what they’re trained to do. You know, I’m going to go to a Ford dealership and beg them for, get pissed off, because I didn’t get a Chevy. (laughs)
AC: (laughs) “You don’t have any Chevys??”
JA: “I’m going to go on Reddit! (laughs) You would not believe the salesperson! He took the manager out of the back office and gave me this deal on a Ford when I really wanted a Chevy!” But I get there are a little bit of sales tactics going on here that I don’t necessarily want to brush over. So she took $30 to go through underwriting. Because I don’t know if you can get underwritten for disability. Maybe you have some stuff going on. I don’t know your medical records. I’m not a doctor. So they pulled 30 bucks, and they put them through underwriting to see what type of premium they could get.
AC: So it’s for testing.
JA: And then so maybe it wasn’t fully clear, fully transparent. That’s a totally different story. We could talk about that until we’re blue in the face – maybe that’s what this is all about. But I think this couple should really get educated on what’s how this process works, maybe versus getting sold. So anyway, that’s my two cents. Hopefully – you probably didn’t enjoy it, but I enjoyed ranting about it.
If you missed the Reddit thread Joe was ranting about, you’ll find a link in the show notes at YourMoneyYourWealth.com. And to make sure you’re educated and don’t get sold something you don’t need, and end up posting on Reddit for Joe to rant about you, let’s talk about life insurance, long-term care, and annuities. Are any of them right for you, and what part do they play in your financial plan?
12:54 – Paul Lim, CFP®: Life Insurance
AC: Right now we’ve got a special guest on, Paul Lim. He’s a CERTIFIED FINANCIAL PLANNERTM with the Wealth Consulting Group in San Diego. You can find him at WealthCG.com. And he joins us today to talk about something that we usually don’t spend a lot of time talking about, which is insurance. Everyone needs different kinds of insurance, and so we’ll kind of get into the gamut of different types. Paul, welcome to the show.
PL: Thanks Al, thanks for having me.
AC: Our pleasure. And just as a precursor I guess, we’re going to talk about different kinds of insurance, we’ll get into life insurance, we’ll get to the long-term care, we’ll actually even get into annuities a little bit. So I guess Paul, just starting out, the different types of insurance that we actually need – car, home, health, disability. Why don’t you kind of just briefly address those, and some top-level things to consider?
PL: Sure. You know, we really utilize insurance to make sure that the client has a backup plan, just so that their financial plan isn’t sabotaged in the event of something unexpected occurring, such as the premature death of an income-earning spouse, or maybe an injury that stops someone from going to work. Or maybe I need help as I’m getting older in my retirement years, and I just don’t want my living expenses to explode when you have to cover the costs of care associated with those particular needs. And so, the insurance policy is there to make it so that we do have a backup plan to address each of those particular contingencies. So the big ones are going to be life insurance disability income protection, long-term care, and those are the main ones we typically place our focus upon during the course of financial planning.
AC: Yeah. And so kind of a follow-up question related to that: is an individual better off going to an insurance agent or insurance company, or talking to a financial advisor about purchasing insurance?
PL: I would generally say that a financial advisor can connect some financial issues to one’s insurance needs in a way that someone who is just an insurance agent may not fully comprehend. You know there’s an old saying that goes, “the man with a hammer every problem as a nail.” And so if you’re working with somebody who’s just an insurance agent they’re going to view everything you do through an insurance lens. But a financial advisor who has competency in multiple areas has the ability to connect tax issues to financial, as we do before, and then, of course, the best way in which to purchase an insurance policy that is based upon one’s income. So my answer to your question, generally speaking, is that an advisor is typically better equipped to address some more of those nuances than somebody who just specializes in insurance.
AC: Yeah I think that’s well said. And thinking about life insurance in particular, how does that fit into an overall financial plan? So you go to your financial planner, you do some cash flow planning, you do some investments, maybe do some tax planning, but where does life insurance come in?
PL: Sure. Typically, we view life insurance as a form of income protection. And what that means is that we want to determine a lump sum, tax-free amount that would be sufficient to recreate all the paychecks we would have expected that person to earn had everything gone according to plan. So for example, if something happened to me yesterday, and a spouse was relying on my income, they’d have to figure out what amount they would need in order to recreate the amount of money I would have expected to earn from now until retirement. So you can basically utilize a formula where you take somebody’s income, and you can use software, or even Excel or some other programs in order to figure out what amount would be sufficient for the other surviving spouse to be as if the person was still there financially. We can never replace them emotionally, but at least you can mitigate the financial impact of having that earnings stream disappear. So to answer your question, it’s really going to be about that.
AC: So what happens then when you retire? Do you no longer need the life insurance?
PL: Generally speaking, once you reach retirement, you’ve got a good amount of money saved up, whether that’s in IRAs 401(k)s, maybe one is eligible for Social Security at that point in time. And you’ve done some diligent planning, of course, so you’ll realize that those piles of money that you have saved up are going to be sufficient to not only make ends meet, but also to account for all of the future inflation that’s going to happen during the course of your retirement. And if those piles of money were enough to cover two people for the rest of their lives, well it should be enough for one person if one of them were to pass away unexpectedly. And so in that case, you’ll generally just leave the unspent dollars that we were expecting to have you consume to the other person, in lieu of a death benefit.
AC: Sometimes when we have a client come in, they’ll be receiving their pension payments and they decided to do you no survivor. And so there’s an example there where you still might want life insurance through retirement in case that person passes.
PL: That’s a great point. Often when you have a defined benefit pension plan, you’ll have a choice as to which versions of the payout you will choose to receive. And so there’s one version that’s very high, but it pays nothing to a beneficiary if you pass away prematurely. But then there’s another version that will continue that income stream to the other person, but it entails having you take a significant pay cut. And so one can sometimes utilize an insurance policy to make up that difference, to say that if you do lose this pension, here’s a lump sum amount that you can use to basically do that income stream on your own with that particular lump sum, and the premiums associated with that life insurance policy are often far less than the pay cut you would have had to take, were you to opt for that 100% survivor pension payout.
AC: Yeah that’s a good point. I think in some cases, you take the survivor benefit if the payment is not that different. But if there’s a large difference, you might just be better off doing the no survivor with life insurance to help cover that, as you said.
PL: Absolutely. Because the 100% survivor payout is basically you buying life insurance, but having it be done through the institution, as opposed to a company on your own.
AC: Right. So let’s talk about, in the case where you’re trying to insure your income while you’re working, you probably want to do like a term policy which has a certain period of time, which maybe goes until you retire, but there may be some cases where you want a more permanent policy. So let’s talk about that.
PL: You’ll run into some cases in which estate planning is of importance. Now, this generally doesn’t affect most people in this country, because of the fact that the exemption limits for the estate tax are extremely high at this point in time. But for those people who do need to have a financial resource available for paying those particular estate taxes, or having a situation where maybe there’s a closely held business and the estate needs to have some funds with which to purchase a share of a company, for example, then you’ll need to utilize a permanent policy, not a term policy, because that particular event is uncertain, it’s in the future, and you’ll want to have that particular item be able to manifest a financial resource, so that you can use those dollars to fund the strategy.
AC: So with the new tax act now it’s an $11.2 million exemption per person. And if you’re married, you’d double up on that. So it’s over $24 million that can pass to the next generation without an estate tax. But if you’re over that, then perhaps a permanent policy might make a lot of sense. Or, before this year, it was roughly one half of that. It was about $5 million per person. And before that when my career started, Paul, $600,000 was the only amount that would pass the next generation tax-free.
PL: It’s remarkable – yes that’s true. So yes, you’re correct in that the people who are over that exemption limit will probably find a great deal of value in leveraging their premium dollars. In other words, purchasing an insurance policy that pays them many times more than the amount they paid in so that they’ll have the resource with which to cover that onerous tax.
AC: Yeah and that’s particularly important when you have real estate or a business that’s highly illiquid, but your trustee, executor, is going to need to have a pile of cash to pay the estate tax after. So anyway it’s something worth considering.
Obviously, tax planning, insurance, and estate planning all go hand in hand in creating a well-rounded financial plan, but this conversation may be leaving you feeling a bit overwhelmed about what you need in your specific situation. For help working it out, visit YourMoneyYourWealth.com and hit that “Free Assessment” button. A free two meeting assessment with a CERTIFIED FINANCIAL PLANNERTM will look at what you’ve got, where you want to be, and give you a plan to get there: how to reduce your taxes as much as legally possible, how to protect yourself and your family with insurance that’s appropriate for your situation, and how to ensure you don’t run out of money before you run out of time. Visit YourMoneyYourWealth.com and click “Free Assessment” or call (888) 994-6257. That’s (888) 994-6257 for your free two meeting financial assessment.
22:27 – Paul Lim, CFP®: Long Term Care Insurance
AC: Now let’s switch over to long-term care. And that’s a thing that a lot of people know about. Obviously, if you have to go to some kind of long-term care facility, that can be pretty expensive. What’s the average care right now annually in Southern California?
PL: Sure. So in Southern California, it’s going to be a bit higher than other places in the country. But I’ll tell you Al, the actual spread between the most expensive state versus the least expensive state is really not as large as you might imagine. And this has to do primarily with the fact that there is a great deal of demand for these services. We have 10,000 baby boomers a day that are retiring and we have some real constraints on the ability of the system to deliver that kind of care. So right now I think you could say $4,000 a month is going to be something that is reasonable to expect in terms of outlay. Now we’ll never know what somebody needs. It could be something as innocuous as having a nurse come in to help you do chores and laundry, all the way up to 24/7 full dialysis kind of care that will cost quite a bit. But if we were to just take the average, I would say that $4,000 a month with after-tax money is probably a reasonable number on which to base one’s estimates. I will say that you really have to earn quite a bit more than that amount to net the $4,000 after taxes. So if we just say taxes are third, and I have to pull $6,000 out of my IRA so that I can pay $2,000 to California and the IRS, that’s going to be the amount that will generate $4,000 net to me after taxes with which I cover that long-term care expense.
AC: Yeah good point. Although in some cases that’s deductible as a medical expense. But there are all kinds of limitations there. So you do have to consider that, and I have seen some long-term care facilities where it’s more like $80,000 or $90,000 a year. So it can be pretty high.
PL: Absolutely. Some of the higher end facilities that do provide some of those more robust services will charge in excess of $7,000. $8,000 a month – especially if you don’t want to live or reside in an average facility.
AC: I think a lot of people don’t realize that Medicare does not cover long-term care.
PL: It does not. It’s a misconception that it does. But really, the restrictions that are imposed on that program are pretty high. You have to have a three-day hospitalization. You then have to be transferred to a facility for the same reason for which you were hospitalized, and then the amount that they pay you is basically limited to about 100 days and the amounts that they actually pay out are just not going to be sufficient in order to cover the full cost of care.
AC: So at this point, of course, I think a lot of us realize – I’m part of the baby boomer generation, so we’re getting older, and we have to be realistic about there may be a long-term care stay required at some point in our life. And then it’s a matter of, I would call it long-term care planning – not necessarily long-term care insurance. Long-term care planning means you have to have a plan to be able to pay for it. And either you can self-insure, or you can get a long-term care policy, or maybe a combination of both. But how should people think about this?
PL: Really at this point, if one is talking about insurance, you’re not going to be able to feasibly afford a policy that will cover the entirety of the costs of care that we’re talking about. If anything, the policy is there to help leverage the premium dollars that you devote to it so that you’ll be able to have a tax free pool of money from which to draw in combination with self-insurance, perhaps from assets that you have saved up elsewhere. Because although the risk of one needing long-term care really is quite high, there’s also a chance that you may live a long healthy life, and you may not want to put premium dollars into a policy that you may or may not use, so to speak. Now that’s, of course, the risk of insurance. But I’ll tell you that the market for insurance has gotten to a point where you do need to be a bit more strategic about the amount of coverage that you do purchase in order to cover those costs that are increasing each year as we go forward.
AC: Yeah, and I think some of these policies have a term, like two years or three years or four years, some of these might be lifetime, some of these might have an inflation rider, some not. What should people be looking for?
PL: So there was a cost study that was done in 2010 that stated that the average duration of care was about four years. So if you have a policy that will cover at least a majority of those four years, whether that’s three years or four years, that will help to cover the average duration of care during which one is likely to need those kinds of services. As far as the other aspect of long-term care planning, you’re really going to want to think about having something that will cover anywhere from 50% to maybe 70% of the average cost that we were talking about. Now again, it depends on the numbers and the assumptions that we’re utilizing. But if we go back to our example saying $7,000 is average for facility care, finding a policy that’ll cover maybe half of that amount would be certainly affordable, but also give you the financial resource to make it so that you don’t have to exhaust the other savings you had earmarked for ordinary living expenses.
AC: So let’s talk about long-term care and life insurance qualifying because it’s not just anyone that wants it. You’ve got to go through a medical exam, right?
PL: That’s correct. And so these are all based upon your health – you may really want a long-term care policy, but in the end are unable to qualify for those based on underwriting restrictions. And so really, between these two different policies, I’ll share with you the differences as far as what they’re looking for. With life insurance, it’s about mortality. They’re concerned about things that will kill you. In other words, cancer and things of that nature. If you do dangerous activities. When it comes to long-term care, they’re looking at morbidity. They’re looking at things that make you very sick for a long period of time. So if you have trouble walking, if you have cognitive impairment, if you have dementia, Alzheimer’s, things of that nature, but also the ability to maybe not pass away, but just hang on for a very long period of time and to be ill for a long period, which makes you unable to perform the everyday tasks of one’s ordinary life. Those things are going to be scrutinized far more heavily with a long-term care insurance policy than a life insurance policy. It’s actually very interesting. The long-term care companies, some of them, are not that concerned about conditions that result in a very quick death, because it means that they won’t have to pay out during those times. Strange.
AC: You know, it’s interesting. Like with life insurance, for example, there’s super-preferred, there’s preferred, there’s standard, there’s table-rated. And it seems like wherever you stand based upon your health, you probably – well, maybe not always, but in many cases – you can get life insurance, but you may pay might be something very different than somebody else that qualifies. Is that also true for long-term care policies?
PL: Generally speaking for long-term care insurance policies, they’ll say yes or they’ll say no. They don’t usually split up the yes into various spectrums like you might find in life insurance. And I think that has a lot more to do with the market, the demographic to whom these policies are marketed. So, people, all the way from age 25 to age 75 will generally be good candidates for life insurance. But when it comes to long-term care policies, this is something that people don’t really start looking into until their 50s and beyond. And so the actuaries must have enough data to realize that the difference in health that one would see from seniors and others people in that age band don’t differ as highly as say, 25 year old versus 75 year old. So I think it has a lot to do, as one would reasonably expect, with the large difference in health that one could see in a pool of life insurance applicants versus a pool of long-term care applicants. So it’s a great point.
AC: And so for long-term care, what age should people be thinking about getting a policy?
PL: I generally have noticed that the rates for long-term care insurance tend to be fairly linear up until about age 55 or so, and after age 55 the trajectory takes a different direction. It kind of hockey sticks upward if you imagine it like a line graph. And so the increases are fairly steady up until about that age, and then right around 55 or so, they start to stair step in a way that is dramatic when you see it visually.
Not sure yet if long-term care is right for you? Visit YourMoneyYourWealth.com and type “long-term care” into the search bar at the top to get more useful information. You’ll find two webinars about long-term care solutions and an episode of the Your Money, Your Wealth® TV show all about long-term care insurance. Type “long-term care” into the search box at YourMoneyYourWealth.com – or if you’d rather talk to a human about your long-term care insurance needs, call us at (888) 994-6257. That’s (888) 994-6257.
4. Paul Lim, CFP®: Annuities
AC: OK, let’s now go into annuities, because there’s a lot of talk about annuities, and there are a lot of people that say annuities are something to avoid at all costs. And I guess I would have to sort of be in that camp, for the most part. There are some exceptions. But a lot of people don’t even know, what is an annuity? So what why don’t you explain that.
PL: Sure. Generally what you’re doing is you’re trading a lump sum of assets in exchange for an income stream. So you basically are purchasing a promise from an insurance company to send you pension-like payments for the rest of your life. And there are various ways that those products will achieve that end. But that’s the way to conceptualize what it is that you’re purchasing. You’re trading a lump sum in exchange for a fixed monthly payment that happens for the rest of your life, no matter how long you live, that is resembling the pension – the defined benefit pension items to which we referred previously.
AC: So that could make a lot of sense for somebody that thought they had a long life expectancy for example. And so on the surface that sounds good, but what are some of the problems or pitfalls or things to watch out for with annuities?
PL: Sure. Often these products will make certain promises to you, and they’ll say that they promise to pay you this particular amount for the remainder of your life, but you’ve got to remember that if I initially put in $100,000 for example, and the insurance company says that they’re going to pay me $5,000 for the rest of my life, for the first few years they’re really just trickling my money back to me. So I get a lot of value from that income stream when I live for a very long period of time and I force the insurance company to continue sending me those amounts. So just realize that there is a break-even, regardless of the dollar amounts on any one of those products. But you have to take into consideration, you have to realize that for the first time periods during which you’re getting these payments, you’re really just receiving your initial principal back. So there’s not a lot of value until you pass that break-even point. That’s number one. Number two, it isn’t going to take inflation into account. So $5,000 in today’s dollars will buy quite a few things. But if we assume that prices are going to double approximately every 18 years, you’ve got to realize that by the time you’ve received that break-even payment, how much have the prices of all other things gone up by that point in time? Generally speaking, those particular products don’t have very robust inflation provisions on them. And so you have to realize that there is some time-value of money concepts to keep in mind, and inflation is something that’s really not addressed very well in the common parlance. And so, being able to assess the true value of what that means to you in the future, when those same dollars will buy less and less stuff, so to speak, is going to be an important consideration.
AC: Yeah I would say some – not all, but some, many, maybe even most – have pretty high fees. What sort of fees are in annuities and what should people look out for?
PL: Yes. So the fees of which you should be aware, really are associated with benefit riders that will come onto various products that are out there. And so that is the way for the insurance company to make possible that they have the financial resources with which to manifest that promise in the future. And so if you were to compare those particular all-in costs to, say, a traditional investment account, you’ll often find that the amounts associated with annuities are far higher. Now, some people look at that consciously and they say, “you know, it’s worth it for me to pay a couple extra points in order to ensure that the onus is on the insurance company. It’s the responsibility of the insurance company to manifest that payment and not me.” And so someone might see value in taking a sliver of their net worth, and saying, “I’m going to trade this portion of my net worth in exchange for an income stream, and I won’t have to be concerned about the value of the principal because that’s the insurance company’s problem, not mine.”
AC: And I think sometimes when you think about your own profile, if you’re the kind of person, when you have a lump sum – sometimes maybe you get a lump sum from whatever, you sold a rental property or something. And if you would be the likely person to spend every penny more quickly than you should, perhaps one of these lower cost annuities might work for you.
PL: That is a way in which to ensure that the entirety of that principal would not be consumed, because again, the insurance company is somewhat rationing those amounts to you over time, and so it’s apportioned year by year. And if you would find value in having that systematic payout occur, then yes, I could see an instance in which that would be valuable.
AC: Who else should consider annuities in your opinion Paul?
PL: I would say if there’s somebody who has very predictable living expenses, who is very concerned about large declines in the stock market, and they want to still have something that will provide them a meaningful payout in the future without having to be overly concerned about the way in which the market is going, that portion of your net worth- the assets that you do devote to something like this, can give you some peace of mind, because you’re essentially purchasing a guaranteed payout in the future that is not overly affected by stock market declines.
AC: Right. Paul, this is great information. I really appreciate you coming on the show. Any final thoughts or comments about insurance in general?
PL: I think that insurance plays a very important role in one’s financial plan and should not be ignored as far as the steps in the process, but you do have to be very careful about the way in which you design your policies, because it’s entirely possible for people to become insurance-poor, where they utilize the wrong product or the wrong strategy, and end up not even receiving the coverage they need at a far too high of a cost.
AC: So how can people find out more from you?
PL: They can be sure to visit www.WealthCG.com, they can speak with me directly and just learn a little bit more about their specific direction and their objectives in order to determine what particular arrangement is most efficient for their needs.
AC: Thanks, Paul. That’s Paul Lim. He’s a CERTIFIED FINANCIAL PLANNERTM with Wealth Consulting Group in San Diego. You can find him at WealthCG.com. Thanks again, Paul. Great information.
PL: Oh absolutely. Thank you, Alan.
JA: Wrapping up the show. Want to thank Paul Lim for hanging out with us for a couple of segments. You guys talked all about some really good stuff.
AC: It was actually quite informative I thought because we don’t normally talk insurance on this show.
JA: We should. We should talk a lot more about it.
AC: We should, because that’s part of a fully-rounded financial plan.
JA: Join us next week we get a lot more fun to go for Big Al Clopine, and I’m Joe Anderson, the show is called Your Money Your Wealth.
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