Impersonal Finance

One thing I should mention is that I am not against 529s per se. Actually, I like them a lot for grandparents, rich uncles, generous family friends and the like. If these people actually think to contribute to your child’s education, by all means let them. It probably means they have the disposable income to do so and I would absolutely not turn them down.

That being said, the point of this article is:

How Best to Fund Your Child’s Education

If you’ve gotten this far, you are at least curious as to where this is going. The fact is that very few people can afford what college will likely cost in the next 10-15 years. I’ve seen a fairly consistent number of 8% inflation on education costs. When I ran a college funding scenario for a friend of mine, we came up with $600,000 as how much a four year education at a top notch institution would cost in 15 years. Look at your own life. How many people do you know who can sock away enough money to have that much money in the next 15 years? One person? Maybe two? The point is that how we fund it and what vehicles we use is infinitely more important than the dollar amount being invested.

There is only one solution in my opinion. That one solution is…Wait for it…

Life Insurance

It seriously bothers me how little value some “experts” give to the amazing uses of cash value life insurance. They think it’s the boogeyman of financial planning almost universally refuse to consider it under almost any circumstance. Here is the rub. Please tell me what is wrong with a product where you can pour unlimited amount of funds in to, will grow tax deferred, and upon need, the money (both the principal and growth) may be accessed tax free. Oh, it also doesn’t matter how much you make since everyone is eligible. The Roth IRA? Nope, there is a hard limit and eligibility requirement and it can only be accessed upon reaching the age of 59 1/2. Brokerage account? I don’t think so! Where is the tax deferral? What about capital gains? Savings account? Same problem as brokerage. Taxes are due on the interest.

This is definitely “outside the box” stuff, so digest this. Really think about it before you thumb your noses. The main objection I hear most is the expense. It comes in different forms: it’s too expensive, there are too many expenses, expenses are too high, buy term and invest the difference, etc.

I don’t get it. Why are people so afraid of expenses? My old boss loved using an analogy of a candy bar. When you buy a candy bar, you also get a wrapper. Part of the money you pay goes towards the making of the wrapper. You don’t care what the wrapper looks like. You just want the candy bar inside. This is exactly the same thing. You want the tax deferral. You want the tax free growth. You want the flexibility to do use the money towards education, since that’s the ultimate goal, but at the same time to use the money elsewhere should education funding not be necessary. Life insurance is the only vehicle available that gives you everything you could possibly want in a plan, with the small price being added expenses in the form of “cost of insurance” charges.

It doesn’t really matter what time of life insurance you choose to use. I will detail the various permanent life insurance options in the next post or two, but the basic choice is conservative growth (whole life or universal life) or aggressive, market based growth (variable). I am a believer in being more aggressive the less time you have to fund education and more conservative if you’re starting at a young age. Either way is fine, so long as you are willing to keep funding the program. I guess that is the one other negative. You have to fund the policy on a regular basis, whether that’s once a month or once a year. A 529 or brokerage account can be funded at your leisure and on your time frame.

As I wrap this up, I wanted to illustrate one example and show the dual use that exists in the product. I will use a one year old boy as our insured for a conservative whole life policy. If the parents deposit $500 per month for ten years, they will have deposited $60,000 by the age of 11. The policy at this point will be completely paid up. The child will never have to put in another dime. At the age of 18, there will be $100,000 in the child’s account. If your child must wait until he’s 55 to touch the money, that $60,000 investment will yield over $1,000,000 dollars tax free. If he waits even longer, say age 65, how does $1,800,000 sound?

I will dig deep in to the “buy term and invest the difference” fallacy at a later date, but I want to mention something about it here. First, you can’t buy term on a one year old. But, if we wrote the same ten year pay policy on a 30 year old parent and assumed a pre-tax portfolio growth of 7%, buying term and investing difference would do well in the early years, but just about the time the 30 year old is retiring, the investing the difference would get creamed. At age 73, the whole life policy would outperform the other strategy by over $100,000. It also assumes that you will invest the difference each month which is a huge assumption.

In the financial services industry, look at any agent/advisor’s business card. You might see acronyms following their name such as: CLU, CFP, CFA, JD, MBA, LUTCF and ChFC. This list is by no means exhaustive. There are dozens of designations one can get from various institutions and organizations. I plan on breaking down a few of the more common ones and should people clamor for specific explanations, I will be happy to oblige. The five I will focus on are: CFP, CLU, LUTCF, JD and MBA. I see these most often and they give a nice cross-section of the various educational requirements necessary to achieve designations.

LUTCF (Life Underwriter Training Council Fellow) - To be honest, I have no idea what any of that means. I even took a poll of people in my office with that designation and most had no idea what the acronym stood for. So why do people get it? It’s an extremely easy designation to get and any designation on your business card and letterhead looks good. Agents get this for the sole purpose of inflating their reputation to present and future clients.

CLU (Chartered Life Underwriter) - The American College is the primary institution giving out designations. They claim this is the most respected designation in the insurance industry. I will say this. Most agents who have this designation at least know what it stands for, so I guess that is something. Another reputation builder, no one I talked to could tell me how they planned to use the letters. Most people just banged out one course after another, studying just enough to pass, but nowhere near enough to retain any of the knowledge. Are clients really supposed to be impressed by three unfamiliar letters after your name? American College uses stats to show why it’s a great designation to have and how agents with it do remarkably better. I bet they do since most agents flame out long before they have a chance to take this exam. Agents that achieve this designation are usually successful enough to take the time to pass the courses necessary. It is not a terribly hard designation to get and people should be wary when they see someone with this designation. I would ask said agent what CLU meant and how long did it take to achieve. Probe further and you may see it for what it truly is: three letters and nothing more.

Now, we’ll get to the three designations that have some teeth. We still should not be fooled, but at least there is something behind them.

CFP (Certified Financial Planner) - I know quite a few people, smart people, who took this exam and did not pass. It is tough and comprehensive and requires extensive knowledge in many areas of financial planning. Furthermore, you must be in the industry for a certain length of time and have taken numerous exams prior to sitting for the CFP exam. Here is the problem, as I see it. It is still just an exam. Just because someone scored high on the SATs does not make them smarter than those who didn’t score as high. Some people are great test takers and others are not. I think this is a legitimate designation, but mostly because high net worth people have made it so. It is a designation familiar to many people and as such is almost a necessity if you want to work with wealthy people. Like with anything, I know a few CFPs I would never take advice from in a million years.

JD (Juris Doctor) - A fancy way of saying, “I graduated from law school”. You could finish last in your class and you would still have your JD. In terms of the financial services industry, it only looks impressive to clients who know what a JD is. Otherwise, when you explain what it is, you may get questions about why you aren’t a lawyer or what good is that degree in your field. It does show you went through three years of graduate school, but nothing about your field of study or retained knowledge. Putting this on your business card seems like definite resume padding since most financial advisors are precluded from offering legal advice anyway.

MBA (Masters of Business Administration) - This one baffles me the most. You don’t see people putting BA or BS after their name, so why an extra two years of school make such an acronym appropriate business card material. It’s a shorter and usually easier graduate program than a JD, so if a JD is silly, all the more reason that an MBA after your name is even sillier. If someone has an MBA after their name, what on Earth would make a client think that they have this heightened ability to provide sound financial advice. That’s like going to a Ph.D in Psychology for heart surgery. Yes, they are both doctors, but only one is competent enough to operate on you. If one advisor has an MBA and the other one doesn’t, would you not still go to the one that seems the best, regardless of what comes after his name?

I am not saying designations are bad, per se. I think taking the time to do extra work and furthering ones education are noble goals worth achieving. However, I want you to realize that most designations are done just for resume padding and nothing loftier. Education does not equal knowledge and letters do not equal proficiency.

If the 401(k) and Roth contributions are all you can contribute, then you can stop here. However, we will assume that if you continue reading, you have more money you want to allocate towards retirement. That’s great, between these two vehicles and what I am about to explain, you will be well on your way to retiring early and comfortably.

5. Permanent life insurance is an under utilized, misunderstood, yet spectacular option for retirement savings. I really do not care what Suze Orman or her ilk say about insurance. Truth is that they really have no idea what they are talking about. Their job is to speak in generalities without learning about the pros and cons of each product and each company. Here is what they won’t tell you. Life insurance works exactly like a Roth IRA with three distinct advantages: 1) it can be accessed pre-591/2 years of age and 2) there are no contribution or 3) adjusted gross income limits. We call a permanent life insurance policy a Roth on roids. It acts like a Roth, only potentially much more powerful.

Think about this for a minute. You max out your 401(k) match and you still have $10,000 that you want to contribute. Take $5,000 and max out your Roth. Ask most advisors what they recommend for the remaining $5,000. The likely response would be to go back to the 401(k) and it’s future tax implications (we will get to that in the next couple of entries). Why wouldn’t you want to pay the tax now and have every cent you earn come out tax free? To quote John Shibley of Lenox Financial, “It’s the biggest no brainer in the history of Earth.”

6. So, you’ve decided to follow my advice and look in to a life insurance vehicle for retirement savings. We are obviously dealing with someone open minded and intelligent so I’m a happy man. The next logical question should be: What kind of life insurance policy should I be looking at? That is a great question and fortunately I have a great answer. It absolutely depends.

Now, now. Please don’t swear at me or log off the site. I am about to elaborate. There are three basic types of permanent life insurance and almost all company specific products fall in to these categories:

Whole Life (WL) - Conservative, but consistant. Cash value will grow slowly and steady, and premiums will never increase

Universal Life (UL) - A bit more risky. Interest rates may slip to the point where the cost of insurance is canibalizing the cash value to keep the policy in force. This can be alleviated by dumping more money in to the policy. Premiums are more flexible than whole life. You can add more or add less depending on your cash flow in a given month or year.

Variable Universal Life (VUL) - In layman’s terms, this is investment grade life insurance. Whereas the cash value in a UL is invested by the insurance company, you control the VUL investment options with “subaccounts” which kind of act like mutual funds. You can be as aggressive or conservativeas you want. The upside is potentially staggering, but the downside is that there is no guaranteed cash value at the end of the road.

7. Thankfully, you are done. At least in terms of retirement contributions. Pat yourself on the back for a job well done.

401(k)s are marvelous investment tools if used correctly. Now that you know how to do that, I truly believe you will be better off than those who use the 401(k) like so many talking heads suggest.

Also, at some point I will probably do a life insurance primer, but for now I just wanted to cover the basics. You can do more research on your own or email me if you have specific questions. I will elaborate on some of the minutiae of the topics covered . Stay tuned for that.

I need to get this out in my first real post. My biggest retirement pet peeve in the world is when people who are Roth IRA eligible, max out their 401(k) instead of contributing something to their Roth. It boggles my mind that people do this and it is a travesty that advisors recommend it (and they definitely do). Let’s take a step by step approach to this fallacy and how to efficiently manage your retirement portfolio. For the purposes of this discussion, we will assume that your adjusted gross income (AGI) is within the Roth eligibility requirements.

1. If your employer has a match, take the match entirely. No investment offered anywhere can beat free money. If the match is 3%, contribute 3%. It really is that simple.

2. Do NOT contribute more than the match. If you truly need the deduction, then take it. I won’t argue with you, but I still think you’re better off without the deduction.

3. Open an Roth IRA. I personally like American Funds, but if you’re comfortable with another Roth option, that’s fine too.

4. If you had enough money to max out your 401(k), presumably you have enough to max out your Roth. The maximum contribution in 2008 is $5,000. If you are married, you should be maximizing your spouse’s Roth as well.

You might be thinking that at this point, if you still have disposable income, that you should contribute the remaining amount towards your 401(k). No! No! No! Seriously, you will need to break this “401(k)s are the greatest retirement vehicle in the world” habit. Contribute up to the max. No more and no less.

To be continued…(post was a little too long)