The Bogleheads' Guide to Retirement Planning (36 page)

For many future retirees, retirement will not start as 100 percent full-time employment on Friday to zero percent on Monday following your 65th birthday. Flexibility allows you to dip your toes into the retirement pool without fully plunging in. This same flexibility will allow you to go back to work, if desired, in retirement. Early retirement is really about flexibility and empowerment.

A key enabler of early retirement is figuring out how to bridge your income between your last paycheck and that first Social Security check, Medicare coverage, and traditional pension income streams. As discussed, there are several possible strategies to meet your early retirement income needs. Some combination of the much underused SEPP program, withdrawals of Roth IRA contributions tax- and penalty-free, tapping home equity or 401k or 457 plans early, and annuitizing some of your nonretirement assets are mechanisms to get you out of the office a few years or even decades before your peers.

You cannot lose by preparing your household for early retirement. Once you have that trump card in your back pocket, you can play it whenever you want to end the game called work. Good luck!

Your greatest asset is your ability to earn a living for yourself and your family. As long as you can continue doing so, you may well earn a fortune during your lifetime. A worker earning $50,000 on the average annually over the next 40 years will generate a total income of $2 million. However, that is only if the person is able to work. With life’s uncertainties, protecting your earnings from premature death or disability is a necessity. Fortunately, insurance plans are available today to protect against these risks. Winston Churchill said, “If I had my way, I would write the word ‘insure’ upon the blotting book of every person, because I am convinced that for sacrifices that are inconceivably small, families can be secured against catastrophes which otherwise would smash them up forever.”

The focus of this chapter is on life and disability insurance programs and proper ways to implement them. We’ll discuss how much and what types of life and disability insurance you need, explore ways to buy coverage including buying tips and how to select insurance agents, and help you avoid some common mistakes. Following these suggestions will help put you in charge of the buying process.

The three main events that can reduce or eliminate your flow of income are death, disability, and retirement. In the United States, a tripod of economic security helps to protect us from the effect of these threats. Government programs, employer programs, and personal insurance and investment programs combine to provide us with a cushion of security. But make no mistake, considering life’s uncertainties, maximizing your personal insurance and investment programs should be the foundation of your security. This is the one area where you have the most control. In the final analysis, planning for the known and insuring against the unknown work hand in hand to achieve your financial goals.

If you have dependents, are accumulating assets for retirement, or wish to pay for your last expenses such as a funeral, you probably need life insurance. Life insurance is one of the best financial instruments available to meet the needs of your dependents at the time of your death if you have not accumulated a level of wealth that would take care of those dependents. Life insurance provides a specific amount of money, exactly when it is needed, and if paid to a named beneficiary, it is income tax-free. Death benefits are not tied up in probate and are usually received by the beneficiary within a few weeks.

Insurance benefits can be taken as a lump sum or in other available settlement options. If taken as a lump sum, the money should be invested according to the principles set forth by John Bogle as detailed in his books and as outlined in this book and
The Bogleheads’ Guide to Investing
. Alternative settlement options include installments of a fixed amount, installments for a fixed period of time, or the proceeds held by the company with interest paid out, or the money can be paid out as a lifetime income annuity (see Chapter 7). Insurance company settlement options can be set in advance by the policy owner if desired. Preset settlement options are a good planning tool to help protect the interests of the beneficiary, including minors who cannot enter into legal contracts or directly receive insurance proceeds.

Perhaps you’re wondering what types of insurance policies are available today. How can you use these products to meet your individual needs? Building a good life insurance program need not be complex. Learn the basics and follow a few simple principles.

The two major categories of individual life insurance policies are term insurance and permanent insurance. Term policies are designed to provide protection for a fixed period of time, such as 10, 20, or 30 years. Permanent policies are designed to provide protection for life. Within each category, there are several types of insurance that you can choose from.

Term insurance is best suited for needs that are temporary, meaning they end at a predictable time in the future. For example, family income needs are typically reduced after your children leave the nest and start providing for themselves. Another example of a temporary need is in the years before you and your spouse become eligible for adequate pension benefits. Still another is prior to inheriting a sizable estate. In these cases, life insurance is wealth replacement. You do not yet have the financial means to take care of your dependents in the case of your demise, and life insurance can fill the gap.

Term insurance is also a good choice to pay fixed obligations such as a mortgage, auto, and credit card debts and for children’s education, as well as for an emergency fund. At younger ages, term insurance is inexpensive for most families. For younger breadwinners, term insurance is the only practical way to provide needed protection at affordable costs. It provides pure protection and builds no cash value (to be explained later).

Group term insurance may be available from your employer. It is purchased in an amount equal to your annual income or some multiple of your income. Some employers pay part of the cost, making it less expensive than individually purchased policies. Another advantage of most employer-sponsored life insurance is that you cannot be denied coverage. If you sign up for the insurance at the inception of your employment, you will get the insurance regardless of your health or preexisting medical issues. You’ll want to consider enrolling in your employer’s plan unless you can purchase it at a lower cost on your own.

Association group term may also be available for those in certain occupations, such as teaching, public accounting, and nursing. Association plans can be less expensive than individual term policies, and they usually have a streamlined underwriting process that may not require a blood test. An Internet search of associations will tell you if plans are available for a group that you belong to or can join. You may also obtain life insurance through your bank if savings bank life insurance (SBLI) is available in the state you live. You’ll want to check their rates against individual term.

Level-premium term policies for periods of 10 to 30 years are very competitive for individuals. They are the best way to build the foundation of your insurance program. Premium rates have never been lower, even as life expectancies have increased. It is best to choose a term period that matches your need so that your coverage does not expire and leave you uninsured. If you choose a term policy for a shorter period than you need, you will have to qualify for a new policy bought later on, and it usually will have a higher price.

By age 60, term insurance is expensive, and age restrictions may disqualify an individual from obtaining necessary coverage. Permanent insurance is intended to remain in force until the insured dies. It solves the problem when coverage is needed for life. That helps a couple reaching retirement age with insufficient assets to be financially independent, should either spouse die. Permanent life insurance is also useful in many estate planning and business situations, which will be discussed later.

Permanent insurance is available in three major types: whole life, universal life, and variable universal life. They each have unique advantages and disadvantages.

Whole life (WL) insurance has been around for more than a century. It features guaranteed death benefits, guaranteed cash values, and guaranteed premiums until death. It costs much more than term because the insurance company invests a portion of the premium to build policy reserves known as cash value to help pay future death claims. The cash value in these policies is invested primarily in intermediate- and long-term bonds. One benefit of building cash value is that the policy owner may take loans against the amount or obtain a cash distribution upon surrender of the policy.

Policies issued by mutual companies and participating policies issued by stock companies pay nonguaranteed annual dividends. Those dividends can be taken in cash, used to reduce premiums, left to accumulate with interest, or used to buy additional paid-up life insurance. A higher monthly premium is paid for these policies, but cumulative dividends usually exceed the extra premiums. Earnings grow tax-deferred while the money stays in the policy. This results in lower policy costs, or higher death benefits and cash values. One disadvantage of all WL policies is that they do not disclose internal expenses and mortality charges for death claims.

Universal life (UL) policies build cash values that are invested mostly in short-term fixed-income securities. They became popular in the 1970s when cash values invested in these products had higher interest rates than long-term government bonds. UL policies also disclose internal expenses, mortality charges for death claims, and interest rates. The major disadvantage of many UL policies is that they can run out of money if any of these elements perform less favorably than illustrated. If that happens, the policy terminates unless the insured pays in extra money to keep it in force.

In recent years, some ULs can now be purchased with a lifetime premium and death benefit guarantee. With this type of guarantee, the premium is lower than whole life because the policy is designed to provide a lifetime death benefit and not build high cash values. It is the closest thing to a term until death policy on the market today. UL can also be purchased with level or increasing death benefits to counter potential future inflation. You pay a little more for the increasing death benefit option.

Variable universal life (VUL) became popular in the 1980s, when stock market returns were outperforming fixed-interest investments. VUL works basically like UL, but your premiums are invested in your choice of a variety of subaccounts that are similar to mutual funds. This option provides the opportunity for potentially higher returns, thus enhancing death benefits and cash values. VUL policies come with higher potential returns and higher risks, like other equity investments. The policies often project level premiums for life, but if investment performance is inadequate, then future premiums can be much higher or the policy can terminate. VULs are often promoted as investments and are often illustrated to provide a lifetime income at retirement. However, in our opinion, VULs are too risky a product for permanent life insurance needs.

Survivorship life insurance (SLI) policies are designed to pay at the death of the second spouse. Because of an unlimited marital deduction, estate taxes often become due at the second death. The survivorship policy can work well in these situations. These policies can be WL, UL, or VUL, and they are less expensive than individual policies on each spouse. Underwriting older ages is easier because the joint mortality of both insured is used.

Establishing a life insurance program to protect your family is more complex now than it was in the recent past. Most families before the baby-boomer generation grew up in one-income homes with the father providing the income while the mother took care of the home and raised the children. Insurance companies developed formulas to determine the amount of life insurance needed to provide for these traditional families.

Today insurance underwriting is more complex. Two-income families are more common; the primary breadwinner can be either partner, or both can contribute equally. Unfortunately, more than half of all marriages end in divorce. Single-parent families are on the rise, and the institution of marriage is constantly undergoing changes. Remarriages often result in blended families. Thus, no single life insurance formula can address the needs of all individuals and families of today.

The amount of life insurance you need depends on your financial goals for yourself and your family. The best place to begin is a thorough and frank discussion with your partner and perhaps other beneficiaries. Address facts and feelings regarding death and its financial impact on their needs. Bear in mind that a lot of emotions regarding death, remarriage, management of proceeds, and help by family members will arise in such a discussion. Disagreements sometimes occur, as thoughts of death and disability are frightening when brought up. Working through this process now, when all parties are healthy, is definitely the best time.