Read The 9 Steps to Financial Freedom Online
Authors: Suze Orman
This is when I met Linda, now fifty-six, who still had it fixed in her head that she wanted $1.5 million in life insurance for her kids. But think about it: For the insurance company to pay that $1.5 million, plus all the commissions and expenses buried in the policy, don’t they have to earn more than $1.5 million from Linda’s money? Of course they do.
This is why they are having Linda pay that extra $22,500 a year for three years right now. If their performance on how they invest Linda’s money, and the money of everyone else covered by their plans, falls short of what they want, no problem. They’ll just tell Linda she’ll have to keep paying that $22,500 a year for as long as they like. And why does Linda, after putting in $67,500, have only $36,000 in cash value in her policy? Simple. Especially in the first few years of the policy, the bulk of her money goes to pay the agent’s commissions; the insurance company also has to take its share. It is totally possible that the agent received that very first year a commission of $18,000, well worth his time that Saturday when he came out to her house. So, $18,000, give or take, of her first payment of $22,500 went out the window as soon as she paid it. In all likelihood the agent also “earns” around $2,000 every year she pays her premium from then on. Not bad.
What is also important to remember when buying universal/whole life or, for that matter, any insurance is to study the chart or illustration your agent will show you of what your premium is going to buy you.
All illustrations have a
projected earnings
side and a
guaranteed earnings
side. The projected side shows how this policy is projected to perform if everything goes according to plan. I can still remember seeing projections on certain life insurance policies of what they would be worth if interest rates stayed at 14 percent, which is what they were when these policies were being sold. Policyholders were in for a rude awakening when interest rates came tumbling down and the policies stopped paying the 14 percent. Projected earnings are “in a perfect world” earnings.
If you look at the guaranteed side of the illustration, it will show you the absolute minimum death benefit, given the highest mortality charges (the maximum the company can charge you for the insurance) and the lowest possible interest rate they can pay you. If you look at the guaranteed side and decide that yes, it still feels like a great deal, buy it by all means, but I doubt you will feel this is the case. If Linda had looked at the guaranteed side of her illustration, she would have seen that the $22,500 would go on for the rest of her life in the worst-case scenario. She hadn’t understood that and wouldn’t have taken the policy if she had. Her agent had emphasized only the projected values. A responsible agent will always, even without your asking, point out the worst-case possibilities as well.
This is not how it works with term insurance. With lower-cost term insurance, the insurance company is taking an actuarial gamble that Linda will still be living when her policy reaches the end of its term and that they won’t have to pay the $1.5 million. Both her children, who were doing just fine, and I tried to
talk Linda out of having insurance at all, even term. By taking her money and investing it carefully, Linda could have built up $1.5 million for her children without paying any insurance premiums. Even so, Linda had her heart set on having a $1.5 million insurance policy for her kids. Therefore term insurance was the only sensible answer.
I suggested that we first apply for a $1.5 million twenty-year level term policy, which would guarantee that her premiums would stay level and not go up for twenty years. At the end of the term, that’s it: no cash value, no insurance. At that time, the only way to get more insurance would be to reapply, but Linda would be seventy-six then, and the cost would be prohibitive. However, if she died within the next twenty years, her children would still get the $1.5 million she had dreamed of leaving them.
Our plan was that if she were accepted for this twenty-year level policy, we would cancel the first policy, withdraw the cash value, and invest that plus the difference in good no-load mutual funds (
this page
) for growth. Then we ran the numbers.
When we priced the twenty-year level term policy with a death benefit of $1.5 million, based on Linda’s age and health, the cost was $5,600 a year for the next twenty years—$16,900 less than she was paying on the whole life policy. Had she been younger, the cost would have been less; it would also be less if the death benefit were lower. This meant that Linda could take the $36,000 cash value from her first policy and add to that the yearly savings of $16,900 for the next twenty years, investing it all for growth.
Her main question was how much her kids would have if she died in the twenty-first year after the term policy ran out. The answer depended on how much those funds returned.
| A T | | 5 PERCENT | | $682,000 |
| A T | | 6 PERCENT | | $774,000 |
| A T | | 7 PERCENT | | $880,600 |
With an insurance policy, the death proceeds are income tax-free (though not estate tax-free), and she would have to take that into consideration as well.
Linda then asked me to do another calculation. What if she lived her normal life expectancy and never again put in another penny after twenty years? Assuming a 6 percent interest rate from the start, how much would she have then? Her life expectancy is eighty-seven, according to the charts, which would be eleven years after the twenty-year policy ran out.
At 6 percent the money she invested outside of the insurance policy would have grown to $774,000 by the time she was seventy-six. Then, even if she never put in another penny, that money would grow to $1,470,000 by the time she was eighty-seven. (There are also a number of ways to invest the money and not have to pay taxes on it while it is accumulating; see
Step 6
.)
In the end Linda agreed. Her insurance agent tried to talk her out of canceling her policy. Until she ran the numbers again, for him.
Happy ending—although if Linda had taken this course from the beginning, she would be in even better shape. At fifty-three her premiums for the exact same $1.5 million term policy would have been only $4,425 rather than $5,620. That alone is a big difference, never mind the fact that she would not have wasted $31,500, the difference between the $67,500 she paid in those three years and the $36,000 she got back.
SHORT-TERM? LONG-TERM?
A twenty-year policy felt right for Linda, but you’ll have to decide the term that’s right for you. Term insurance is available in all different term lengths, from yearly renewable term, where every year your premium will go up, to level term for longer terms—five, seven, ten, fifteen, and so on—where the premium is fixed for the term. The longest level term I know of is a thirty-year level, which is not available in all states. (See “Long-Term-Care Insurance,” below, for information about how to choose an insurance company and agencies to call for the best rates.) Insurance companies are always coming up with new concepts, so scan the papers for offers that sound promising.
Linda thought we had finished discussing insurance, but I asked her one more thing. What if she ever had to go into a nursing home? She was so concerned about leaving money to her children. Did she know how fast nursing home costs would eat away at her assets?
LONG-TERM-CARE INSURANCE
“I’m only fifty-three,” said Art. “I’m not going into any nursing home, and I’m not spending my money on
any
nursing home insurance.”
Art can’t tell his story now; his speech is still too slurred from the stroke. I will tell it for him.
When Anna and Art came into my office, I hardly noticed Anna, she was so tiny. Art, on the other hand, was huge, built
like Smokey the Bear, with a great booming voice. Though soft-spoken, Anna, a schoolteacher, was not the least bit intimidated by her husband of twenty-seven years. Art had been offered early retirement, and they had come to see me about whether he should take it. After going through all their finances, we decided that although it was going to be close, they should take the offer, which was an excellent package. Only one thing worried me. Anna had a heart condition, which had already necessitated two operations. She was also scheduled for a third operation in four months. The good news was that as a teacher, her health insurance coverage was excellent. But knowing of her condition, and considering Art’s age, I suggested that we look into long-term-care (LTC) insurance for Art.
LTC insurance covers some of to all of the expenses the policyholder will incur if he or she were to enter a nursing home; it’s that simple. As you will soon be able to tell, I love long-term-care insurance. I believe that it’s one of the most important policies you can have. Long-term-care insurance is called into service more than any other kind. Yes, yes, I know, a nursing home would be decades off if you ever even had to enter one, right? Your parents aren’t even in a nursing home. If you’re twenty, thirty, or forty, I agree, this is not a policy to think about right now—for yourself, at least. But as you read this chapter, think about your parents. If you are hitting that magical fifty mark—well, you should read this chapter for you as well. It is when people reach fifty that I start suggesting LTC insurance. At fifty-three Art was about to hear me suggest it.
Like most health or life insurance policies, LTC policies require that you qualify for them, and I knew that with her weak heart, Anna would never be eligible. But Art would, and such a policy, if he ever needed it, would provide protection for Anna that could make all the difference in the world to her.
You see, what happens all too often with couples is that one of them ends up in a nursing home, and it takes every penny of income they both have coming in just to pay for those nursing home bills. The person who is healthy and at home is left with no money to live on and so has to start using the savings, retirement plans, and the principal that they had spent a lifetime saving. Before you know it, all the savings are used up, and then, when the partner in the nursing home dies, the one who is alive and well is left penniless and perhaps with many years remaining to live. I see this happen all the time, and it’s devastating, which is why I brought up the subject of LTC insurance with Art and Anna. The subject went over like a lead balloon. “Do I look like a man who is ever going to end up in a nursing home?” Art boomed, and I had to admit he had a point. I said okay for now but one day soon we would talk about it again.
That day came just five months later. I received a call from Anna, who sounded very weak. She was slowly recovering from the heart surgery she’d had the month before, but her news this time was about Art. While she was still in the hospital, he had had a massive stroke, leaving his right side paralyzed and slurring his speech. If either of them got worse, how would they manage? They both remembered that I had said good nursing home care in the area in which they lived today cost $3,500 a month—a huge amount, given their financial situation. Did I think there was any way Art could still qualify for LTC insurance? No, I didn’t, not now.
But Anna and Art got a very lucky break. The company that handled Anna’s retirement plan was starting to offer group LTC insurance, and as part of their enrollment campaign they were accepting all employees and spouses, regardless of their current health. I don’t generally like group plans as much as individual insurance, but the plan offered Anna and Art protection that most people in their situation couldn’t get at all.
What if you never use long-term-care insurance? It will be wonderful if that’s the case. The purpose of insurance is to cover catastrophes. You should always hope you’ll never have to use it.
This is the question people ask me all the time about LTC insurance. Now, let me ask you a few questions.
Do you have fire insurance? If you own a home, you have to have it. If you do, have you ever used it? Only 1 out of every 1,200 people ever uses fire insurance. But that doesn’t mean it isn’t a good idea.
Do you have automobile insurance? If you have a car, you do. If so, have you ever used it? Many of us are afraid to file a claim even when there’s a reason to, for what it might do to the cost of our premiums. Only 1 out of every 240 people ever uses car insurance. But most of us still have it.
How many people do you think use long-term-care insurance? One out of every two, among those who have it. It is used more than any other kind of insurance, yet it’s the kind of policy that way too few of us have.
Why do you think you’d need LTC insurance if you already have medical insurance? Because
there is not one medical insurance policy in existence that covers long-term care
.
If this situation were this dire, are you thinking it would be better all around just to dump the bills on Medicare? You couldn’t, because Medicare won’t pay them. Medicare will only pay 100 percent for the first twenty days of an LTC stay and will pay only if the facility is a Medicare-approved skilled nursing home. This means that the home must be approved by Medicare and have registered nurses on hand twenty-four hours a day, seven days a week.
Even if you needed skilled nursing care, you would have had to spend three days in the hospital before being admitted to a skilled nursing facility, and both stays would have had to be for the same illness. Also, after those first twenty days, if Medicare
miraculously paid in the first place, for the next eighty days in the year 2011 you would be responsible for paying the first $141.50 a day out of your own pocket before Medicare kicked in. This daily amount changes, so please check out the current amount by going to
http://www.medicare.gov
. In essence, then, Medicare pays for the first twenty days in just a few cases, and then it’s your turn. Medicare payments for LTC care stop after day 100.