Ask Linda: Which type of life insurance should we buy?

Dear Linda,My husband and I need life insurance. Should we purchase a Term Life or Whole Life policy to protect our young children? Please explain the difference.

Underinsured Uma

Dear Uma,

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The purpose of life insurance is to protect those who are dependent on your income in the event of your death. A dependent can be a spouse or a young child, but it can also be a sibling or a parent whom you help financially. While there are exceptions, we typically recommend Term Life over Whole Life for the following reasons:

Whole Life is much more expensive.

Both Whole and Term Life premiums are fixed, but Whole Life premiums can be up to 10X more expensive. Given this price difference, many people simply can't afford the amount of coverage they need if they purchase a Whole Life policy.

Life is unpredictable and you need flexibility.

Even if you can afford the higher premium associated with Whole Life today, there is no guarantee you can afford it in the future. Affordability is one reason why a quarter of whole life policies are terminated within the first 3 years and nearly half within the first 10 years. Think about how different your cash flow was 3 years ago. If money gets tight for whatever reason - a job change, a new baby, or a new car payment - you can stop contributing to your Roth IRA, 529 or 401k, but you can't stop paying your insurance premiums without the risk of losing coverage.

The Whole Life investment component, or cash value, tends to be oversold.

Both Whole and Term Life have an insurance component (death benefit), but only Whole Life has an investment component (cash value). Whole Life is a poor investment if you end up canceling the policy in the first few years - the cash value will be eaten up by surrender charges and you shelled out higher premiums than if you purchased Term. You have to hold onto a Whole Life policy for about 16 years to at least break-even.If you die, the cash value goes to the insurance company, not your beneficiaries, unless you take action such as purchase an increased death benefit. And if you borrow from the cash value, the loan amount plus interest is deducted from your death benefit.

Term Life allows you to secure protection for the period you need it.

For example, you can choose 10, 20 or 30 years, which allows you to tailor the coverage to precisely the years you need it. For many, that is until they are retired, the mortgage is paid off, or the children are launched. You can also ladder policies - purchase multiple policies for different terms - since the amount of coverage you need will likely vary over time. Alternatively, Whole Life covers you until you stop paying premiums or reach a certain age, such as 100. Do your dependents really need coverage when you are in your later years? Many find that if they want to leave an inheritance, home sale proceeds and untapped investment accounts are sufficient.

There are situations where a Whole Life policy may make sense, such as if you have an estate tax issue or a special needs child, but the situations are limited. In our practice, Term Life is the best solution for most people because it allows you to obtain the life insurance you need, when you need it, and at a lower price.

“Ask Linda” is a monthly personal finance column where the founder of Planning Within Reach, LLC, Linda Rogers, picks one question from her readers and publishes a detailed answer. If you would like to ask Linda a question, email linda@planningwithinreach. Due to the volume of questions received, she may not be able to answer every question in a timely manner. For advice on your personal situation, schedule an initial call to learn about our services.

Why You Need to Ask Your Parents: "What's your estate plan?"

Do you have any idea what your parents' estate plan is? Do you know if they even have one? Unfortunately, when a parent passes away, you as their child most likely have an obligation to close their estate and finalize their financials. Below is a list of questions you should go to your parents with and have them answer. Start having these conversations now to understand the role you will play in finalizing their estate.

1. Do you have an Estate plan in place?

If the answer is yes, what documents do they have and where are they located? The four most common documents are; a Will, Trust, and Durable Power of Attorney (DPOA) for Finances and Healthcare. Once you know what documents they have, ask to review them and make sure you understand their wishes for burial and the division of their assets. Encourage your parents to meet with an estate planning attorney as soon as possible to create a plan if they do not have one. Having these documents allows you to be able to take legal action without having to go to court to get appointed.

2. What am I required to do?

Read the documents they have. Are you a successor trustee of the Trust? The Agent on a Healthcare or Financial DPOA? What roles will you play and who will play the others? Discuss with other siblings or named agents, whom you will have to co-sign or make co-decisions with, about working together or separately. Having to make decisions jointly can slow down the process, especially if co-signers live in different cities or states. It can be better to separate some tasks between siblings based on individual skills. If you are good at handling financials, you could take the job of Agent on the DPOA for Finances. If you and your siblings decide there are decisions and tasks you cannot handle, ask your parents to delegate the work to an estate or trust company. Companies offer this service, for a fee, but it can be worth it if the tasks seem too overwhelming.

3. Where are the other important documents?

You will need to know the location of important documents. In the house? A safety deposit box? In the cloud? Know where to find items such as: - Tax returns and income statements (examples include W-2, 1099, K-1) - Social Security cards and birth certificates - Titles to homes, cars, boats, trailers and any other motor vehicles - A balance sheet or list of assets and debts - A list of beneficiary designations for retirement accounts, life insurance, and pension plans Also, if your parents manage their bank accounts, investment accounts, and credit cards online, make sure you know where to access logins and passwords when the time comes. You can use a family password manager such as 1password to share these safely on an encrypted server. Having these documents and passwords easily accessible after a passing makes the process go much quicker than having to contact all the individual companies for duplicate copies.

4. What items are important for me to keep and what is of actual value?

Do your parents have family heirlooms that have been passed down for generations or a collection they want to make sure you keep? Find out what physical items your parents want you to hold onto. Ask if they have specific pieces they would want you to sell, donate, or gift to someone else in your family. Also, have your parents tell you the location of collections and obtain an inventory list of the collectibles and their approximate value. You can always have an appraiser come to look at items before or after a parent's passing to make sure you don't throw out something of value.

5. What are your digital assets?

In this digital age, we have collected more than just physical things. We also have to plan for our Digital Assets. What do they want you to do with their cell phone's data like pictures and messages? Would they want you to keep their Facebook or social media accounts open? Electronics like computers and cell phones host a massive amount of data that either needs to be distributed or deleted upon a person's passing. Airline miles or credit card points are good examples of other valuable digital assets*. Ask your parents to maintain a digital asset inventory list.

6. Who am I supposed to contact?

Your parents probably have financial professionals who will have access to some important documents and could help you through different aspects of the process. Ask your parents to write out a list of professionals they have a good relationship with and who you should call if you need help. Professionals could include: - Financial planner/Investment Manager - CPA/Accountant - Lawyers - Insurance agents - Real estate agents Being prepared saves you time, money, and stress. Schedule a family meeting when your parents turn 60 and at least every five years after to revisit any new changes to the plan.

While this is not a fun conversation to have, and you may get pushback from your parents to have it, remind them that no one wants to have this conversation, but it is one that needs to happen. It is a challenging period after a loved one passes and consecutively trying to discover the answer to these essential financial and estate planning questions only makes it more difficult. We never know when someone will pass, and for that reason, it is never too early to plan.

This article contains general advice. We are not attorneys and are not giving legal advice. Always review your plans with your estate planning attorney.

*You can read more about digital assets in our previous blog post.

529 Plan Rules Have Changed

They are still the best tool in your toolbox for college planning, but there have been some changes. Here is a quick re-cap. What are 529 plans?

They are investment vehicles that are named after the Internal Revenue Code that created them. They have helped many of our clients pay for college for their children as they offer tax advantages when used for qualified education expenses at eligible educational institutions.

What tax advantages do they offer?

When used appropriately, the money placed in the 529 account is allowed to grow and be distributed tax-free. Additionally, many states are now offering a state tax deduction for contributions into the account. Here is the most recent list. It is subject to change, so continue to check back annually for the most up to date information. You are not obligated to use your state's 529 plan. A common scenario is that your state does not offer a state tax deduction (or you don't pay state taxes at all), therefore you can open a 529 plan in any state of your choosing, as long as the plan doesn't have residency requirements. What is an "eligible educational institution"?

Any college, university, vocational school, or other post-secondary educational institution eligible to participate in a student aid program run by the U.S. Department of Education (1).

New to the tax law passed in 2017, up to $10,000 in 529 withdrawals are allowed (once per year) to pay for K-12 tuition. Qualifying schools include public, private, and religious schools. That being said, you should check with your 529 plan to make sure they are conforming to the new federal law.

What are the qualified education expenses that the money can be used for?

Tuition, mandatory fees, room and board (limited to the cost of school housing), books, computers and related computer equipment. What about financial aid?

Having a 529 plan will affect your child's financial aid package, but very minimally, and not enough to dissuade you from using a 529 plan altogether. Assets owned by the parents, such as a 529 plan, will reduce a student's aid package by 5.64%. So if the 529 account is $50,000, the financial aid reward will be reduced by $2,820. The tax benefits and earnings on the 529 account are likely going to outweigh that $2,820. This also assumes you are eligible for any aid at all, which many children are not. Compare this to a UTMA account (another vehicle used for college savings) which would reduce the aid package by 20% ($10,000) since it is an asset owned by the child. Grandparent-owned assets are not included at all in the financial aid calculation, but they do affect the FASFA form in the year following the distribution as we noted in one of our previous blog posts.

Who can save to them?

Anyone. You can open as many 529 plans as you want and name anyone as a beneficiary. The most common scenario we see is that the account owner is the parent and the beneficiary is the child.

What if my child doesn't go to college?

The money in the 529 plan has to be used as directed. If not, you will owe federal and state taxes on the earnings and an additional 10% penalty. You may also have to refund an amount to the state if you received a state tax deduction. There are a few ways to avoid this tax bill and headache:

- You can transfer the leftover funds to a qualified family member, such a sibling. You would simply change the beneficiary on the account.

- If your child receives a scholarship, you are allowed withdraw the amount of the scholarship without penalty (but you will still owe taxes on the earnings).

- If your child goes to a trade school or coding school, the school may still qualify! This is the list of the current institutions that are qualified and it includes some trade schools. If the school is not on the list, it is recommended you contact the school directly to confirm. As noted above, if they are eligible to participate in a student aid program run by the U.S. Department of Education, you can use your 529 money.

Contribution limits

Contributions to 529 plans are considered gifts. Therefore you can contribute up to the annual IRS gifting limits ($15,000 per person or $30,000 per married couple filing jointly for 2018). There is also an exception for 529 plans where you can contribute a lump sum of 5 years worth of gifting ($150,000 per married couple filing jointly) but you cannot make any additional contributions for the following 4 years for that beneficiary.

Get another perspective

Read the fine print for the specific plan you are interested in. Rules in the financial and tax world are always changing, so make sure you review your financial strategy annually to make sure you are within present guidelines and benefit as much as possible with what is available to you.

(1) https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit/eligible-educational-inst

Allowances for Children

Age 5 is a common age when parents start thinking about issuing an allowance to children.   The goal with an allowance is to teach children about personal finance and delayed gratification.  Children who practice delayed gratification tend to be more successful in life.  Thankfully, this is a skill that can be acquired with practice. You may choose to tie the allowance to chores, or not.  There are two schools of thought on the topic, which you can read about here.  Personally, I thought everyone tied the allowance to chores but after researching this article, I am considering the alternative.  There are certain things that children need to learn to do for personal hygiene or to be considerate while living with others.  If they don't do these things, taking away an allowance may not be enough to motivate them, leaving the chores undone.  Rather, you can take away things like attending a birthday party or the car keys if they don't do these basic requirements of being a family member.  An allowance can be seen more as a way to allow children to learn from their money choices and make mistakes now, versus when they are 18 or older.

Experts vary on the amount of allowance to give, but a formula based on age per week (say 50 cents or $1 per age) is simple, and easy to follow, even as they get older.  Some parents issue allowance monthly versus weekly, or round to the nearest dollar so they don't have to worry about the change.  Choose a system that you can realistically afford and maintain over the long-term.

We use the Jar System in our household.  It consists of 3 jars: Charity, Savings, and Spending.  A child splits her allowance into each jar by the following percentages: 10% to charity, 40% to savings and 50% to spending.

Charity Jar

This can go towards a charity that interests the child, such as an animal shelter or place of worship.   My daughter used to attend a school that allowed a different charity to solicit money from the children virtually every week.  They would tell the children that if they donated $5 or $10, they would get some knick-knack.  My daughter got very frustrated with me for not giving her the money, but I told her we already donate all we can afford to the charities we most care about and have researched.   She started giving money from her charity jar.  The first time, she emptied her jar completely on one charity.  The next week, another charity came that she would have preferred to give to, but she had no money left.  She is learning to be more thoughtful about who she is giving to and why, and she tries not to completely empty her charity jar on any one cause.

Spending Jar

This can go to any immediate wants.  Examples in our household include gum or mints, which I don't typically purchase for the children.  It is so nice to be in a grocery store or Target and just say "You don't need that, so you can buy that with your money if you want."  It prevents anyone from getting emotional, and clarifies the way things work: We, the parents, will provide your needs and a small allowance, and you get to choose how to spend that allowance.  We need to be in control of our budget, just like you.

Savings Jar

You can put this money in a bank account for them or add 2 cents for every dollar they have in their jar at the end of the month.  This will teach them about "compound interest", where they earn money on the savings, not just what was put into the jar originally. You can let them dip into this savings at their discretion or require they save it for long-term expenses like college or a car.

Interested in books for children about personal finance?  I read all of these books and can personally recommend them.

Trouble With Money

The Rag Coat

Alexander, Who Used to be Rich Last Sunday

A Smart Girl's Guide: Money

Lemonade in Winter

Personal Finance For Children

When it is relevant for a client, PWR financial plans include a section on personal finance for children.  We compile information from a few sources including Money as You Grow.

Here are some age appropriate activities I started doing with my 3 1/2 year old.

1)  Identify what costs money versus what is free.  For example, we pay money when we go to the local pool.  We don't pay money when we go to the library, park or the beach.  Those are free activities.

2)  Explain that people can get money by working.  Mommy and Daddy go to work to get money.  A couple of neighborhood kids were selling snow cones one day - they were working too!

3)  There is a difference between what we need versus what we want.  We need to buy fruits and vegetables at the store or farmer's market.  We don't need to buy lollipops and cookies.  Those are special treats we get every once in a while.  We need a place to live and a car to drive, but we don't need an automatic bubble maker (yes - these exist!) or a new scooter.  Those things are nice to have, and we may want and enjoy them, but we don't need them.

Use these examples or create your own using the Money as You Grow site as a start.

The Dark Side of UTMA Accounts

With this next post, I wanted to share an issue I have seen a couple times within the last few months. Parents have called asking how to postpone their child from receiving a UTMA account at age 18. The answer is, you cannot postpone the inevitable. Minor children cannot legally hold mutual funds, stocks, bonds and life insurance policies. If parents want to transfer these to their children, they have the option to set up a UTMA (or UGMA) account for them. The issue is that this money needs to be handed over to the child at the age of majority (age 18 or 21 depending on the state).

This may seem in the distant future when you are holding a newborn in your arms, but the reality is that the age of majority, whether 18 or 21, is still incredibly young. Not surprisingly, there are some young adults that are just not ready or responsible enough to receive a lump sum.

UTMA funds are irrevocable gifts. The article below is a good overall summary of UTMA’s. It mentions that one option is to spend the money for the benefit of the child before the age of majority. You would need to use the money for items other than parental obligations and work with a qualified accountant.

http://www.finaid.org/savings/ugma.phtml

An alternative vehicle for parents looking to gift assets to their children is a 529 account. It is often the one I recommend. While it also has its limitations, when presented with the pros and cons of each, parents often choose the 529.

I recommend meeting with a financial planner to review your specific situation and see which vehicle may be better for you.

Can We Teach Our Kids Delayed Gratification?

I came across something interesting while reading Thinking Fast & Slow by Daniel Kahneman. He talks about an experiment conducted among 4-year-old children. They were given one Oreo. They could eat the Oreo now, or wait 15 minutes before eating it, and they would get a second Oreo. While waiting, they had to remain alone in a room without any distractions (books, puzzles, video games, etc.) About half of the children managed to wait. These “resisters”, 10-15 years later, were more successful (defined as less likely to take drugs and having substantially higher test scores). Another, similar, experiment can be found on Ted TV here.

This experiment is fascinating to me because a lot of financial planning is about delayed gratification. I see adults that are resisters. They can easily adjust their lifestyle as needed when children are born or when a spouse loses a job. I also see those who struggle with impulsive spending and prioritizing wants vs. needs.

I spoke with Kathryn Mercurio, MSW, who practices in the greater Boston area. She provides some great tips for teaching kids delayed gratification:

1. Set a good example – While shopping with your children, show them that everything you buy has meaning. For example, use a shopping list and stick to it.

2. Teach mindfulness - Help children become aware of their thoughts, emotions, body sensations, and the surrounding environment. When your child seems distressed, ask them what they are thinking. If they are old enough, have them write down every thought that goes through their mind. You can help them challenge/reframe thoughts that may be distorted or irrational. For example, "I can't go on unless I get the new iPhone. I will be the only girl in school without a smart phone and everyone will think I'm a loser."

3. While parenting, practice healthy emotional regulation – By giving children treats or TV time to calm them down during tantrums, we may be making it more difficult for them to self-soothe or emotionally regulate and thus, learn delayed gratification. Try instead to give your child some time to regulate their emotions. Show them you believe in them and teach them to sit with their distress. You can say something like, "I know you are mad right now. I will sit next to you and we'll wait together for this mad feeling to pass."

4. Teach your child how to make informed decisions - Your 10-year-old tells you he's changed his mind about his goal of saving towards a skateboard because he wants to buy a new hat that has become the hottest new trend. You might ask him these questions: What led you to this new choice? How will you feel after you have bought the hat? How will you feel 2 weeks after you buy the hat? Will you regret not buying the skateboard down the road?

I have a couple more suggestions for the list:

5. Provide a weekly allowance – Start teaching your child money skills with their income. Suggest (or require) they use a portion for short-term items, like going to the movies with friends, a portion for more expensive wants, like designer jeans, and the balance for the future, like college savings.

6. Consider sharing your budget – I have a neighbor who was a single Mom for a while. Money was tight and she was always fighting with her daughter about purchases. She sat down and showed her daughter what money comes in each month and what money had to go out for necessities. The woman said her daughter just “got it” and wasn’t resentful or upset. The daughter now applies those skills in her own life.

Personally, I can’t wait until my daughter turns 4 so I can do the Oreo experiment with her. ☺

Baby’s 1st Year: Reduce the Financial Strain

It can be very easy to get overwhelmed with a new baby coming.  Everyone is excited to offer advice on what you “need” to have.  And after one trip to Babies "R" Us, you realize that baby supplies (while small and cute) aren’t cheap.  Here are some tips to keep the first year costs from ruining your budget.

  • Register for gifts before the baby.

I was hesitant to do this for our wedding, as well as for our baby.  I felt like registries were impersonal and like I was saying “buy this for me please”!  The fact is, people want to get you something you actually need.  Left to their own devices, they will likely get you clothes.  That is fine, but many people find themselves with an abundance of clothes – some of which are hardly used.  Family members and friends are thrilled to be able to chip in on a big-ticket item like a jogging stroller or baby swing.   Plus, registering is a great way to stay organized with what you want and what you have already received.

  • That being said - don’t overdo the registry!

The best book I got as a gift was “Baby Bargains”.  (I don’t receive anything for saying that).  Towards the back, they had a sample registry for a minimalist.  I just followed that list and knew I could supplement as needed.  It probably kept me from having to run around returning a lot of things with a newborn. 

  •  Resist the urge to buy or register for clothes.

Everyone loves buying baby clothes!  My advice - get your fix when buying clothes for other people’s babies as gifts.   You will likely get more clothes than you could have ever imagined and if you have to supplement, check out your local baby thrift store.  There are so many cheap clothes there that were hardly (if ever) used.

  •  More about thrift stores….

We had a thrift store near us while growing up.  All I remember was the horrible smell and outdated clothes.  Times have changed!  We have a baby thrift store down the street in Mission Valley that is incredible.  It has baby clothes, toys and even maternity clothes.  When our daughter was first born, she didn’t fit into any of the 0-3 month clothes we had.  So my husband went and bought a handful of newborn outfits for a total of $10.  She only wore the clothes for a couple weeks, so why pay 4 times as much elsewhere?  You can of course also check out Craigslist or swap with a friends, but the thrift store may give you more options in a pinch.

  •  Add a line item in your budget for miscellaneous kids items and stick to it. 

If you register and have a baby shower, you should have plenty of things for at least the first few months.  But after that you will be amazed by everything you need to keep buying.  By having a budget (as with everything) you are more likely to resist buying items that aren’t necessary.  If you don't use up your budget amount one month, save the difference.  You will need it for bigger items like the upgraded carseat at 1 year.

  • Start talking about college.

Yes, it is 18 years down the road, but most people need to get a college degree if not more these days.  You and your spouse need to be in agreement about what your intentions are.  Do you want to pay for your child’s undergraduate education?  What about graduate school?  Do you want them to work through school like you had to?  Do you want to plan for paying 50% of the costs?  Start saving now if you plan to foot at least some of the bill and there will be a lot less pain in the future.

  •  Set up a savings account and notify family members.

Whether it is a 529 or other savings plan, let your friends and relatives know you set something up for your child.  A contribution to the account is a great idea for holidays or a child’s first birthday.  When kids are that little, they can’t really appreciate tangible gifts anyway.

  • Meet with a financial planner.

If you haven’t already met with a financial planner, get moving!  It will be so helpful to have your family goals and financial plan in writing so you can stay focused during this incredible but busy year.