There is no shortage of available information in today’s world. And while this information is empowering, it can also be unsafe. This is true of all industries, but I’ll provide you a few examples as it relates to financial planning.
Take something very basic like term life insurance. It’s a commodity. Most carriers have very similar pricing. You’re young, you have a family, you need it, it’s affordable. You do some research and purchase a $1MM, 20-year term policy online. Generally speaking, this is a sound purchase.
But how did you determine the amount, duration, and type? Did the $1MM take into consideration all the factors you intended, lost wages, future retirement contributions, college education planning, liquidity needs, your spouse’s lost income? Remember their world has been turned upside down, they’re left to take care of grieving children. Do we want them returning to work at the end of their company’s bereavement leave?
After 20 years, assuming your health is still good, do you purchase more insurance or just let the current policy lapse? This is a much tougher call. While you may still feel the need to have insurance, you question if it’s worth it. Maybe you should have purchased another policy, 10 years into your existing term. Or maybe you should have purchased a 30-year term policy to start with.
Was term insurance the right coverage? Perhaps, but did the reason for having it change? Originally it was meant to replace lost wages. Should you just cancel coverage in retirement? Maybe, but what about estate taxes, the loss of one spouse’s Social Security benefit, the loss of a pension, etc.? Not to worry, you chose the joint survivorship pension option. Was that the right option?
When selecting a pension, you’re provided a series of choices. Would you rather have a $9,000 monthly, single life benefit or a $6,000 monthly, joint survivorship benefit? Most choose a joint survivorship benefit but what if you took the $9,000 monthly, single life benefit and purchased or kept your existing life insurance coverage. Assuming you could purchase a $1.8MM permanent life insurance policy for $2,000 a month, your spouse would receive $1.8MM at your passing. If the $1.8MM could earn 4% interest, it would replace the pension benefit of $6,000 a month and you’d be ahead $1,000 a month. Your pension wouldn’t be reduced if your spouse died first and the kids would receive an inheritance.
Let me be perfectly clear, I’m not saying the $1MM, 20-year term policy you purchased was wrong. I’m merely asking did you consider the totality of the situation?
This example extends across all areas of financial planning. Consider an investment that is generally known to beat all other investments over a 20+ year timeframe, with low cost and no time commitment. Call it Investment A. Sounds good, right? What’s there to debate? Remember insurance and investments are tools. You could have the best hammer, but it won’t help you chop wood.
As you’ve neared retirement, the question becomes should you continue with Investment A because it has performed well, or do you pivot?
One of the first things to consider is, are there any tax implications in selling Investment A? If the answer is no, you could do it, but should you? Assuming Investment A is held in a taxable account, could the dividends and/or interest of Investment A support you financially? If they can, you might consider keeping it to avoid capital gains and at your death your heirs could receive a step up in basis. However, if dividends and/or interest are not enough to support you then you will have to sell it anyway. Can you delay selling it? Could you drawdown from other investments first or drawdown from the fixed income portion of another portfolio, assuming a bear market? Should you sell it systematically or all at once? Although selling systematically could lessens your tax burden, what about volatility?
While volatility does not matter much during the accumulation phase, it does matter during the distribution phase. This situation is commonly referred to as sequence of return risk. While accumulating assets, the sequence of returns (-17%, +22%, -6%, +8%, etc.) do not matter. But when distributing assets, it can mean the difference between running out of money and having millions of dollars at your death. It is important to model Investment A to make sure it provides you with a high probability of success (known as Monte Carlo analysis) relative to your goals and objectives.
As you can see, the scenarios are endless. It’s important to be thoughtful. While you can find a lot of information online, it’s what you don’t consider and what you don’t know that can cause the most harm.
Scott Ida, CFP®, CEPA is a partner with Open Advisors, LLC. He has over 18 years of industry experience with a primary focus on business owner clients. In particular, Scott works with numerous veterinary clients throughout San Diego. References available upon request. Please call 858-550-2867 for a complimentary consultation.
Scott Ida is a registered representative of Lincoln Financial Advisors Corp., a broker/dealer, member SIPC, and offers investment advisory service through Sagemark Consulting, a division of Lincoln Financial Advisors Corp., a registered investment advisor, 4250 Executive Square Ste 700 La Jolla, CA 92037 phone: (858) 550-2867. Insurance offered through Lincoln Marketing and Insurance Agency, LLC and Lincoln Associates Insurance Agency, Inc. and other fine companies. This information should not be construed as legal or tax advice. You may want to consult a tax advisor regarding this information as it relates to your personal circumstances. Open Advisors is not an affiliate of Lincoln Financial Advisors. CRN-5488638-022823