Over the course of our careers, insurance is the one expense that a client has the hardest time with. Products are confusing, insurance (can be) expensive, and the underwriting process is cumbersome. However, insurance plays such an important part of financial planning nonetheless. We have seen clients pass away at a young/old age, become disabled, and require long term care. Most of our clients listened to our advice regarding their insurance, and are incredibly gracious, particularly those who had to utilize their insurance – they will tell us to use their story as an example when speaking to other clients of the importance of insurance. However, I do have the outliers who do not follow such advice, and then have to deal with a very difficult situation when there is an insurance event – there is not only the emotional stress of the specific event (whether their spouse dies, becomes disabled, or has a long term care event, etc.), but there is also the financial burden that accompanies such stress. Our goal with this article (Part III) is to explain the importance of insurance, and how a CFP® can help you in making sure you have sufficient coverage and that it is tailored to you and structured properly.
If you missed Part I, we explain the differences between having a CFP involved in your financial planning vs. the various other types of advisors, as well as the ethical ramifications of which type of advisor you choose. In Part II, we discuss how a CFP can help you prepare for retirement (and if applicable your children’s college) by making the right choices now. In Part III, we will discuss the role of a CFP in devising an investment plan that fits your “personal benchmark.” Lastly in Part V, we discuss how a qualified CFP can assist you along with your estate planning attorney in devising a tailored, precise estate plan and also support you in titling your assets/beneficiaries appropriately.
Ugh…Insurance (The Stats Say)
Assuring that you are properly insured is just as important as making sure you are saving for retirement, yet many individuals do not see it this way. Do Americans feel they need to own life insurance? The answer may be “yes,” but the statistics do not support this claim. In a recent 2017 study by LIMRA, it was determined that 41% of US citizens do not own life insurance, and those that do, nearly a third of those that do only have coverage through work. 1 How about disability insurance? Similarly, according to the American Council of Life Insurers, 54% of non- retired households do not have disability insurance, and only 48 percent of American adults indicated they have enough savings to cover three months of living expenses in the event they’re not earning any income. What about long term care insurance? Only 13% of long term care expenses for home healthcare are paid by private long term care insurance. This is a huge problem in this world of uncertainty, and while you never believe it is going to be you, I would ask you to consider these three questions:
- Can you name anyone (friends, family, colleagues) that has died earlier in life than expected?
- Can you think of someone who has become mentally/physically disabled in their working years?
- Has anyone you know gone into a nursing home or is receiving care in their home?
We challenge you to consider each of these questions, and we can almost guarantee that you answered yes to all three questions. This is the very reason why it is prudent to make sure you are properly insured in all three areas. Thus, in a CFP’s® plan, there should most certainly be recommendations to purchase such insurance in all three areas, unless you already have sufficient insurance in place or you have such sizeable wealth where the insurance is not as needed. However, even if you in fact have such sizeable wealth, such insurance may still very well make sense given the leverage it provides. The only way one can determine such impact is running cash flow analysis.
The first need we address in our planning is life insurance. We will discuss with the client on a high level the different types of products and where they have the most impact, especially if the client is new to life insurance. For life insurance (and disability/long term care for that matter), the very first step we take when building our plans is to run cash flow models noted above with one major change – the client dies in the first year of the plan. This analysis should already take into account any life insurance the client currently has. This type of analysis will magnify a potential life insurance need immediately, and will demonstrate the importance of obtaining a specific dollar amount of death benefit – this provides objective proof to the client of such need. The type of insurance will differ according to the type of analysis we construct; the type of life insurance needed in the scenario noted above is for traditional purposes, I.E. survivorship. However, there are other types of analysis depending on the desired use of the life insurance – more on this later.
Let’s discuss an example of the type of survivorship analysis we will build/discuss with our clients. For instance, let’s assume a client, married, is 40 years old, is the sole breadwinner, has two children (6 and 4), and already has $1m of 20 year term insurance taken out in 2004. Let’s also assume that our client is on track for retirement but has not reached the point of being financially independent, and our cash flow modeling quantifies that our client will need to work until age 60 in order to reach financial independence. Let’s also assume our modeling tells us that there is a need of $1m of additional insurance today.
Thus, we know that our client’s insurance will run out when he is 50 years old, at which point the client’s children have yet to go to college. There are thus two issues here – our client will not have enough saved for retirement at age 50 (since our modeling tells us he has to work until age 60), and his children have yet to go to college so there is a large expense looming. However, at our client’s age 50, we would presumably nudged our client to save for retirement and save for his children’s college, so there is little need to keep the entire $2m of term insurance at that point. We can thus latter his term insurance – add $1m of additional 20 year term insurance today, and keep his current policy in place. This will maximize his life insurance protection ($2m) during the critical period in the client’s life (the next 10 years), at which point he should have more saved for both retirement/college. At his age 50, he will then allow his 2004 $1m term policy to lapse, and keep the $1m of 20 year term we purchased today to get him/his wife to his financial independence age 60, at which point his children will be through college as well. If you did not follow all of this, it is perfectly normal (and sort of the point) – insurance decisions can be very complex and this is why it is important to have a CFP® who can look at the entire picture when making insurance decisions.
Survivorship is just one possible use of life insurance. While term insurance makes perfect sense for survivorship needs, permanent insurance (insurance you pay for the rest of your life) may make sense in other scenarios, specifically if you want to leave a certain amount of assets for your children or to pay estate taxes. We have several clients who came to us with the desire to leave a certain amount of assets to their children. However, the uncertainties of life make it difficult to know whether such assets will be there when you and your spouse perish. Thus, permanent insurance can remove this uncertainty, and can also provide the necessary leverage to leave (if structured properly) estate tax free assets to your children, allowing you to spend down your assets without worrying that nothing will be left for your kids. There are several different types of permanent products, and each offers differing pros and cons depending on how the insurance is structured – it is best to have a CFP® with the necessary insurance experience to help you navigate this complex world. Lastly, insurance can be a great help in paying Uncle Sam.
When analyzing a client(s) disability, again, the very first step is to run cash flow analysis taking into account any disability insurance the client(s) currently has/have. For instance, in our plans, we run a model where our client becomes disabled tomorrow in order to see if he/she is fully protected from a disability event. Many of our clients have some form of disability through their group (work) insurance, but there are two important caveats when considering whether your group disability insurance is sufficient – taxation and what specifically is covered by the group plan.
First, if you become disabled and do qualify for protection under your policy, if you are not purchasing such insurance through your group plan and it is provided by your employer free of charge, your disability benefits will be fully taxable. Also, the majority of group plans we look at are very watered down – such insurance may not cover mental disability, may not provide “own occupation” coverage (or for a limited term), or require total disability before coverage kicks in. Own occupation coverage means that if you cannot work in your specific field (i.e. engineering, consulting, etc.), your policy would provide the corresponding disability benefits. Thus, if you do not have such “own occupation” coverage, and you become disabled and cannot work in your field but can flip burgers at McDonalds, your policy will not provide you with benefits. Also, some policies require total disability – meaning if you have a disease that is progressing slowly (cancer, multiple sclerosis, etc.) and you can work part time, your policy would not kick in.
After looking at the fine print of your group benefits (if you have them) and determining disability insurance needs through our cash flow modeling, we can determine whether or not private disability insurance makes sense. With private benefits, since you would be paying the premiums out of pocket, any disability benefits would be completely tax free. Also, the private individual policies generally are not watered down and will provide protection for own occupation, partial disability and mental disability as well. However, the rub is that this type of insurance can be quite expensive – thus, it is important to weigh the pros vs. the cons and a qualified CFP® should be able to assist you in doing so.
Long Term Care Insurance
Finally, there is long term care insurance. The first step should be to discuss the client(s) family history to see whether there is significant longevity in the family, and also whether there is a potential proclivity for prolonged long term care illnesses (Alzheimer’s, Parkinson’s, dementia, etc.). This will help guide us as planners as to the length of a potential long term care event. We then run cash flow analysis to determine the potential dollar amount of a long term care event. For instance, we generally will look at the effect on cash flow/retirement assets if there is a long term care need at age 85 for a certain amount of years (depending on family history), with a monthly long term care need of $6,000 inflating at 5%. This will provide a test as to whether your assets can withstand a significant long term care need.
If there is a need and there is not adequate long term care insurance in place, we will then educate our clients on the different options. In doing so, we have already provided the first option – self funding. For many clients, the expense is so astronomical that it wipes out a great portion of our client’s assets, and thus it is not always a feasible alternative. Also, it is important to explain what Medicare covers in retirement, as many clients confuse Medicare’s coverage in the case of a long term care need. Medicare generally covers health expenditures in retirement, but that is not necessarily long term care. In fact, Medicare really only covers 30 days in a nursing home (and a part of the cost of the next 60 days) – the client is on the hook thereafter. While Medicare may not provide the necessary coverage, the other option after spending down your assets is to spend down nearly all of your assets and go on Medicaid. However, this option should be avoided if necessary. Medicaid can have the effect of leaving the non-care spouse destitute (since its parameters requires the spend down of a client’s assets) and will provide only nursing home care at a “Medicaid facility,” I.E. the types of facilities most clients would prefer to avoid.
Another option is traditional long term care insurance, which will provide an inflation protected monthly benefit for a certain number of years, and will cover the four main types of long term care – nursing home, assisted living, home healthcare and adult day care. These policies typically spring in when two of the six activities of daily living (eating, bathing, dressing, toileting, transferring and continence) cannot be completed on one’s own, as certified from an independent doctor (not affiliated with the insurance company). There are of course drawbacks of such insurance – the annual premium may increase (if the state department of insurance agrees to such increase), and if you do not make use of the policy prior to the policyholder’s death, you can lose the premiums you have put into the policy over the years. However, this type of policy has premiums that are reasonable in nature and provide the necessary protection so that if there is a catastrophic long term care event, the client is adequately protected, as is their spouse.
There is another type of policy which may make sense, a linked benefit life/LTC policy. With this type of policy, you will receive a certain amount of long term care protection which looks very similar to traditional long term care insurance (inflation protected monthly benefit, covers the four main types of care, etc.). The long term care pool, which represents the amount of total benefits the policy will pay to the policyholder if there is a long term care need, will increase over time, thus providing the necessary protection when presumably you will need the care most – in your 80s/90s. The main difference is, unlike traditional long term care insurance, your beneficiary will receive a death benefit if you do not make use of the policy; this life insurance benefit will start out high and decrease over time, so that by the time you are in your 90s, they will receive slightly more than what you paid in premium. This policy is also a good option since you either put in a single lump sum or pay a set premium over 10 years (or less), thus you do not have to worry about a premium increase. The rub of this type of policy is its significant upfront cost, but if you can afford it, this policy makes perfect sense.
We hope that this article was helpful to you – as always, if you have any questions or would like to discuss any issues further please feel free to reach out to either of us.
Karen DeRose and Anthony DeRose are registered representatives of Lincoln Financial Advisors Corp.
Securities and advisory services offered through Lincoln Financial Advisors Corp., a broker/dealer (Member SIPC) and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. DeRose Financial Planning Group is not an affiliate of Lincoln Financial Advisors..