General & Misc. Planning: September 2006 Archives
It shouldn't surprise anyone that there are things you should do before you make your first investment. The SEC, NASD and all of the various other financial planning organizations all explicitly list three things that should be in place in most cases prior to making your first investment in anything.
The first of these is an operating reserve. This is a fund of ready cash outside of any investment account, that you can use for emergencies. The minimum is three months of your normal expenditures, but six months is better. People lose jobs, have accidents, have health problems, things come up - you get the idea. Unless your job is rock steady, your cash flow predictable, and you can live on less than fifty percent of your take home pay, you really want to have living expenses for six months saved up, and for some self employed situations where your cash flow is uneven (like say, financial planner or real estate), twelve months is better. Having this much cash on hand gives you a certain security, and you likely won't have to cash in your investment for some minor emergency.
The second of these is a life insurance policy. This isn't from any deep-seated desire to sell you a life insurance policy. Investment professionals have only been getting insurance licenses since about 1980, and this recommendation is far older than that. Almost everyone is going to need a life insurance policy at some point in their life, and it is cheaper and more effective to purchase while you are young. and especially before health problems are likely to develop. As I've found out, sometimes things happen to you that prevent you from obtaining life insurance (as in no company will issue you a policy, or will only do so on prohibitive terms), and if you want a family eventually, it is wise to take care of this now. Furthermore, certain life insurance policies are among the very best investments you can make, and more effective the sooner you start them. This is not to say that life insurance is for everyone. I have a client who's older, has no dependents and never will, has plenty of assets to cover final expenses, and those assets are titled so that they will pass immediately and correctly to his heirs. A life insurance policy would still be of benefit if he had certain goals, but he doesn't. So we've decided it's not for him.
The third of these is estate planning. This is actually in the requirements as a will, but there are other elements such as durable power of attorney for health care, living trusts, and so on. These do cost a certain amount of money, but it's money well spent. If something happens to you without doing this planning, every state in the US has a different law as to what happens to your assets, your minor children, your pets, etcetera. These are all cookie cutter approaches, and that cookie cutter was likely enacted a long time ago, to where the societal assumptions that the legislature made at that time are no longer valid for any large proportion of the population. The majority of your assets should not be transferred by a will, anyway - wills can be and are challenged successfully every day. Trusts are far better.
If the person you work with is any kind of financial planner, they should add two additional concerns to the list. They are disability income insurance and long term care insurance. The need for both goes away as you become more affluent. Remember, that insurance companies exist to make a profit and if you can afford the risk of losing what they insure, you shouldn't buy a policy. So if you've got a couple million somewhere, and if you never made another penny you would be comfortable, there is no need for disability insurance. The same applies to Long Term Care, albeit probably requiring more affluence. Average base per diem cost in California is $180, with another $60 or so in supplemental charges. So when you can afford $240 per day (between $85,000 and $90,000 per year) for a period of several years in addition to what ever else you may need for your family to live, you are not a good candidate for long term care insurance. On the other hand, long term care facility prices keep rising, and as medical capabilities for keeping you alive get better, you can expect to spend longer in such a facility.
(For all the money and research we throw at prolonging lives, you'd think we could spend more on making it a robust life, or allocate more of what we already spend towards that end. More and more, we are statistically tending towards living longer in an increasingly frail, helpless and joyless condition. As long as people are enjoying life, more power to them. When it becomes a miserable painful existence, as I have seen too much of, I just don't see the point. When I see what so many people put themselves or their loved ones through, I'm making certain I'll always have a "check out" option under my own control, and if I don't have control to exercise, my wife and I are agreed that neither one of us wants to hang around).
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I have never liked or favored the estate tax, and yet I am very much of two minds about actually abolishing it. I'm glad of the benefits to the individuals involved, and yet it is only one of the issues involved in planning for what happens to all of us eventually, and abolishing it removes the most obvious motivation for handling the rest.
The benefit of abolishing the estate tax is obvious: people don't get taxed, so their heirs get what they earned rather than the government. This is a good thing, and I favor it for that reason.
On the other hand, there were so many mechanisms varying from outright gifting to 529 accounts to life insurance to trusts, each of which except the first can be used to retain control and benefits of assets while avoiding estate tax liability, that estate tax is and always has been essentially voluntary. You have to just not plan in order to pay estate tax, and some of the mechanisms available actually increase your available estate over what would have been its original gross value otherwise. Since we know that death is something each of us is going to have to face, there can be no reason except stupidity for not undertaking to plan for it. Estate tax was a voluntarily paid tax on stupidity.
Furthermore, there are other estate and contingency planning options that people need to take care of, and fewer people are doing so as estate tax was one of the primary levers that moved people to do it. All of this planning is just as necessary as estate tax planning, and usually taken care of at the same time.
Here are just a few of the other issues:
Will: The will probably should not be used for financial purposes, but resolves other functions such as who gets custody of minor children. Please note that a will is not necessarily binding upon the states where your will is probated, and can be challenged. Many wills are challenged, a large portion of them successfully, and even if your estate wins the battle it will be diminished in the process.
Durable Power of Attorney for Health Care: if you can't make health care decisions, this tells who you delegate that power to. If there's a court case brought, it's going to be very short and abrupt. Case closed.
Trusts, revocable and irrevocable. I'm not certain it's possible to successfully challenge a well-constructed trust where the assets that are actually transferred to it are concerned. You didn't own them. The trust does, and the trust didn't die. The instructions live on, like a corporation. The named successor trustee also usually gets the ability to manage the trust's assets if you are alive but incapable. Assets in a trust can avoid not only estate tax, but probate as well. If you want to be certain of the disposition of what you leave, particularly in a speedy manner, this is probably the way to go. Many estates are not finished with probates for years, and until they are, your heirs don't get control of the assets. Nor are we certain that estate tax is going away forever. Probate is also expensive, time consuming, and lucrative for attorneys. Seven percent of probated assets seems to be about the minimum cost, and it can easily top thirty percent. I haven't investigated, but I suspect the trial lawyers would be solidly behind banishing estate tax for this reason.
Business operations: many small to medium sized businesses have no plan to keep them going in the event the owner-operator dies or becomes disabled. Certainly nobody else working there has the knowledge, the experience, and often the necessary licenses. If the business closes because the proprietor isn't there, it's worthless. If there's a plan of succession to keep it open and operating, however, you or your family can likely sell it as a going concern with consistent profit.
Retirement plans: If you have certain types of tax deferred retirement plans, they can be expensive to convert to assets in your heirs' possession, even without estate tax. Better to draw these down and keep other accounts available.
Life Insurance: There are going to be expenses when you go. These vary from taking care of the body you leave behind to probate to keeping your business running if you have one. The people doing these things want cash. Life insurance is usually the cheapest way to pay them. Your family is also likely to need something to replace your income in many cases. Life insurance is about the only choice.
One hopes you begin to get the idea. Consult an attorney and financial professional in your area to find out how it works, but all of this needs to be taken care of, or your family will wish you had.
Caveat Emptor.
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