Chapter 5

 

Wills, Life Insurance,

and Responsibility

 

"WELL, WELL," ROY GREETED US as we came in from the sunshine. "Has it been a month already? It seems as though you three were here just last week."

"They say time flies at your age, Roy," Tom laughed.

"Cathy, you look gorgeous, as always. Tom, you don't. Hey, Dave, when's school out? Your vacation must start soon."

"Week after next. Sue and I will stick around Ann Arbor until mid-July, and then we'll be here for five fun-filled weeks at the summer home we've rented in Lexington. You should drop by for a barbecue one night, Roy . .. but don't tell Clyde," I added loudly enough for Clyde to hear. He just smirked and doffed his Cleveland baseball cap.

"Roy you're going to be really proud of us," Cathy began, always one to turn a conversation serious. "All three of us have started our save-ten-percent programs." "That's great! Did you use preauthorized checking to buy mutual funds?" Roy asked.

"Cathy and I did," I answered. "Tom went another route. But before he tells you about it, I've got a quick story for Wills, Life Insurance, and Responsibility

 

some teachers in the staff room. They couldn't believe those compound interest examples. Even the math teachers were amazed! I explained why a monthly purchase plan of mutual funds was such a good idea: dollar cost averaging, forced savings, long-term growth .. . even the low PITA factor. Everything. Most of the teachers seemed really interested, but a couple were skeptical. Then Mary McGrath, an older English teacher spoke up. She said that fifteen years ago, she had started a preauthorized checking plan to purchase a well-known growth fund, with one hundred dollars a month. She has had all her dividends reinvested and has never withdrawn a cent. Today, her fund is worth almost seventy thousand dollars ... and that's with only one hundred a month over a mere fifteen years! I'll tell you, that impressed them! When one of the teachers in his mid-forties asked if it was too late for him, Mary replied, 'The best time to plant an oak tree was twenty years ago. The second best time is now.' Great line, huh?"

"I couldn't have said it better myself." Roy nodded ap-provingly. "Obviously, starting young will benefit you tremendously, but so will starting today. Oh sure, you won't save as much starting later, but even a forty-five-year-old can still save a significant sum—very significant. As you pointed out, look what your teacher friend has accomplished in only fifteen years with a fairly small monthly saving."

"I was in my late forties when I started paying myself first, and I've done real good," Clyde contributed.

"I've done really well," I corrected him.

"You too, Dave? That's great," was his quick comeback.

"So, Tom, what's this other route?" Roy inquired slowly, probably still stunned by Clyde's unusual display of wit.

"Well, Roy, I know that you recommend mutual funds Wills, Life Insurance, and Responsibility

 

together to buy a property. The place next door to his had been for sale for a couple of months. It needs some work, but it has definite possibilities. Brian said that if we bought it together, he would do all the yard work and all the repairs and renovations. My job would be to find a reliable tenant and handle the paperwork. We had James come out and take a look, and he agreed that, with the proximity to the water, the size of the lot, and the good neighborhood, the property was definitely underpriced. The deal closes next month.

"We're borrowing twenty-two thousand dollars against Brian's house and amortizing the loan over five years. That's going to cost us less than two hundred and fifty dollars a month, each. We're putting eighteen thousand dollars down and using the other four thousand to fix the place up a bit. Our mortgage is for sixty-two thousand. Principal, interest, and taxes are going to cost us around five hundred and seventy-five dollars a month."

"Have you found a tenant?" Roy asked.

"That's the beautiful part, Roy," Tom answered eagerly. "Kyle MacKenzie and his wife have signed a three-year lease with us for six hundred and twenty-five a month, plus utilities."

"It really is a sweet deal, Roy," James Murray broke in. "In five years I wouldn't be surprised if the place was worth a hundred and twenty thousand, especially after Brian's improvements. They've got a good tenant, balanced cash flow, low interest-rate exposure, and Tom All-Thumbs here doesn't even have to get his hands dirty."

"What's more, Roy, Brian assures me that if I were ever laid off he'd handle the loan payments until I got back on my feet—he's got the cash flow."

"I'm impressed Tom. 'You done good,' as Clyde would Wills, Life Insurance, and Responsibility

 

"Thanks, Roy. It's funny, but on the way here, all three of us agreed that, even though it's only been one month, we feel a lot better about our finances already. For the first time in my life, I actually believe that I'll be wealthy someday. It's great."

"Yeah, Roy, and you know what else?" Cathy beamed. "As Tom said, it's only been a month, but I haven't missed that ten percent at all, just as you promised."

"Don't get a big head, Roy. Your advice last month may have been great, but I'm not all that happy with my haircut," I kidded.

"I guess I'll have to get a new bowl," Roy quipped. "Are you three ready for the second lesson? I'd better warn you, it's not quite as exciting—"

"Or as long, I hope," Tom interjected.

"Or as long," Roy confirmed. "But, in a different way, today is just as important. We're going to look at estate planning. You know ... wills, life insurance—those fun things."

"And to think that I looked forward to this for a month," Cathy groaned.

"Maybe wills and insurance aren't the most thrilling topics in the world, but they sure are important. And what's more, more people foul up in this area than in any other part of financial planning.

"Way more than half the people I know don't even have a will. That's ridiculous. And as for life insurance .. . well, most Americans have the wrong kind, the wrong amount, and often even have the wrong person insured."

"Yeah. I read an article the other day saying that the majority of Americans are overinsured," I pointed out, thinking that for once I'd look informed.

Wills, Life Insurance, and Responsibility

 

the majority of us are underinsured—in some cases, dra-matically, even alarmingly so.

"But we'll talk more about insurance in a few minutes. First, I want to deal with wills.

"You know, estate planning is really nothing more than what you do before you die to make sure that the people and things that you care about are well taken care of after your death. You want your living estate, in other words, your assets less your liabilities, combined with your insurance proceeds, to provide the necessary capital to carry out your wishes. Your will should make sure that that capital is distributed according to your wishes.

"The importance of an up-to-date will cannot be over-stated. Contrary to what most people believe, if you die without a will, things will not automatically work out as you would have wished. Disaster can result.

"Dave, let's say your father were to die tomorrow. If he didn't have a will, what do you think would happen?"

"My mother would inherit everything?" I hazarded, shrugging my shoulders.

"No. I bet the court decides. They'll look at how many children there are, how old they are, and all that stuff," Cathy ventured, in a somewhat more confident tone.

'You're both wrong," Roy stated. "When no will is available, the estate assets are frozen and the court winds up the deceased's affairs and pays off his or her debts. The remaining estate is then divided according to a rigid set of rules found in the state's intestacy laws."

"Intestacy?" Cathy and Tom echoed in chorus.

"Intestacy, from intestate: having made no will," Roy explained.

"No thought is given to the deceased's known wishes or Wills, Life Insurance, and Responsibility

 

according to the rules. The bulk of the estate might be tied up in a trust for the children.

"In our state, and the rules do differ from state to state, if your father died intestate, the first sixty thousand dollars, along with some other allowances, would go to your mother. The remainder of the estate would be divided, one-half for your mother, one-half for you two kids."

"So, Mom would still get the lion's share," I summarized.

"Lion's share, yes, but I think you'll agree with me that it's your dad's wish for your mom to have everything and then, upon her death, for you children to inherit the family estate. Who knows? Over the years she may need the entire amount."

"Boy, you two had better hope your dad doesn't have a will," cracked Jimmy.

"Charitable donations, scholarship awards, gifts for grandchildren or godchildren ... none of these will be taken care of if there is no will.

"Even if you're single, you should have a will. Cathy, if you died tomorrow, your entire estate would go to your parents. That may be what you want but, more than likely, it isn't," Roy continued.

"You're right, Roy, it isn't. I'd like to leave Dave and Sue something. I mean, they need it more than Mom and Dad do. And I'd like to leave the Big Sister organization something for all the fine work they do. And Dave and Sue have asked me to be godmother to their baby. I never thought about it before, but I really do need a will."

"Me, too," I added. "When I die, I want to make sure everything goes to Sue and doesn't get tied up in a trust for years. That's no good."

"Even I need a will," Tom mused. "I'm not really all that Wills, Life Insurance, and Responsibility

 

"Don't forget your best friend, either," I reminded him.

"All right. I don't think it's necessary to go around the room stating why each of us needs a will, or you'll end up being here longer than you were last month. The point is that everyone does need a will, period. We haven't even talked about problems that intestacy can cause for common-law spouses and business partners. It gets pretty scary."

"How do you make a will?" Cathy wondered.

"Don't do it yourself. I can't stress enough the impor-tance of that bit of advice. Go to a professional. Many lawyers have experience in drawing up wills and in estate planning. They know the ins and outs of the various estate-planning alternatives, so seeking out their advice is mandatory. For instance, it is sometimes advisable to set up, in place of or in conjunction with a will, a revocable living trust. This particular type of trust allows you to retain control of your assets while at the same time letting you designate the assets to whomever you wish, whenever you wish, even prior to death, if you want to. Because of their flexibility, and because they allow your estate to bypass the often time-consuming and costly probate process, revocable living trusts in some cases are more efficient than wills. Note the phrase 'in some cases.' Living trusts are not for everyone. Because the initial setup costs are relatively high and there are maintenance and updating costs, living trusts are frequently best suited to larger and more complicated estates. Again, this underscores the importance of seeing a good lawyer. He or she can help you develop an estate plan that suits your specific situation. Everything from guardians for dependents to a living will should be covered."

"A living will—I've heard of that. It's a document that states that a terminally ill person doesn't have to be kept Wills, Life Insurance, and Responsibility

 

"Precisely," Roy concurred. "Often a very prudent thing to look into. Another wise move is to discuss with your lawyer the granting of power of attorney. Obviously, there is no way of predicting when you may become temporarily or permanently incapacitated. In the tragic event that that happened, a power-of-attorney agreement can be key to your family weathering the storm."

"Boy, I can see why using a lawyer's services is vital," I consented. "Is there anything we should do before con-sulting a lawyer?"

"Before you go to a lawyer, sit down and map out ex-actly what your estate would consist of and how you want it to be divided. If you're married, make sure your spouse sits down with you.

"Then choose an executor. This is the person or insti-tution that will carry out your will's instructions. The ex-ecutor may have to do everything from providing a complete inventory of your assets, to collecting money owed to you, to paying off your debts, to filing all proper tax documents, to distributing your estate, and more. It's a heavy responsibility.

"If you choose an individual as an executor, make sure he or she lives near you. It's unfair to ask your cousin Eddy to fly across the country to wind up your affairs, especially since it may involve several trips. Also, choose someone your age or younger. It doesn't make sense to name your father or aunt as executor, when the odds are they'll predecease you. And don't be too quick to name your spouse! If he or she has no money-management skills, there may be other, more suitable choices. Besides, your spouse is going to have a hard enough time without having to handle all the work involved in being an executor. Co-Wills, Life Insurance, and Responsibility

 

is absolutely honest and reliable. Two: Don't forget to name contingent executors in case your first choice is unwilling or unable to act when the time comes."

"Boy, you sure were right, Roy," Tom commented.

"About the importance of a will?"

"No. About this not being as exciting as last month."

"Ha, ha! Actually, you'll find the part on insurance very interesting. Just let me wrap up wills.

"Also, keep in mind that a change of state of residence, business ownership, divorces, remarriages, et cetera, et cetera, all can complicate the estate-planning process. Make sure the lawyer you're using is fully aware of any potential problem areas. Lawyers know how to plan for all the standard problems, like the simultaneous death of two spouses, but they're not mind readers. They can't know all the relevant details of your personal situation unless you tell them.

"A final point to keep in mind is that you must keep your will updated. Births, deaths, divorces, business deals, whatever, may make a will obsolete. Review your will at least once a year and, for heaven's sake, make sure that your executors know where to find it! In fact, give them a copy and keep another copy at your lawyer's.

"Oh, and always keep a complete, up-to-date net-worth statement listing everything you own and everything you owe, along with a copy of your will, in your safety deposit box and at home. A friend of mine died ten years ago and they didn't discover until last year that he owned shares in a number of large companies. The certificates were registered in the brokerage company's name and held on account, and the firm had never been notified of his death. A lawyer I know tells me this kind of thing happens frequently."

Wills, Life Insurance, and Responsibility

 

times less. In view of its importance, that's certainly not a lot of money to spend."

"I don't know why, but I always figured a will would cost a lot more than that."

"No. It's not the cost of a will that prevents most Amer-icans from having one. It's just pure procrastination. We all know we're going to die someday, but we don't want to admit that day could be soon, so we put off planning for it. But you three won't do that. Do you know how I can be so surer

"Because you know we're responsible people?" Tom speculated.

"No. Because next month each of you is going to bring me a copy of your lawyer's bill showing that you've had a will drawn up. If you don't, the fountain of your financial knowledge will suddenly dry up."

"Roy," Cathy protested, "we're not little kids. We're mature adults."

"Speak for yourself!" Tom roared.

"We all started our save-ten-percent program without being forced to, didn't we?" my sister persisted.

"Good point, Cathy. Very good point. But bring me the bill anyway," Roy commanded, over the chuckles of James Murray.

Procrastination is my middle name, but I didn't need Roy's strong-arm tactics to get me moving. After learning about intestacy laws, I decided that only a fool wouldn't have a will. A few hundred dollars is an insignificant price to pay when you consider what's at stake.

"The bottom line, Roy, is that if you don't have a will, your loved ones could suffer," I concluded aloud. "I'm not going to do that to my survivors."

Wills, Life Insurance, and Responsibility

 

"I can't believe that," James Murray scoffed.

"It's true. You can ask Roy."

"No, no. Not the part about the dog. What I can't believe is you knowing the word 'bequeath'!"

"I hate to break up this scintillating dialogue, but we've got more material to cover." Roy's announcement immediately silenced Port Huron's Laurel and Hardy.

"On to insurance. Let me caution you now to pay strict attention to the rest of today's lesson. I say this for four reasons. One: The financial future of your loved ones may depend on you having the proper amount of life insurance. Two: It is, without a doubt, essential to your own financial future that you have the right type of life insurance. Three: There's a good chance that James and I are two of the few people you'll ever meet who have a solid understanding of insurance, and who are willing to share that understanding with you. And four: My tape recorder is broken."

"What about insurance agents?" Cathy asked.

"Are you kid—"

"Whoa, slow down, James. Slow down," interrupted Roy. "We'll talk more about insurance agents in a few minutes. For now, suffice it to say that there are some good insurance agents, and some who are not so good."

"Many who are not so good," James Murray grumbled.

"Perhaps," Roy agreed. "But that holds true in any oc-cupation. There are good teachers and bad teachers, good real-estate agents and bad real-estate agents—"

"And really bad real-estate agents," Clyde shot at James.

"The problem with insurance is that most people are so poorly informed that they have no way of telling the good agent from the bad agent. If I consistently give you a bad haircut, you'll eventually stop coming here."

Wills, Life Insurance, and Responsibility

 

only by an informed observer. So, the answer is simple: Become an informed observer! Fortunately, that's not as difficult as you might think.

"Let's get started. Cathy, why do people buy life in-surance?" Roy asked.

"Well, if you die prematurely, you want to have enough money to support your spouse and kids, I guess."

"Close. People buy, strike that, should buy life insurance so that when they die, their living estate, again, that is their assets less their liabilities, combined with their insurance proceeds, can allow for the proper winding down of their financial affairs and provide the desired standard of living for their dependents. Now, that's pretty basic, isn't it?"

A collective "yes" was offered.

"Fine." Roy nodded as he turned back toward Cathy. "Bearing that in mind, how much insurance do you need, Cathy?"

"I just bought a fifty-thousand-dollar policy."

"I didn't ask how much you have. I asked how much you need," Roy reminded her politely.

"Apparently not fifty thousand dollars," Cathy frowned. "I don't know ... I guess ..." She paused to think.

"How much would your dependents need?" Roy helped.

"I don't have any dependents," my puzzled sister re-sponded.

Roy nodded his head slowly and emphatically.

"None. You're saying I don't need any life insurance?" she asked.

"That's precisely what I'm saying. Life insurance is a wonderful thing. It is, no doubt, the most important of all financial products. It is a must until a sufficient living estate has been acquired to protect one's dependents. Purchased Wills, Life Insurance, and Responsibility

 

targeted standard of living if premature death occurs. Really, life insurance is better termed financial protection for dependents or income replacement insurance. But despite all that, you have to remember it is still an expense. The life insurance companies aren't giving it away. So, like everything else that costs money, you only want to buy it when you have a need for it.

"Think about car insurance for a moment. It's a won-derful product, too. But no one in his right mind would buy it if he didn't own a car. Well, buying life insurance when you have no need for it is equally foolish."

"Shouldn't I at least have enough insurance to cover my funeral expenses?" Cathy wondered.

"In addition to taking care of your dependents, your living estate and your insurance proceeds combined must also allow for the proper winding down of your financial affairs. That includes eliminating all debts, settling taxes, treating business partners and employees fairly, and paying funeral expenses. If your living estate is sufficient to do that, no insurance is needed. For most single people, that's the case," Roy replied.

"Hmm . . ." Cathy started slowly. "My assets would definitely cover my debts and my funeral costs, with money left over."

"Mine, too," Tom realized. "As of right now, I don't have any debts, and the twenty-five-thousand-dollar group insurance coverage I get as a benefit at work should cover my funeral."

"Twenty-five thousand! That's a heck of a funeral," Clyde whistled. "I'll look forward to it, Tom."

"Tom, how much insurance do I need?" Roy pressed on.

"Zero. Your living estate, as you put it, is sufficient to Wills, Life Insurance, and Responsibility

 

"Zero. No one is dependent on the baby," I replied, with equal confidence.

"Very good," our instructor said approvingly. "Although we love them dearly, children are financial liabilities, not assets. You don't insure a liability! If you had an uncle move in with you, eat your food, drink your beer, and watch TV all day, would you insure him? Of course not! He's a liability. Although parents would cringe at that comparison, I hope you three get the point.

"You only buy insurance when there is a definite need to protect your dependents and to help in winding down your financial affairs. Single people, therefore, often don't need insurance. Young married couples, especially those with children, almost always need insurance. The question for them then becomes not 'Do we need it?' but 'How much do we need?'

"Often the answer to that is, 'More than you think.' Your living estate, not including your non-investment assets, plus your insurance proceeds must provide enough capital to accomplish a number of things. One: All debt must be paid off. The last thing the surviving spouse needs is to be saddled with debt. Two: Enough capital must be available to cover future lump-sum obligations. This is something that is often forgotten ... your funeral expenses, for example. A better example, though, would be college expenses for the children. It costs quite a bit of money to send a child to college. Although the child should be responsible for a fair amount of the total cost, he or she may need help. That money to help has to come from somewhere. It should be taken into account when analyzing insurance needs. Three: There must be enough capital and other sources of income present to provide sufficient cash flow to support your Wills, Life Insurance, and Responsibility

 

provide a block of capital sufficient to bring in the other thirty thousand dollars annually. How much is that? Well, unfortunately, most people arrive at that answer by assuming they will always be able to earn a guaranteed ten percent on their money. That assumption leads them to believe they need a capital pool of three hundred thousand dollars."

"I don't see any problem with that logic," I confessed.

"The problem, since you must invest this money ultraconservatively for obvious reasons, is that you can't be sure you'll always be able to earn a ten percent rate of return. When it comes to loved ones, you're better to err on the conservative side. I would base my calculations on an eight percent assumed rate of return—certainly an achievable rate even with a relatively conservative in-vestment approach. So, to generate thirty thousand dollars, I would need a three-hundred-and-seventy-five-thousand-dollar pool of capital.

"The last thing that your living estate plus insurance proceeds must cover is often totally neglected: inflation! Inflation is a widow's or widower's number one enemy. For example, an insurance program is designed so that a widow is left with an annual income of thirty-five thousand dollars, the desired amount. The problem is that the entire thirty-five thousand is needed to support the family; none is saved for the future. Ten years later, that thirty-five thousand may be worth only twenty thousand in purchasing-power terms. A middle-aged, untrained woman is forced to go back to work and, even then, the family has trouble surviving. Unlikely? Hardly! That's exactly what happened to my wife's aunt... and to many, many other people. Inflation's eroding effect on purchasing power is as relentless as compound interest's Wills, Life Insurance, and Responsibility

 

"Dave, let's look at your case. Pretend that it's a year from now. You've bought your home, and you and Sue are proud parents. How much insurance do you need? And how much insurance should you buy on Sue's life?"

"With our down-payment fund gone toward the pur-chase of the house, we won't have any investment assets to speak of, so the insurance proceeds are going to have to cover all of Sue's and the baby's needs," I started.

"Good," Roy commended me. "Continue."

"First, we'll have to have a lump sum available to eliminate our debts. I should say debt. The only money that we'll owe will be our mortgage of, say, one hundred thousand.

"Future lump-sum obligations. Hmm ... Davey Junior's college education, the funeral expenses, and within a couple of years, a new car."

"Ten thousand should give you a good start on the ed-ucation costs. There will be eighteen years to invest the money and make it grow," Roy explained.

"And ten thousand for burial costs and ten thousand for the car. So, future lump-sum obligations total thirty thousand," I tallied. "Then there's the need for a sufficient income. You know, I don't want Sue to feel she has to work outside the home ... especially before the baby's in school. So, I think I'm going to assume that her income after my death will be confined to the ten thousand dollars a years she makes freelancing as a travel writer. To live comfort-ably, she'll probably need around thirty thousand a year. With no debt and no rent to pay, that should be plenty."

"You know what I would do, Dave?" Cathy suggested. "If she could live comfortably on thirty thousand dollars, I would buy enough insurance to give her an income of Wills, Life Insurance, and Responsibility

 

Cathy. Dave, I'm sure you'd agree that Sue deserves not only to live comfortably, but also to have the finer things in life. Well, you've learned how she can!"

"Thirty-three thousand it is," I concurred. "To create an investment income of twenty-three thousand a year, assuming an eight percent interest rate, I would need how much, Roy?"

"Now, you've forgotten that Sue would receive a Social Security benefit of—I'm guessing a bit—say, just under ten thousand a year, until your child reaches at least the age of sixteen. That income certainly has to be factored in, too. Actually, your child would also receive a Social Security benefit, but knowing your wife, I'm going to assume that amount would be set aside for the child's future ... perhaps a down-payment fund," Roy advised.

"I hadn't thought of that," I reluctantly admitted. "All right, then, I need only enough insurance to spin off an income of thirteen thousand a year. I realize that the Social Security benefit stops when my child gets older but I'm sure that, by then, Sue will be back at work anyway—"

"Or remarried ... to me," Tom smirked.

"How much coverage would I need, Roy?" I pressed on, undaunted.

"One hundred and sixty-two thousand and five hundred dollars," James Murray intervened, proudly showing Clyde the calculator on his watch.

"As for inflation," I went on, "I really don't think I'd need that much. With Sue saving ten percent and with her certain to re-enter the travel agency business when the baby gets a little older, she should be fine." I looked around smugly.

"Excellent, Dave," Roy congratulated me. "The last bit Wills, Life Insurance, and Responsibility

 

how much insurance you decided you needed? Two hun-dred and ninety-two thousand five hundred dollars' worth." I was dumbfounded.

"He won't be able to afford his premiums, will he?" asked Tom, who uncharacteristically, seemed genuinely concerned.

"I get forty-five thousand dollars' coverage free with my benefit package, but I'll still have to buy almost a quarter of a million worth. I'll need the insurance," I griped. "Paying the premiums is going to kill me!"

"Dave, my boy, you're wrong. If you buy the proper types of insurance, your premiums will be quite reasonable. For now, though, let's stick to the amounts and not get ahead of ourselves.

"Making the same assumptions ... house, baby, et cetera .. . how much insurance should you place on Sue's life?" Roy then asked.

"Sue's no longer working at the travel agency, so our current family income would only drop by the ten thousand dollars she makes selling her travel articles. But the expenses would also drop with one less person to support. With my income being fairly good, I'm going to say zero. No insurance on Sue's life."

"I can see your logic, Dave—" Roy conceded.

"But—" I anticipated.

"But I want to make two points. Always insure both spouses for at least the amount of the outstanding debt, in your case, one hundred thousand dollars. A debt-free balance sheet substantially reduces stress, along with freeing up cash flow. Raising a child, making payments on a one-hundred-thousand-dollar mortgage, and enjoying a good standard of living wouldn't be easy on your salary Wills, Life Insurance, and Responsibility

 

entire income from Sue's writing, but you want at least enough to cover the cost of child care."

"So, I probably need two hundred thousand dollars' coverage on Sue," I surmised. "One hundred thousand to pay off the mortgage, ten thousand for the funeral, and the rest to pay for a nanny for a few years."

"Again, don't forget to include any potential Social Security benefits in your analysis," James Murray reminded me.

"The point of all this was not just to help Dave." Roy motioned toward Tom and Cathy. "It's to help you two bored-looking individuals, as well. There may be a woman out there crazy enough to want Tom as a husband. There might be an even crazier man who would tolerate Dave as a brother-in-law. So, eventually you may both be in the position of needing insurance. And when you are, you've got to be able to figure out exactly how much you need. All it takes is the knowledge I've given you—remembering the four needs for insurance proceeds—and some common sense."

"I'm going to talk to my brother about this tomorrow, Roy." Tom shook his head disbelievingly. "He's got two young children and a wife. I now know for a fact that he doesn't have nearly enough insurance. He has one hundred thousand dollars' coverage through work, but that's it."

"You may be doing him the biggest favor of his life . . . or at least doing his loved ones the biggest favor of his life," Roy replied. "Now, before we move on to the different types of insurance, let me give you three illustrations of some tricky evaluations you may be faced with in the future.

"One: Both spouses are working and making excellent Wills, Life Insurance, and Responsibility

 

his or her own without insurance proceeds. Their house is fully paid for, and their two children could easily be supported on either parent's income. What's wrong with their analysis?"

For a few seconds, everyone was silent. Then I realized where Roy was headed. "What if they both die at the same time? Their children would be left with only the house."

"Excellent, Dave! Does everyone see? James, didn't you tell me about a case just like that?"

"Yes. That happened to friends of Barb's parents several years ago. You have to protect against situations like that by buying a policy that pays only when both of the insureds die," James answered.

"All right. A second example," Roy continued without missing a beat as Tom got into the barber chair. "Cathy sells half of her business to Joe Schmoe. A year later, Joe dies, leaving his half to his wife, who has no business experience. She has no desire to enter the business world and decides that she wants to sell her half back to Cathy. Unfortunately, Cathy has no liquid reserves and has exhausted her lines of credit. Suddenly her lifeline, Richardson Landscaping, is in jeopardy. Will it be shut down? Will Schmoe's half be sold to an inappropriate person?"

"I should have had insurance on his life. Is that what you're saying?" asked Cathy.

"Yes. It's another example of how difficult it can be to analyze how much insurance to buy. It's not enough that you are properly insured so that your loved ones will be taken care of. You also have to make sure that anyone you're dependent upon is properly insured."

Since I'm not dependent on anyone, this point didn't strike me as too important. It sure had an impact on Tom, Wills, Life Insurance, and Responsibility

 

after we close our real-estate deal, I'd be in trouble. I couldn't afford to pick up the payments on his half of the down-payment loan. I'm going to have to talk to him about us getting insurance on each other's lives."

"Take care of that soon," Roy encouraged him. "One final example of insurance-needs analysis. Thirty years from now, Tom has parlayed his monthly savings and ap-parent knack for buying undervalued properties into a three-million-dollar real-estate empire. Unfortunately, he is hit by a bus." This drew applause from both Jimmy and Clyde. "A substantial estate tax is levied. Tom felt that he was self-insured, so the estate was limited to his personal residence, real-estate holdings, and baseball-card collection. So, his estate is forced to sell several properties to pay the tax bill. Sadly, real estate is at its lowest point in two decades, making it a terrible time to sell. But there is no choice. The point is that, for liquidity reasons, it would have been a good idea for Tom to carry enough insurance to cover his tax liability.

"I gave these three examples to show you that a lot of thought is needed to correctly analyze your insurance needs. Don't be lazy. Do the necessary thinking. Get a book out of the library. Talk to an insurance agent. They've had years of experience and have encountered almost every possible scenario. For heaven's sake, be insured for the correct amount! You owe it to yourself and to your family."

It was now evident to everyone that Roy's promise of this month's lesson being shorter than last month's had a better-than-even chance of being broken. We hadn't even delved into the different types of insurance policies. I had nightmarish visions of Tom and me missing our tee-off time.

Wills, Life Insurance, and Responsibility

 

types of policies still to be discussed, could we perhaps finish this off next month?"

"That won't be necessary, Dave. Although, as you pointed out, there are a number of different types of poli-cies, there is only one that you, Cathy, and Tom will probably ever need: renewable and convertible term insur-ance. It won't take me long to teach you why.

"I'm sure that even you three, with your limited financial backgrounds, have heard the age-old argument of whole life versus term, better stated as cash-value insurance versus term insurance."

"I certainly have," Cathy remarked. "You won't believe this, but when I went to buy insurance last month, I actually decided to do a little research beforehand. All three books I read suggested that term insurance was a better alternative than cash-value insurance. Yet both agents I saw were very insistent that I buy cash-value. I bowed to their expertise."

"I don't even know the difference," Tom admitted candidly.

James Murray leapt in, "Those agents recommended cash-value because—"

"Hold on, James," Roy ordered. "You'll have your chance. First, let's look at a couple of definitions.

"Term insurance is like fire insurance. It pays out the face amount of the policy if the insured dies, just as fire insurance pays out the face amount if the insured building burns down. Term insurance is in force for a stipulated length of time, or term, hence its name. It's most often sold in one-year, five-year, ten-year, or twenty-year terms. When the term expires, so does the insurance. There are no cash values, savings, or investment elements. It is insurance in its most basic and least expensive form.

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policy. Or, in other words, the amount that you've built up in savings and that you would receive if you were to cancel the policy. Dave, are the odds of you dying next year if you own a cash-value insurance policy higher or lower than the odds of you dying next year if you own a term policy?"

"The same, of course. Even I know that."

"Yes, I think anyone could answer that question cor-rectly. It's the significance of the answer that most people miss," Roy explained patiently.

Damn. He had lost me. "I'm not sure I follow you."

"I'm sure you've heard the expression, 'Buy term and invest the difference.' What does it mean to you?" Roy put the ball back in my court.

"Well, instead of buying a cash-value policy, you buy the same amount of term coverage, which is less expensive because it doesn't include a savings element. Then you invest the difference between the two costs in a savings vehicle."

"That's right. So, remembering your answer to the 'odds of dying' question, what's wrong with the oft-heard question, Ts it better to buy term and invest the difference or to buy a cash-value policy?' I'll tell you what's wrong. They're the same thing. As you said, the odds of dying are the same, regardless of what type of policy you buy. So, there is really only one type of life insurance, and that is pure protection based on a mortality table. That's what term insurance is. Cash-value insurance is pure protection, or term insurance, plus a savings element. 'Buy term and invest the difference' is exactly what a cash-value policy does. The problem is, it often doesn't invest that difference nearly as well as you can on your own."

"If that's the case, why do insurance companies issue Wills, Life Insurance, and Responsibility

 

sponded hotly, before Roy had a chance to speak. "The premiums on cash-value policies are much higher—and so is the commission rate! The companies and agents make far more money by selling cash-value insurance than they could by selling term."

"You're pretty agitated, James!" Cathy exclaimed. "Do you agree with him, Roy?"

"No. With all due respect, James, I don't. Sure, there are a number of unscrupulous salespeople, but, as I said earlier, I don't think it's any worse in the insurance industry than in any other business. Maybe it was fifteen years ago, when James was an agent. But now many agents do a conscientious job not only of placing insurance, but also of estate and financial planning. The products have improved, and so have their prices. Now you can get price distinctions based on sex and based on smoking versus non-smoking, for example. Professionalism is definitely on the rise, too. More and more agents are becoming better educated about all financial matters, not just insurance."

"If all that's true, why do they sell so much of what you claim is sometimes an inferior product?" Cathy persisted.

"Yes! If all that's true, why do they sell so much of what you claim is an inferior product?" James Murray echoed.

"The policy I just bought on my agent's recommenda-tion was a cash-value policy," Cathy remarked, before Roy could offer a response.

"First, let me say that not all agents exclusively push cash-value policies. Many sell primarily renewable and convertible term insurance. Many also espouse the benefits of paying yourself first, saving ten percent, and building up an IRA or other retirement plan. Those people are doing good jobs for their clients.

Wills, Life Insurance, and Responsibility

 

amount of coverage, but also to become self-insured through saving and investing. For obvious reasons, in-surance costs increase dramatically later in life. So, you have to have saved the funds necessary to pay them or to have saved enough not to even need insurance in your later years. Most agents feel that a cash-value policy ac-complishes this goal of saving while insuring you as well.

"They argue that although 'Buy term and invest the difference' sounds good in theory, it seldom works in practice. Why? Because for most people the more accurate expression is 'Buy term and spend the difference.' Agents see that a lot of clients don't have the discipline or the knowledge to invest the difference. So, even though they start out properly insured with inexpensive term coverage, they end up facing a retirement that includes high insurance costs and an empty bank account."

"Do most people end up that way?" I wondered.

"Unfortunately, a lot do. It's staggering the number of people over the age of fifty-five who are in serious financial trouble. But you won't be," Roy assured us.

"How can you be so certain?"

"Because you're getting financial advice from the wealthy barber. Between your ten percent fund and your retirement planning, you'll be self-insured at a very rea-sonable age—very reasonable. You're not only buying term and investing the difference; you're investing more. And you're investing it well!"

"That sounds great, Roy. But if the insurance company is offering to do it all for you by selling cash-value insurance—insurance plus savings—why not let them? Won't they do a better job investing than we would, anyway?"

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tution, you must buy life insurance. You must pay for it even if you don't need it. We'll take everything you deposit in the first year for ourselves. In future years, we'll charge you to deposit money into your savings account. You can borrow the money at any time, but we'll charge you interest. If you happen to die while this loan is outstanding, we'll decrease the amount we were to pay your beneficiary by the outstanding amount of the loan. If you don't borrow from this account and you die, we'll pay the beneficiary only the face amount of the policy—we'll keep your savings for ourselves. Oh, and finally, we don't offer the greatest rates of return.'"

"No, thanks. I think I'll keep buying houses with my brother."

"You see," Roy went on, "the deal I offered Tom isn't far removed from the deal offered by the traditional cash-value policy. In a way, you can't blame insurance compa-nies for trying to make money. They have to cover expenses, pay their agents, and make a profit for their shareholders. That can't leave much for you, the policy-holder. To save successfully, you have to cut out the mid-dleman—"

"And you have to invest for growth," a fervent Tom in-terrupted.

"A good point indeed. As we saw last month, the last thing we want is for our long-term savings to be tied up earning low rates of return. We want to be owners, not loaners," Roy reminded us.

"You mentioned that if we buy a traditional cash-value policy and die, all we get back is the face value of the insurance we have paid for. The insurance company keeps our savings," I remarked.

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alive and dead, you are restricted to receiving the benefits of only one service," James Murray pointed out.

"I'd like to make one other point. Some agents agree that cash-value policies might not be the best way to save, but argue that they're still worthwhile because they're compulsory savings plans. That," Roy snorted, "is nonsense. If you have the self-discipline to make premium payments over a long period of time, you certainly have the self-discipline to manage a suitable savings program on your own. In fact, you three have already started."

"I'm confused by one thing." Cathy stared at Roy in-tently. "The cash-value policy I bought last week was a lot different than the traditional one you two are describing. It's called universal life, and my agent assures me that the rates of return are very competitive. He also told me that, when I die, my beneficiary gets both the insurance proceeds and the policy's savings component. In fact, I can even invest the savings in a vehicle similar to a mutual fund if I want to. That doesn't sound like a bad deal, does it?"

"The insurance industry really has expanded its product line over the last few years. Universal life can be a better product than the traditional whole life policy. Most universal life policies unbundle the insurance and savings elements, meaning that when you die, as you said, your beneficiary will receive both. They also offer more competitive rates of return. That being said, though, for a couple of reasons universal life usually still isn't as good as buying term and investing the difference. First, the term insurance component may be purchased much more cheaply outside the package. Second, because the company has to cover expenses and make a profit, the investment-savings portion may not yield as great a return inside the package as Wills, Life Insurance, and Responsibility

 

high. If, for example, after ten years you cancel your uni-versal life policy because you no longer need the insurance, the rate of return on your savings component is often only in the three percent area—which is ridiculous. Third, you must buy your investment component from the same insurance company that you're buying your life insurance from, obviously, as they're two parts of a single product. This, equally obviously, may not be ideal.

"Universal life does have one major benefit, which is that, at the moment, the savings portion is allowed to grow tax-free until withdrawal. But because of the sometimes inferior rates of return, the absence of reasonable long-term guarantees on both the investment and insurance sides, and the comparatively high costs of the term component, that advantage is usually negated. The bottom line still is—buy term and invest the difference, especially when you can invest that difference in the retirement plans we'll talk about next month. However, it can't hurt to talk with an agent and examine all your alternatives.

"Cash-value policies carry level premiums whereas term becomes more expensive as you get older. Why is that?" Roy tested us.

"I know," Tom stated. "It's because, with cash-value policies, you overpay in the early years to subsidize the rising costs in the later years. The overpayment is invested and compounded so the rising costs in later years are easily covered."

"Tom, I'm impressed." Roy's compliment was genuine. "Is this a good thing?"

Tom spoke up again. "No. Why overpay in the early years when there's a good chance you won't even need the coverage in the later years? I'll be self-insured by the time Wills, Life Insurance, and Responsibility

 

"Tom, I take back all the things I've thought about you over the years. You are definitely smarter than the average bear," remarked Roy.

"Bear, perhaps, but not human," I muttered, belying the fact that I was impressed.

"OK. I see that term insurance is the way to go, but what about my agent's argument that buying insurance now was a good idea so I would guarantee future insurability?" Cathy absentmindedly pushed a fallen lock of hair with her toe. "That seems to make sense, doesn't it?"

"I'll answer that, Roy," James Murray offered. "I don't think you should buy life insurance unless you need it. I believe fewer than two percent of people are turned down for life insurance. Yes, there is a chance you might become one of them, but there's also a chance you'll be in a car accident today. I'm sure you'll still drive. In life, you can't avoid all risks. If you do insist on buying to guarantee insurability, though, make sure you buy term insurance so that, for the same premium dollars, you can guarantee as much insurability as possible."

"Very diplomatically spoken, James. I'll hurry along so you two can make your golf game."

"Yeah. If we miss that tee-off time, you'll wish you had insurance," Tom advised Roy with a wink.

"I mentioned the terms renewable and convertible earlier. Renewable means that, at the expiration of the stated term, you can renew the insurance without having to prove insurability by taking a physical. It's obvious why that's important. If you got cancer but weren't going to die before your term insurance expired, guaranteed re-newability would be your salvation.

"It's often a wise move when you purchase renewable Wills, Life Insurance, and Responsibility

 

company design or are caused by some other phenome-non—AIDS, for example—you won't be protected unless your policy has guaranteed future premium costs.

"Usually, you're allowed to renew until age sixty-five or seventy. This will be more than sufficient for you three, because you'll all be self-insured long before then.

"Convertible means that the policyholder has the right to convert the face amount of the policy to any cash-value plan sold by the issuing company, again without proving insurability. This feature is important in case you need insurance past age sixty-five and can no longer renew your term insurance. I doubt if any of you will have to call on this feature, but buy it just the same. It's very cheap," Roy finished.

"I feel very strongly that no company should be allowed to sell non-renewable or non-convertible term insurance. The reasons are self-evident," remarked James Murray. "There are just too many ways the policyholder can get hurt."

"Should we shop the market for the lowest rate?" was Cathy's next question.

"Yes," James Murray replied.

"No," Roy countered. "You should always attempt to get a competitive rate, but not necessarily the lowest rate. Many agents are restricted to offering only the products of the company they're licensed with. If you are dealing with such an agent, and he or she is doing a good job helping you to analyze your insurance needs and giving you other financial planning advice, it is probably prudent to stick with that agent. This may mean not getting the lowest rate. Your rate, however, should still be a competitive one. Too much loyalty can be expensive! It's also imperative that you Wills, Life Insurance, and Responsibility

 

many consumers pay no attention to the financial health of their insurance company. Yes, that responsibility should be partially borne by a good agent, but consulting ratings of the various insurance companies' financial strengths—such as those published by A.M. Best, Duff & Phelps, and Standard & Poor's—sure can't hurt.

"It's important to note that you probably won't be buying all your term insurance from an agent. A non-agent source of term insurance is the group insurance offered through work. Cathy, this won't apply to you at this point. Group insurance can, and I stress 'can,' be a great deal. Because it is distributed to the consumer more efficiently, group insurance is often an inexpensive alternative to an individual policy.

"There are some caveats with group insurance, though. It isn't always better than an individual policy. Group rates are based on the average person within the group. If you are substantially younger than your colleagues, you may be better off with an individual policy. Likewise, if you are female and the group policy has no distinction based on sex. Or if you are a non-smoker and the group policy has no distinction based on smoking. Get your group-rate quote from your company's personnel department and then get a quote from your agent for the costs of an individual policy. Also, if you leave your company, you may not be able to take your insurance with you on a convertible and renewable basis. That's not a good situation. Instead, almost all group policies allow you to convert to a cash-value plan within thirty-one days of leaving the group. We don't want cash-value, so only accept this conversion if you are unable to qualify for individual term insurance at the time of your departure. The fact that you don't have full control over Wills, Life Insurance, and Responsibility

 

"Also, don't restrict your analysis of group policies to the one offered at your place of work. You may be able to qualify for a plan available through your university alumni, a fraternal society, or a union. Some of these plans are excellent."

"Tom's a card-carrying member of the Archie Fan Club. Do they have a group policy?" Cathy teased.

"I'm getting forty-five thousand dollars' coverage free at work. Should I take it?" I asked.

"Two months and that's our first stupid question. Not bad. Not bad. Take anything you can get for free, Dave," Roy replied, shaking his head.

"How much does term insurance cost?" I asked, hoping not to embarrass myself again.

"Let's look at your example, Dave. We decided that next year you'll need around two hundred and ninety-two thousand dollars' coverage, and Sue will need around two hundred thousand. Well, using the forty-five thousand you get as a benefit along with properly selected term insurance, perhaps purchased through group coverage at work—I'm speculating a bit, but you're probably looking at about forty-five or fifty dollars a month."

"That's it?" I was amazed. "I thought it would be hun-dreds a month."

"No. Term insurance is a bargain, no doubt about it. And the nice thing is that, as you get older and your cost per thousand dollars of coverage goes up, you'll have less need for insurance," Roy explained. "Your living estate will be increasing each year."

"What about disability insurance, Roy? Do I need it?"

"We'll talk about disability insurance and medical in-surance in an upcoming lesson, Cathy."

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"All I'm doing for you three and that's how you treat me ... Oh, the disrespectful youth of today. Hey, you two should score a little better this time out."

"Why's that?"

"It's after eleven o'clock. You're going to miss the first three holes."

"Ooh, wealthy and witty. What a deadly combination," I said with a grin, as we stepped back out into the sunlight.

"Don't worry about it." Tom patted me on the shoulder. "By the time we get to the course, your dad will have paid for our greens fees. Now, that's sound financial planning!"