Tag Archives: personal finance

Life Insurance: the options

Hello world!  I’m back after being MIA for a few days.  It’s been a nice, relaxing weekend.  Yesterday, I finally bought Vibram Five Fingers after thinking about it for over two years.  REI had a 20% off promotion for members (side note: the $20 fee for a lifetime membership is totally worth it) and I received a $55 REI member dividend so I only paid $23 for them.  I wore them on a walk with Macy this morning and they were very comfortable!  I think they’ll be great for short runs and my Tough Mudder circuit training.

Today, I am working on the eulogy for my grandma’s funeral.  She lived a very long, full life… and it’s hard to even begin to figure out how to summarize that into a 20-minute speech.  I hope I am lucky enough to lead the long and fulfilling life my grandma lived.

Sometimes life is unpredictable though.  (whomp, whomp… I know that makes me sound like Debby Downer)  My grandma passed away at 91, my aunt passed away unexpectedly at 49 and my friend from graduate school has been in critical condition for two weeks at age 33.  No one likes to think they won’t be the person living to 91, but sometimes you need a contingency plan to protect the loved ones you leave behind.  By a strange coincidence, I purchased life insurance earlier this month.  So, this post is intended to give you a quick reference guide on life insurance options.

There are two basic types of life insurance: term and permanent.  A good analogy is that term insurance is like renting and permanent insurance is like owning.  With term life insurance, there is no cash value accrued and coverage is only guaranteed for a set period of time.  With permanent life insurance, cash value is accrued and coverage is guaranteed for your entire life at the same monthly premium.

Term insurance is the least expensive and the premium is usually about $10/month per $100,000 if you’re a young, healthy adult (but gets more expensive as you get older and/or less healthy).  You pay the premium for a set time period that you want coverage.  This is usually good for younger people with limited financial responsibilities/means and parents who want to insure their minor kids are taken care of if something happens to them.  The idea is that you may only temporarily want life insurance because you’ll eventually hit a point in life when the equity in your house or your other savings and assets will eliminate the need for life insurance.

Permanent life insurance is more expensive and premiums vary based on the plan. The most basic benefit is it provides insurance protection and builds up a cash value (savings).  This is a little more detail about the benefits:

  • You can access the cash value by taking a loan against the policy, it can be used as supplemental retirement income, and it can be used as collateral for loans
  • You may get paid dividends if and when the insurance company declares them or you can have the dividends rolled into your cash value.
  • You are guaranteed the benefit for life at your initial premium, whereas term insurance expires and renewing may not be at the same premium rate.  With term insurance, you might not re-qualify for a renewal or it might become very expensive because of age or health.

So, there are a lot of benefits!  That is probably why premiums can be 8-10x more expensive than term insurance when you are a young, healthy adult.

How does permanent life insurance build up cash value?   Part of your premium pays for the insurance and the rest is invested by your insurance company (or, in my case, Northwestern Mutual).  The benefit of this versus saving or investing it yourself is there is usually a guaranteed rate of return.  You can also choose how quickly you want the cash value to accrue, which will be factored into your premiums (the faster you want it to build up, the higher your premium).

There are three basic types of permanent life insurance: whole life insurance, universal life insurance and variable life insurance.  I stole the descriptions of these from the National Association of Insurance Commissioners ‘Life Insurance Buyer’s Guide’:

  • Whole Life Insurance covers you for as long as you live if your premiums are paid. This is the most common form of permanent insurance.  You generally pay the same amount in premiums for as long as you live. When you first take out the policy, premiums can be several times higher than you would pay initially for the same amount of term insurance. But they are smaller than the premiums you would eventually pay if you were to keep renewing a term policy until your later years.  Some whole life policies let you pay premiums for a shorter period such as 20 years, or until age 65. Premiums for these policies are higher since the premium payments are made during a shorter period.
  • Universal Life Insurance is a kind of flexible policy that lets you vary your premium payments. You can also adjust the face amount of your coverage. Increases may require proof that you qualify for the new death benefit. The premiums you pay (less expense charges) go into a policy account that earns interest. Charges are deducted from the account. If your yearly premium payment plus the interest your account earns is less than the charges, your account value will become lower. If it keeps dropping, eventually your coverage will end. To prevent that, you may need to start making premium payments, or increase your premium payments, or lower your death benefits. Even if there is enough in your account to pay the premiums, continuing to pay premiums yourself means that you build up more cash value.
  • Variable Life Insurance is a kind of insurance where the death benefits and cash values n the investment performance of one or more separate accounts, which may be invested in mutual funds or other investments allowed under the policy. Be sure to get the prospectus from the company when buying this kind of policy and STUDY IT CAREFULLY. You will have higher death benefits and cash value if the underlying investments do well. Your benefits and cash value will be lower or may disappear if the investments you chose didn’t do as well as you expected. You may pay an extra premium for a guaranteed death benefit.

Which one is better?  If you don’t have a good retirement savings or already feel financially strapped, term insurance is probably the best option right now so you can focus on increasing (or starting) your 401k and building up a savings.  If you are looking to make more long-term investments in your life, a mix of term and permanent is probably the best.  I have both because I want a little extra protection for when I have kids (and you usually get a discount when you buy them together) and I want to diversify my retirement and savings.  If you’re young, now is definitely the time to investigate your options because you will get a better rate.  Even if it is a small term policy, it is better to have some coverage.  No one likes to think they would need it, but sometimes life can be unpredictable.

Who can you talk to if you want to investigate options further?

  • I know everyone dreads going to them, but talk to a Financial Planner.  They will be able to recommend if it is something you should consider or if you should focus your financial efforts somewhere else.
  • Your car insurance company probably offers term life insurance.  I know State Farm offers it.
  • When I was doing my research for this post, I discovered the Consumer Federation of America will evaluate your permanent policy (if you already have one) to determine if it is worth keeping.

Do you currently have term or permanent life insurance?  What was the reason you decided to buy life insurance?

Is anyone still going strong with their March Madness bracket?

Thrifty Thursday: Credit Score Breakdown

Credit score.  We all know the term and that we want it to be good.  But how is it determined, what is “good”, and does it really matter?

How is it determined?

The most common method to determine credit scores is the FICO method.  It was formulated in the early 1980’s between Fair Isaac and the three major reporting agencies: Experian, Equifax, and TransUnion.  I am going to be a lazy blogger tonight and share with you exactly how your credit score is broken down, as reported in a Money article (these bullets are literally a copy and paste so I know I’m being lazy, but why recreate the wheel when they explained it so well??):

  • 35 percent of the score is based on your payment history. This makes sense since one of the primary reasons a lender wants to see the score is to find out if (and how promptly) you pay your bills. The score is affected by how many bills have been paid late, how many were sent out for collection and any bankruptcies. When these things happened also comes into play. The more recent, the worse it will be for your overall score.
  • 30 percent of the score is based on outstanding debt. How much do you owe on car or home loans? How many credit cards do you have that are at their credit limits? The more cards you have at their limits, the lower your score will be. The rule of thumb is to keep your card balances at 25 percent or less of their limits.
  • 15 percent of the score is based on the length of time you’ve had credit. The longer you’ve had established credit, the better it is for your overall credit score. Why? Because more information about your past payment history gives a more accurate prediction of your future actions.
  • 10 percent of the score is based on new credit. Opening new credit accounts will negatively affect your score for a short time. This category also penalizes hard inquiries on your credit in the past year. Hard inquiries are those you’ve given lenders permission for, as opposed to soft inquiries, which include looking at your own score and have no effect on the score. However, the score interprets several hard inquiries within a short amount of time as one to account for the way people shop around for the best deals on a loan.
  • 10 percent of the score is based on the types of credit you currently have. It will help your score to show that you have had experience with several different kinds of credit accounts, such as revolving credit accounts and installment loans.

(this is Anna speaking again!)  Your credit report isn’t always going to be accurate because sometimes information is reported inaccurately to Fair Isaac.  This could be: a company didn’t correctly report or update your payment history, someone else’s information was accidentally reported on your credit report, or some other fluke caused your information to be incorrect.  This is why it is important to take advantage of pulling your FREE report every year.  Checking over your report could save you a lot of money in the long run if it means your score will get a boost.  (be careful not to get suckered into the monthly credit monitoring for $9.95/month… not worth it)

What is “good” and how do you get there?

Most people have a score between 650 and 750, and anything over 700 indicates good credit management.  Getting a good credit score takes time.  You need to pay on time, reduce your debt (strive for 25% of your available limit), watch the kind of debt you take on, and follow all the other good advice that I copied and pasted from Money earlier in this post.  This is a breakdown of all the ranges:

  • Between 700 and 850 – Very good or excellent credit score.
  • Between 680 and 699 – Good credit score.
  • Between 620 and 679 – Average or OK score.
  • Between 580 and 619 – Low credit score.
  • Between 500 and 579 – Poor credit score.
  • Between 300 and 499 – Bad credit score.

Does it really matter?

Yes, you want a good credit score but having a great credit score may not get you much more.  A good score will save you a lot of money — and not just because you will get lower interest rates on loans.  These are a few instances where your score matters:

  • Loans and credit cards.  You will get a lower interest rate, and in some cases a bad credit score will prevent you from being accepted for the loan altogether (and the rejection could also hurt your score).  For example, if you are approved for a $100,000 home loan at a 7% interest rate and your friend is also approved for a $100,000 home loan at a 6% rate, your friend’s monthly payment will be $65 less each month than yours.
  • Insurers.  Car insurance companies may use your score to determine your insurance premiums.
  • Landlords.  Landlords may want to know if you consistently pay your bills a time. A low score due to late payments could prevent you from being approved for housing.

However, the difference between a great score (above 750) and a good score may be minimal.  This is because lenders see the risk of someone with a score of 800 defaulting as being about the same as someone with a score of 740.  Therefore, they will both qualify for good interest rates.  Don’t get me wrong, the person with a higher score will save more on interest but it will be a much smaller spread than between someone with a score of 740 and someone with a score of 675.  The person with a great score might save an additional $10 or $20 per month on a $30,000 car loan.

Do you check your credit report annually?  

Have you watched any of the March Madness games today?  Which upset did you pick in the tournament?  (Matt didn’t invite me to be in his bracket!)

Put your tax returns to work

Tax return time is a good time of year to take a financial step forward without an impact to your day-to-day lifestyle (if you get a return).  This is probably the only time of year I’m glad I have my townhome that is $80k under water.  Well, not glad it is under water, but glad I get to deduct the interest!

I’ve read through a few suggestions of how tax returns can best be used to improve financial situations, added my own opinion, and created this lovely flowchart of how to make the most of this annual cash infusion.  These are some of my references: Real Simple, Go Banking Rates, MSNBC Money, Kiplinger’s Personal Finance.  I especially like the “What You Shouldn’t Do” section in Real Simple.


Pay overdue bills & establish an emergency fund.

Both of these should be done first to “stop the bleeding”.  Getting yourself current on your bills will help improve your credit score (and stress level).  Establishing an emergency fund will prevent you from reaching for credit cards or other high interest debt options to pay for car repairs, house issues, or other emergencies that come up.  One-thousand dollars won’t cover a catastrophe, but it will cover most emergencies.

Indulge Yourself.

Most of my references had this listed last, but I chose to have it further up the list.  I think setting aside money for a personal indulgence, whether it is now or a few months from now, will prevent you from reaching for a credit card.  You should be able to enjoy a small indulgence for sanity reasons and limiting it to 10% will ensure you still have enough to make progress on other financial goals.  I plan to use mine on new clothes when my butterfly on the right toolbar hits 10 pounds lost.  🙂

Pay toward high-interest debt.

Credit cards are expensive, but they aren’t listed first because building an emergency fund and paying off bills will prevent the need to use credit cards.  The first step to paying off cards for good is to only use them if you can pay the full balance every month.  When I accumulated credit card debt, I wasn’t able to make progress until I set a fixed monthly payment and stopped using them.  Before that, I would stretch myself to make really high payments and then resort to using credit cards when I didn’t have the cash in my checking account.  In this case, slow and steady wins the race. 

Build up a healthy savings account.

Life happens.  Unfortunately, you can’t always plan for it.  I think we all felt that in some way after the economy crashed in 2008.  The recommended amount to have in savings varies from 3 months to 9 months, depending on the source.  The best advice I’ve heard is to figure out how many months it takes, on average, to find a new job in your field and strive to put that in savings.

Save for large planned expenses.

I think this one is pretty self-explanatory!

Start an IRA.

Roth IRA’s are a great retirement vehicle because the money is not taxed when you take disbursements at retirement.  This is because the money was already taxed when you put it into the IRA.  About.com has a good explanation of the difference between a Roth and Traditional IRA and the benefits of both. 

I did not mention anything about 401k here because my recommendations are focused exclusively on what to do with an annual cash infusion.  I think it is important to use part of your raise to adjust your 401k contribution, which I discussed in a previous post.

Work on your cash flow.

Good job if this is you!  It can take years to get here, so don’t beat yourself up if you aren’t.  You’ll get there with a little patience and dedication.  This is where you put extra money toward your student loans, car loan, or other debt not considered high-interest.  You might not cover the full loan in one year, but you will be glad you did this when the loan gets paid off early!

Tax returns, in general.

If you’re getting a lot back every year, you should look at your withholdings.  While it is nice to get an annual payout of cash, it is even nicer to have that money throughout the year. 

What will be your indulgence with your tax returns this year?

Don’t throw away free (retirement) money!

Some people say we should plan for the worst and hope for the best.  With retirement, I think we should plan for the best and hope for the best.  When I hit my golden years, I don’t want the stress of work to be replaced by the stress of paying bills.  That doesn’t sound very relaxing!

Many people don’t plan well for retirement and a lot of people give away free money (yes, you read that correctly, FREE money!).  According to the Employee Benefit Research Institute (ERBI), only 40% of employees participate in employer-sponsored programs and the average savings for a person under the age of 35 is $6,306.  This is what I mean by giving away free money – the other 60% are missing out on employer matched contributions and the younger people are missing out on significant compounding interest by not contributing more.

Let’s take Sally as an example.  Sally makes $30,000/year but doesn’t contribute to her 401k plan.  The most frequent company match is 50% up to 6% of pay (i.e., if you put in 6%, your employer puts in 3%).  Sally’s employer is average so this is what they offer.  If Sally is 30 and doesn’t plan to retire until she is 65, she is missing out on $31,500 of free money.  This doesn’t even include the compounding interest that money would generate.

What is compounding interest?  It is the interest that interest earns.  Let’s say Sally decides to contribute $2,700 to her 401k every year ($1,800 of her own money and $900 of her employer’s money).  The interest from her first year of contributions would almost quadruple from $108 in the first year to $410 when she retires at age 65.  This is how the compounding interest works over time:

  • Year 1: $2,700 * 4% = $108 interest
  • Year 2: $108 + 4% earned interest = $112.32
  • Year 3: $112.32 + 4% earned interest =  $116.81
  • Year 35 = $394.03 + 4% earned interest = $409.78

This example is only for that very first year of interest.  If Sally contributed $2,700 every year for 35 years, she would invest $81,000 of her own money but she would end up with approximately $200,000 because of compounding interest and matching from her employer.  The point of this example is: invest early and take advantage of employer contributions.

If you don’t currently contribute to a 401k or contribute enough to take advantage of your full employer match, it can be a big adjustment to add in those extra deductions every month.   My recommendation would be to phase in the investments over time.  It will be a lifestyle adjustment to “lose” that monthly money, but it is an investment in your future.  It is the same as when you start an exercise routine or improve your eating habits.  It is hard to find the time to exercise or prepare healthier meals, but it is an investment in your life that you won’t regret.

When I started contributing to my 401k, I didn’t take full advantage of the match (if only I knew then what I know now!).  I increased my 401k match over a few years.  If I got a raise, I would increase my 401k contribution by 1% and pocket the rest of my raise.   I also decreased my match for a few years after I bought my townhome because I needed the extra money to help with living expenses.

One common misperception I have heard since the big crash in 2008 is that the stock market isn’t a good investment so there isn’t much point in contributing to a 401k.  The first issue with this perception is that investing in a 401k doesn’t necessarily mean investing in the stock market.  You can select the percentage of your 401k that goes toward stocks versus bonds.

The second issue with this misperception is the stock market is a good long-term investment, which is what is most important for retirement savings.  If you look at the stock market performance over the past 5 years in the chart below, it doesn’t look like a good investment because we aren’t even back to 2007 levels yet.

However, if you look at the stock market performance over the past 30 years in the chart below, it looks like a great investment.  Black Monday, the stock market crash in 1987, looks like a tiny bump in the road.

I planned to write this post about different ways to save for retirement so I guess I will need to do a follow-up post about other options!  Watch for that post if your employer doesn’t offer a 401k plan.

Happy investing!

How do you envision your retirement?  Do you plan to travel or retire to a nice cabin on a quiet lake?