How to Mitigate Risk and Establish Financial Stability

Catastrophe can strike at any time. How well protected are you?

While insurance salespeople get a bad rap and are the butts of many jokes, insurance is a necessary evil. Insurance is like a firewall against catastrophic financial loss. With so many of us living paycheck-to-paycheck, we may be one illness, one layoff, one traffic accident, or one recession away from bankruptcy.  Therefore, we need to ensure we are covered sufficiently to protect ourselves and our families in case of an emergency. Let us sort out what you do need from what you do not.

What you need: the following items are considered a necessity when building a secure financial foundation.

An Emergency Fund

Although we will talk a lot about insurance in this article, an emergency fund is just as important, if not more important, than some types of insurance. An emergency fund is your own private insurance plan that you can use in case you suffer a loss of income (for example, if you’re ill and cannot work or get laid off from your job.) Also, an emergency fund is a resource when you need to produce a large amount of cash at once to pay for a new dryer, to fix your car, or to pay the deductible of your insurance. Furthermore, an emergency fund can stand between you and bankruptcy or having to borrow money from friends and family until you can get back on your feet.

How much money is enough for a rainy day?

Generally, we recommend at least six months’ living expenses if only one person in the household is earning an income, and three months’ living expenses if there are two full-time incomes.

To some, this can be a lot of money. However, you can start small and put your savings on autopilot by setting up an automatic transfer from your checking to your savings every month. Better yet, have part of your paycheck deposited directly into the savings account so you will never even see it. Pretend that account does not exist unless it is a true emergency like the ones listed above. The peace of mind you achieve from an emergency fund is well worth the pain of building it.

Where should this money be kept and how accessible should it be?

For an emergency fund to serve its stated purpose, it must be highly liquid. So typically, a savings account or money market fund is the best place to store your emergency fund. While it may not earn much in the way of interest, keep in mind that growth is not the job of this money. Rather, this money’s job is to keep you and your family safe from financial ruin – it is that simple.

Term Life Insurance: The Benefits of Term Life Insurance over Whole Life Insurance.

The right type of life insurance for the right person is the keystone to any sound financial plan, and its absence can spell disaster.

Term life insurance is pure insurance - there is no savings element, so there is no cash value. You cannot “cash it out” or borrow from it. Instead, you pay a lower premium for a higher death benefit than you would for whole or universal life. The “term” refers to how many years you purchase the insurance for. Typically, the shorter the term, the cheaper the insurance is, although your age, health, family history, and hobbies (such as skydiving) also affect the cost of the insurance.

Why is life insurance necessary?

Most people receive one times their salary or $50,000 (whichever is lower) worth of life insurance as part of their benefits package at work. Why $50,000? Because that is the amount of insurance your employer can provide you without you paying income tax on the premiums they are paying for on your behalf. So, the question we often hear is, do I need more coverage than that?

The following are reasons to have life insurance:

1. Replacing Income
   1. Providing income during a readjustment period
      Whether you are the sole breadwinner or have a dual-income family, your family will go through a period of adjustment after you are gone. They will need time to grieve before jumping back into employment. Your significant other may need time to be reeducated and retrained to join the workforce if you have been the primary wage-earner. They may also need time to adjust to a lower standard of living.
   2. Providing financial support for dependents
      Dependents can mean minor children, but it can also mean a spouse who cannot earn as much as you could. If you have elderly parents or other relatives who depend on you for support, their needs should also be considered.
   3. Earmarking funds for specific goals
      You may also want to provide a college education for your children or pay off a mortgage.
      
2. Estate Preservation
   If you want to leave a legacy for your family, friends, or charity, life insurance can help preserve it, whether your estate is worth millions or thousands. This is even more important for those whose families have very few resources, as these after-death expenses could leave your family in debt.
   
   1. Funeral expenses
      Even the least expensive funeral is costly, and most people do not have enough savings to pay for it.
   2. Probate expenses
      Some or all of your estate may have to go through probate, a process determined by the state court system. Depending on the state you live in, this can be expensive and time-consuming.
   3. Taxes
      During the probate process, your heirs will have to pay any back taxes you owe and may have to pay inheritance taxes as well, depending on your state.
   4. Paying off debt
      In addition to paying off a large debt like a mortgage, you may want to pay off credit cards, student loans, and car loans to leave your heirs with a clean slate.

If you are single and have no dependents, you probably do not need more life insurance than the cost of your funeral unless you want to leave money to friends, family, or a charity. If, however, you are partnered and/or have dependents, read on.

How much life insurance is needed to protect me and my loved ones?

This is tricky to answer with any certainty without a detailed analysis of your situation. For example, someone who is the primary breadwinner for a family with young children would need significantly more life insurance than a 55-year-old in a two-salary family with no children.

The main questions to ask yourself are:

1. What will be the income needs of my family?
   To answer this question, you will need to determine what you spend now and what portion is discretionary versus fixed. Mortgage payments, utility bills, taxes, etc., are fixed expenses, while vacations, eating out, and entertainment are discretionary. Additionally, think about the standard of living your family will want after you are gone. Are you OK with their standard of living being lower, or do you want it to stay the same? Although some people find death difficult to talk about, this is an important conversation to have with your loved ones.
2. What other resources are available to fund those needs?
   First and foremost, how much money does your spouse make, or can they make, to meet that income need? If they have been out of the workforce for a while, they may have a diminished ability to bring in a salary equal to yours.
   What benefits are your family members eligible for? For example, if you are married and have children under 18, both your surviving spouse and minor children will receive Social Security benefits. Your spouse will stop receiving benefits once the youngest child turns 16 but will be eligible to begin retirement benefits early, at age 60. Your children will receive benefits until age 18, and your dependent parents can receive benefits as well.
   Other resources that may be available to fund your survivors’ living expenses could include survivor pension benefits, and your retirement accounts such as 401(k)s and IRAs can help support a significant other’s retirement.
3. If you have children, what are your expectations for funding their college educations? How much have you saved so far? If you want to pay for their educations, you will need to determine how much you will need for that. Your financial advisor can help.
4. Do you have sufficient savings to pay for funeral expenses that will not leave your family behind without an emergency fund?
5. If you are not the primary breadwinner, there would still be an economic impact beyond funeral expenses if you passed away. Who would take care of your home and children? If your partner is working a full-time job, they may need to hire help for cooking, cleaning, childcare, yard work, and home maintenance. This could be expensive, so do not overlook it.

What type of length should I consider for Life Insurance?

For most people, life insurance is not a permanent need because they accumulate assets such as retirement accounts, investments, and homes as they age. At a certain point, there is usually a break-even point where they have enough income from Social Security benefits, pensions, and investments to support their loved ones even if something happens to them. For some individuals, this could happen in their forties, while for others, it may not occur until their sixties. It just depends on the spending needs, the savings rates, the incomes, and the existence of outside resources like pensions.

A good rule of thumb is to get term insurance for as long as you plan to work, up to a maximum of 30 years. If you end up not needing it for the entire 30 years, you can always cancel it in the future.

Disability Insurance

Disability insurance provides replacement income if you become disabled and are unable to work. Most policies replace between 40 and 80% of your income. Short-term disability can provide income after you have had surgery or for some other event that you will recover from quickly (a maximum of two years). Long-term disability covers you if you are unable to work for an extended period and usually provides a benefit until retirement.

You are much more likely to become disabled than to die, so disability insurance is just as important as, if not more than, life insurance. Most people receive disability insurance through their employer, but if you are self-employed or not covered at work, you can purchase it individually. Even if you have long-term disability insurance through your employer, you may be able to buy your own supplemental policy. But generally, your combined coverage cannot exceed 75% of your salary.

Health Insurance

Protect yourself, and those close to you as well.

Health insurance can, and does, comprise entire books and book series. Ask your financial planner for help determining the right policy for you.

Auto Insurance

You must have car insurance if you own a car. The most significant decisions here concern the amount of the deductible and whether to purchase coverage for damage to your auto.

Deductible - How to find the right balance between your deductible and your premium.

In most cases, the higher your deductible is, the lower your premium. Since you will (hopefully) go many years without filing a claim on your auto insurance, you should get the highest deductible your emergency fund can cover to reduce your premiums. If you are beginning to build your emergency fund, it is OK to start with a lower deductible. As your emergency fund increases, make sure you review your auto policy each year when it renews to see if you can raise the deductible. Over your lifetime, this can save you thousands of dollars.

Coverage for damage to your car

Most lenders will require you to carry both collision and comprehensive coverage on your car if you borrow the money to buy the car.

• Collision covers “the upset of your covered auto or its impact with another vehicle or object.” In other words, it pays to repair damages to your car caused by an accident with another car or a collision with an object such as a tree.
• Comprehensive coverage protects you from damage to your car from anything other than a crash. Examples include falling trees, theft, vandalism, fire, hitting a deer, and flood.

If you do not have a car loan, or once the car loan is paid off, you can decide to drop coverage that pays for damages to your own car. Most of the time, this only makes sense if the car is worth very little and the amount the insurance company will pay you if they consider the vehicle "totaled" less the amount of your deductible is an amount you are willing to forego. Totaled means the insurance company considers the vehicle a total loss and will not pay to fix it but will pay you the vehicle's actual cash value. For example, if you own a 15-year-old car with a value of $2,500, and you have a deductible of $1,000, the insurance company will only pay you $1,500 if something happens to your car. They are very unlikely to pay to fix it. If you are willing to trade that possible $1,500 for reduced premiums for the life of the car, then you should drop collision and comprehensive coverage.

Homeowners Insurance or Renter’s Insurance

Homeowners insurance and renters insurance are topics that could fill books on their own. Your financial advisor can help you pick the right type of insurance for you.

What You May Need: These items are not imperative for every person, but they do carry significant benefits for those who choose to employ them.

Long Term Care Insurance

Many people are under the mistaken assumption that Medicare pays for nursing homes. It does not. Medicare pays for skilled nursing facilities. To be qualified for a skilled nursing facility, you must be unable to perform two out of the six following “activities of daily living:”

1. Bathing
2. Dressing
3. Continence
4. Transferring from bed to chair
5. Transferring from wheelchair to toilet
6. Feeding oneself

As you can see, this can be a high hurdle. In addition, even if you meet these criteria, Medicare only pays the full cost of skilled nursing care for 20 days (about 3 weeks)! After that, it only provides partial coverage for an additional 80 days (about 2 and a half months) - then you are on your own.

Medicaid is what pays for nursing home stays, but there is a catch - Medicaid is designed for people with minimal assets. So, to qualify for Medicaid, you must be very poor, which would mean spending all your money to pay for your care before you could apply. Some people try to get around this by giving their assets away to their children or other beneficiaries. However, there is a five-year “look back” period to qualify for Medicaid, so any assets you gave away in the five years before applying for Medicaid will count as your assets.

Because nursing home stays can be expensive, long term care insurance was introduced in the 1970s and became popular in the late 80s and early 90s. Long term care insurance can be pricey, though, so do a careful analysis before you decide to purchase it. It can provide great peace of mind for the right people, but it is just not worth it for others.

Long term care insurance might be right for you if:

1. You have significant assets that you want to pass on to your heirs, and you do not want those assets depleted by paying for a potentially lengthy stay in a nursing home.
2. You are single and/or have no children who can help you coordinate or pay for the costs of long-term care.
3. You are in your 60s and are in good health with no history of serious illness. Otherwise, the insurer will either reject you outright or will charge you exorbitant rates.

Long term care insurance might not be right for you if:

1. You have significant assets and are not concerned about leaving a legacy. You care more about paying for a facility where you feel safe and comfortable.
2. You have minimal assets that you will eventually use up, so Medicaid will pay for your care.
3. You have a chronic condition such as diabetes, heart disease, or COPD. Any one of these will immediately disqualify you from applying for most long-term care policies.

Liability/Umbrella Insurance

Liability and umbrella insurance are designed to protect you from losing everything if you are sued. Younger individuals or those with very few assets have a limited need for this type of insurance protection. Most people have liability insurance as part of their homeowner’s insurance. This type of insurance protects you if a person is injured on your property or if your dog runs out of your yard and bites someone. We usually recommend that homeowners have $300,000 of liability insurance as part of their homeowner’s policy. Liability insurance is also part of your auto insurance and pays for damage to property or injury to people that is caused by your driving errors.

If you have accumulated more substantial assets or are engaged in riskier pastimes, you should purchase umbrella insurance, which pays to protect your assets in case of lawsuits. This type of insurance is quite inexpensive, and you can purchase $1,000,000 of coverage for only a couple hundred dollars a year. My family recently added umbrella insurance, which we purchased from the same insurance company we bought our homeowners and car insurance from. Our daughter has taken up horseback riding, and we recently started leasing a horse for her to ride. If the worst should happen, she could lose control of the horse, it could run out on the road, and someone could hit it with their car, causing damage to the car and possible injury to the car’s occupants. For less than $200 a year, we do not have to worry that we could lose everything in that type of situation.

Sewer Line/Gas Line Insurance

This is another type of insurance that is inexpensive but could save you from significant expenses later. For instance, my family purchased a beautiful 1920’s arts and crafts style home in a neighborhood full of large, mature trees. A couple of years after we moved in, the sewer line started backing up - it turned out that the sewer line was the original terra cotta line, and it became clogged with tree roots. $9,000 later, we had a new sewer line but a destroyed back yard, so we still had to pay for landscaping to restore our yard. For $10 or less a month, we could have saved over $10,000. If you own a home, we recommend this insurance.

What You Probably Do Not Need

When it comes to protecting yourself financially, more protection is good, but no insurance policy is free.  There are many insurance policies out there that are not worth the cost.

Cancer Insurance

Specialized insurance that only pays in the event of the policy holder dying of a particular illness may not be expensive, but it is a waste of money. You are better off paying for a term life policy that covers you regardless of the cause of death.

Accidental Death and Dismemberment Insurance

Many times, accidental death and dismemberment insurance is included with another insurance policy. The accidental death insurance pays a benefit in addition to the life insurance benefit if the insured person dies accidentally (such as in a traffic accident). The dismemberment insurance pays out different benefit amounts depending on the dismemberment that has occurred. For example, someone who has become quadriplegic usually receives a higher benefit than if they had lost their vision.

These policies are a nice addition to a policy if you do not have to pay for them, but do not spend extra money on them. Employers often offer them to workers for a small premium, but they are not worth it unless you work in a particularly risky field; otherwise, your risk of accidental death or dismemberment is very low.

When in doubt, ask your CERTIFIED FINANCIAL PLANNER^(TM) Professional

All our advisors at Allegheny Financial Group are CERTIFIED FINANCIAL PLANNER^(TM) Professionals, so we are trained and experienced in helping you assess your risk management plan.

Allegheny Financial Group is a Registered Investment Advisor. Security offered through Allegheny Investments, LTD, a registered broker/dealer. Member FINRA/SIPC.

Author: Trina Brown, CFP® | Associate Financial Advisor | Allegheny Financial Group | December 2020

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The information included herein was obtained from sources which we believe reliable. This report is being provided for informational purposes only. It does not represent any specific investment and is not intended to be an offer of sale of any kind. Past performance is not a guarantee of future results.

Allegheny Financial Group is a Registered Investment Advisor. Securities offered through Allegheny Investments, LTD, a registered Broker/Dealer. Member FINRA/SIPC.