Do I need a financial plan?
PROTECT YOUR INVESTMENT!!
I have a bias on this topic and with good reason. Most people don’t know what financial planning is or what it accomplishes. To build yourself a financial plan, you first need to go through the financial planning process, which is where the real value is found!!
I’m going to share several real world examples of mistakes I found and fixed for my clients that will save them an enormous amount of stress and money over time. This will be a 4 part series: Cash Flow/Budgeting, Insurance, Taxes, and Investments. For each section, I’ll go through The Mistake, The Risk, The Fix, The Savings and then provide a Real World Example. Last week we covered Cash Flow/Budgeting here, this week is Insurance.
Hopefully, through these examples you can learn a little bit more about what the financial planning process can accomplish and a few red flags you can look for when going through your own finances.
The mistake: Auto/Home/Liability/Umbrella - having very low limits of liability
The risk: With automotive liability, if you’re found to be at fault in an accident which caused damage and/or injuries you may be liable for damages or costs associated with their injuries. With personal home/renters/umbrella liability coverage, it may cover bodily injury or property damage caused by your actions or negligence. Any dollar amounts owed beyond your liability policy limits will be coming out of your pocket.
The fix: Increase your limits of liability on your policies, I usually recommend the max your auto/renters/home insurer offers ($500k-$1m which can then be aligned with your additional liability/umbrella policy). You can add additional liability coverage beyond those policies with an Umbrella policy.
The cost: Increasing liability on Auto/Home/Liability is usually pretty inexpensive (recently a client went from $100k liability to $1m liability on their auto policy for an extra $180 a year).
My most extreme real-world example: Missing a rider on umbrella coverage for a rental property. As an owner renting your property, you are subjecting yourself to increased liability. As soon as you start to use personal property to earn income, the insurance company may look at this as a business and the risk may not be covered. Depending on your insurer, you can either add a rider on your existing homeowners/umbrella coverage or start a separate policy. Are your risks properly insured given your occupation and investments?
The mistake: Too much or too little life insurance
The risk: The only downside to having too much life insurance is that your monthly outlays could be saved elsewhere. The downside to having too little life insurance is that your family will be unable to continue their existing lifestyle if you pass away and this is a huge problem.
The fix: Decrease or increase coverage
- If you have too much life insurance you should consider reducing it. If you’re reducing whole life coverage your monthly cost savings could be enormous.
- If you have too little coverage, you should consider increasing it. The cost of increasing coverage can be variable depending on the type of Life Insurance you would like to acquire (term, whole life, universal life, variable life, additional group coverage) and how much coverage you should add. Term can be inexpensive (healthy 35-year-old male could get $1,000,000 20-year level term for ~$1,000 a year). Whole and universal life are variable in cost but are usually more expensive than term for the same coverage. The upside to whole/universal life is that a portion of your deposits grow a cash value within the policy and the cash value is accessible at any point in time via various methods.
My most extreme real-world example: A year before a couple became my clients, they were sold whole life policies a few years before they wanted to retire. Most whole life policies need to be funded for seven years before you should stop paying on them (tax reasons), this wasn’t the best plan for them before retirement. We did an analysis that illustrated that they were over insured. Considering their savings and additional insurance, we could reduce their coverage and monthly life insurance outlays by over $1,000 a month. That extra thousand a month is now going to pay off debt, pad their retirement accounts, and is $1k less per month they will need to drain their retirement accounts in retirement. If you subscribe to the 4% retirement withdrawal rate, that is $300k of their portfolio that either doesn’t need to be spent down or doesn’t need to be saved ($12,000/4%=$300,000)
The mistake: No disability coverage. I see this most often with freelancers.
The risk: Inability to meet monthly financial obligations or drain emergency funds if you have a disability. A claim may be made for something as little as a medical procedure that has you out of work for a month (if your disability policy is past the elimination period).
The fix: Shop disability income and disability overhead expense policies.
The cost: This varies depending from the coverage. Several hundred to several thousand dollars a year.
My most extreme real-world example: At a prior firm, we had a client that was a high earner go on a disability claim in their 50’s. Their policy covered them for $15k/month until they turned age 65. Since the policy was paid by them and not an employer, their benefit was paid to them tax free. $15k per month for 10 years is $1,800,000 tax free! ($15,000 x 12months x 10 years). This is money they could use for living expenses, healthcare expenses, or to save for the future (many long-term disabilities will cause you to be separated from service from your employer, this means you can no longer contribute to your employer’s retirement plans or receive a match).
As you can see, risk management is an extremely important part of your financial planning. It is there to protect your nest egg in the event of an accident, death, or inability to work due to “disability” (long or short). Protect your investment!!
Next week I will cover common mistakes I regularly see on your tax planning and ways to fix. Tune in!