Managing Risk

Jake Cross, CFP?, a financial planner at Falcon Wealth Advisors, recently joined me on?Upticks?to discuss how we manage risk for our clients. Jake recently earned the CERTIFIED FINANCIAL PLANNER? designation and one of the topics he learned more about when studying for the CFP? exam is insurance, which is an important element of risk management. A summary of my conversation with Jake is below.

Falcon:?Let’s kick off our conversation by discussing life insurance. Even though I don’t really sell life insurance products, I’m happy I’m a licensed life insurance agent, because I’ve been able to learn a lot about that industry. I know you’re a licensed life insurance agent as well, Jake. If you’re a client with insurance needs, we have agents we can refer you to who spend their entire day focused on life insurance. And since we are fiduciaries at?Falcon Wealth Advisors, I avoid selling products from which I would earn a commission. Jake, can you talk about what life insurance is and who should have it?

Cross:?Life insurance is essentially a death benefit, allowing people to pay a monthly, quarterly or annual premium, and if they pass away, their survivors will receive money they can use to replace the deceased’s income, pay off debt or for any reason they want. For example, if you’re the main income earner in your household, life insurance would allow your family to maintain their lifestyle if something were to happen to you. Life insurance makes sense for all kinds of people, especially those with children still living at home.

Falcon:?This is of course a morbid conversation, and I don’t envy life insurance salespeople who have to talk about this every day. It’s worth noting that the cost of your life insurance premium corresponds with the cost of the benefit—the higher premium you’re willing to pay, the higher the benefit. And your health also impacts the cost of the premium—life insurance companies look at your weight, if you’re a smoker, etc.

One perk of life insurance is that if something does happen to you, the life insurance benefit your heirs receive is tax free. For some people with a high net worth, it can be a useful estate planning tool and can also be used to help pay off estate taxes.

Not all life insurance policies look the same. There is term life insurance, in which you pay a premium for a set number of years. Hopefully nothing will happen to you during the specified timeframe, and if that’s the case, the policy will lapse. Then there is permanent life insurance, also called whole life insurance, which allows you to put in money and cash out later should nothing happen to you.

However, we don’t encourage clients to use these permanent life insurance products, as the fees can be expensive. We don’t think it’s accurate to describe these products as investment vehicles, which life insurance salespeople often do. At?Falcon Wealth Advisors, we believe there are many investment vehicles more efficient than life insurance. Life insurance should be used to pay off significant debt, take care of your survivors and replace your income.

Cross:?Yes, and you have to be careful when purchasing life insurance, because a life insurance salesperson isn’t required to act in your best interests. They’re trying to make a sale.

Falcon:?Correct, it’s on you as a consumer to do research and be informed prior to purchasing a life insurance plan. Thankfully for?Falcon Wealth Advisors?clients, we can offer advice on what type of life insurance would be a good fit for you, and as I mentioned, we can connect you with salespeople we regularly work with.

Let’s now talk about a topic that feels like the opposite of life insurance—long term care insurance. What do people need to know about?long term care insurance?

Cross:?Long term care insurance is often structured similarly to life insurance, as you pay a premium for a benefit you may or may not use some day. Policyholders can typically begin using their benefit from long term care insurance when they are unable to do two of the following “daily activities”—bathing, dressing, using the bathroom, eating and basic mobility. But often, you have to wait 90 days of not being able to do those activities before you can use the benefit.

Traditionally, long term care insurance has been a “use it or lose it” type of product, similar to life insurance. But in recent years, the industry has begun offering additional types of products—but like with life insurance, it’s so important to be cautious and understand the fine print of what you’re purchasing. There are sometimes administrative expenses and hidden fees. Our team at?Falcon Wealth Advisors?is happy to help you review potential insurance plans.

Falcon:?Well said, Jake. We typically like to review a client’s financial plan and determine if they can self-fund elder care before we pursue long term care insurance. It may not make sense for someone to purchase long term care insurance if they can self-fund.

Relatedly, you shouldn’t assume living in a nursing home will quickly wipe away your savings. Many?Falcon Wealth Advisors?clients have enough in their accounts that they can live off dividends and interest, even in a nursing home. People in these situations shouldn’t automatically assume they need long term care insurance.?

Remember, life insurance and long-term care insurance companies are in business to make money. If policyholders often came out ahead, these companies would go out of business. These companies are betting on you?not?using their product. And I should note these companies offering long term care insurance can change the policy by raising premiums or lowering the benefit even after you’ve purchased the plan.

Cross:?And some people actually spend less money once they’re living in a long-term care facility, as they’re not often dining out and spending money on entertainment. Plus, they may be able to sell their home and bring in additional money from that. So, to your point, people shouldn’t assume their savings will vanish if they have to live in a long term care facility.

Falcon:?Long term care insurance is a way to manage risk, but the default shouldn’t be “I need long term care insurance.” Instead, you should first work with your fiduciary wealth advisor to review your financial plan and determine if you can afford care out of pocket.

Cross:?I think the time to look into long term care insurance is around age 60-65. But everyone is different. If your family has excellent longevity, long term care insurance may make less sense for you than most.

Falcon:?Thanks, Jake. Another topic: health insurance. Why is it important for managing risk?

Cross:?Health insurance?is a must-have. Not having it opens you up to too much risk. So, what kind should you have? You have to make realistic decisions about you and what type of healthcare you may need. If you’re in good health, a low-premium, high-deductible plan may make sense. If you’re older and need lots of healthcare services, it may not.

If you have a high deductible plan, you’re able to invest in a health savings account (HSA), which offers a “triple tax benefit.” You can receive a tax deduction for the dollars you invest in a health savings account; those dollars can grow tax deferred; and then you don’t have to pay taxes on withdrawals, if the money is used for qualified health expenses.

If you’re planning to retire and not yet 65 years old and eligible for Medicare, it’s important to think about how you will get health insurance that you can afford and serve you will.

Falcon:?Yes, unlike the other topics we’ve discussed today, everyone should have?health insurance. You don’t want to roll the dice and not have it, as paying for something like a surgery out of pocket can do significant damage to a financial plan. At?Falcon Wealth Advisors, we help clients everyday plan for how they will pay for health insurance in retirement. And we work with independent healthcare agents who can help you find the right plan for you.

Would you talk about property and casualty insurance?

Cross:?Sure. I know it’s easy to not look at what your home insurance covers, but you want to make sure your coverage amount is at least 80% of your home’s replacement costs, which of course increase over time. Ideally, your home insurance should cover 100% of your home’s replacement costs.

Regarding auto insurance, if you own a luxury car, you may be more likely to be sued should you be in an auto accident, as people will assume you’re wealthy. That’s one reason it’s important to make sure you have the right type of auto insurance that covers liabilities.

I think people should review their property and casualty insurance any time they change vehicles or buy a new home, but even if you don’t make a change, I recommend reviewing it every two years to make sure you have the right coverage at the right cost.

Falcon:?And don’t forget to insure any jewelry, watches, art or other expensive items. Regarding home and auto insurance, it’s really important to make sure you have the proper coverage. Having to pay out of pocket should an accident happen can damage your financial plan. That’s why we recommend working with an independent agent and also educating yourself about what your plan does and does not cover.

Finally, let’s talk about annuities, which we aren’t huge fans of at?Falcon Wealth Advisors.

Cross:?Annuities are designed to supplement your retirement income. You can pay monthly premiums for an annuity, or make a large payment all at once. In exchange, the annuity holder will send you a certain amount of money each month for the rest of your life.

Like life insurance and long term care insurance, annuities are products designed to make money for the insurance companies. At?Falcon Wealth Advisors, we believe many investors would be better served by trading stocks and bonds and buying options, for a number of reasons.

• Annuities aren’t usually flexible and can lock you into paying a regular premium without being able to collect any money for a set number of years.
• There are often high and sometimes opaque fees associated with annuities.
• Money the annuity pays you can be taxed as ordinary income and if you’re not yet age 59.5, you may have to pay an IRS penalty on that money.

Falcon:?Yes, there are so many fees associated with annuities. The advisor who sold you one is going to get paid. The insurance company that advisor buys it from is going to get paid. And if it’s a variable annuity with an investment option, whoever is investing the money is going to get paid.

And as you said, if a life event happens and you need to access money, annuities can be very restrictive and make it difficult and expensive to pull a chunk of money from the product, even if you’ve been paying into it for years. These are some of the big reasons we don’t encourage our clients to use annuities. Broadly speaking, we don’t believe they make sense and think there are far better ways to invest and protect risk in your portfolio.

Thanks so much for joining me to discuss managing risk, Jake. Some of the products we discussed today—health insurance and property and casualty insurance—are necessary as we navigate life, but others are not. That’s why it’s so important to be both an educated consumer and work with a fiduciary wealth advisor who acts in your best interests, like our team at?Falcon Wealth Advisors. If you would like to learn more about how we can help you efficiently and smartly manage risk, please contact me today. You can reach me directly at?[email protected].

Clients choose to work with us to enhance their financial literacy and explain exactly what?their?financial plan means to?them.

Hightower Advisors, LLC is an SEC registered investment adviser. Securities are offered through Hightower Securities, LLC member FINRA and SIPC. Hightower Advisors, LLC or any of its affiliates do not provide tax or legal advice. This material is not intended or written to provide and should not be relied upon or used as a substitute for tax or legal advice. Information contained herein does not consider an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Clients are urged to consult their tax or legal advisor for related questions.