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“Perhaps the most valuable result of all education is the ability to make yourself do the thing you have to do, when it ought to be done, whether you like it or not; it is the first lesson that ought to be learned; and however early a man’s training begins, it is probably the last lesson that he learns thoroughly.” — Thomas H. Huxley, English biologist (1825 – 1895)

Often the biggest challenges most people face in reaching their objectives, financial or otherwise, are not external, but internal. For reasons we can’t entirely comprehend, great plans and good intentions are undone by our poor behavior.

We may blame it on a lack of willpower, a character flaw, or even a psychological condition; regardless the explanation, we find we are our own worst enemy. And even the best among us feel the frustration. Paul the Apostle once wrote:

“For what I am doing, I do not understand; for I am not practicing what I would like to do, but I am doing the very thing I hate.”

At one time or another, we’ve all been there. So if some of the biggest obstacles are internal and psychological, what can be done to fix them?

Hey, this isn’t a Dr. Phil column. There are a bunch of ways to resolve your issues, and a bunch of people to help you. But when it comes to achieving your financial objectives, there is one simple, practical thing anyone can do to improve their chances for success:

“GET IT IN WRITING.”

Seriously. Whether you use a pencil or a word processor, getting things out of your head and onto paper increases your chances of achieving your objectives. As Will Farrell would say in Anchorman, “It’s science.”

First, the physical act of preparing a paper document requires a greater level of engagement. Thoughts and words are vapors that can easily dissipate when new distractions emerge. But getting things in writing usually focuses thought and encourages clarity. And the physical act of writing (or, to a lesser degree, typing) engenders another level of reinforcement – your thoughts take on a visual aspect, and even acquire some “muscle memory.”

Second, getting it in writing leaves a trail, including one that is visible to others. Getting it in writing provides you with a definitive reference point, for the past and the future. You’re saying “on this day, here’s where I was, and there’s where I wanted to be.” And when you put it in writing before a spouse, partner, or advisor, that document becomes a common point of reference. It can be used by others to understand you, help you, remind you, and challenge you.

When it comes to my finances, what should I get in writing?
1. Write (or type) your present financial condition. Most people believe they have a general sense of their financial status. They can tell you if they’re current with their bills, if they’re saving money, and roughly how much they earn in a year. But move beyond the generalities, and you’ll find most people don’t have a good grip on what’s really going on – it’s all sort of fuzzy.
Consequently, it’s difficult to make new financial decisions with any degree of confidence. Are you sure you can afford a new car payment? What about re-financing? If you start a new life insurance program, will you be able to make the premium payments? When you’re not sure, you either make guesses or put off deciding, and neither of those options have a high success rate.

Imagine what could happen if you committed to preparing an accurate cash-flow statement every month. First, just attempting it would improve your financial organization. Checks would be written from the correct account, receipts would be kept – if nothing else, you would begin to have a paper trail.

For some, making an accurate monthly cash-flow statement might be a challenging task. It might take a lot of effort to set up the process and sort through your piles. If you find a cash flow statement requires too much work, start by picking one or two financial categories that need the most attention, like tracking your debt reduction progress, or monitoring the monthly accumulations in your savings and investments. Just collect some accurate information, and write it down.

2. Write (or type) your financial objectives. In general, everybody wants more money. But how much do you want, and for what purpose?
Everyone knows the job of sales and marketing departments is to convince consumers to buy their products. And most people understand that sales and marketing experts use a range of psychological ploys, both blunt and subtle, to compel people to buy. If you’re not clear on what you really want, you are much more susceptible to being sold something else.

Writing down what you want to accomplish makes it easier to resist the daily bombardment of sales pitches. You’ve embedded your own financial values, which allows you to see which items align with your objectives and which ones don’t. Clearly articulated objectives help you recognize that a flat-screen TV priced 50% off is a great deal – but only if you really want a flat-screen TV.

3. Write (or type) your plan of action. The default option for contemporary American culture is often the tyranny of the urgent; what’s immediately in front of us demands our attention. We deal with one momentary crisis after another, then either collapse in exhaustion or seek some recreational escape. And then we do it all over again the next day.

At some point we may notice the track we thought we were on is really a treadmill, but those moments of recognition are fleeting; there are new items hitting our in-box, and each one seems to be stamped “urgent.” Even if you decide to get off one treadmill – by changing careers, relocating, etc. – you may find yourself on another treadmill, running just as hard, yet still staying in the same place. Taking the time to write down a course of action in order to achieve your financial objectives gets you off the treadmill, first to reflect on, and then to redirect, your activities.

Does getting it in writing really work?
Intuitively, most people know getting it in writing would help them make progress. Of course, there are caveats. Making a direct cause-and-effect connection between writing it down and success is difficult because so many other factors are involved. You may have some financial issues that aren’t going to be resolved by simply writing them down (like back taxes to the IRS), but the very act of deciding to get your financial life in writing means you’re giving it a higher priority and a higher likelihood of success.

Thomas Stanley and William Danko are the co-authors of the Millionaire Next Door. Released in 1996, the book was a comprehensive study of the character traits and actions of American millionaires, particularly those the authors classified as PAWs – prodigious accumulators of wealth. Stanley and Danko found that the most successful millionaires spent a significantly higher percentage of their time reviewing their financial condition and planning their next financial action. Both activities required them to obtain accurate information, and develop clear plans of action – in some fashion, you could say they were “getting it in writing”.

You can find a lot of information about financial recording and goal-setting. Those details may help you, but the basic issue is this: When it comes to your finances, do you have it in writing? If you don’t, you have a simple question to answer: Are you going to get it in writing?

•   HOW MUCH OF YOUR FINANCIAL LIFE IS IN WRITING?

•    DO YOU HAVE A MONTHLY CASH FLOW STATEMENT?

•    DO YOU HAVE A WRITTEN LIST OF FINANCIAL OBJECTIVES?

•    DO THE FINANCIAL PROFESSIONALS YOU WORK WITH HAVE COPIES OF YOUR WRITTEN INFORMATION?

•    OR… WOULD YOU LIKE TO HAVE A FINANCIAL PROFESSIONAL HELP YOU TO GET IT IN WRITING?

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IDEAS THAT ENDURE

Ideas matter. The value of every statistic, every calculation, is determined by the ideas and philosophies to which the numbers are applied.

In the past several years, several trade publications have republished a short commentary on the essential elements of life insurance. Originally titled “Just a Life Insurance Policy,” this is a brief yet powerful statement of the timeless ideals that make life insurance a financially relevant product.

The article, probably written at least 50 years ago, was resurrected by Marvin Feldman, a prominent Ohio insurance agent and industry authority, in 2006. Feldman notes in an accompanying commentary that he was unable to identify the original author, and while the article can be found in a number of publications and websites, none of these sources cites an author either. Feldman also acknowledges he had to reword some of the article because the original syntax reflected a different era. Still, the financial and social concepts at the heart of life insurance remain relevant to the challenges and aspiration of today’s world.

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If the early announcements are any indication, 2010 could be the Year of the Roth IRA conversion. How do we know this? Well…  

An August 27, 2009 article from Morningstar (news.morningstar.com) calls the chance to convert to a Roth IRA “the planning opportunity of the decade.”  

In an article for the Detroit Free Press, on November 19, 2009, Susan Tompor reported “the Roth IRA conversion is definitely building buzz.”  

On November 24, 2009 Forbes.com led with “Get ready to be bombarded with information about Roth IRA conversions.”  

Admittedly, three sources by themselves do not make a trend, but they are representative of the general media buzz. What’s the big deal? Here’s the story:  

Roth IRA retirement plans have the following features:  

• Eligibility to make deposits to a Roth IRA is dependent on your income level.
• Deposits receive no tax deduction.
• Once you have held the Roth IRA for at least five years, and are at least age 59 ½, withdrawals are tax-free.
• There are no required minimum distributions from a Roth IRA at any age.
• Roth IRA assets can be left to children or other heirs.

A change in tax law, effective 2010, broadens the ability of owners of Traditional IRA accounts to convert them to Roth accounts. This is what the fuss is all about.  

Beginning in 2010, the income limits on Roth IRAs will be eliminated, so investors of all income levels will be able to convert their Traditional IRA assets to Roth IRA assets. This is significant, because prior to this change, only those with a modified adjusted gross income (MAGI) of $100,000 or less could execute a conversion.  

Reasons to consider a conversion to a Roth IRA
You may pay less in taxes. If you convert your Traditional IRA balance to a Roth IRA, you’ll pay taxes on the amount being converted. But because of recent market volatility, your account balance may be lower than it was when the market was stronger. In effect, you may pay less in taxes.  

If you convert in 2010, you have the option to spread the tax burden over two years. When you convert to a Roth IRA, you will have to pay taxes on any deductible contributions and investment earnings. But, if you make the conversion in 2010, you can pay the taxes in 2010 or you can spread the taxes over the subsequent two year, 2011 and 2012.  

There are no required minimum distributions. Unlike Traditional IRAs, Roth IRAs do not require that you take minimum distributions when you reach age 70½. That means your account can continue to grow tax-free until you – or your heirs – are ready to withdraw the money.  

Reasons to not convert to a Roth IRA
Money. The Roth conversion isn’t a freebie. In order to convert to a Roth IRA, you must pay income taxes on the Traditional IRA as if you had cashed out. If you pay the tax from funds in the IRA account, it will decrease the transfer amount and diminish the tax-free growth that might occur over time. Further, if you use funds from the IRA and are younger than 59 ½, the amount used to pay the tax may be subject to an early withdrawal penalty. “A Roth conversion is expensive. There’s a big up-front cost to doing this,” Tim Steffen told Tompor. Steffen is a financial and estate planning manager for Robert W. Baird & Co. in Milwaukee.  

You think you’ll be in a lower tax bracket in retirement. If your financial situation is such that you anticipate future income will be much lower than it is today, paying the tax now may not make sense.  

You have a short time until you intend to withdraw the funds. Money transferred to a Roth IRA must remain in the account for five years, or it will lose its tax-free withdrawal status.  

 

Another twist:
What might happen to tax rates in the future? In the Detroit Free Press article, Garvey points out that the current federal income tax rates expire at the end of 2010. If Congress takes no action to renew these rates, the highest tax rate would jump to 39.6%, up from 35%. And with the deficit ballooning, it’s not unthinkable that Congress might authorize even higher marginal tax rates.  

The conversion decision is “a little more art than science,” according to John Carl, president and founder of the Retirement Learning Center in Brainerd, Minnesota. “How much [in] taxes are you willing to fund now for a lifetime of tax-free income?”

IRA Help is Everywhere. To assist you in your decision, many financial companies are offering Roth Conversion Calculators on their web sites. But this is a transaction that probably can’t be decided by answering a few questions or entering some numbers in an on-line calculator. A consultation with your tax advisor is a must, as well as the financial professionals who will be handling the conversion paperwork.

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A November 11, 2009 article in the Wall Street Journal titled “529 Plans – More Parents Are Becoming Dropouts” notes diminished participation in what “have been pitched as the ultimate college savings vehicle.”

In brief, 529 accounts allow investors to contribute after-tax dollars into an account that typically offers a range of mutual funds and other investments. Distributions and earnings from the account are tax-free as long as they’re used for higher education. 529 plans are sponsored by states, and their investment options and fees can vary widely.

Why the decline in participation? There are several external factors: Many individuals have experienced a decline in their ability to save, due to unemployment or underemployment; they just don’t have the money to save. In addition, the stock market collapse triggered some high-profile fund implosions, complete with accusations of mismanagement, exorbitant fees and lawsuits.

The nature of government programs
But the internal design factors of 529 plans may also account for the decline in participation. Like many other government-sponsored savings programs, 529s are singular, stand-alone vehicles that “don’t play well with others” from a financial standpoint. These government sponsored programs create a separate bucket with a new number or acronym – IRA, 401(k), HSA, 529, etc. – and once the money goes into the bucket, it is expected to leave the bucket under very specific circumstances, such as retirement income, medical expenses, or a college education. It is difficult to transfer funds from one bucket to another, and penalties are assessed for any alternative use of the funds. These restrictions can make it difficult to integrate a government-sponsored plan into the larger financial picture, especially when money is tight.

A tax benefit, but at what cost?
The principal incentive with government-sponsored savings plans is usually some form of tax break. But as the Journal article noted, “in today’s jittery investment environment, some consumers are forgoing the tax benefits of a 529 to retain the flexibility to use the money for whatever they wish.” Tax breaks are legitimate financial incentives, but especially in tight economies, many consumers are finding that financial flexibility and control hold a stronger attraction. As Michael Singer, a 49-year-old teacher who recently lost half of his value in a 529 account, told the Journal, “Any new money going to my kids’ college education is going into something that I manage myself.”

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“The wise man does at once what the fool does finally.” – Niccolo Machiavelli

“Sully” is Capt. Chesley Sullenberger, III, the pilot of US Airways flight 1549, who flawlessly executed an emergency landing of his Airbus A320 in the Hudson River on Jan. 15, 2009, preserving the lives of all 155 passengers on board. As a result of his heroic response, Sully became an instant celebrity.

Unlike many media-manufactured celebrities, the individual behind the deed turned out to be just as impressive. Speaking with genuine modesty, Sullenberger credited his training and vocational commitment as the elements that prepared him to perform coolly under pressure. The public’s positive response to Sullenberger’s action and his explanations created a demand for more information. This summer Sully collaborated with Wall Street Journal writer Jeff Zaslow to write Highest Duty: My Search for What Really Matters. The book, released October, 2009 not only recounts the details of the emergency landing, but devotes significant time detailing the upbringing and character-shaping events that equipped Sullenberger to handle the challenge of safely landing a plane on the water with both engines out.

For Sully, the ability to perform the unexpected under pressure was the result of a lifetime of preparation. In an October 14, 2009 WSJ column about writing the book, Zaslow discusses Sullenberger’s diligence in preparing for circumstances he might face as a pilot. This diligence was more than safety checks or reviewing accidents experienced by other pilots. Sully also believes one aspect of preparing well is having the right mindset. He tells Zaslow:

“In so many areas of life you need to be a long-term optimist, but a short-term realist.”

When you consider it, being a long-term optimist and short-term realist is a pretty solid financial philosophy as well. Things may happen, some of them bad, some of them good. Some issues may be hazardous, other benign. But on the whole, if the short-term items are handled appropriately, the long-term prognosis is over-whelmingly favorable.

This perspective usually resonates with people; at a gut level they know it is true. But quite often, other perspectives on personal finance subtly influence us to ignore or override this approach, particularly the short-term realist part of the equation.

Here’s an example: When asked, what do most Americans state as their primary financial objectives? The frequent answer: “Retirement.” This is certainly a worthy long-term objective. But applying Sully’s mind-set, what’s the best way to prepare for positive long-term success? By addressing the short-term issues realistically.

Realistically, one of the best ways to sustain a long-term saving plan is to first establish some cash savings, typically equal to three to six months of income. A financial cushion can absorb unexpected expenses without requiring either an end to long-term saving or expensive withdrawals from a retirement plan.

Realistically, one uninsured incidence of disability longer than 30 days could seriously delay or derail any retirement plans. Implementing a disability income replacement program solves this short-term challenge.

Realistically, the best time to buy life insurance is when you are young, healthy and most insurable. If circumstances deny you the time to build a retirement fund, life insurance steps in to replace your earning and saving potential.

Realistically, the longer debts remain outstanding the greater the long-term lost opportunity costs that compound against you. Planning (and acting) to become debt-free is a short-term action that will undoubtedly deliver long-term dividends.

Realistically, some of this might sound boring, and not very sophisticated. But when you consistently address your short-term economic realities, it makes you a long-term optimist.

DO YOU WANT TO GIVE YOUR LONG-TERM PROSPECTS THE BEST CHANCE TO SUCCEED?

BE DILIGENT ABOUT YOUR SHORT-TERM FINANCIAL REALITIES.

DOES PERSONAL FINANCE MEDIA “FLIP” SULLY’S PERSPECTIVE?

Just for fun, check the covers of the most popular personal finance magazines at your local bookstore rack. What do you see? How about these headlines, culled from current issues:

•    “Put Off Retirement? No Way!”
•    “The Best Time to Invest in a 401(k)? Now!”
•    “How to Be a Better Investor”

A sizable chunk of words, column space and conversation in the personal finance media is devoted to long-term activities, like investing and retirement planning. Nowhere to be found in the headlines or as a lead story: debt, disability, life insurance, emergency savings. Even the things to do “now” (i.e., the supposed short-term things that require immediate action) are really long-term items. Why don’t the short-term realities get more ink?

Perhaps personal finance magazines figure most of their readers have already taken care of their short-term financial realities. But any quick study of Americans’ financial habits will find most of them underinsured, deficient in savings and carrying significant debt.

Another possibility is the feeling that long-term financial issues, like saving for retirement, must be addressed even if the short-term realities aren’t under control: better to start making deposits in a 401(k) at an early age and possibly have to borrow from the account than wait until the short-term issues, like debt and insurance, are resolved.

It’s not that the majority of the financial media is against savings accounts, insurance, or debt reduction. Probably the biggest reason the short-term financial issues receive less attention is because they aren’t attention-getting. There are no extraordinary gains, or tantalizing potential fortunes. The short-term issues are not often inspiring or heroic.

Interestingly, Sully acknowledges the ordinariness of his own situation, saying he is not comfortable with being called a hero for his actions. “A hero runs into a burning building,” he says. “Flight 1549 was different because it was thrust upon me and my crew…I don’t know that ‘heroic’ describes that. It’s more that we had a philosophy of life, and we applied it to the things we did that day.”
Sully received correspondence from people saying similar things. One that he found most touching said:

“It’s clear that many choices in your life prepared you for that moment when your engines failed.

“There are people among us who are ethical, responsible and diligent. I hope your story encourages those who toil in obscurity to know that their reward is simple – they will be ready when the test comes. I hope your story encourages others to imitation.”

Heroic incidents, including financial successes, are inspiring. It is good for us to know about them. But much of the success we see has a foundation of diligence and preparation. And it wouldn’t hurt if the process of laying a successful foundation received a little more press.

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“Unfortunately, no one can be told what the Matrix is. You have to see it for yourself.” – Morpheus, from The Matrix

In some circles, a million dollars is chump change; it takes only minutes for our government to spend that much, and big corporations have many millions pass through their hands in one day – even during a recession.

But for most individuals, a million is still a big number when it comes to their personal finances. For a long time (probably since the beginning of the 20th century), becoming a millionaire has been a financial milestone for Americans. Even though inflation has dramatically changed the purchasing power of a million dollars, the number is big enough to still have significance. If you have account balances – in the bank, in your portfolio, in your 401(k) – that add up to $1,000,000, prevailing wisdom says you’re doing pretty well.

There are a lot of real-life variables involved in accumulating $1 million: career choice, physical health, personal lifestyle, geographic location, the general economic climate, even luck. Ask 10 millionaires for the key ingredients in their success, you’ll probably get 10 different answers.

The real-life variables probably have the greatest impact on whether or not someone will become a millionaire, but some of the mathematical variables – and the conclusions that can be made from them – are interesting as well.

Entering the Million-Dollar Matrix
There are three mathematical variables involved in accumulating $1 million:

• Time
• Amount deposited; and
• Rate of return

These three variables are interrelated. The Million-Dollar Matrix shown below is a way to illustrate how changing one item can speed up or slow down one’s progress toward reaching the million-dollar milestone. And a deeper look indicates that different variables have greater importance at different points in the matrix.

Here’s an example to help you use the matrix. Suppose you want to know the monthly deposit that would be needed to accumulate $1 million in 20 years. This information is found in the second shaded column from the left (the one that says “20 years” at the bottom). If you earned a steady annual rate of return of 8% for the entire 20-year period, a deposit of $1,686 would be required each month to realize a $1 million accumulation. If the projected rate of return increased to 12%, the deposit requirement would decrease to $1,001/mo. If the projected rate decreased to 4%, the deposit would have to increase to $2,717/mo.

Remember: The Matrix is not real life – it’s just math. In real life, the financial variables aren’t static. Rates of return don’t stay the same year after year, so any comparison to actual returns is going to differ (although average rates of return over a specific period will correlate with a steady rate of return over the same time period). The matrix doesn’t make any recommendation about what type of financial vehicles will be used to generate these projected returns, doesn’t factor in any investment risks that might be part of financial instruments that offer the possibility of higher rates of return, and doesn’t consider how taxes might impact any of these decisions.

However… the math of the Matrix prompts some interesting thoughts about accumulation. Such as:

The shorter the time period, the greater the emphasis on the size of the deposit. Look at the 5-year column. If you’re starting at zero, and plan to accumulate $1 million in 5 years, it’s all about the size of the deposit. Sure, there’s a difference between depositing $12,123 each month at 12% and $15,835 at 2%, but the 12% earning deposit requirement is a 23% reduction over what’s needed with a 2% annual rate of return. Compare that spread with the 12%-2% difference at 40 years: $84/mo. is 94% less than $1,359/mo.

Look at the comparisons between the 2% and 12% annual returns at the 10- and 15-year periods. While the monthly requirement is almost halved, you still must consider whether the additional investment risk required to earn 12% per year would be worthwhile, especially for extended time periods. If you choose to project a lower rate of annual return (say 6%), the deposit numbers don’t move very much. At any time period less than 20 years, the main ingredient in accumulating $1 million is funding. You must be able to save a lot of money in a relatively short period of time.

With longer time periods, the challenge is consistency, both in deposits and rates of return. As the time period gets longer, the deposit required gets smaller and increased rates of return deliver exponential results. Less money can do more when the time is long and the return is high.

But in longer time frames, it’s easy to see how real-life issues could undo the math. Question: For a responsible, future-oriented 25-year-old, which would be harder: saving $84/mo. for 40 years, or earning 12% a year for 40 years? Answer: Both.

Can you imagine making a monthly savings deposit for 480 months and never missing a payment? Can you imagine an investment that delivers 12% annual returns for 40 years without a hiccup? Math says it’s possible, real life says no. (See the blog post “Buy-and-Hold: Hanging On, or Gone for Good?”)

If the higher long-term rates of return are not realistic, this means 40-year savers should set aside more than $84/mo. At a 6% annual rate instead of 12%, our typical 25-year-old needs to save $500/mo. – for 40 years. That’s a big challenge, for anyone, let alone most 25-year-olds. How many people keep anything – the same job, the same house – for 40 years?

If you think you’re getting a late start on accumulation, be cautious about “catching up” by seeking higher returns. According to the Employee Benefits Research Institute’s 2009 survey, released April 16, 2009, almost half of American workers 55 and older reported their savings and investments were less than $50,000 – and 30% said they had less than $10,000. These are people with a short accumulation horizon, and most of them aren’t close to accumulating $1 million.

Given their circumstances, some older accumulators may feel their only hope is to swing for the investment fences, hoping to hit a financial home run. But remember the math is in the Matrix. A few percentage points in higher returns isn’t going to deliver as much impact as figuring out how to set more aside. Further, if you lose money attempting to achieve a higher return, you have a shorter time to recover the loss.

It’s worth remembering that most Americans at all income levels currently experience their peak earning years between the ages of 45 and 54. This peak earning period has steadily increased over the past 20 years, and there are indications this trend will continue. So, while the monthly deposit to achieve a $1 million dollar accumulation in a short time may seem steep, it’s also possible that your ability to save larger amounts may be ramped up as well.

Where Are You in the Matrix?
Even if the Matrix isn’t real life, the math gives you some things to think about.

As mentioned earlier, saving starts with funding. Once they understand the format, almost everyone who enters the Matrix gravitates toward a time frame that matches their current age and projected retirement. A 40-year-old checks out the columns for 20, 25 and 30 years. A 55-year-old looks at the 10-year column, or if he doesn’t have much savings, scans the 15 and 20-year columns. The rate of return matters, but mostly, you’re checking to see if you can match the required deposits.

This is a natural and productive starting point. “How much are you saving each month?” is a pivotal question, and the Matrix gives you some perspective on whether you ought to be looking to save more, depending on your objectives and circumstances.

Next, there should be a consideration of what you believe is a reasonable rate of return. During the boom years in the financial markets over the past two decades, it was common to believe averaging double-digit annual returns was realistic. Now…well, most people are less optimistic. It’s not that double-digit returns are out of reach, it’s the awareness that they may also be accompanied by double-digit losses that tends to dampen expectations – or bring them to more realistic levels.

Assuming a lower rate of return means higher funding levels will be required to reach your objectives. That can be a bummer, because more money allocated to saving for the future means less allocated to spending today. However, overfunding your financial objectives and underprojecting your rate of return is better than the reverse – underperforming and underfunding would be the worst of both worlds.

Making The Matrix Work For You
In terms of accomplishment, accumulating $1 million by saving is still a big deal. Most millionaires didn’t become millionaires by saving. They did something, owned something, built something, or sold something to acquire their millionaire status. So while it’s mathematically possible for a middle-class American to save his way to $1 million, it’s a project that requires diligence and discipline – and one that will most likely take a minimum of 15-20 years to accomplish.

If you’re looking for help in the million-dollar Matrix, ask yourself this question: Would you rather work with someone who helps you find a way to

a.)    Save $2,568/mo. for 25 years at 2%, or
b.)    Save $1,001/mo. for 25 years at 12%

The answer to this question speaks to our perception of that loosely defined term “financial planning.” Most often, the phrase is used when discussing investment strategies, but there are other possible applications. For example, planning could include strategies for debt structuring, budgeting, tax planning or risk management. If those strategies make it possible to save more money, they are certainly just as valuable, maybe more, than those that focus on trying to squeeze out higher returns.

In general, it is easier, and less risky, to earn 2% than 12%. If a financial professional can show you (through better management of debt, expenses, taxes, etc.) how to meet the demands of the Matrix through higher deposits at lower risk, your chances of succeeding are better than the reverse. The TV stock pickers and newsletter writers get a lot of press when they hit a home run, but you may find that financial efficiency combined with steady, conservative returns gets the job done just as well.

After all, you don’t care where you enter the Matrix. All that matters is if you leave with a million dollars.

WHERE ARE YOU IN THE MATRIX?

IS YOUR FOCUS ON HIGHER RETURN, OR MORE SAVING?

COULD YOU BENEFIT FROM GREATER FINANCIAL EFFICIENCY?

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As a way to encourage individuals to save for retirement, the Employee Retirement Income Security Act (ERISA) of 1974 established the first Individual Retirement Accounts (IRAs), which eventually gave birth to other tax-favored retirement plans such as 403(b)s, 401(k)s, SEPs etc. The basic format for these qualified retirement programs is a tax deduction on deposits and tax-free accumulation; distributions taken in retirement are then taxable as ordinary income.

Over the past three decades, the ongoing logic for participating in qualified retirement plans has been straightforward. Because retirement is projected to be a period of lower income, distributions taken from IRAs or similar accounts will be taxed at a lower rate. Thus, receiving a tax deduction now (against a higher tax rate), and paying tax later (at a lower rate) is a financial advantage. At some time, every proponent of qualified retirement plans has intoned “You should have an IRA because you’ll be in a lower tax bracket in retirement.”

The financial advantage of IRAs was predicated on several present-event biases. First, that income tax rates would remain the same. Second, that retirement living expenses would be less than while one was working. Over time, both of these variables have changed. Income taxes have both increased and decreased for segments of the population. And retirement expenses, especially medical costs, have dramatically increased. In short, what was thought to be always the same has changed.

In response to these on-going changes, government has continually tweaked the rules, trying to keep IRAs and other qualified retirement accounts beneficial for participants. But often, even the best government responses are a step slow.

Take for example the recently implemented one-year reprieve in required minimum distributions (RMDs). In order to capture some of the tax eventually due on IRAs, previous IRA regulations required individuals over age 70½ to make mandatory minimum withdrawals from retirement accounts each year. But in December 2008, lawmakers suspended this provision for 2009, hoping to give investors a chance for their “accounts to rebound after a brutal year in the markets,” according to a February 11, 2009 Wall Street Journal article (“New IRA Law Bewilders Investors”). Instead of being forced to sell investments to take their RMD, account holders will be able to sit tight and wait for a possible recovery of their account values.

However, retirees still had to take their RMD for 2008 or face a stiff penalty from the IRS. Thus, in a year when major US stock indexes had declines of 30% or more, account holders still had to sell out at low prices to meet the RMD requirement. In other words, a one-year suspension of RMDs might have been more beneficial last year instead of this one.

In addition, the one-year RMD suspension has created both aggravation and confusion for account holders. Financial institutions holding IRA funds are scrambling to establish procedures for contacting RMD recipients (some are contacting only those receiving monthly checks, others not planning any contact until April, 2009, and still others are automatically suspending payments). Company administrators of 401(k)s are trying to determine if they first must amend their plan documents. In addition to the unresolved detail, there is uncertainty as to whether the reprieve will be extended for 2010.

Because IRA policy is often present-event driven, more changes – and more uncertainty – seem likely in the future. (Although assuming that government will “always” be a step behind might be a present-event bias as well. Maybe one day, the politicians will get it right in advance.)

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The bottom-line objective of any individual financial program is to provide an ongoing stream of income to meet the necessities and pleasures of life.

Market values for different assets might add up to significant net worth, but net worth doesn’t buy groceries, pay the bills or take you out to dinner; your income does. People pray “give us our daily bread,” not “give us asset appreciation.”

This post emphasizes the primary position of generating income in your financial programs, because income is what makes all other financial decisions possible.

How Long Can Your Human Asset Keep Paying Dividends?

When it comes to asset values, we know the numbers are ugly. How ugly?

• In the 2008 calendar year, the S & P 500 stock market index registered a 37% decrease, its worst calendar year performance since 1931. From January 1, 2009 to March 19, 2009 the index has declined an additional 15%.

• Meanwhile, the Federal Housing Finance Agency reported on February 24, 2009 that home prices dropped 8.2% from a year earlier, the largest annual decline on record since 1991.

• In total, the Federal Reserve reported that the wealth of American families plunged nearly 18% in 2008 – a loss of net worth estimated to be around $11 trillion.

But guess what? As securities and real estate markets have taken a pounding, another asset has returned to prominence. Featured on the cover of the March 23, 2009 paper version of Time magazine is the headline “10 Ideas Changing the World Right Now.” And according to Time, the No. 1 world-changing idea is…

…Jobs Are the New Assets.

That’s right; you – and your ability to deliver a steady income by working – are the “new” asset class that can make a difference during this down economy. Here’s an excerpt from the article, written by Barbara Kiviat:

“Houses and stocks – those were the things we paid attention to, the things that gave us the confidence to be good American consumers (Hello, home-equity lines of credit). At the same time, the percentage of income we saved dropped and dropped and dropped – until, thanks to the power of credit cards and other debt – it went negative in 2005. That was neatly explained away by the ‘wealth effect’: we spent money we didn’t have because we felt – and technically were – richer because of our assets.

All the while, we blissfully ignored a little concept economists like to call human capital. The cognition you’ve got up there in your head – your education and training – it’s worth something. We can extract value not just from our homes and our portfolios but from ourselves as well. The mechanism for extracting that value? A job. ‘The income you earn from working is like the stream of interest income you might get from owning a bond,’ says Johns Hopkins University economist Christopher Carroll. ‘Think of it as a dividend on your human wealth.’”

While it might make for nice headlines, identifying human capital as the core of financial prosperity isn’t a new idea. From ancient cultures that penned proverbs extolling the value of work (“Do you see a man skilled in his work? He will stand before kings…”) to 20^th century champions of free enterprise and capitalism like Ayn Rand (“Wealth is the product of man’s capacity to think.”), human capital has always been recognized as the key ingredient in creating wealth. Real estate doesn’t gain value on its own – it has to be developed. An increase or decrease in stock prices ultimately reflects the decisions and productivity of the people in the company – both the employees and owners.

Given the media infatuation over the past decade with other assets, the article provides some much-needed financial perspective. Too often the most overlooked or undervalued financial asset is you and your abilities. Your ability to produce a regular income makes you a powerful dividend-paying asset, and it’s the type of asset that satisfies the basic objective of an individual financial program: to provide an ongoing stream of income to meet the necessities of life – and hopefully afford some of the luxuries as well.

When stock market and housing values were soaring, some people lost this focus on income production, because prevailing sentiment said you could always turn value into income at a later date by selling or borrowing against the assets. But when values decline and borrowing standards tighten, the assets don’t have the same convertibility.

Building Up Your Human Capital
This sounds obvious, but in a time when other asset classes are faltering and the economy is struggling, steady income from a job is critically important to your long-term financial well-being. And like any other business that wants to remain profitable, your human capital must remain competitive in the market place. You may need to consider an investment in continuing education, or an upgrade in your technology skills. And “under-employment” – i.e., working in a position below your qualifications – may be better than not working, because of the future opportunities that may arise from connections with other productive people.

But even if you remain employed, there are other threats to your human-capital dividend production. Your human capital doesn’t last forever. At some point, you may get tired or break down. Eventually age takes some or all of your productive capacity. So unless you die young, it isn’t reasonable to expect you will remain fully productive for your entire life. This is the biggest financial challenge in using human capital to provide an ongoing income: At some point, there will need to be a transition from income/dividends from your human capital to income/dividends from other capital. But when?

The Longevity of Human Capital
The statistical realities of human capital in developed nations are eye-opening.

First, consider life expectancy. According to the Social Security Administration, a 40-year-old American male has an average life expectancy of another 37.28 years. (See Fig. 1 for life expectancies at other ages). And the older you are now, the greater your life expectancy – while an average 40-year-old male can expect to live until 77, an average 60-year-old male can expect to live to 80.

But there’s a distinction between being alive and being healthy enough to work. In most cases, people will not be able to work as long as they are alive. To account for this distinction, longevity statisticians have developed a Healthy Life Expectancy (HALE) calculation. HALEs (pronounced haleys), are defined as the average number of years that a newborn can expect to live in “full health,” and are used by statisticians to adjust life expectancies for the amount of time spent in poor health.

The World Health Organization (WHO) provides a HALE calculation for each country in the world. In the United States, the current HALE is 67.0 years for males and 71.0 years for females. When compared with current life expectancies for newborn Americans, the difference is 8 years for males and 9 years for females. From this data, it might be possible to consider average human capital to be “used up” 8 or 9 years before the end of one’s life.

But this data is for newborns – those born today. Other current information, while not providing an apples-to-apples comparison with the HALE data, is even more sobering…

The following statistics come from reports issued by the Urban Institute in December 2008 and February 2009:

• About one-third of all Americans develop a health-related limitation in their fifties and sixties.
• Four in 10 workers in their fifties have jobs with some physical demands, which they might not be able to meet as they grow older.
• Even for workers in jobs that aren’t strenuous, health problems can keep many from working. More than a quarter of adults age 65 to 69 have a health problem that limits the work they can do.
• As a result, 37% of American workers do not retire on their own timetable, but rather are forced into retirement due to layoffs, illnesses or injuries.

In other words, human capital, while the key to all wealth production, is a fragile asset. It needs to be protected, and eventually, must be replaced by other assets.

Protecting Your Human Capital
Some of the best protection for your human capital is simple self-maintenance. Eating sensibly, exercising, and avoiding bad habits are not guarantees of a long HALE, but all evidence points to a clear correlation. Good health is essential to maximizing the value of your human capital. The longer you can produce an income, the greater the likelihood of financial security.

The rest of your human capital protection issues are best handled through insurance.

In the insurance business, there’s an old analogy that compares your human capital to a business machine that generates thousands of dollars in income per year. Considering its value, it makes sense to insure the machine (you) for direct damages, as well as coverage for lost income if the machine were broken or worse yet, if it were destroyed. Life, health and disability insurance exist to protect against the risks to your personal wealth-generating machine.

If you are unable to work due to sickness or injury, health insurance is designed to cover “repair” costs, as well as provide an ongoing income during the period you are “out of service.” If your injury or illness is more long-term, disability insurance helps supplement your lost income. And if you are no longer able to provide for your dependents because of death, life insurance is designed to provide assistance for final expenses and ongoing income.

Because a major medical incident has the potential to cause the most immediate financial damage, health insurance seems to be a front-and-center issue for workers, employers and politicians. But the current obsession with solving the health-care crisis shouldn’t obscure the need to address individual disability and life insurance issues as well.

Don’t Undervalue Your Human Capital
A lot of space in the popular financial press is consumed with dissecting the fallout from the decline in asset values. Experts are trying to determine when the stock and real estate markets will rebound. Individuals are trying to decide if they should continue to buy-and-hold or cash out. These are important issues and legitimate financial concerns because assets, cash, stocks, bonds, and real estate have a place in your financial life.

But perhaps current events are also helping to reshape their importance of these types of assets in relation to the essential position human capital holds in every individual’s financial program. Developing and protecting your human capital sets the stage for long-term financial success – in all types of economic conditions. More than any prognostication or rearrangement of your other assets, your human capital is the one asset most likely to carry you through tough economic times.

This awareness should prompt some assessment of the condition of your human capital.

• Should your human capital be upgraded through education or the acquisition of new skills?
• Is your human capital healthy, or should you implement a better maintenance plan?
• Have you adequately protected your human capital?
• Is now a good time to use other assets to improve your human capital?

WHEN OTHER ASSETS START TO SLIDE, YOU WANT TO BE SURE YOUR BEST ASSET IS ON SOLID GROUND. DOES YOUR HUMAN CAPITAL NEED AN “ASSET CHECK?”

A Longevity Annuity as “Income Insurance”

Here’s an intriguing financial transaction:
A 60-year-old man places a small portion of his retirement savings in an annuity that will produce a guaranteed income once he reaches an advanced age, say 85. Based on current assumptions, here are some details: On a deposit of $50,000, the annuity is guaranteed to pay $5,211 a month, beginning at age 85 – for the rest of his life – no matter what happens to interest rates or mortality costs in the future.

If you do some future value calculations, the rate of return of the $50,000 placed in the annuity seems pretty high; at 6% annual interest, it would take more than $1 million in assets to provide an equivalent ongoing income. But even over 25 years, $50,000 would have to earn an average annual return of almost 13% to equal $1 million. So how does a longevity annuity achieve this result?

One key feature: If the policy holder dies before age 85, the annuity expires without value. Heirs receive nothing.

As John Olsen, a Chartered Life Underwriter from Kirkwood, MO writes in the January 2009 issue of the trade publication Life Insurance Selling,

“Why would anyone buy such a thing? Why buy a policy that won’t pay him a penny for 25 years and if he doesn’t make it that long, he loses his entire investment? Sounds like a very bad investment.”

But Olsen goes on explain this annuity, known as an advanced life delayed annuity, or longevity annuity, is not an investment. “It’s a risk transfer instrument – a pure insurance play. The risk that the purchaser transfers to the issuing insurer is the risk he’ll run out of money at an advanced age (when he cannot expect to earn income).”

The structure of longevity annuities are not limited to deposits at age 60 and payments at age 85. Deposits can be made as early as age 40, and payments can begin earlier as well. Earlier deposits will generate higher payments. Payment at younger ages will result in lower monthly amounts.

Longevity annuities are relatively new products in the marketplace, but have received some surprisingly positive reviews from the popular press, all because of the guaranteed income feature. In a January 21, 2008, Money article, senior editor Walter Updegrave writes:

To my mind the concept behind longevity annuities makes a lot of sense. In effect it’s like buying a homeowners or health insurance policy that has a very large deductible. You’re insuring yourself against a catastrophic risk you can’t handle on your own – in this case, running out of money late in life – while holding your premium to a minimum.

You guarantee yourself an income to cover your spending late in retirement while leaving more of your savings available to you today (or available to your heirs if you die young). And you can comfortably spend down a greater portion of your savings earlier in retirement, knowing that those longevity annuity payments will eventually kick in.

Martha Hamilton, writing in the Washington Post (“Live Long and Prosper,” August 12, 2007), emphasizes the cost-effective way that insurance can handle the need for income later in life.

You buy insurance because you get protection from a possible disaster at a reasonable cost. Same thing with a longevity annuity. It’s insurance that you won’t end up living on nothing but Social Security if it turns out that there’s more life at the end of your money than money at the end of your life.

The Spend-Down Concept Behind the Longevity Annuity
In examples used to illustrate the financial effectiveness of a longevity annuity, the hypothetical policy buyer allocates between 5-15% of his/her current accumulation to a longevity annuity; a 60-year-old with a $1 million portfolio sets aside $50,000-$150,000.

Even though buying this “protection” decreases the overall account balance, having the longevity annuity allows one to “spend down” assets over a specific period of time instead of living only on interest or investment earnings and preserving principal. The insurance allows other assets to be spent more efficiently – in other words, more income is derived from the assets.

According to an online article from CNN/Money (money.cnn.com/retirement), putting 10% to 15% of retirement savings into a longevity annuity “provides roughly the same spending power as devoting 50% to 60% of savings to an immediate annuity, according to a paper by Jason S. Scott, retirement research director for Financial Engines of Palo Alto, Calif.”

Another Way to Accomplish the Spend-Down Concept
For those who own permanent life insurance, the spend-down concept may be executed even more efficiently. A life insurance policy that is in force in old age may have a significant value as a cash asset, as investors or financial institutions might be willing to make either payments or a lump sum to the insured based on a collateral assignment agreement – in exchange for rights to some or all of the life insurance proceeds at death, the insured receives money now. Having the life insurance available as a back-up (a whole life insurance death benefit may grow in value as you grow older), you are free to spend more of your accumulated assets.

Further, the insured does not have to live to a specified age to enter into a collateral assignment or life settlement agreement. If certain health situations precipitate the need for additional assets, an Accelerated Benefit Agreement will provide payments directly from the insurance company – no investor or other third party is needed. And of course, if the insured dies before needing to enter into a collateral assignment or similar agreement, the life insurance proceeds are distributed income tax-free to heirs.

If you understand the spend-down concept behind the longevity annuity structure and already have permanent life insurance, it might make economic sense to allocate 5-15% of your annual retirement income to permanent life insurance premiums. If you don’t have life insurance or find yourself uninsurable, a longevity annuity may be a suitable alternative.

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On some financial topics, people have become so conditioned to seeing things from a single perspective it makes them incapable of recognizing other – perhaps even better – ways of addressing these issues. The on-going fallout from the “meltdown/crisis/recession/global-economic-funk” offers a striking example of an obvious solution that almost no one seems to see:

For one reason or another, everyone wants whole life insurance.

Don’t believe it? The disbelief just further proves the point. Whole life insurance is so far outside the awareness of both average Americans and the mainstream financial press that collectively “advises” them, that they have become blind to what’s been there all along. Think about it. As various “better ideas” have fallen short of expectations or been unable to respond effectively to new economic realities, have you heard any experts, commentators, or consumers clamoring for whole life insurance as a viable answer?

And yet, the following news items and commentary make a compelling case for seeing whole life insurance for what is really is, and why everyone wants it – even if they won’t admit it.

Do Americans want a 401(k)… or do they really want Whole Life Insurance?

Here are some excerpts from a January 8, 2009 Wall Street Journal article by Eleanor Laise titled “Big Slide in 401(k)s Spurs Calls for Change.”

When 401(k)s were first established in 1978, one of the selling points was the opportunity for individuals to participate in the uncertain (but historically profitable) market fluctuations. However, as Ms. Laise notes, “a market meltdown near the end of their working careers can …blow their savings to smithereens.” Quoting Alice Munnell, director of Boston College’s Center for Retirement Research: “That seems like such a fundamental flaw. It’s so crazy to have a system where people can lose half their assets right before retirement.”

In response, Congress has begun looking at ways to overhaul the 401(k) system. How? Among the proposals: government-supervised universal retirement accounts offering a “guaranteed, but relatively low, rate of return.” Another idea is an index fund of stocks and bonds whose mix becomes more conservative as workers near retirement age.

But there’s more to the 401(k) issue than just guaranteeing a retirement balance. Ms. Laise shares the experiences of another individual:

In both Ms. Gardner’s and Ms. Kelley’s comments, 401(k)s seem to present a number of “either/or” financial decisions. Ms. Gardner sees her investment options as either a low-yielding money market account or “huge market risk.” In a roundabout way, Ms. Kelley agrees, seeing her choices as either not getting rich, but at least avoiding poverty by choosing lower-risk, lower-return financial instruments. When it comes to extra funds, Ms. Kelley has to choose either pay down debt and build emergency funds, or contribute to the 401(k). And because of other financial needs, Ms. Kelley has already borrowed from her 401(k); like many Americans, she doesn’t have enough money to fund all the buckets (one for retirement, another for emergencies, big-ticket purchases, college funding, etc.) so filling one means stopping another.

If you were to summarize the comments from these two individuals, they could easily be considered representative of the accumulation issues of most Americans:

• They want some guarantees, yet want to achieve annual returns better than 1%.
• They have a need for accumulating liquid emergency funds.
• They want opportunities to access funds prior to retirement, either as loans or withdrawals.

Guess what? With some variation in the sentence structure, those very features will be mentioned in almost any insurance company’s brochure about whole life insurance! And these features aren’t either/or. When you make deposits to a whole life insurance policy, you can address all of those issues simultaneously. Cash values can be accumulated for emergencies or retirement. The long-term rates of return on cash values are greater than the 1% low-risk options Ms. Gardner is aware of – and they include some guarantees.

In addition, many whole life policies will offer a Waiver of Premium rider; if the insured is disabled, the insurance company will pay premiums to ensure the future growth of the cash value. And in tragic situations of an early, unexpected death, the insurance benefit delivers significant tax-free dollars in a time of great need.

As a depository for tax-advantaged retirement savings, 401(k)s may fill the bill. But as more and more Americans are discovering, they want a financial multi-tool that can serve several different functions – before and after retirement. For many Americans, a custom-fit whole life insurance policy could be their ideal solution.

Do Americans want a “Medical Expense Fund”… or do they really want Whole Life Insurance?

What is the cost of health care in retirement? Robert Powell, in March 14, 2006 MarketWatch column said:

That was almost three years ago. Does anyone think medical costs have gone down since then? No? That means the need for a “tidy $200,000″ is larger today.

Powell’s column elaborated on the Fidelity report, noting that Medicare B and D premiums accounted for $64,000 of the estimated costs, while cost-sharing co-pays ($72,000), and out-of-pocket costs ($64,000), comprised the rest. The $200,000 amount also didn’t include expenses from over-the-counter medicines, dental care and long-term care, and was based on an assumed life expectancy of 85. The estimate assumed the couple enjoyed reasonably good health. Add nursing home or other long-term care expenses to the list, and the total health-care cost in retirement could be staggering. To make matters worse, expenses have been increasing at a rate of 5.8% annually since Fidelity started conducting the surveys in 2002.

Now, even if you have a couple million accumulated for retirement, setting aside $200,000 in a safe, low-return financial instrument could result in a significant decrease in retirement income. It’s another one of the either/or, lose-lose decisions. Either you lose income because some assets can’t be invested in potentially high-profit, long-term opportunities, or you lose the security of having the liquidity to meet possible medical expenses.

Guess what? Whole life insurance might offer some unique solutions to medical expenses in retirement. The cash values can not only serve as a great reserve fund, but many life insurance companies offer riders that delineate terms under which a portion of the life insurance benefit can be distributed to pay costs resulting from a long-term care situation or a catastrophic terminal illness. Further, because of provisions in the 2006 Pension Protection Act, these benefits could be received on a tax-favored basis in many circumstances. In terminal situations, the amount paid could equal up to 80% of the life insurance face amount. In chronic situations, the amount paid usually varies with the age of the claimant – the older the policyholder, the higher the percentage.

These riders (sometimes referred to as Accelerated Death Benefit riders) are not intended to serve as a replacement for the stand-alone long-term care insurance (usually the whole life rider’s definitions of what constitutes an “LTC event”for which a claim can be made are not as generous or comprehensive as those in a long-term care contract). But these provisions give the insurance benefit – not just the cash values – a clearly defined financial value before death. And, Robert Lehmert explained in the June 2006 issue of the Life and Health Advisor: “Accelerated benefit riders do not require the negotiations associated with life settlements; the formula is predetermined and the entitlements can be taken at will.” Even better, if the Accelerated Benefit option is not used, beneficiaries will receive the full insurance benefit tax-free. That’s a win-win, either/or decision.

Lehmert goes on to note: “in an era of dramatically increased longevity, permanent (whole) life insurance has the potential to play a critical role in helping individuals live out their days with enhanced financial security.”

Do Americans want “Yeah, buts…” or do they really want Whole Life Insurance?

If whole life insurance is such a good product, why don’t more popular “financial experts recommend it? And why don’t more people own it? It goes back to the opening comment: When someone is so invested in seeing things from one perspective, it can be difficult to see it differently, even if the alternative is supported by facts and logic. For these people, the answer to retirement is a 401(k), the answer to emergency funds is a savings account, the answer to college funding is a 529, and the answer to life insurance is term. Anything outside their framework doesn’t fit, and generates a dismissive “yeah, but…” response. For example:

“Yeah, but…” Hindsight Sees a Better Idea

By design, whole life insurance is conservative and predictable. It’s boring. Here’s what happens: Someone looks at historical results and says “You could have done better if you had…invested in the tech stock…, speculated in beach-front condos…flipped houses… bought term insurance, etc.” Looking backward, it’s always possible for someone, somewhere, to construct a better outcome than the one you have. This is true for every financial decision, not just life insurance. In hindsight, you could have bought a nicer home on better terms, earned more with a different mutual fund, paid less for a car.

But while hindsight can always develop a better scenario for the past, hindsight insights cannot guarantee future outcomes. Two decades of historically superior returns were irrelevant when the S & P 500 dropped over 30% in 2008. So instead of looking backward to guess what might be most profitable in the future (and occasionally guessing wrong), take a look at this: the accumulation focus of whole life insurance policies is consistent, guaranteed, long-term cash value growth.

“Yeah, but….” The Costs Exceed the Benefits

No one really argues the benefits of whole life insurance; the issue is the perceived cost of obtaining them. When compared to term insurance, whole life insurance seems inordinately expensive. (Typical comment: “If I can get $500,000 of term insurance for $35/mo., why do I have to pay $750/mo. for $500,000 of whole life?”)

But other than the life insurance benefit, whole life and term insurance are radically dissimilar products. In a different context, whole life isn’t over-priced. Consider a household with take-home earnings of $100,000/yr. that is attempting to save 12% of their income (a percentage which, by the way, most “experts” say must be increased to ensure a comfortable retirement). Maybe some of that $12,000 goes to a retirement account, some to emergency savings, some to buy term insurance, and some to an after-tax college savings fund. Or instead, maybe a sizable chunk of it is applied to a whole life policy, because the whole life policy can provide cash values, which can be used for  retirement supplement income, emergency reserves, money for college – and life insurance.

“Yeah but…” There’s Up-Front Commitment, and Delayed Gratification!

Whole life insurance is a long-term financial instrument with a long-term funding commitment. Although a whole life insurance program can be constructed in such a way that premiums can be paid for a limited period as opposed to one’s entire lifetime, the shortest paid-up period is usually seven years. A whole life insurance purchase is big-ticket purchase, paid for over time – like a car, a home, a college education. While there is some payment flexibility in most whole life policies after the first few years, whole life works best with regular funding.

Because whole life is designed with the intention of being in-force at death (unlike term insurance), the costs of providing the insurance benefit – whether death occurs tomorrow or 50 years from now – must be secured by the insurance company. Thus, in the first years of a whole life insurance policy, most of the scheduled premiums do not accumulate as cash value. For some short-term thinkers, these “start-up costs” are an insurmountable psychological barrier.

The diagram below doesn’t represent a specific numerical comparison. Rather, it illustrates the conceptual difference between whole life insurance and other non-guaranteed accumulation strategies. Plan A is a slow-starting, well-planned financial path; if you stay on the path, the desired long-term results will be attained. In contrast, Plan B, while having the potential to deliver better results than Plan A, offers no guarantees; ups may be followed by downs.

As many Baby Boomers are finding out, what happens at the end of the plan is arguably more important that what happens in the beginning or the middle. But even though the long-term benefits of a whole life insurance program will accrue at an ever-increasing rate over time (Plan A), and even though various Plan Bs offers little assurance of finishing strong, some people simply can’t handle the longer start-up curve that comes with whole life insurance.

“Yeah but…” Is Anything Really Secure in This Economy?

In light of recent events, there’s general skepticism about any financial promises. Considering the wide-spread turmoil at once-solid financial institutions, who can say that a similar meltdown might not also occur with life insurance companies? It’s a fair question.

If we experience a complete economic and social collapse that plunges the world into a new “Dark Ages”, life insurance companies will probably go down the tubes, along with everything else. But if your sense of pessimism is that high, you better start watching your “Mad Max” and “Waterworld” DVDs for survival tips in a post-apocalyptic world, because there is no safe place for your money or your financial future.

Otherwise, there are good reasons to think life insurance companies will remain viable financial institutions, even in tough times.

In a January 11, 2009 Palm Beach Daily News article by R. Marshall Jones, JD, CLU, ChFC titled “Life Insurance: An Additional Asset Class in Difficult Times,” the author makes the following observations about whole life (or permanent) insurance companies in the wake of the past year’s economic turmoil:

Fortunately, the life insurance industry has almost none of the problems of Wall Street… Until recently, permanent life insurance was arguably the financial industry’s most complex instrument. Fortunately, due to its complexity, life insurance is highly regulated to assure there are always sufficient, safe assets to honor its guarantees. This is referred to as statutory accounting. For more than 100 years, every life insurance death benefit has been paid.

All life insurance companies use statutory accounting. In addition, publicly traded insurance companies use GAAP accounting. It allows them to report the expected profitability of products that require reserves to back their contractual liabilities.

Jones doesn’t say life insurance companies can’t fail. But life insurance companies have a proven track record of stability. And while whole life insurance may be considered a complex financial instrument, it isn’t an untested new idea (like credit-default-swaps or other next-generation financial derivatives that were “virtually unsupervised,” according to Jones). Whole life insurance has been around, been regulated, been through good times and bad – and succeeded.

“Yeah but…” It’s Too Complex and Too Boring for Media Sound Bites

Like Mr. Jones said in the previous paragraph, whole life insurance is a complex financial instrument. It takes time to explain it (even a slim “overview” article like this one takes over four pages!). And it takes even more time and personal attention to tailor a whole life program that fits an individual’s unique financial circumstances. There is no one-size-fits-all plan for whole life, and this is not a do-it-yourself project.

These characteristics are not ones that fit easily in column-length newspaper or magazine article, or a thirty-second analysis from a financial talking-head on a television program. And since whole life insurance is a long-term financial instrument, there’s not much demand for headline-grabbing topics like “Experts Pick Top 5 Life insurance Policies for 2009″ or “Best Whole Life Plans to Implement Right Now!”

Instead, establishing a successful whole life insurance program requires several face-to-face consultations with a knowledgeable professional, and regular reviews. Yeah, it sounds more like going to the dentist than dinner and a movie. Whole life insurance may be serious, complex, boring – but it works.

Bottom Line: Everyone wants Whole Life Insurance

Consider these common “yeah buts…” concerning whole life insurance. Should any of them really stop someone from taking a closer look at how whole life insurance might fit in their financial situation?
No.
Does everyone need whole life insurance?
No.
Does everyone want whole life insurance?

The opinion here is yes. Whole life insurance delivers a unique and flexible assortment of financial benefits. Properly situated in your financial program, having whole life insurance is better than not having it. And with the assistance of a skilled insurance professional, there are many ways to make whole life fit your plans.

Whole life insurance is a “financial classic.” Newer products and approaches may grab popular attention, but as a solid financial foundation for every stage of life, whole life continues to be in style.

It’s time to admit it…Everyone Wants Whole Life Insurance.

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  • Get It In Writing (Your Finances, That Is)
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  • Flawed Financial Thinking-Part 3: The Subtle Influence of “WACronyms”
  • Flawed Financial Thinking-Part 2: Why a “Nirvana” Mindset Delivers Grungy Results
  • 5-MINUTE FINANCIAL THOUGHT: Which is easier: Managing your debt, or managing your assets?
  • Flawed Financial Thinking-Part 1
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