Author Topic: Case study: Single mom needs help with life insurance and general questions  (Read 4708 times)

mom22boys

  • Stubble
  • **
  • Posts: 180
Hi everyone! This is my first post as a newbie MMM-wannabe.  Iím a 41 yr old single mom of two boys, 9 and 7. After my divorce, I was a little lost financially for a while.  I hired a financial planner 2 years ago, but then I found MMM 2 months ago (then JLCollins and MadFIentist).  Wow, my eyes are open!  I plan to fire my financial planner and move forward myself with everything Iíve learned between all the forums and blogs. Hereís my basic info, along with my questions.  I summarized a few things that I didn't feel were important to my questions. I can provide more detail if requested.

Gross Salary/Wages: $10300/m
Pre-tax deductions:
    401K = $1500/m (max),  Dependent care flex = $416/m (max),  HSA = $333/m (max) (Employer contributes $2500/yr, I wasnít sure where to put this since itís not direct income)
Adjusted Gross Income: $7701/m
Other Ordinary Income:
   Stock award = $17,000 average per YEAR, this year I have about $23,000 vesting (after taxes)
   Bonus = $7,000 average per YEAR (after taxes)
Taxes:
   Federal = $1181, State (MN, high income tax) = $396, FICA = $702  (This doesn't include taxes on my stock award and bonus)
MONTHLY NET INCOME (NOT including bonus/stock) = $5741

Monthly current expenses:
    Mortgage = $1000 (actual payment is $775 but I add extra to pay off sooner), interest rate is 4.125%
    Property tax +Specials = $612 total ($282/m Taxes + $330/m Specials *I have about $23,000 remaining in specials, almost all @ 6% interest. Once I pay off the specials, this will make my taxes more manageable.)
    Tithe = $900 (Non-negotiable)
    Private school for both boys = $1111 (Non-negotiable unless I lose my job)
    Daycare = $620  *This will start to drop within 1-2 years given the ages of my boys. 
    Life insurance = $111 total, whole life policy $80 for $250,000 (for the next 3 yrs), term life $31 for $625,000 ($425,000 through work, $150 personal policy)
    Other (such as food, utilities, insurance, phone/internet, sports for boys, etc)* = $1283
*I have the breakdown of all these expenses, but Iím trying to shorten my post and these arenít relevant to my questions.
TOTAL MONTHLY EXPENSES = $5637

Assets:
Cash = $16,700, Home = $350,000, 401K = $229,000, HSA = $15,600, Ameritrade account = $15,650, ESPP cash = $2,220, Indexed Universal Life Insurance = $20,659
TOTAL ASSETS= $649,829*
*I also have a Toyota RAV4 worthy $20,000, paid in full, but I donít like to include that in my assets.

Liabilities:
Mortgage = $158,000 @ 4.0125%, 30 yr mortgage, I just bought this house, so most of the 30 yr remaining.  $1000 Payment broken down as $775 + $225 extra principal. With extra principal, the house will be paid off in around 20 years
Specials = $23,000 @ 6%, repaying over 17 years 
TOTAL LIABILITIES= $181,000

Plan moving forward
1. My monthly income covers my expenses, but my bonus and stock are sweet. After a ton of reading, I plan to do a back door Roth IRA through my company.  My company allows $20,000/yr, with a quarterly roll over into the ROTH IRA.  Iíll start funneling my income to that in Aug/Sept after I sell my vested stock so I don't have to dip into my cash emergency fund. Any remaining amount after the $20,000 will be put toward my $23,000 specials, since that is at a higher interest rate. After the specials are paid off (maybe 2-3 years), Iíll put the extra toward my mortgage.  Yes, Iíve read a lot of the forums on paying the mortgage off early, but that is a goal before I FIRE.
2. I plan to roll over my Ameritrade account to Vangaurd.  I was shocked when I saw the fees I was paying.  (Thanks JLCollins for opening my eyes to fees!)
3. I currently have 15% of my check set aside for ESPP. That is converted to stock every quarter and I immediately sell for a 10% gain.
4. For the last 3 years, Iíve gotten large tax refunds (average around $7500).  I file Head of household, and just bumped up my exemptions from 3 to 4.  I can only claim one of my sons for taxes, but due to my charitable giving and mortgage interest, I have a large $ for itemized deductions.  Iím debating whether I should increase my exemptions to 5, because this is my first year doing the full $18,000 into my 401KÖ..again stupid, stupid, stupid.
5. My goal for FI is 10 years, which I think is doable based on the different calculations Iíve done.  I expect my expenses to be a lot lower (no daycare, no private school, much lower tithe due to lower income, two less boys to feed (which adds up fast). I love my job so I may work longer and possibly help the boys with college.

Questions:
1. Any mistakes in my plan?  Anything I should do differently?
2. Should I bump up my exemptions even more now that Iím pumping the full $18,000 into my 401K?  Previously I was only doing about $8000/yr (it pains me to write that).
3. Life insuranceÖ.this is where I need the most help.  I know from reading that I really should be fine with only term life insurance.  I already have $625,000 in term, which I think is plenty for my boys, considering their ages.  My biggest dilemma is this stupid Indexed Universal Life policy. I previously had a Ďregularí whole life policy, and my new financial advisor talked me into rolling that over into this new fancy IU life policy. Honestly I still donít totally understand it (but I trusted herÖ.face punch), and trying to find reliable information on the web is almost impossible.  My premium is about $960/yr.  Should I just cancel the darn thing and cash it out, and put the money into Vanguard?  Right now I would take a $6400 penalty if I did that, so I would maybe net around $14,000.  Plus, I donít know what my tax implication would be.  I found that I should only have to pay taxes on the gains and not the cash I paid for premiums, but I have no clue what that would be. If you need more info, Iíll try to provide it.
4. Iím currently paying $53/m for a security system (included in my Other expenses).  I live in a really good neighborhood now, and donít need it any more, as this was a carryover from my previous house. I cringe every time I see that monthly charge.  Iíve tried to get out of the contract (of which Iím 2 yrs into a 5 yr contract) and I canít find a way out.  One thing Iím considering is just paying off the contract, which would be about $1800 (Ouch!).  I rarely use the system.  Maybe I could try and find someone to take over the contract, but I have no idea where to start.  Any ideas?

Thanks for any advice.

MidWestLove

  • Bristles
  • ***
  • Posts: 317
Let me know if you can access the li below -  Peter Katt writes on  Index Universal Life

http://www.aaii.com/journal/article/index-universal-life-the-latest-risky-life-insurance-product

"Around 2009, another new policy type became popular with agents: index universal life (IUL). Index universal life promises that its interest crediting rates are determined by referencing to the S&P 500 stock index with no losses. I have seen illustrated rates as high as 9.0% that also included a 0.5% bonus rate starting in the 11th policy year for illustration purposes.

The problem is that index universal life premiums collected are not being invested in the S&P 500 by the selling companies. Something on the order of 95% of their premiums are invested in fixed-income instruments. The insurance companies claim they can make up the difference by using various hedging techniques to cover promised crediting rates that are much larger than their investment portfolios produce. Even if companies have actually designed hedging formulas, such exotic strategies are notoriously inaccurate. It is a mystery that index universal life isnít in obvious violation of even the tepid illustration regulations from the 1990s.

I think it is very likely that index universal life will turn out to be just a marketing gimmick, using stock returns to justify illustrating much higher interest crediting rates than a companyís investments can possibly attain. Sales pitches using 8% and 9% crediting rates are backed up by such contract language as: ďthe annual index growth that will be recognized in the calculation of the index earnings for an equity indexed segment on a segment anniversary. We will determine in advance the participation rate applicable to each equity indexed segment for each 12-month period and will communicate it to you in an annual report or in notices to you.Ē

This means the insurance company can credit whatever they want. I see no reason why they will provide better actual performance than universal life or participating whole life. The problem for buyers is raised expectations of performance measured either by lower premiums or higher cash values than would otherwise be expected or in fact delivered.

And of course agents are using index universal life to replace all the participating whole life and universal life they can with what I believe are false comparisons. Unlike guaranteed universal life that does have a place, index universal life should be avoided.
"

Monkey Uncle

  • Handlebar Stache
  • *****
  • Posts: 1452
  • Location: West-by-god-Virginia
Regarding the universal life policy, I would not suggest just canceling it and paying the penalty without knowing a little more about the contract.  You said you have 3 years left to pay a monthly premium of $80, which adds up to way less than the penalty you would pay for canceling early.  And you'll be getting at least some sort of return on those premium payments.  Yes, you might make better returns in a stock index fund over that time period, but essentially you'd be starting out by paying a 30% load on the investment ($6,400 penalty out of a $20k cash value).  Don't compound one stupid mistake with another one (sorry if that sounds harsh; I mean it in a helpful way ;) ).

The situation with the security system seems similar.  If your only way out is to buy out the contract for essentially the amount of money you would pay in monthly fees over the next 3 years, why not just keep the system until the service expires?  At least you'll get some protection out of it.

I know you're kicking yourself over making these unwise commitments, but it sounds like you can't go back and un-do them.  Think about them from the perspective of what they will cost you going forward from today.  If you can find a way out that costs less than keeping them, great.  But don't spend even more money getting out of those commitments just because you're having buyer's remorse.

former player

  • Magnum Stache
  • ******
  • Posts: 3962
  • Location: Avalon
Instead of paying extra on your mortgage debt (interest rate 4.0125%) you should be putting that cash into your "Specials" debt (interest rate 6.0%), as it gives you an equally risk-free return which is 1.9875% higher.

MidWestLove

  • Bristles
  • ***
  • Posts: 317
"Don't compound one stupid mistake with another one"
... careful there. one of the most common fallacies with insurance is the sunk cost dilemma. the money your agent got from you are already lost (mostly paid to the agent), they are not coming back. worrying about "losing" it again by getting rid of the policy is part of behavioral finance anchoring. You do not have that money, it is already gone. instead compare future cash you are putting into this vs putting cash elsewhere and see how the numbers work.

Monkey Uncle

  • Handlebar Stache
  • *****
  • Posts: 1452
  • Location: West-by-god-Virginia
"Don't compound one stupid mistake with another one"
... careful there. one of the most common fallacies with insurance is the sunk cost dilemma. the money your agent got from you are already lost (mostly paid to the agent), they are not coming back. worrying about "losing" it again by getting rid of the policy is part of behavioral finance anchoring. You do not have that money, it is already gone. instead compare future cash you are putting into this vs putting cash elsewhere and see how the numbers work.

I think you and I are in agreement.  Sorry if my post was unclear.  I'm talking about the $6,400 penalty she would have to pay in addition to the costs that are already sunk.  Comparing return on future cash into the insurance policy vs. putting the cash elsewhere is exactly what I mean when I say don't compound one stupid mistake with another.  If she choses "elsewhere" and pays the $6,400 penalty, she is starting out with a -30% return on the current value of her investment.  She needs to do the math herself to be sure, but I'm guessing that fulfilling her three year commitment to the policy will cost less.
« Last Edit: May 24, 2015, 08:22:14 AM by Monkey Uncle »

MidWestLove

  • Bristles
  • ***
  • Posts: 317
Thank you Monkey Uncle

The piece where we differ is that her current account cash value is not 20k, it is already 13k, taking it or not taking it is not changing that fact  and it is mostly about when you are going to recognize the lost that has already occurred.   Take a look at this article which I think covers it a little bit on difference between  "account value" and cash value

http://www.peterkatt.com/articles/AAII_jan2014.pdf

and also this
http://www.peterkatt.com/articles/AAII_jul2002.html

I have no relationship with Peter Katt or know anything about the gentlemen or his practice - however, the articles he published in AAII specifically match other research I was doing in that space as I researched various insurance products my own family got sold and as such think he has pretty good idea explaining fairly complex legal agreements in common English.



Monkey Uncle

  • Handlebar Stache
  • *****
  • Posts: 1452
  • Location: West-by-god-Virginia
Thank you Monkey Uncle

The piece where we differ is that her current account cash value is not 20k, it is already 13k, taking it or not taking it is not changing that fact  and it is mostly about when you are going to recognize the lost that has already occurred.   Take a look at this article which I think covers it a little bit on difference between  "account value" and cash value

http://www.peterkatt.com/articles/AAII_jan2014.pdf

and also this
http://www.peterkatt.com/articles/AAII_jul2002.html

I have no relationship with Peter Katt or know anything about the gentlemen or his practice - however, the articles he published in AAII specifically match other research I was doing in that space as I researched various insurance products my own family got sold and as such think he has pretty good idea explaining fairly complex legal agreements in common English.

I was reading the OP as saying the $6,400 was some kind of early cancellation penalty, and that she would not have to pay that penalty if she waited three years.  However, if the $6,400 is the difference between account value and cash value, then yes, the decision rests on how much the cash value would increase (minus the additional premiums) if she waited vs. how much return her $14k would make if she pulled it out now and redeployed it elsewhere.  That said, I'm not sure how difficult it would be to project the future cash value with any accuracy.

mom22boys

  • Stubble
  • **
  • Posts: 180
Thanks for the feedback everyone!
Formerplayer Ė I definitely plan to pay down my Specials first, and then move on to the mortgage.  Sorry if that wasnít clear enough in my Plan moving forward #1. 

MidwestLove Ė Yes, I can access the link.  Thanks!  Just confirms my thinking that I made a mistake.

MonkeyUncle Ė No offense taken at the stupid comment! Thatís why Iím here!    Already know that I made a stupid mistake, and just want help understanding how to best deal with it, and not make another stupid decision.

Just a little clarification also.  My plan currently shows a Cash value of $20,600 but a Surrender value of $14,200 (surrender charge of $6400).  The surrender charges go down each year, but not by much. Even after 10 years, the surrender charge is still $5,800.  To eliminate the surrender charge, I have to keep the policy for 15 years, not 3 years. 
With losing 30% from the start, I do agree that itís probably a stupid mistake to cash out.  I think I need to meet with my financial advisor again (before I fire her) to get a better understanding.  Maybe I can reduce amount of the policy, or reduce the # of years? Iíll have to run the numbers then after I talk to her and see if I can recoop that surrender charge. 

MDM

  • Walrus Stache
  • *******
  • Posts: 9108
My plan currently shows a Cash value of $20,600 but a Surrender value of $14,200 (surrender charge of $6400).  The surrender charges go down each year, but not by much. Even after 10 years, the surrender charge is still $5,800.  To eliminate the surrender charge, I have to keep the policy for 15 years, not 3 years. 
What will the Cash (= Surrender) value be in 15 years, based on whatever participation rates, caps, spreads, etc., you predict will be used to calculate annual yield?

What would the annual growth rate for $14,200 have to be in order to reach the above value?

If you think you can match or beat that annual growth rate on your own, take the surrender charge and wave good-bye to the IUL.  If you don't think you will match or beat that annual growth rate on your own, keep the IUL.

Adjust the calculations above as needed to account for any continuing premiums you would have to pay if you keep the policy.

You can redo this calculation annually if needed.

MDM

  • Walrus Stache
  • *******
  • Posts: 9108
Gross Salary/Wages: $10300/m
Pre-tax deductions:
    401K = $1500/m (max),  Dependent care flex = $416/m (max),  HSA = $333/m (max) (Employer contributes $2500/yr, I wasnít sure where to put this since itís not direct income)
Adjusted Gross Income: $7701/m
Don't know if it matters, but 10300 (gross) - 1500 (401k) - 750 (sum of flex+HSA) = $8,050, or ~$350/mo more than the listed AGI.

Quote
Questions:
1. Any mistakes in my plan?  Anything I should do differently?
2. Should I bump up my exemptions even more now that Iím pumping the full $18,000 into my 401K?  Previously I was only doing about $8000/yr (it pains me to write that).
3. Life insuranceÖ
4. Iím currently paying $53/m for a security system (included in my Other expenses).  I live in a really good neighborhood now, and donít need it any more, as this was a carryover from my previous house. I cringe every time I see that monthly charge.  Iíve tried to get out of the contract (of which Iím 2 yrs into a 5 yr contract) and I canít find a way out.  One thing Iím considering is just paying off the contract, which would be about $1800 (Ouch!).  I rarely use the system.  Maybe I could try and find someone to take over the contract, but I have no idea where to start.  Any ideas?
1.  Looks good.  If you hit your employer max of $20K for the mega backdoor Roth, you can also do your own $5.5K backdoor Roth.
2.  Yes.  Better to get the money now and use it to save 6% than let the IRS hold it and give you 0%.  Some popular calculators are
     http://www.paycheckcity.com/calculator/salary/
     http://www.bankrate.com/calculators/tax-planning/1040-form-tax-calculator.aspx
     https://turbotax.intuit.com/tax-tools/calculators/taxcaster/
     Also see http://forum.mrmoneymustache.com/ask-a-mustachian/how-can-we-optimize-our-withholdings/.
3.  That horse has been well beaten.
4.  No good suggestions.  If the payoff is simply $53 x (number of months remaining), don't pre-pay.

Financial.Velociraptor

  • Handlebar Stache
  • *****
  • Posts: 1344
  • Age: 46
  • Location: Houston TX
  • Devour your prey raptors!
    • Financial Velociraptor
Can you use the current cash value to "autopilot" the policy?  That is, some whole life lets you keep the life insurance component without ever paying another premium based on redeploying the cash value to future premium.  You won't get the cash but you keep the insurance and can reduce spending on term by appropriate amount.

mom22boys

  • Stubble
  • **
  • Posts: 180
MDM Ė Thanks for the additional analysis.  You are correct on the $350 difference.  I snuck my child support into the Gross income to simplify things and probably forgot to update my other numbers. 
Can you give me more info/link to another thread on how to do the additional 5.5K backdoor Roth?  Iíve done a lot of reading and didnít see this as an option? Iíll check out the tax calculators.  Iíve tried to do this in the past, but itís hard when I have to guess what my bonus and stock grants will be.

Financial.Velociprator Ė Thanks for adding this.  I just looked at my policy, and yes I think I can do this.  The policy says I have a no-lapse guarantee for 15 years. This might be a good option, so I can invest the extra $960 each year instead. Iím just not sure what it means when I get to the end of year 15. Iíll have to ask my financial planner when I meet with her.

MDM

  • Walrus Stache
  • *******
  • Posts: 9108
Can you give me more info/link to another thread on how to do the additional 5.5K backdoor Roth?  Iíve done a lot of reading and didnít see this as an option?
See http://www.bogleheads.org/wiki/Backdoor_Roth_IRA.  I'm assuming, based on the "through my company" phrase, that the plan in the OP is to go through your 401k on the way to a Roth IRA.  This is usually dubbed a "mega backdoor Roth."  Making a non-deductible contribution to a tIRA, then converting to a Roth, is usually dubbed a "backdoor Roth."

Quote
Iíll check out the tax calculators.  Iíve tried to do this in the past, but itís hard when I have to guess what my bonus and stock grants will be.
It is highly likely that the bonus, and perhaps the stock exercises as well, are treated as supplemental income with 25% withheld for federal tax.  E.g., see http://blog.turbotax.intuit.com/2011/12/09/bonus-time-how-bonuses-are-taxed-and-treated-by-the-irs/.  If so, that makes things easy for you because 25% is your marginal rate for 2015 if your taxable income is between $50,200 and $129,600 - which, based on the OP, it will be.  Given that, you can figure your withholding for the non-bonus, non-stock income and all will be well.

Monkey Uncle

  • Handlebar Stache
  • *****
  • Posts: 1452
  • Location: West-by-god-Virginia
Thanks for the feedback everyone!
Formerplayer Ė I definitely plan to pay down my Specials first, and then move on to the mortgage.  Sorry if that wasnít clear enough in my Plan moving forward #1. 

MidwestLove Ė Yes, I can access the link.  Thanks!  Just confirms my thinking that I made a mistake.

MonkeyUncle Ė No offense taken at the stupid comment! Thatís why Iím here!    Already know that I made a stupid mistake, and just want help understanding how to best deal with it, and not make another stupid decision.

Just a little clarification also.  My plan currently shows a Cash value of $20,600 but a Surrender value of $14,200 (surrender charge of $6400).  The surrender charges go down each year, but not by much. Even after 10 years, the surrender charge is still $5,800.  To eliminate the surrender charge, I have to keep the policy for 15 years, not 3 years. 
With losing 30% from the start, I do agree that itís probably a stupid mistake to cash out.  I think I need to meet with my financial advisor again (before I fire her) to get a better understanding.  Maybe I can reduce amount of the policy, or reduce the # of years? Iíll have to run the numbers then after I talk to her and see if I can recoop that surrender charge.

I'm sorry for mis-reading your situation.  MDM and Financial.Velociraptor are right on with their advice.  Please ignore what I said.

If you do decide to use the cash value to autopilot the policy, remember to keep track of it on a regular basis.  The projected returns that they use to set up that feature are just estimates.  I used to have a whole life policy that was set up that way, and the returns didn't keep up with the projections.  Because it wasn't generating enough returns to cover the premiums, it automatically borrowed from the cash value.  When I finally realized it, it cost me several thousand dollars off the cash value to repay the loans, and I would have had to start paying premiums out of pocket again.  At that point I decided I didn't really need the insurance any more, so I took what cash I had left and cancelled the policy.