When it comes to life insurance recommendations, I am pretty much in the term camp. There are several reasons for my position, the most important being that life insurance is first and foremost about protection. And since whole or universal life can literally cost over 10 times what term costs for the same coverage, not many of us can actually afford the protection we need in a permanent product.
You may have heard that it’s better to own your coverage than to rent it, and other such nonsense. I’m not buying it. The fact is, most term products provide cheaper coverage at every level – including cost of insurance. And the argument that you’ve thrown your money away if you don’t die (yes, I’ve heard it) is ridiculous. Every insurance product carries cost of insurance, which is not recovered by either the policy-holder or the beneficiary when the policy pays out or is liquidated.
With all that said, I do actually own a permanent insurance product; a VUL, or variable universal life insurance policy. If you Google VUL, you’ll find predominantly two camps: those who sell them and those who hate them. Not a good sign, generally speaking. But I don’t believe that any product is inherently bad, and the policy that I hold works very well for me.
What is a VUL?
First, though, a quick explanation. A VUL combines an insurance product with an investment. Part of the premium paid by the policy holder goes to cost of insurance, and the rest to an investment sub-account. The account can be overfunded, which means paying more than the required premium, with the extra money going into the subaccount. That money can be borrowed down the road for whatever the policy holder wants to spend it on, with any remaining balance on the loan paid off by the death benefit.
A product for a narrow market
There are many features of the VUL that make it different from other investment accounts, but I’d like to highlight two.
Earnings grow tax-deferred. A Variable Universal Life policy is an insurance contract with an investment account attached. Your premium amount will represent your minimum payment every month, but you can and should contribute more in this situation. Overfunding a VUL allows you to invest the amount of the overage and take advantage of tax-deferred earnings. The opportunity is not limitless – there is a point at which you will be penalized for investing too much at once – but there is still a fair amount of wiggle room. The cash value of your policy – or the amount in your investment account – is available for you to borrow without penalty, since any interest is paid back to you.
Benefits are paid out tax-free. Life insurance benefits pass straight to the beneficiary without being taxed or going through probate. If you’re overfunding a VUL, for example, all the assets held in your VUL – the death benefit amount plus the amount held in the investment account – will pass straight to your beneficiaries tax-free. This makes VULs a potentially excellent tool for distributing wealth.
A word of warning
No doubt, there are a few readers who are fuming right about now, given some of the drawbacks of VULs. But as I often repeat, I believe that an informed investor is a more responsible investor. While the niche for this product is rather limited, it definitely deserves consideration in some quarters. If you make too much to qualify for a Roth IRA, for example, and are maxing out your retirement contributions each year, a VUL might be worth a look. Or if you have assets to distribute among heirs, you might consider this option.
The bottom line is that VULs are complicated products that vary greatly between options, so it is imperative to do your homework. They often carry high fees and expensive insurance, so it is important to shop around. Lastly, insurance agents are generally well-compensated for selling them, so it is important to work with someone you know and trust, who is experienced in this area.
It’s been a difficult few years. Many people found themselves in trouble as the effects of the recession reached every corner of society. The days of growth were swept away, and that situation lasted for a few years. There is an argument that the effects still endure in many places today. A large number of US citizens are still finding it difficult to come to terms with their financial position.
It is a common observation that the first thing anyone needs to do if they have a problem is to identify the fact and then look at the situation. They say that recognition is the beginning of the solution. In the case of finance that usually involves writing down income and expenditure, as well as assets and all debts. The aim is to try to prepare a manageable budget. It may involve economies of course. Every case is different.
The budget is arguably only going to be successful if someone with a problem thinks about the reasons why they have got into trouble in the first place. It may be an actual event such as losing a job, but that is far from the complete picture. Many people get into trouble because of their behavior and financial indiscipline. No amount of planning can help if they behave in the future in the same way as they have in the past.
Do you see yourself? If you have financial worries, have you thought about yourself, your strengths and weaknesses? Sometimes you might find it difficult to criticize yourself for being tempted to buy something you cannot afford. If you have a fixed amount of money each month, you will know the limiting factor on what you can safely spend.
If you are ignoring those limits, then you are likely to get into trouble in the coming months if you are not already in trouble. You have to act by first recognizing you have a problem. If your debt is primarily on credit cards, your monthly expenditure will likely be the minimum payments each of the cards require of you. Even if this is manageable, the reality is that the balances you are leaving at the end of each month will barely be diminishing. You need to resolve to not only get rid of these balances but also resist the temptation ever to build up balances again.
You can get personal loans that currently charge far less interest than credit cards. It is likely that you can get loan from excellent service orientated companies to pay off debt that is incurring penal interest. However, it is not a solution that you will be likely to have more than once. If you are unable to resist the temptation of using your credit cards to build up significant balances again you may have no escape route. A personal loan over three years may be able to pay off core credit card debt. It is three years before you can negotiate another loan to repeat the exercise unless your financial circumstances improve. The best budgetary exercise in the world cannot get you out of difficulties unless you, first of all, understand the importance of self-discipline.
The other important element is to understand your spending habits. That understanding brings you closer to the detail that should go into your budget. The exercise involves looking at your weekly food, transport, and leisure spending. Spending less on these things does not necessarily mean sacrifice. You may find that simply walking a little more rather than taking the auto for short journeys results in your enjoying the extra exercise. Eating out is fun but so is cooking. A sandwich taken to work is every bit as good as having lunch from a fast food outlet, arguably better. There are a number of simple everyday habits that will result in your spending falling.
The incentive to return to a financially sound position if your problems have only occurred in the last decade should be a spur to you. Your memory is certain to tell you how carefree your life was in those days. They can return if you sit down and think about things, starting with yourself.
At every family birthday celebration, my mother-in-law buys each family member “Set for Life” scratch off tickets. Part of our traditional birthday fun includes a hunt through purses and pockets for enough coins to discover who among us might receive $5000 every week for the rest of our lives. Cognitively, I am aware of the futility of this game. But I am also a person for whom hope springs eternal, and each birthday celebration brings a millisecond of breathless anticipation of a lifetime of effortless income.
Of course, it is possible, through careful planning, to arrange for automatic income. Retirement planning is based on that premise. But what about those of us who would like to earn passive income before we retire? Advice on the subject is so plentiful as to be ubiquitous, and frankly, most of it is fairly obvious. Here are a few observations of my own.
You may have to expand your concept of “passive”
Rent is a classic example of passive income, and one that illustrates some of the important points on the subject. I have personal experience with this one, and it is not an experience I am anxious to repeat.
Rental property is an asset that must be maintained, and occupied, in order to keep earning money for you. And maintenance and occupancy are hard work, it turns out. Furthermore, if you don’t start with a sound plan (my rental income experience was reactionary to a crashing real estate market), you may find that your returns are less than spectacular, Even less than zero, some months.
That’s not to say that it doesn’t work for lots of folks. Tempermentally speaking, I am spectacularly unsuited to the role of landlord. But those with a well-thought-out plan, solid financials on the property or properties in question (i.e. rents that outpace the costs involved), and room in the budget to outsource caretaking and tenant-seeking functions can and do enjoy great success in this endeavor. So what’s the point of my story? There are a couple.
- Passive income opportunities are not one size fits all. And all are not equally suited to a particular option.
- Unless you are starting out with a great deal of money, many passive income sources do not start out that way. In order to truly make money without lifting a finger, you need to be able to outsource, and make sure that the money you pay to maintain your property/website/vending machine business doesn’t cut into your margins to the point that the investment is no longer worth your time. If these conditions don’t apply, you may have income, but it certainly won’t be passive.
Of course, that doesn’t mean that an option like this isn’t for you. Being in possession of a strong work ethic, I applaud and admire industry. Just make sure that you’re investing your sweat equity wisely, and understand that truly passive income may not come until later.
Investing for income
Of course, you always have the option to put your money to work for you in the market. Most of us are doing that anyway, saving for retirement and other goals. But if you’re looking to use some of your nest egg for current income, here are some considerations.
- Pick a mutual fund or ETF for truly passive income. Researching individual securities is a lot more work.
- Designate a pool of money specifically for income. It seems obvious, but it is important to consider that the money you designate will no longer be growing, which should be factored into your long term planning.
- Be realistic about how much you can earn. A consistent interest rate or dividend of 6%, or less realistically, 10% sounds like a lot until you consider that $200,000 would get you $12,000-$20,000 per year. Living off of your interest requires more money than you might think.
- If you’re withdrawing all of your earnings, be prepared to see your principal lose value. Consider reinvesting enough to keep pace with inflation.
Make it worthwhile
The most sensible advice I’ve ever been given on this subject is to pay attention to what you could earn risk-free. If the 10-year treasury is paying 2%, you probably don’t want to bust your hump or taking on excessive risk for 4%. Your time – and money – may be more profitably spent elsewhere.
My first, briefly-held job out of college had nothing to do with finances. In fact, I was so ignorant on the subject that I somehow failed to realize that one of the job’s very few perks was an automatic, employer-funded 12% annual contribution to a retirement plan. It’s a benefit nearly unheard of these days, and to my knowledge it is still available to employees. (Before anyone gets too excited, I should stipulate that my employer was a nonprofit, and the salary – even factoring in the extra 12% – was ridiculously low.)
Shortly after I had moved on, the retirement plan was liquidating smaller accounts in an effort to cut costs, and I received a check for $786. As a personal finance writer, I would love to tell you that I promptly executed an indirect rollover and that the $786 is worth much more today. Alas, it is not so. I, of course, spent my supposed windfall on something I can no longer recall, and was unpleasantly surprised with a tax bill at the end of the year. Live and learn, I suppose.
The mistake that keeps on taking
I had reason to recall this error in judgment recently, and I began wondering how much it cost me. Turns out, my $786 spending spree has so far cost me $1,388 in lost earnings (assuming a 6% annual return), plus nearly $200 in taxes and penalties in the year that I spent it. I have no idea what I spent it on, but I doubt very much that it needed it badly enough to justify sacrificing $1,588 in the intervening 17 years. And I am quite certain it pales in comparison to the approximately $10,000 it will have cost me by the time I retire.
It’s easy to see how a person could take this line of thinking way too far, so if you’re the obsessive type I recommend you limit this analysis to retirement dollars. But if you’ve ever thought of cashing out all or part of your retirement for anything less than a life or death emergency or qualified purchase (such as a first home), think again.
Consider, for example, a $10,000 distribution from a traditional IRA used to fund the “vacation of a lifetime.” The rationale is that the memories from such an experience will be priceless, so the cost is irrelevant. It would be interesting to find out if the vacationer feels the same way once he or she finds out that those “priceless” memories actually cost over $50,000 in taxes penalties, and lost interest (assuming a 6% annual return over 35 years.)
$50,000. Seriously. If you don’t believe me, do the math yourself. If you put that vacation on a credit card and paid the minimum, your total interest payments would be in the neighborhood of $5,000. One tenth the cost to your retirement nest egg.
The math doesn’t work
The take away is rather obvious here, but I’ll say it anyway. If you are under age 59 1/2 , your retirement is about the last place you should look for extra cash. The sole exception to this would be if you are using a portion of your Roth IRA as an emergency fund, which, as I have written before, is only advisable under certain circumstances. Look for another option.
Are you scrambling to find cash to keep your business afloat? The stress of managing an inadequate cash flow, combined with worries about the future, can leave you feeling defeated. You may think that no lender or investor would want to join your struggling operation, but that’s not necessarily true. A second round of funding is common when your seed funding runs out and the revenues aren’t enough to sustain operations yet. Here’s some very practical advice on finding funding for your operation, even if it’s running in the red.
Analyze Your Situation
Image via Flickr by 401(k)2013
Be certain, first, that your business is worth saving. Make sure you aren’t deluding yourself. Entrepreneurs are, by nature, optimistic. It’s typical for a business owner to look at lousy projections and then tweak the revenue and expense figures to force a better outcome, with the idea that “we’ll just have to make this happen.” Make sure your projections are realistic.
Prepare Your Spin
Present the current cash flow problem as a minor speed bump on the road to success. Scour your books for evidence that your business model is solid. Present your profit margins, encouraging initial sales figures, or the media attention you’ve received. Briefly address your financial concerns, taking responsibility for your part in the problem (i.e. “Our initial funding estimates were inadequate” or “We used an inaccurate pricing model for our earliest sales, and that hurt profitability”). Then use current contracts or other solid criteria to present your rosy vision of the future.
If your first round of funding dinged your credit score and you’ve maxed out your credit line at your regular bank, find a lender who specializes in alternative funding, such as Bad Credit Business Loans. These lenders are willing to overlook common credit issues in exchange for a slightly higher interest rate. If you believe in your business, you might happily pay that higher rate to avoid parceling out profit shares to investors.
Negotiate With Vendors
Vendors don’t want to see you go bankrupt, and your sales rep has a fiscal interest in going to bat for you. Discuss your current situation honestly and see if your vendors would be willing to grant you more lenient terms or finance a past-due balance so you can pay it off over time. Vendors will usually ask you to pay off this kind of debt even if your LLC or corporation declares bankruptcy, so be prepared to sign a personal guarantee.
Offer Prepayment Discounts
Would some of your bigger customers be interested in prepaying their contracts if you approached them with a generous discount? It’s common to offer a 10 to 20 percent discount for prepayment.
Maybe you didn’t raise enough seed capital because you were unwilling to bring in investors. If that’s the case, reconsider. Start with your friends, family, and acquaintances. You might also invite your biggest customers to invest since they already like what you do.
Your business may be struggling, but you don’t have to give up. Prepare a proposal and go find some second-tier funding.
Generally speaking, most of us fall squarely into one camp or another when it comes to the question of whether to hire a financial advisor. This isn’t that debate. What I’m talking about today is financial advice – and we all need it.
Let me be clear about what I mean when I say advice. I’m not talking about reading blog posts, or researching investments, or keeping up on current trends. These things fall under the heading of financial education, which is certainly a worthwhile endeavor, but they are general. Financial advice, on the other hand, needs to be specific. It requires knowledge of the particulars of your situation, as well as your sophistication level, risk tolerance, time horizon, and investment goals.
Too much of a good thing
I read today that a recent survey indicates that 59% of Americans would give themselves an A or a B when it comes to their personal financial knowledge. While I think that confidence is generally a good thing, misplaced confidence is somewhat less so. While I certainly think there are a fair number of people who are capable of competent financial management, giving oneself an A or a B is more suggestive of mastery. And I find it highly unlikely that nearly 60% of the American population possesses that level of financial acumen.
Of course, anyone who would have given him or herself an A or a B is probably feeling a bit defensive right about now, which I can certainly understand. Had I been a survey respondent, I would probably have given myself a high B or a low A without even thinking about it. But I’m not sure I would have deserved it. Certainly I would score high on financial topics – I enjoy discussing finances and I think investing is interesting, ergo I am motivated to be informed about them. But there is a vast gulf between understanding financial and investing concepts and making good financial decisions, and failing to understand that may keep us from asking for advice when we need it.
The elusive standard of rationality
It is important to be wary of overconfidence, certainly, but there is a second, more insidious reason that we need to seek advice. Humans are not, by nature, rational beings. This one is difficult for me to admit. I put great value on logical behavior, and like to think of myself as more rational than most. The fact that I think this way proves it isn’t true – behavior is either rational or it isn’t. It is not “more” or “less” rational. But neither that fact nor the sheer number of examples available to me of my own illogical behavior stops me from thinking this way.
Our own lack of rationality is a concept so accepted that there is a branch of study that seeks to reconcile financial and economic theory with the behavior of real humans. I’m talking, of course, about behavioral finance, and since it is one of those things I find so interesting, this won’t be the last time I talk about it. The field of behavioral finance holds that we all have biases, whether or not we are aware of them. And simply being aware of them isn’t enough to combat their influence.
Consider the source
There are many ways to go about seeking advice if the traditional advisor route isn’t for you. It isn’t necessary to find the most knowledgeable person on earth, though a foundation of financial knowledge will certainly help the process. The important thing is to find someone who understands you and your goals, but is not so similar to you that he or she will simply confirm your own bias.