Revisiting the Efficiency of your Life Insurance Plan

A common issue upon which I revisit with clients on a regular basis is the efficiency of their life insurance.  Typically people will have either an old policy that was taken out when they first started their career and/or a specific amount provided by an employer.  While updating your coverage to a new policy can sometimes lower your costs with greater amounts of coverage because of the changing nature of insurance company mortality tables, often the original intention of the insurance has changed for the person.  For me, the question of reviewing their coverage always starts with the “Why?” question.  Why did you initially set up this coverage?

In my estimation, the main reasons for having life insurance protection in place are as follows:

• Income Replacement—purchasing enough coverage that would provide your heirs or dependents with enough money to replace the income you would have provided during your working years.  From a cost efficiency standpoint, this can often be accomplished through buying a term policy with a term that matches the number of working years remaining before retirement—with the idea that you are using the cost savings to fund retirement plans.

• Estate Tax Mitigation—purchasing permanent insurance coverage (sometimes via an irrevocable life insurance trust) to mitigate estate taxes that will be owed by your beneficiaries upon your passing.  While this type of plan should be orchestrated with an estate planning attorney, it can be helpful when estates are in excess of the government’s estate tax threshold (currently estates valued at $5MM).
• Tax-Favorable Savings Vehicle—For those people who are max funding retirement savings plans, Roth IRAs, personal savings, and emergency funds, a permanent life insurance policy could be a good way to grow cash value in tax-favorable way.  This typically is not a cost-viable plan until these other types of savings vehicles are being maximized.

I believe it is important to be careful with the overall cost of your life insurance plan.  Do not make the premium cost an impediment to other savings vehicles (especially tax-deferred savings potential).  When looking particularly at permanent life policies, be careful not to make it too large of a cash-flow item in the retirement budget.  It is always best to review your life insurance plan to be sure that it fits with the rest of the elements in your financial plan an overall wealth management.

Rollercoaster or Train Track?

I have sat down intently several times over the last 7 days to write an entry that addresses the volatility in the headlines.  First topic was the lack of impact that the debt ceiling deal had on markets.  Next was flight to US Treasuries despite the downgrade of US credit rating by S&P.  And then was the continued influence of the European banking problem that is potentially pouring over into US financial companies.

In the end I decided to shelve all of that to highlight the difference between simply investing versus investing with a plan backed up by infrastructure.  This kind of day to day volatility can definitely churn your stomach like a rollercoaster, as investment managers struggle to sift the data and find a support level in the investment markets.  However your exposure to the volatility should differ based upon your time horizon and overall appetite for risk.

The Phases of Investment Exposure

While the traditional savings paradigm is a simple save/accumulate to distribute illustration (seen to the right), I would argue for several phases along the way:

Distribute, Protect, & Grow—Having a plan for efficient and consistent distribution of assets is critical to meeting your expense needs; however more than likely you will still need some tilt for future growth because of the extended timeframe of retirement

1. Save & Grow--early in saving for a long term goal like retirement, where you may have the ultimate stomach for short-term volatility on a significant portion of your savings.
2. Save, Grow, &  Protect—As you start to amass a significant savings for your goal, beginning to build a protection infrastructure around your savings becomes important.  This may involve using different investment vehicles and alternative asset classes that are not correlated with traditional liquid investments.
3. Protect & Grow—At some point in the cycle, protection trumps growth as you get closer to needing to tap funds for retirement.
4. Distribute, Protect, & Grow—Having a plan for efficient and consistent distribution of assets is critical to meeting your expense needs; however more than likely you will still need some tilt for future growth because of the extended timeframe of retirement.
5. Distribute, Protect, & Transfer—While not the primary concern for retirement planning, efficient wealth transfer should be addressed once you have come through the danger zone of pre-retirement and early retirement years.  This may involve re-checking beneficiaries on retirement accounts, and tending to trust matters for after-tax assets.

Using All of the Asset Classes

When volatility spikes your exposure to alternative asset classes could prove to be a nice anchor for your savings.  While these investments require a suitable income and net worth because of their liquidity & risk profile, vehicles such as non-traded real estate investment trusts, equipment leasing partnerships, and business development companies could provide consistent income that is not correlated to the day to day volatility of investment markets.  For those that this type of planning is suitable for, I recommend that the alternative asset class sit right along with equities, bonds, and cash, and be between 5-20% of your allocation (dependent on which phase of retirement transition you are in).

Consistent Income

Lastly, the biggest worry about the fluctuations in your retirement account ultimately goes back to the accounts ability to produce income for you on a consistent basis in retirement—either through income generating investments or through liquidation of assets.  It is for this reason that you should revisit your income plan on a regular basis during pre-retirement and early retirement years.  This includes looking at Social Security projections, pension plan provisions (and the adjustment to your spouse’s income if something were to happen to you), and then looking at the efficient distribution of your savings so that it lasts through your entire retirement.

Just like a good business plan is written down, your retirement & financial plan should be codified somehow so that you can review it as necessary, but also so that when volatility re-enters investment markets (which it inevitably does) you can feel confident that you have an infrastructure in place to weather the dips.

Alternative investments are subject to significant risks and therefore, are not suitable for all investors. When considering alternative investments, you should consider various risks, including the fact that some products use leverage and other speculative investment practices that may increase the risk of investment loss, can be illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual funds, often charge high fees and in many cases, the underlying investments are not transparent and are known only to the investment manager. With respect to alternative investments in general, you should be aware that returns from some alternative investments can be volatile and you may lose all or a portion of your investment. 

Between the Lines of the Debt Ceiling Agreement

The deal to cut more than $2 trillion in government spending over the next decade and extend the government's ability to borrow until at least 2013 has been signed, sealed, and delivered.  So what was all the fuss about?  And what was really gained by this polarized government brinksmanship?

The debt ceiling debt debate over the last few months achieved one unintended goal.  It surfaced a sleeper issue with the American public to raise the importance of our country’s out of control debt and unsustainable entitlement programs.  Politicians on both sides of the aisle have talked about addressing the problem for a long time, but this has forced the country to face this problem head-on.

The agreed upon bill will cut spending slightly in the early going; which is certainly better for the fragile state of the recovery. The spending cuts will begin with just $25 billion in 2012 and $46 billion in 2013.  This is the tightrope that legislators walked while attempting to form this bill, as economists weighed in that cutting any spending could reduce US GDP (a measure that is already quite low signaling potential sluggish economic growth).

While everyone seems to agree that government debt and spending are out of control, agreement on where to make significant enough cuts to actually impact debt remains unseen.  Major expenditures of Medicare and Social Security, as well as national security seem to be areas that the average American does not want disturbed, but these also remain major weights to the ballooning debt.  It may be clear that we need and want smaller government, but achieving that may be more painful than we want.

The next step in the debt debate will be the appointments made to the bi-partisan super-committee in Congress, and what potential plans can be agreed upon heading into a presidential election year.