What is a subprime mortgage? This is where the lender approves the loan for someone who has a credit rating below 620. Interest rate is also higher than conventional mortgages because the borrower is deemed high risk on defaulting on the loan. How high the interest goes depends on the size of the down payment, how often the borrower missed his/her payments in the past, and the credit score.
Many subprime mortgages comes with a prepayment penalty. If the homeowner pays off the loan faster than predicted or he/she refinances, he/she will pay a prepayment penalty. Some subprime mortgages are balloon mortgages. This is where the borrower will have to pay the full remaining balance at the end of loan term (usually in 5 to 10 years).
In the year 2007, many homeowners with subprime mortgage were force to foreclose on their home because of rising interest rates, which leads to higher monthly payments. In fact, some mortgage companies went into bankruptcy because of all the foreclosures.
Sunday, November 11, 2007
Monday, September 10, 2007
ROP Term Insurance
As I thought the life insurance industry can't screw people up more than they already have with the cash value life insurance, a new type of term insurance called Return of Premium (ROP) Term Insurance been showing up these days.
ROP Term Insurance is nothing more than screwed up version of whole life insurance. While its less expensive than Whole Life insurance, its more expensive than term insurance. If you don't know this fact, whole life insurance builds cash value which you can borrow at anytime (don't that sound awesome to borrow your own money?). In ROP Term Insurance, it doesn't build cash value. Instead, the insurance company takes the extra money and invest it into their own accounts. You maybe able to borrow the money, but that will cost you more money. At the end of the term, they will return all premiums back to you and keep the gains for themselves.
Does that mean this type of life insurance is free? Absolutely not. Take a look at this example:
Lets say you are in perfect health and you are 30 year old. You purchase a 30 year term policy with $500,000 coverage. With a level term policy, it will cost you around $45/month. With ROP Term policy, it will cost you around $80/month. The insurance company will invest the difference of $35/month in their own account. At a 12% rate of return, they will accumulate about $124,000 in 30 years. The total amount you paid in for those 30 years is $16,200. How excited are you to get back the $16,200 you paid for while the insurance company made a profit of $107,800?
As you can see, insurance is never free. The cost of you buying a ROP term policy in that example is $107,800. You could of made $124,000 in your own investment account. How excited are you about getting a 0% return on your money?
What if you die during the term? If you died during the term, then you have overpaid your premiums. No one knows when they are going to die, which makes ROP term insurance more costly to the consumer. Most people think they will live well beyond the 20 year or 30 year term, but anything can happen. Are you willing to take that bet by paying more on ROP term insurance than a regular term insurance? I wouldn't. I would rather get more coverage and pay less money on a regular term insurance than to get ROP term insurance. At least I know I won't be overpaying my premiums if I die. I would also invest my own money somewhere else than to bundle them together with life insurance. If I live beyond the term, I would have a nice nest egg built up.
In closing, no matter what crazy idea that the life insurance industry may come up with, traditional level term policies are always the best type of life insurance for the consumer. Its inexpensive and it enables you to put your savings where ever you want such as CDs, money markets, mutual funds, IRAs, 401(k), etc.
SOME ADDITIONAL FACTS:
-The shorter the term on ROP term insurance, the more costly it is. A 20 year ROP term will cost 3 to 5 times more than 30 year ROP term because there is less time for the additional funds to grow (the additional funds is the difference between ROP term insurance and the regular term insurance).
-Insurers tend to promote policies of 30 years as financially most sensible. But that's a lengthy commitment many people may have trouble keeping. People are notorious for letting their coverage lapse because of changed family conditions, budget constraints, or the lure of a better rate at a different firm. Drop out early with a return-of-premium policy, and at best you'll get back only a portion of your premiums--perhaps 10 percent after 10 years on a 30-year policy, building to about 35 percent or so by year 20. In the unkindest cut, if you do die your heirs will get the policy's face value just as if you had bought the cheaper regular term.
ROP Term Insurance is nothing more than screwed up version of whole life insurance. While its less expensive than Whole Life insurance, its more expensive than term insurance. If you don't know this fact, whole life insurance builds cash value which you can borrow at anytime (don't that sound awesome to borrow your own money?). In ROP Term Insurance, it doesn't build cash value. Instead, the insurance company takes the extra money and invest it into their own accounts. You maybe able to borrow the money, but that will cost you more money. At the end of the term, they will return all premiums back to you and keep the gains for themselves.
Does that mean this type of life insurance is free? Absolutely not. Take a look at this example:
Lets say you are in perfect health and you are 30 year old. You purchase a 30 year term policy with $500,000 coverage. With a level term policy, it will cost you around $45/month. With ROP Term policy, it will cost you around $80/month. The insurance company will invest the difference of $35/month in their own account. At a 12% rate of return, they will accumulate about $124,000 in 30 years. The total amount you paid in for those 30 years is $16,200. How excited are you to get back the $16,200 you paid for while the insurance company made a profit of $107,800?
As you can see, insurance is never free. The cost of you buying a ROP term policy in that example is $107,800. You could of made $124,000 in your own investment account. How excited are you about getting a 0% return on your money?
What if you die during the term? If you died during the term, then you have overpaid your premiums. No one knows when they are going to die, which makes ROP term insurance more costly to the consumer. Most people think they will live well beyond the 20 year or 30 year term, but anything can happen. Are you willing to take that bet by paying more on ROP term insurance than a regular term insurance? I wouldn't. I would rather get more coverage and pay less money on a regular term insurance than to get ROP term insurance. At least I know I won't be overpaying my premiums if I die. I would also invest my own money somewhere else than to bundle them together with life insurance. If I live beyond the term, I would have a nice nest egg built up.
In closing, no matter what crazy idea that the life insurance industry may come up with, traditional level term policies are always the best type of life insurance for the consumer. Its inexpensive and it enables you to put your savings where ever you want such as CDs, money markets, mutual funds, IRAs, 401(k), etc.
SOME ADDITIONAL FACTS:
-The shorter the term on ROP term insurance, the more costly it is. A 20 year ROP term will cost 3 to 5 times more than 30 year ROP term because there is less time for the additional funds to grow (the additional funds is the difference between ROP term insurance and the regular term insurance).
-Insurers tend to promote policies of 30 years as financially most sensible. But that's a lengthy commitment many people may have trouble keeping. People are notorious for letting their coverage lapse because of changed family conditions, budget constraints, or the lure of a better rate at a different firm. Drop out early with a return-of-premium policy, and at best you'll get back only a portion of your premiums--perhaps 10 percent after 10 years on a 30-year policy, building to about 35 percent or so by year 20. In the unkindest cut, if you do die your heirs will get the policy's face value just as if you had bought the cheaper regular term.
Sunday, August 26, 2007
Life insurance medical exam
Depending on how much coverage you purchase, your life insurance company may required you to do a medical exam on you. They will check your weight, height, urine, and blood to figure out whether you qualify for life insurance or not. If you do qualify for life insurance, they will categorize you with the appropriate rate. For example, if your weight matches with your height and you are in perfect health, you are very likely to be rated as "preferred" or "preferred plus". If your weight doesn't match with your height or if you have high blood pressure, you will be rated as "non-tobacco user." If you smoke or had smoke in the past 12 months, you are automatically rated "tobacco user."
Usually, if you purchased $100,000 coverage or more, a medical exam is required. Some life insurance companies advertise that no medical exam is required. I would be very careful when you buy life insurance from companies that doesn't required a medical exam. First, their rates are usually higher than the industry's average. Second, they rarely pay out their death claims. Why? You have to be in perfect health when you die, which means you have to die naturally and not by any other factors such as cancer or heart attack or from an accident.
I don't know why some people have a big deal with the medical exam. Its standard procedure and all the information collected is kept strictly private. If you take illegal drugs and it shows up in the urine exam, the medical examiner is not going to call the police. The life insurance company will just deny coverage on you. So, there's no harm done. Also, they might find something about you that you don't know about such as cancer or HIV. So there's no reason to not get a medical exam. Best of all: this medical exam is free!
Usually, if you purchased $100,000 coverage or more, a medical exam is required. Some life insurance companies advertise that no medical exam is required. I would be very careful when you buy life insurance from companies that doesn't required a medical exam. First, their rates are usually higher than the industry's average. Second, they rarely pay out their death claims. Why? You have to be in perfect health when you die, which means you have to die naturally and not by any other factors such as cancer or heart attack or from an accident.
I don't know why some people have a big deal with the medical exam. Its standard procedure and all the information collected is kept strictly private. If you take illegal drugs and it shows up in the urine exam, the medical examiner is not going to call the police. The life insurance company will just deny coverage on you. So, there's no harm done. Also, they might find something about you that you don't know about such as cancer or HIV. So there's no reason to not get a medical exam. Best of all: this medical exam is free!
Thursday, July 12, 2007
Life insurance: What is a dividend?
When a life insurance agent says your life policy will pay dividends, you have to know that dividends are never guaranteed. There are three reasons why your life policy may pay dividends:
1) You have overpaid your premiums, so the insurance company refunds the excess premiums to you as a "dividend."
2) Many life insurance companies during the 1990s were fined by individual states for lying and deceiving consumers about cash value life insurance. Many companies were able to pay the fines and many were not able to. Some companies opted to sell stocks to its customers to recoup the loss. Of course, the company will have a sales charge and have high annual expenses. You will never get a good rate of return if you have investments in life insurance policy. It's just not physically possible.
3) Your life policy is a "participating policy." The dividends represent the favorable experience of the company and result from excess investment earnings, favorable mortality and expense savings.
In all cases, you must know that dividends are never guaranteed. Any agent that says otherwise would be subjected to fines set by the SEC.
1) You have overpaid your premiums, so the insurance company refunds the excess premiums to you as a "dividend."
2) Many life insurance companies during the 1990s were fined by individual states for lying and deceiving consumers about cash value life insurance. Many companies were able to pay the fines and many were not able to. Some companies opted to sell stocks to its customers to recoup the loss. Of course, the company will have a sales charge and have high annual expenses. You will never get a good rate of return if you have investments in life insurance policy. It's just not physically possible.
3) Your life policy is a "participating policy." The dividends represent the favorable experience of the company and result from excess investment earnings, favorable mortality and expense savings.
In all cases, you must know that dividends are never guaranteed. Any agent that says otherwise would be subjected to fines set by the SEC.
Thursday, June 28, 2007
Checking account & How to write a check
Similar to a savings account, its an account in which you can write checks. When you open a checking account, you will get a check book. Many banks charge a fee, others give the first check book for free. Instead of using cash to pay for things, you can now write a check. Its convenient and somewhat easy to use. I say somewhat easy because at the beginning, you may make mistakes when you write a check. You have to be more financially responsible with your checking account than your savings account. If you write a bad check (meaning there is insufficient funds in your checking), the bank will charge a fee and the check may either bounce back or the bank will cover it.
Here's one thing you should take from my experience: "ALWAYS BALANCE YOUR CHECKING ACCOUNT." If you put money in, record it and add it to the current balance. If you take money out or wrote a check, record it and make the deductions from the balance. If you get lazy and you don't do this, you are going to throw yourself off and you are going to wonder how much money you have in your checking account. I personally use Microsoft Money software to track my checking account (I also use it for other purposes such as tracking my investments and other money stuff).
HOW TO WRITE A CHECK
In the age of digital technology and internet, the art of writing a check may be lost. Most people pay their bills online than mailing their check and putting a stamp on the envelope. But there will be a time when you need to write a check out and so here, I will teach you how to write a check
Step 1) Very simple, write the date next to the "Date". You might want to use numbers instead of writing it out. You don't have much space to write the whole date out in letters and numbers.
Step 2) Find out who you are writing the check to and write the name on the line next to "Pay to the Order of"
Step 3) After that, write the correct amount in the box next to the "$"
Step 4) On the line under "Pay to the Order of", write out that amount from Step 3 in LETTERS. You can either print it or write in cursive. Most people tend to mess up here. If you are writing a check out for $1433.21, it should read "One Thousand Four Hundred Thirty Three and 21/100" MAKE SURE YOU WRITE THIS OUT CORRECTLY!!! Be careful where you put the word "and". ***If there's lots of space between your writing and the word "Dollars", draw a line in between them.***
Step 5) Sign (DON'T PRINT) your name on the line near the lower left hand corner.
Step 6) This is optional, but on the line next to your signature is the memo line. It may say "For" next to it. You don't have to put anything on there. Some companies ask you to write the account number or policy number on the memo line so that they can credit the right account. (There could be more than one person who has the same name as you).
Step 7) Note the check number, date, the payee and the amount on the check. You should record this in the check ledger, located near the front of the check book. Make the appropriate adjustments on the balance. In my example, if you had $5000 in the checking account and you wrote a $1433.21 check, the new balance would be $3566.79.
Step 8) When you get your monthly bank statement, you want to make sure everything is accurate. (even banks can make errors. Its rare, but it does happen).
Near the end of your check book are deposit tickets. If you want to deposit money into your checking account, you would use these ticket. I personally deposit money into my savings account and then go home and then transfer the money from my savings to my checking account online. You don't have to do it my way, I just find that way easier for me.
About those numbers on the bottom of your check:
1) The numbers on the bottom of your check includes your bank routing number, your checking account number, and the check number.
2) The first 9 digits is your bank routing number.
3) The next 9 digits is your checking account number.
4) The final 3 or 4 digits is your check number, which is also located on the top right hand corner of the check.
Here's one thing you should take from my experience: "ALWAYS BALANCE YOUR CHECKING ACCOUNT." If you put money in, record it and add it to the current balance. If you take money out or wrote a check, record it and make the deductions from the balance. If you get lazy and you don't do this, you are going to throw yourself off and you are going to wonder how much money you have in your checking account. I personally use Microsoft Money software to track my checking account (I also use it for other purposes such as tracking my investments and other money stuff).
HOW TO WRITE A CHECK
In the age of digital technology and internet, the art of writing a check may be lost. Most people pay their bills online than mailing their check and putting a stamp on the envelope. But there will be a time when you need to write a check out and so here, I will teach you how to write a check
Step 1) Very simple, write the date next to the "Date". You might want to use numbers instead of writing it out. You don't have much space to write the whole date out in letters and numbers.
Step 2) Find out who you are writing the check to and write the name on the line next to "Pay to the Order of"
Step 3) After that, write the correct amount in the box next to the "$"
Step 4) On the line under "Pay to the Order of", write out that amount from Step 3 in LETTERS. You can either print it or write in cursive. Most people tend to mess up here. If you are writing a check out for $1433.21, it should read "One Thousand Four Hundred Thirty Three and 21/100" MAKE SURE YOU WRITE THIS OUT CORRECTLY!!! Be careful where you put the word "and". ***If there's lots of space between your writing and the word "Dollars", draw a line in between them.***
Step 5) Sign (DON'T PRINT) your name on the line near the lower left hand corner.
Step 6) This is optional, but on the line next to your signature is the memo line. It may say "For" next to it. You don't have to put anything on there. Some companies ask you to write the account number or policy number on the memo line so that they can credit the right account. (There could be more than one person who has the same name as you).
Step 7) Note the check number, date, the payee and the amount on the check. You should record this in the check ledger, located near the front of the check book. Make the appropriate adjustments on the balance. In my example, if you had $5000 in the checking account and you wrote a $1433.21 check, the new balance would be $3566.79.
Step 8) When you get your monthly bank statement, you want to make sure everything is accurate. (even banks can make errors. Its rare, but it does happen).
Near the end of your check book are deposit tickets. If you want to deposit money into your checking account, you would use these ticket. I personally deposit money into my savings account and then go home and then transfer the money from my savings to my checking account online. You don't have to do it my way, I just find that way easier for me.
About those numbers on the bottom of your check:
1) The numbers on the bottom of your check includes your bank routing number, your checking account number, and the check number.
2) The first 9 digits is your bank routing number.
3) The next 9 digits is your checking account number.
4) The final 3 or 4 digits is your check number, which is also located on the top right hand corner of the check.
Wednesday, June 27, 2007
Savings account
I don't know why I'm posting this. But it seems that there are people who don't have one and probably don't understand what it is.
Simply put, a savings account is a place to save your money and you will earn monthly interest on it. You can open a savings account at any bank. In the United States, almost all the banks are FDIC insured. That means, if something were to happen to your account, your account is insured up to $100,000. So if you had $20,000 in the savings account and someone stole it, you are insured up to $20,000.
Keep in mind, interest rate on your savings account are subject to change. I remember I was getting 5% on my savings account in the 1980s. In the late 1990s to the time I write this, I now get less than 1% on my savings. Then I came across online savings such as EmigrantDirect, HSBC Direct, Citibank e-savings, and so on that gives 4.50% to 5.10% on their savings accounts. These too are also FDIC insured.
So how you open a savings account? Go to a bank and ask to open one up. They will tell you what you need to open one. I would pay special attention to their fees (if any), the minimum balance requirement, and the interest rate they offer.
What can you do with your savings account? You can deposit and withdraw money from it at anytime. Though, you won't be able to pay your bills with cash (and no legit company is going to accept cash as a method of payment). You need a checking account to pay your bills.
How much should you have in there? I wouldn't keep too much in there since they don't have a great return on them. They are good for short-term uses such as going on vacation or buying a home or for emergencies. Though, I would recommend using money market funds as your emergency fund. They tend to perform slightly better than what you get in your savings account.
If you are going to save for long term such as retirement, you need to invest. This is how people become wealthy when they retire. They invest early and stick with it for the long term. I suggest investing into mutual funds. Some say you should invest in no load funds. I say, it doesn't matter if the fund is a no-load or load fund. Both will get the job done.
Simply put, a savings account is a place to save your money and you will earn monthly interest on it. You can open a savings account at any bank. In the United States, almost all the banks are FDIC insured. That means, if something were to happen to your account, your account is insured up to $100,000. So if you had $20,000 in the savings account and someone stole it, you are insured up to $20,000.
Keep in mind, interest rate on your savings account are subject to change. I remember I was getting 5% on my savings account in the 1980s. In the late 1990s to the time I write this, I now get less than 1% on my savings. Then I came across online savings such as EmigrantDirect, HSBC Direct, Citibank e-savings, and so on that gives 4.50% to 5.10% on their savings accounts. These too are also FDIC insured.
So how you open a savings account? Go to a bank and ask to open one up. They will tell you what you need to open one. I would pay special attention to their fees (if any), the minimum balance requirement, and the interest rate they offer.
What can you do with your savings account? You can deposit and withdraw money from it at anytime. Though, you won't be able to pay your bills with cash (and no legit company is going to accept cash as a method of payment). You need a checking account to pay your bills.
How much should you have in there? I wouldn't keep too much in there since they don't have a great return on them. They are good for short-term uses such as going on vacation or buying a home or for emergencies. Though, I would recommend using money market funds as your emergency fund. They tend to perform slightly better than what you get in your savings account.
If you are going to save for long term such as retirement, you need to invest. This is how people become wealthy when they retire. They invest early and stick with it for the long term. I suggest investing into mutual funds. Some say you should invest in no load funds. I say, it doesn't matter if the fund is a no-load or load fund. Both will get the job done.
Saturday, June 02, 2007
Debt Payment: Simple interest vs Schedule Interest
What is the difference between simple interest versus schedule interest?
Schedule interest is where payments are credited to interest and principal on the due date, whether you pay it a little early or little late. Most lenders use schedule interest method. Your amortization schedule is already fixed since the first day you sign the loan contract.
Simple interest is where the interest portion of the payment depends on the actual number of days that have elapsed since the last payment. If you pay it early, more of your payment is applied toward the principal. If its late, more goes toward interest. If its on time, there is no difference between schedule interest and simple interest. However, if you were offered a bi-weekly payment (meaning your monthly payment is split in half and you pay this amount every 14 days), the savings on a simple interest method is huge!
Take a look at this example:
$100,000 loan with a 10% interest.
Monthly payment is $877.57
With schedule interest calculation (which is used in mortgages), this is how the loan work:
Month 1: $100k x 10% = $10,000 interest
$10k divided by 12 months = $833.33 is 1st month interest
$877.57 - $833.33 = $44.24 goes toward the principal
Month 2: $99,955.76 x 10% = $9,995.576
$9995.576 / 12 = $832.96 is 2nd month interest
$877.57 - $832.96 = $44.61 goes toward the principal
As you can see, it takes a very long time to build equity in your home.
With simple interest calculation (which is used in student loans) and you pay every 14 days, this is how the loan work:
Month 1 (day 1 - 14): $100k x 10% = $10,000 interest
$877.57 divided by 2 = $438.79 bi-weekly payment
$10k divided by 365 days = $27.40
$27.40 x 14 days = $383.60 (first 14 day interest)
$438.79 - $383.60 = $55.19 is applied toward principal
Month 1 (day 15-28): $99,944.81 x 10% = $9994.481
$9994.481 / 365 = $27.38
$27.38 x 14 = $383.32 (second 14 day interest)
$438.79 - $383.32 = $55.47 is applied toward principal
Month 1 summary: Your total payment from day 1-28 is $877.58. $766.92 is interest payment and $110.66 is applied toward principal.
Month 1 - 2 (day 29 - 42): $99889.34 x 10% = $9988.934
$9988.934 / 365 = $27.37
$27.37 x 14 = $383.18 (third 14 day interest)
$438.79 - $383.18 = $55.61 is applied toward principal
Month 2 (day 43-56): $99,833.73 x 10% = $9983.373
$9983.373 / 365 = $27.35
$27.35 x 14 = $382.90 (forth 14 day interest)
$438.79 - $382.90 = $55.89 is applied toward principal
Month 2 summary: $766.08 is interest payment and $111.50 is applied toward principal.
Eventually, the bi-weekly payment plan with simple interest will pay this 30 year loan off sooner by a few years than a traditional mortgage that uses schedule interest.
So far, I have found only one company that use simple interest in debt payments and that is Citicorp Trust Bank, who only deals with Primerica Financial Services' clients. If you are serious about paying your mortgage off faster, I recommend checking out Primerica. When it comes to repaying your debt, there are three questions you should ask yourself before considering to refinance or consolidate:
1) What is my total cost?
2) When will this debt be paid off?
3) What is my interest rate?
The financial industry knows that interest rates is what gets people attention and its a great way to attract new business. What most people forget is that interest rate really doesn't do anything for you. All interest rate does is set the fix payment for the life of the loan. Higher interest rate means higher monthly payment. Lower interest rate means lower monthly payment. Interest rate does not help you pay off the loan faster. Its the rate at which you pay, meaning how fast you pay, that determines your total cost and how soon you will be out of debt. If one bank offers a 6% interest on your mortgage and your current mortgage has 8%, you better ask yourself the first two questions before getting all excited. If you look at all the other people who fall into the interest rate advertisement, all it did is put these people back into longer debt and costing them more in total interest.
Schedule interest is where payments are credited to interest and principal on the due date, whether you pay it a little early or little late. Most lenders use schedule interest method. Your amortization schedule is already fixed since the first day you sign the loan contract.
Simple interest is where the interest portion of the payment depends on the actual number of days that have elapsed since the last payment. If you pay it early, more of your payment is applied toward the principal. If its late, more goes toward interest. If its on time, there is no difference between schedule interest and simple interest. However, if you were offered a bi-weekly payment (meaning your monthly payment is split in half and you pay this amount every 14 days), the savings on a simple interest method is huge!
Take a look at this example:
$100,000 loan with a 10% interest.
Monthly payment is $877.57
With schedule interest calculation (which is used in mortgages), this is how the loan work:
Month 1: $100k x 10% = $10,000 interest
$10k divided by 12 months = $833.33 is 1st month interest
$877.57 - $833.33 = $44.24 goes toward the principal
Month 2: $99,955.76 x 10% = $9,995.576
$9995.576 / 12 = $832.96 is 2nd month interest
$877.57 - $832.96 = $44.61 goes toward the principal
As you can see, it takes a very long time to build equity in your home.
With simple interest calculation (which is used in student loans) and you pay every 14 days, this is how the loan work:
Month 1 (day 1 - 14): $100k x 10% = $10,000 interest
$877.57 divided by 2 = $438.79 bi-weekly payment
$10k divided by 365 days = $27.40
$27.40 x 14 days = $383.60 (first 14 day interest)
$438.79 - $383.60 = $55.19 is applied toward principal
Month 1 (day 15-28): $99,944.81 x 10% = $9994.481
$9994.481 / 365 = $27.38
$27.38 x 14 = $383.32 (second 14 day interest)
$438.79 - $383.32 = $55.47 is applied toward principal
Month 1 summary: Your total payment from day 1-28 is $877.58. $766.92 is interest payment and $110.66 is applied toward principal.
Month 1 - 2 (day 29 - 42): $99889.34 x 10% = $9988.934
$9988.934 / 365 = $27.37
$27.37 x 14 = $383.18 (third 14 day interest)
$438.79 - $383.18 = $55.61 is applied toward principal
Month 2 (day 43-56): $99,833.73 x 10% = $9983.373
$9983.373 / 365 = $27.35
$27.35 x 14 = $382.90 (forth 14 day interest)
$438.79 - $382.90 = $55.89 is applied toward principal
Month 2 summary: $766.08 is interest payment and $111.50 is applied toward principal.
Eventually, the bi-weekly payment plan with simple interest will pay this 30 year loan off sooner by a few years than a traditional mortgage that uses schedule interest.
So far, I have found only one company that use simple interest in debt payments and that is Citicorp Trust Bank, who only deals with Primerica Financial Services' clients. If you are serious about paying your mortgage off faster, I recommend checking out Primerica. When it comes to repaying your debt, there are three questions you should ask yourself before considering to refinance or consolidate:
1) What is my total cost?
2) When will this debt be paid off?
3) What is my interest rate?
The financial industry knows that interest rates is what gets people attention and its a great way to attract new business. What most people forget is that interest rate really doesn't do anything for you. All interest rate does is set the fix payment for the life of the loan. Higher interest rate means higher monthly payment. Lower interest rate means lower monthly payment. Interest rate does not help you pay off the loan faster. Its the rate at which you pay, meaning how fast you pay, that determines your total cost and how soon you will be out of debt. If one bank offers a 6% interest on your mortgage and your current mortgage has 8%, you better ask yourself the first two questions before getting all excited. If you look at all the other people who fall into the interest rate advertisement, all it did is put these people back into longer debt and costing them more in total interest.
Saturday, April 28, 2007
Myths about cash value life insurance
Here are some of the things I hear when an agent is trying to sell whole life, universal life, or variable life insurance. If you want the real truth about your life insurance, read the policy. The facts may surprise you.
Myth 1: "In a few years, your life insurance will be paid up."
Fact: Unless you choose a payment option where it says in your life policy will be paid up on this certain time, your life insurance is never paid up. There is nothing free in this world. If your life insurance will be paid up in 10 or 20 years, that means you paying lots of premiums now to increase the growth of the cash value. That way in 10 to 20 years, there will be enough cash value to pay the standard premiums for the rest of your life without affecting the face amount of the policy. You want to be careful when someone is trying to sell you a limited pay life policy such as 20-pay whole life or Life Paid Up at age 60. They may say that you only need to pay for a limited time and it builds a large savings. Life insurance is to protect your family's income when you die, not as a way to build savings for your retirement.
In most cases, you are paying the premiums until age 98 or 100 because most people can't afford the limited pay option. If for some reason you can't pay your premiums in the future, the cash value will be used to pay it. The death benefit will be reduced each time you missed your premiums and each time you take a loan out of your policy.
To find out when your life insurance is paid up, check your policy. Usually on the first page it will state when its paid up. Don't believe what your insurance agent say since his/her primary goal is to make you buy it by making the life insurance look really good.
Myth 2: "Your life policy will pay dividends."
Fact: Dividends are not guaranteed. If the life insurance company pays you a dividend, that is because you have overpaid your premiums. So they refund the excess amount back to you as a dividend.
Myth 3: "Life insurance is a great way to build tax-deferred savings" or "It is a great investment."
Fact: Life insurance is the worst way to build tax-deferred savings because you may lose it all when you die. Unless it says in the policy your family will get both, the insurance company will keep all the cash value upon your death. In any case, whether your beneficiary gets cash value or not when you die, they are still the worst way to build tax-deferred savings. In the United States, there are various ways to build tax-deferred savings such as 401(k), 403(b), annuities, and all types of IRAs and all these plans can achieve a higher rate of return than investments in a life insurance policy.
Why is it good to keep investments or savings separate from life insurance? One advantage is that you don't pay surrender charges when you close your account. Second advantage is that you pay lower operating expenses. Mutual funds and life insurance have their own individual operating expenses. If you put them together, you are paying bunch of expenses that eats away the returns on your savings. Third advantage is that you own the money and have complete control on your savings. In life insurance, if you want to take money out, you have to borrow it and you have no control on where you want to save your money.
Myth 4: "You can use the cash value to pay for your kid's education."
Fact: You have to take a loan out of the cash value to pay for anything you want. By borrowing the cash value, you will lower the death benefit and the cash value until you pay it back. If there is a loan interest, this too will lower the death benefit and the cash value. In many retirement plans, especially IRAs, you can use the money to pay for higher education and never have to pay it back.
If you surrender the policy and didn't pay the loan back, the IRS will recognize that you have earned income and you will pay income taxes on the loan. If you paid the loan off or did not take any loans out of the cash value, you will not owe any income taxes. Unless the amount of cash value in the policy is greater than the total premiums you paid in, then you will pay income taxes on the gains. For example, if you paid a total of $50,000 in premiums and the cash value (after surrender charges) is $60,000, you will owe income tax on the $10,000.
Myth 5: "You own the cash value."
Fact: If you truly own it, then why the policy says that you can borrow it versus withdrawing it anytime? Why are there surrender charges? Why can't you only pay for the insurance and not the cash value? If you had a savings account, is there surrender fees? Do you have to put the money back when you take it out?
So the cash value doesn't belong to you. It belongs to the insurance company until you surrender the policy. Its like you giving $10,000 to the insurance company, they hold on to it and give you 4% interest on it. If you ever want to use it, you can borrow it and pay them a 8% loan interest on it. Oh, if you want to cancel the policy, they will charge you couple thousand dollars on the cash value for leaving them.
Myth 1: "In a few years, your life insurance will be paid up."
Fact: Unless you choose a payment option where it says in your life policy will be paid up on this certain time, your life insurance is never paid up. There is nothing free in this world. If your life insurance will be paid up in 10 or 20 years, that means you paying lots of premiums now to increase the growth of the cash value. That way in 10 to 20 years, there will be enough cash value to pay the standard premiums for the rest of your life without affecting the face amount of the policy. You want to be careful when someone is trying to sell you a limited pay life policy such as 20-pay whole life or Life Paid Up at age 60. They may say that you only need to pay for a limited time and it builds a large savings. Life insurance is to protect your family's income when you die, not as a way to build savings for your retirement.
In most cases, you are paying the premiums until age 98 or 100 because most people can't afford the limited pay option. If for some reason you can't pay your premiums in the future, the cash value will be used to pay it. The death benefit will be reduced each time you missed your premiums and each time you take a loan out of your policy.
To find out when your life insurance is paid up, check your policy. Usually on the first page it will state when its paid up. Don't believe what your insurance agent say since his/her primary goal is to make you buy it by making the life insurance look really good.
Myth 2: "Your life policy will pay dividends."
Fact: Dividends are not guaranteed. If the life insurance company pays you a dividend, that is because you have overpaid your premiums. So they refund the excess amount back to you as a dividend.
Myth 3: "Life insurance is a great way to build tax-deferred savings" or "It is a great investment."
Fact: Life insurance is the worst way to build tax-deferred savings because you may lose it all when you die. Unless it says in the policy your family will get both, the insurance company will keep all the cash value upon your death. In any case, whether your beneficiary gets cash value or not when you die, they are still the worst way to build tax-deferred savings. In the United States, there are various ways to build tax-deferred savings such as 401(k), 403(b), annuities, and all types of IRAs and all these plans can achieve a higher rate of return than investments in a life insurance policy.
Why is it good to keep investments or savings separate from life insurance? One advantage is that you don't pay surrender charges when you close your account. Second advantage is that you pay lower operating expenses. Mutual funds and life insurance have their own individual operating expenses. If you put them together, you are paying bunch of expenses that eats away the returns on your savings. Third advantage is that you own the money and have complete control on your savings. In life insurance, if you want to take money out, you have to borrow it and you have no control on where you want to save your money.
Myth 4: "You can use the cash value to pay for your kid's education."
Fact: You have to take a loan out of the cash value to pay for anything you want. By borrowing the cash value, you will lower the death benefit and the cash value until you pay it back. If there is a loan interest, this too will lower the death benefit and the cash value. In many retirement plans, especially IRAs, you can use the money to pay for higher education and never have to pay it back.
If you surrender the policy and didn't pay the loan back, the IRS will recognize that you have earned income and you will pay income taxes on the loan. If you paid the loan off or did not take any loans out of the cash value, you will not owe any income taxes. Unless the amount of cash value in the policy is greater than the total premiums you paid in, then you will pay income taxes on the gains. For example, if you paid a total of $50,000 in premiums and the cash value (after surrender charges) is $60,000, you will owe income tax on the $10,000.
Myth 5: "You own the cash value."
Fact: If you truly own it, then why the policy says that you can borrow it versus withdrawing it anytime? Why are there surrender charges? Why can't you only pay for the insurance and not the cash value? If you had a savings account, is there surrender fees? Do you have to put the money back when you take it out?
So the cash value doesn't belong to you. It belongs to the insurance company until you surrender the policy. Its like you giving $10,000 to the insurance company, they hold on to it and give you 4% interest on it. If you ever want to use it, you can borrow it and pay them a 8% loan interest on it. Oh, if you want to cancel the policy, they will charge you couple thousand dollars on the cash value for leaving them.
Friday, April 13, 2007
Money markets
Before I go on, there is two types of money markets you should know. One is called money markets accounts and the other is called money market fund.
What is a money market account? A money market account is a type of savings account offered by banks and credit unions. Usually, money markets have higher interest than regular savings accounts and may also have higher minimum balance requirement. Money market accounts only allow 3-6 withdrawals per month and only up to 3 check writings. All money market accounts are FDIC insured, meaning if anything shall happen to your bank, the government will insure your account up to $100,000.
Like many other bank accounts, your bank may charge you fees such as minimum balance requirement and excess withdrawals fee. There may also be a service charge. You should look around to find a bank that has the lowest fees and the best interest rate.
What is a money market fund? Money market funds are mutual funds that invest in short-term securities such as US Treasury Bills, short-term commercial papers, and CD's. They are offered by financial institutions and investment companies, and some banks. Anytime you see the word "invest" or "investment," you should know that there is no guarantee that your investments will earn money. But money market funds are very low risk mutual funds. The money manager will try to keep the price per share at $1/share. Even though its very rare that you may lose money in money market funds, you should know that the price per share may fall below $1/share. Because they are safe investments, money market funds may not be able to keep up with inflation.
The plus side of having a money market fund is that it pays you dividends almost every month. Dividends are earnings that a mutual fund makes and the mutual fund shares this earning to its shareholders in a form of a dividend. Your money market fund may also earn a higher return than a money market account because money market funds has risks (higher risks = higher rewards), while money market accounts has no risks. Money market funds are not FDIC insured because they are investments.
Similar to money market accounts, money market funds are easily liquidable, meaning you can withdraw money from it and you will get the proceeds in a few days (at most 7 days). Before investing into money market funds, you should obtain the fund's prospectus to find out its fees and expenses. A fund with high annual expenses are never good because it takes away your annual returns.
To sum this up, here is the difference between a money market account (MMA) and a money market fund (MMF):
1) MMA are FDIC insured, while MMF are not.
2) MMA may have bank fees, while MMF have annual operating expenses.
3) MMA pay monthly interest, but MMF may pay monthly dividends.
4) MMA are fixed rate accounts, but can be changed at anytime by the bank. MMF are variable rate accounts because they are base on how the market is doing.
Which one should you pick? Its really up to you, if you want guarantees and want no risks, then pick money market accounts. If you want higher returns and willing to accept some risks, then choose a money market fund.
What is a money market account? A money market account is a type of savings account offered by banks and credit unions. Usually, money markets have higher interest than regular savings accounts and may also have higher minimum balance requirement. Money market accounts only allow 3-6 withdrawals per month and only up to 3 check writings. All money market accounts are FDIC insured, meaning if anything shall happen to your bank, the government will insure your account up to $100,000.
Like many other bank accounts, your bank may charge you fees such as minimum balance requirement and excess withdrawals fee. There may also be a service charge. You should look around to find a bank that has the lowest fees and the best interest rate.
What is a money market fund? Money market funds are mutual funds that invest in short-term securities such as US Treasury Bills, short-term commercial papers, and CD's. They are offered by financial institutions and investment companies, and some banks. Anytime you see the word "invest" or "investment," you should know that there is no guarantee that your investments will earn money. But money market funds are very low risk mutual funds. The money manager will try to keep the price per share at $1/share. Even though its very rare that you may lose money in money market funds, you should know that the price per share may fall below $1/share. Because they are safe investments, money market funds may not be able to keep up with inflation.
The plus side of having a money market fund is that it pays you dividends almost every month. Dividends are earnings that a mutual fund makes and the mutual fund shares this earning to its shareholders in a form of a dividend. Your money market fund may also earn a higher return than a money market account because money market funds has risks (higher risks = higher rewards), while money market accounts has no risks. Money market funds are not FDIC insured because they are investments.
Similar to money market accounts, money market funds are easily liquidable, meaning you can withdraw money from it and you will get the proceeds in a few days (at most 7 days). Before investing into money market funds, you should obtain the fund's prospectus to find out its fees and expenses. A fund with high annual expenses are never good because it takes away your annual returns.
To sum this up, here is the difference between a money market account (MMA) and a money market fund (MMF):
1) MMA are FDIC insured, while MMF are not.
2) MMA may have bank fees, while MMF have annual operating expenses.
3) MMA pay monthly interest, but MMF may pay monthly dividends.
4) MMA are fixed rate accounts, but can be changed at anytime by the bank. MMF are variable rate accounts because they are base on how the market is doing.
Which one should you pick? Its really up to you, if you want guarantees and want no risks, then pick money market accounts. If you want higher returns and willing to accept some risks, then choose a money market fund.
Sunday, April 01, 2007
Theory of Decreasing Responsibility
This theory further reinforces my point that term insurance and investing the difference makes more sense than having any type of cash value life policy.
IN THE BEGINNING YEARS...
IN THE LATER YEARS...
When you are young, you may have young children to support, a new mortgage payment, and many other obligations. But you haven't had the time to accumulate much money to retire on. This is the time when the death of the breadwinner could be devastating and when you need coverage the most.
When you are older, you usually have fewer dependents and fewer financial responsibilities. Your kids grow up, the mortgage is paid up or almost paid off, and many routine payments such as loans have disappeared. As a retiree, you no longer need to protect your income for future obligations. Plus, you've had years to accumulate wealth through savings and investments. At this point, your need for life insurance has reduced dramatically and you have cash to see you through your retirement years.
What it all comes down to is that most people want to accumulate money for a secure retirement and life insurance is simply a way to protect your family until then. Of course, individual circumstances may dictate special needs.
IN THE BEGINNING YEARS...
- You may have kids
- Have a mortgage to pay off
- You probably have lots of debt (credit cards, student loans, car loans, etc)
IN THE LATER YEARS...
- Your kids grow up and probably move out of the house
- Your mortgage should be paid off
- You shouldn't have too much debt to pay (hopefully all your loans are paid off and you have taken control of your credit card spending)
When you are young, you may have young children to support, a new mortgage payment, and many other obligations. But you haven't had the time to accumulate much money to retire on. This is the time when the death of the breadwinner could be devastating and when you need coverage the most.
When you are older, you usually have fewer dependents and fewer financial responsibilities. Your kids grow up, the mortgage is paid up or almost paid off, and many routine payments such as loans have disappeared. As a retiree, you no longer need to protect your income for future obligations. Plus, you've had years to accumulate wealth through savings and investments. At this point, your need for life insurance has reduced dramatically and you have cash to see you through your retirement years.
What it all comes down to is that most people want to accumulate money for a secure retirement and life insurance is simply a way to protect your family until then. Of course, individual circumstances may dictate special needs.
Thursday, March 15, 2007
Rule of 72
Why is that we go through high school and even college, that teachers and professors don't talk about the Rule of 72? And when they do to teach it, they briefly go over it and say "its not important on the exam." That's great there's one less question on the exam because calculating it is so simple. But in real life, this can have a big impact on your view on savings accounts, CDs, and investments.
What is the Rule of 72? Rule of 72 is a mathematical formula that tells you how long it will take for your money to double given the interest rate. This formula was discovered by Albert Einstein, who is one of the most brilliant physicists genius in the entire history of civilization. Let's say the average yield or interest rate on a savings account is 3%. 72 divided by 3 = 24. If you put in $1000 now in the bank and never touch it again, it will take 24 years for your $1000 to become $2000. Stinky isn't it?
What if you put it into CDs? CD's have an average yield of 6%. 72 divided by 6 = 12. It will take 12 years for your $1000 to become $2000. A little bit better, but still a little slow.
What if you put into mutual funds and it historically earn a 12% rate of return in the past 25 years? 72 divided by 12 = 6. It will take 6 years for your $1000 to become $2000. How great is that?
Now you seen the various ways you can save your money, which one makes more sense to you? What interest rate or average rate return are you earning on your money? How many doubling periods do you have left until you retire?
"Compound interest is the most powerful force in the universe" -Albert Einstein
If you don't believe that, then take a look at this:
Let's say you open a Roth IRA and you invest $200/month into it. Lets say your IRA portfolio earns an average rate of 10%. If you begin investing at age 25 and you retire at age 60, you will have: $765,655. Let's say you retire at age 60 and you withdraw $4000/month from your IRA. By age 65, if your portfolio continues to earn 10%, you will have: $947,410. If you continue to invest $200/month instead of withdrawing $4000/month, you would of have: $1,275,355 at age 65.
Anyway, lets say you starting withdrawing $4000/month at age 60. If your IRA continues to earn an average rate of 10%, at age 75, you will have: $1.7 million! Even though you stop contributing at age 60 and started withdrawing $4000/month, your investments continue to grow.
What is the Rule of 72? Rule of 72 is a mathematical formula that tells you how long it will take for your money to double given the interest rate. This formula was discovered by Albert Einstein, who is one of the most brilliant physicists genius in the entire history of civilization. Let's say the average yield or interest rate on a savings account is 3%. 72 divided by 3 = 24. If you put in $1000 now in the bank and never touch it again, it will take 24 years for your $1000 to become $2000. Stinky isn't it?
What if you put it into CDs? CD's have an average yield of 6%. 72 divided by 6 = 12. It will take 12 years for your $1000 to become $2000. A little bit better, but still a little slow.
What if you put into mutual funds and it historically earn a 12% rate of return in the past 25 years? 72 divided by 12 = 6. It will take 6 years for your $1000 to become $2000. How great is that?
Now you seen the various ways you can save your money, which one makes more sense to you? What interest rate or average rate return are you earning on your money? How many doubling periods do you have left until you retire?
"Compound interest is the most powerful force in the universe" -Albert Einstein
If you don't believe that, then take a look at this:
Let's say you open a Roth IRA and you invest $200/month into it. Lets say your IRA portfolio earns an average rate of 10%. If you begin investing at age 25 and you retire at age 60, you will have: $765,655. Let's say you retire at age 60 and you withdraw $4000/month from your IRA. By age 65, if your portfolio continues to earn 10%, you will have: $947,410. If you continue to invest $200/month instead of withdrawing $4000/month, you would of have: $1,275,355 at age 65.
Anyway, lets say you starting withdrawing $4000/month at age 60. If your IRA continues to earn an average rate of 10%, at age 75, you will have: $1.7 million! Even though you stop contributing at age 60 and started withdrawing $4000/month, your investments continue to grow.
Wednesday, March 14, 2007
Objections to Term Insurance
Here are some of the things that many agents, financial planners, financial advisors or whoever is certified or licensed to talk about finance will say about term insurance. I'm not saying all are bad, just most of them are.
1) "The problem with term insurance, is that premiums will go up." That is true, but every insurance, not just in life, has rising costs. For example, doesn't your car insurance premiums rise over time? Doesn't your homeowner insurance premium go up? In cash value life policies, while the premiums remain level for life, the cash value is used to pay the rising cost. With term insurance, your premiums are low and level for certain period, which enables you to save your money elsewhere. When level term expires, most term policies are renewable without the need to provide proof of insurability. By buying term and keeping investments separate, you can change one without one affecting the other. For example, if you lower your coverage, would that slow down the growth in your investments? In cash value policies, when you lower your coverage, you slow down the growth in your cash value because less premiums are going toward it. If you stop investing, would your life insurance be affected? In cash value life insurance, you don't have the option to stop putting money into the cash value becaue your life insurance and savings are bundle together in one premium payment. If you cancel your life policy, do you pay surrender charges on the savings? In cash value life insurance you do, but in term insurance, your investments are not affected. Instead, you have more money to invest.
2) In response to above paragraph, someone said "But the premiums remain level in whole life and it never goes up." But the cost of having it does. As you get older, less and less of your premiums are going to the cash value and more toward the insurance payment. Premiums remain level, but not the cost.
3) "Life insurance companies loves to sell term insurance..." If that was true, then why only less than 2% of American families have it and 38% own some sort of cash value life insurance? The other 60% don't even have life insurance.
4) "... because less than 2% of term insurance are ever paid out." This is a myth and there is no data on this comment. The real truth is that less than 2% of Americans own term insurance. Anyway, do you know when a person going to die? How would this person know that term insurance rarely pays out? Maybe he/she think that term insurance rarely pays out because he/she never sold a term policy or maybe because he/she keep converting all the term policies to whole life insurance. Would you rather die with $100,000 whole life policy or a term policy of $500,000 coverage?
5) "Investing the difference is a scam." If investing was a scam, then what's the point of having a stock market? What's the point of having companies selling stocks? Why do bonds even exist?
6) "Insurance companies makes lots of profits by selling term insurance." Hmm, you either pay $1000/year for term insurance or pay $2000/year for whole life. How does that compute that life insurance companies makes lots of profits by selling term insurance? Why is that average face amount of whole life policies is only $100,000 and that term insurance is $275,000? The real truth is that life insurance companies makes lots of profits by selling cash value life insurance. You pay lots of premiums for low amount of coverage. Do you know that if you want to use your cash value, that you have to borrow it and pay 6-8% interest on it? Do you know that if you die someday, that the insurance company keeps your cash value? So which product is the life insurance company really making more money off of?
7) "If you invest the difference, you pay taxes on them. With my life insurance, you don't pay taxes on the savings." Of course you don't pay taxes on them because you are paying at a loss. Do you pay taxes on a loss? What is the loss? Its the difference between total premiums you pay in and the net cash surrender value. If there is a gain, then you will pay taxes on them when you withdraw the money. I guess this guy or girl doesn't know about IRA accounts or variable annuities either. If they did, they would of suggested of investing your money into these tax-deferred accounts instead of putting it in a life policy. I always try to open Roth IRA for every client I sit down with. Currently, not everyone can get a Roth IRA, so I open a Traditional IRA instead.
8) "Buying term is like renting an apartment. With whole life, you build equity just like as you pay your mortgage." Apples and oranges... this person is comparing an insurance product to a house. The truth is that the equity in your home is count as part of your asset. Life insurance does not count as part of your asset. If you die, all the "equity" in your life insurance is kept by the insurance company. The equity in your home will still be there because someone in your family will get ownership of the home, which is mostly likely to be your spouse and then your kids.
9) "Permanent life policies pays out dividends." Of course it does because you are over paying your premiums. For example, lets say you pay $1800/year in premiums, when it really cost only $1600 for that year. So they pay you a dividend of $200. You may take it in cash or re-invest into the cash value. I would take it in cash and put into a Roth IRA. Of course, I wouldn't own cash value life policies in the first place.
10) "Nobody invests the difference." If you are not securities license, of course you are not helping anyone invest the difference. I am and therefore I can help people invest the difference. All my clients invest the difference using dollar cost averaging and they are still doing it today. So don't say "nobody" because its really agents who can't help clients invest the difference because they don't have the proper license to do so and/or their company doesn't offer investments.
11) "What if you outlive the term? Then all your money spent on it was a waste." What if you don't? Do you know when you going to die? Would you rather leave behind a $100,000 cash value life policy or a $500,000 term policy? If you outlive the term, you didn't waste your money. In fact, its money well spent because the premiums were low and you had more flexibility to save your money elsewhere instead in a life insurance policy. Its like you buying car insurance and you never get into an accident. Is that a waste of money? No because you were protecting yourself in case something does happen.
12) "Buy term and invest the difference doesn't fit for everybody needs." Let me ask you this, who in the right mind would want to keep life insurance and savings together and then find out you can only get one back? Who would want to spend more on insurance coverage with a whole life or universal life versus spending less and maxing out the coverage needed with term insurance? Who would want to invest their money in a life insurance policy that has expense ratios above 3% versus getting 1% if they keep the investments outside of a life policy? Term insurance fits for everybody needs because people can buy the right amount of coverage for the lowest possible cost.
13) "Most people are not discipline enough to invest their money." That maybe true, but I teach my clients on why they should invest on a monthly basis. I teach them to pay them self first because the most important asset in their life is themselves. So I setup a systematic investment plan for them. They can invest as little as $25/month into their mutual fund. Most people don't add themselves as another bill and they really should. If you don't pay yourself first before paying others, the chance of you becoming financially independent or even wealthy will be very slim (unless you win the lottery or inherit large amount of money).
As you can see, if someone is trying to sell you that whole life, universal life, or variable life insurance as the "right" plan for you, its really the right plan for them because they earn lots of money by selling these products. They don't care about your finances. Why would they sell you a cash value life policy and you can only afford a small amount of coverage? Why would they recommend investing or saving money in a life policy rather in an IRA account or your 401k plan? Why is it good to bundle life insurance and savings together and that it only pays out one benefit?
I believe greed affects many people judgments and therefore, they make bad decisions. If people step back and think about what they are saying, does any of it make logical sense? They should put themselves in the client's shoes and ask, "What would I do if I were in his/her position?"
1) "The problem with term insurance, is that premiums will go up." That is true, but every insurance, not just in life, has rising costs. For example, doesn't your car insurance premiums rise over time? Doesn't your homeowner insurance premium go up? In cash value life policies, while the premiums remain level for life, the cash value is used to pay the rising cost. With term insurance, your premiums are low and level for certain period, which enables you to save your money elsewhere. When level term expires, most term policies are renewable without the need to provide proof of insurability. By buying term and keeping investments separate, you can change one without one affecting the other. For example, if you lower your coverage, would that slow down the growth in your investments? In cash value policies, when you lower your coverage, you slow down the growth in your cash value because less premiums are going toward it. If you stop investing, would your life insurance be affected? In cash value life insurance, you don't have the option to stop putting money into the cash value becaue your life insurance and savings are bundle together in one premium payment. If you cancel your life policy, do you pay surrender charges on the savings? In cash value life insurance you do, but in term insurance, your investments are not affected. Instead, you have more money to invest.
2) In response to above paragraph, someone said "But the premiums remain level in whole life and it never goes up." But the cost of having it does. As you get older, less and less of your premiums are going to the cash value and more toward the insurance payment. Premiums remain level, but not the cost.
3) "Life insurance companies loves to sell term insurance..." If that was true, then why only less than 2% of American families have it and 38% own some sort of cash value life insurance? The other 60% don't even have life insurance.
4) "... because less than 2% of term insurance are ever paid out." This is a myth and there is no data on this comment. The real truth is that less than 2% of Americans own term insurance. Anyway, do you know when a person going to die? How would this person know that term insurance rarely pays out? Maybe he/she think that term insurance rarely pays out because he/she never sold a term policy or maybe because he/she keep converting all the term policies to whole life insurance. Would you rather die with $100,000 whole life policy or a term policy of $500,000 coverage?
5) "Investing the difference is a scam." If investing was a scam, then what's the point of having a stock market? What's the point of having companies selling stocks? Why do bonds even exist?
6) "Insurance companies makes lots of profits by selling term insurance." Hmm, you either pay $1000/year for term insurance or pay $2000/year for whole life. How does that compute that life insurance companies makes lots of profits by selling term insurance? Why is that average face amount of whole life policies is only $100,000 and that term insurance is $275,000? The real truth is that life insurance companies makes lots of profits by selling cash value life insurance. You pay lots of premiums for low amount of coverage. Do you know that if you want to use your cash value, that you have to borrow it and pay 6-8% interest on it? Do you know that if you die someday, that the insurance company keeps your cash value? So which product is the life insurance company really making more money off of?
7) "If you invest the difference, you pay taxes on them. With my life insurance, you don't pay taxes on the savings." Of course you don't pay taxes on them because you are paying at a loss. Do you pay taxes on a loss? What is the loss? Its the difference between total premiums you pay in and the net cash surrender value. If there is a gain, then you will pay taxes on them when you withdraw the money. I guess this guy or girl doesn't know about IRA accounts or variable annuities either. If they did, they would of suggested of investing your money into these tax-deferred accounts instead of putting it in a life policy. I always try to open Roth IRA for every client I sit down with. Currently, not everyone can get a Roth IRA, so I open a Traditional IRA instead.
8) "Buying term is like renting an apartment. With whole life, you build equity just like as you pay your mortgage." Apples and oranges... this person is comparing an insurance product to a house. The truth is that the equity in your home is count as part of your asset. Life insurance does not count as part of your asset. If you die, all the "equity" in your life insurance is kept by the insurance company. The equity in your home will still be there because someone in your family will get ownership of the home, which is mostly likely to be your spouse and then your kids.
9) "Permanent life policies pays out dividends." Of course it does because you are over paying your premiums. For example, lets say you pay $1800/year in premiums, when it really cost only $1600 for that year. So they pay you a dividend of $200. You may take it in cash or re-invest into the cash value. I would take it in cash and put into a Roth IRA. Of course, I wouldn't own cash value life policies in the first place.
10) "Nobody invests the difference." If you are not securities license, of course you are not helping anyone invest the difference. I am and therefore I can help people invest the difference. All my clients invest the difference using dollar cost averaging and they are still doing it today. So don't say "nobody" because its really agents who can't help clients invest the difference because they don't have the proper license to do so and/or their company doesn't offer investments.
11) "What if you outlive the term? Then all your money spent on it was a waste." What if you don't? Do you know when you going to die? Would you rather leave behind a $100,000 cash value life policy or a $500,000 term policy? If you outlive the term, you didn't waste your money. In fact, its money well spent because the premiums were low and you had more flexibility to save your money elsewhere instead in a life insurance policy. Its like you buying car insurance and you never get into an accident. Is that a waste of money? No because you were protecting yourself in case something does happen.
12) "Buy term and invest the difference doesn't fit for everybody needs." Let me ask you this, who in the right mind would want to keep life insurance and savings together and then find out you can only get one back? Who would want to spend more on insurance coverage with a whole life or universal life versus spending less and maxing out the coverage needed with term insurance? Who would want to invest their money in a life insurance policy that has expense ratios above 3% versus getting 1% if they keep the investments outside of a life policy? Term insurance fits for everybody needs because people can buy the right amount of coverage for the lowest possible cost.
13) "Most people are not discipline enough to invest their money." That maybe true, but I teach my clients on why they should invest on a monthly basis. I teach them to pay them self first because the most important asset in their life is themselves. So I setup a systematic investment plan for them. They can invest as little as $25/month into their mutual fund. Most people don't add themselves as another bill and they really should. If you don't pay yourself first before paying others, the chance of you becoming financially independent or even wealthy will be very slim (unless you win the lottery or inherit large amount of money).
As you can see, if someone is trying to sell you that whole life, universal life, or variable life insurance as the "right" plan for you, its really the right plan for them because they earn lots of money by selling these products. They don't care about your finances. Why would they sell you a cash value life policy and you can only afford a small amount of coverage? Why would they recommend investing or saving money in a life policy rather in an IRA account or your 401k plan? Why is it good to bundle life insurance and savings together and that it only pays out one benefit?
I believe greed affects many people judgments and therefore, they make bad decisions. If people step back and think about what they are saying, does any of it make logical sense? They should put themselves in the client's shoes and ask, "What would I do if I were in his/her position?"
Tuesday, March 13, 2007
What your financial plan should have.
I believe everyone should have a financial game plan, but many don't have a clue on where to start. Hopefully this blog will help understand what your financial plan should include. I'm not sure how to draw a house in Google Blogger, so you have to follow these instructions to draw it.
1) Grab a blank piece of paper
2) Draw a large simple house (a vertical rectangle box with a triangle on top of it)
3) Now draw 3 horizontal lines, evenly spaced, in the rectangle box. Each of these boxes represent a floor of your financial house.
4) On floor one (which is the bottom floor), write, "DEBT"
5) On floor two, write, "Emergency Fund"
6) On floor three, write, "Retirement"
7) On floor four, write, "Education"
8) In the roof, write, "Will"
Now I'm going to explain why you should have each part included in your financial plan. The first step is to eliminate debt, which is floor one. Having debt will make you worry every day on when you going to pay it off. If you don't find a way to eliminate debt, you will be in debt for a very long time. I have found that Primerica Financial Services is one of the better companies that is good at tackling personal debt without any extra cost to the client.
Second step is having an emergency fund. An emergency fund is an easily liquidable asset that in case of an emergency, you can take money out. You should put in between 3-6 months of your income into an emergency fund. For example, if you were fired at work, where would you go to pay off your bills and be able to survive without income? Or if you become hospitalize and you can't work for awhile, where would you go to draw income from?
Third step is retirement. This should be the primary step that everybody should focus on. I believe there is no such thing as "saving too much money." But if you don't have anything or not much saved for retirement, you are going to be in deep trouble. Social security don't pay out much, pension plans are going extinct, and the government is going to make it very difficult for you to get help (because the government is in debt too). Where are you going to go to get money? From you kids or grandkids? They are more likely to have problems of their own. Do you want to put this huge burden on their shoulders as well? There's various retirement plans out there for all kinds of people from IRAs to Variable Annuities.
Forth step is setting up an education fund for your kids (if you have any). Before funding your kid's education, you should make sure that your own retirement plan is in order. Your kids will grow up and find ways to save money. Hopefully you will teach them the importance of saving. Anyway, there are several ways to fund for your kid's education. They are 529 plans, Coverdell, UGMA, US Government Bonds, and Certificates of Deposits.
Fifth step is having a Will. If you die tomorrow, who should get your assets? Who should take ownership of your home? If you don't have name a beneficiary, everything that doesn't have a name beneficiary will be held by the state and the state will decide on who should get what. This usually leads to family wars and your family will pay taxes on your estate. So you want to take care of this as soon as possible.
But if you look at your financial house, do you notice anything that is missing? What are all buildings built on top of? A foundation! Step 9: Draw a horizontal rectangle below floor one. Write: "Income Protection" in the foundation.
Without a foundation, your house will begin to sink or fall apart. In life, without having income protection (also known as life insurance), you are putting a high risk on your family that you are going to live for a very long time and that nothing is going to happen to you. But what if you do die unexpectedly, how would your family survive? Without life insurance, your spouse will first use the emergency fund. Soon that will disappear. Then your spouse will go either into the kid's college fund or the retirement plan. Eventually those will disappear until your spouse finds a new partner or your kids go to work to keep the family in the house. If not, the family will have to move in a cheaper home or rent an apartment. If you and/or your spouse don't have life insurance right now, then the entire financial house is resting on you and/or your spouse shoulders because both of you are providing income to the family (unless your spouse doesn't work, or you are not married, then the whole burden lies on you).
With life insurance, you are managing your risks. There are many types of life insurance out there and the ones that are commonly sold are whole life or universal life. I can give you many reasons why they are sold more, but I pretty much revealed the whole truth about cash value life insurance in this blog. With cash value life insurance, you can only buy what you can afford. That's why many families are under-insured. With term insurance, you can buy the right amount of coverage because premiums are low.
In every financial house (your financial plan), you should have life insurance to protect it. You should have a game plan to eliminate debt, open an emergency fund, save for retirement, save for kid's education, and complete a Will. This is what I do for every family I sit down with.
1) Grab a blank piece of paper
2) Draw a large simple house (a vertical rectangle box with a triangle on top of it)
3) Now draw 3 horizontal lines, evenly spaced, in the rectangle box. Each of these boxes represent a floor of your financial house.
4) On floor one (which is the bottom floor), write, "DEBT"
5) On floor two, write, "Emergency Fund"
6) On floor three, write, "Retirement"
7) On floor four, write, "Education"
8) In the roof, write, "Will"
Now I'm going to explain why you should have each part included in your financial plan. The first step is to eliminate debt, which is floor one. Having debt will make you worry every day on when you going to pay it off. If you don't find a way to eliminate debt, you will be in debt for a very long time. I have found that Primerica Financial Services is one of the better companies that is good at tackling personal debt without any extra cost to the client.
Second step is having an emergency fund. An emergency fund is an easily liquidable asset that in case of an emergency, you can take money out. You should put in between 3-6 months of your income into an emergency fund. For example, if you were fired at work, where would you go to pay off your bills and be able to survive without income? Or if you become hospitalize and you can't work for awhile, where would you go to draw income from?
Third step is retirement. This should be the primary step that everybody should focus on. I believe there is no such thing as "saving too much money." But if you don't have anything or not much saved for retirement, you are going to be in deep trouble. Social security don't pay out much, pension plans are going extinct, and the government is going to make it very difficult for you to get help (because the government is in debt too). Where are you going to go to get money? From you kids or grandkids? They are more likely to have problems of their own. Do you want to put this huge burden on their shoulders as well? There's various retirement plans out there for all kinds of people from IRAs to Variable Annuities.
Forth step is setting up an education fund for your kids (if you have any). Before funding your kid's education, you should make sure that your own retirement plan is in order. Your kids will grow up and find ways to save money. Hopefully you will teach them the importance of saving. Anyway, there are several ways to fund for your kid's education. They are 529 plans, Coverdell, UGMA, US Government Bonds, and Certificates of Deposits.
Fifth step is having a Will. If you die tomorrow, who should get your assets? Who should take ownership of your home? If you don't have name a beneficiary, everything that doesn't have a name beneficiary will be held by the state and the state will decide on who should get what. This usually leads to family wars and your family will pay taxes on your estate. So you want to take care of this as soon as possible.
But if you look at your financial house, do you notice anything that is missing? What are all buildings built on top of? A foundation! Step 9: Draw a horizontal rectangle below floor one. Write: "Income Protection" in the foundation.
Without a foundation, your house will begin to sink or fall apart. In life, without having income protection (also known as life insurance), you are putting a high risk on your family that you are going to live for a very long time and that nothing is going to happen to you. But what if you do die unexpectedly, how would your family survive? Without life insurance, your spouse will first use the emergency fund. Soon that will disappear. Then your spouse will go either into the kid's college fund or the retirement plan. Eventually those will disappear until your spouse finds a new partner or your kids go to work to keep the family in the house. If not, the family will have to move in a cheaper home or rent an apartment. If you and/or your spouse don't have life insurance right now, then the entire financial house is resting on you and/or your spouse shoulders because both of you are providing income to the family (unless your spouse doesn't work, or you are not married, then the whole burden lies on you).
With life insurance, you are managing your risks. There are many types of life insurance out there and the ones that are commonly sold are whole life or universal life. I can give you many reasons why they are sold more, but I pretty much revealed the whole truth about cash value life insurance in this blog. With cash value life insurance, you can only buy what you can afford. That's why many families are under-insured. With term insurance, you can buy the right amount of coverage because premiums are low.
In every financial house (your financial plan), you should have life insurance to protect it. You should have a game plan to eliminate debt, open an emergency fund, save for retirement, save for kid's education, and complete a Will. This is what I do for every family I sit down with.
Monday, March 12, 2007
Why Buy Term and Invest the Difference?
Why buying term and investing the difference makes more sense than cash value life insurance?
1) You can afford more protection for lower premiums in the beginning.
2) Most term policies contains provision to continue coverage until age 100.
3) Paying less premiums in the beginning allows you to free up money to save money elsewhere.
4) This enables you to find the right savings vehicle to meet your objective.
5) By keeping insurance and investments separate, you have more flexibility on how to spend your money. You can change your life insurance or your investments without either one of them affecting the other. For example lets say you pay $50/month for $500,000 policy and invest $50/month into a Roth IRA. You can lower your coverage to pay less premiums and invest more money or you can stop investing and get more coverage.
6) You control how and where your money is invested.
7) You maintain full access to your savings and investments.
8) If you die during the level term, your family gets the death benefit and all your savings and investments.
9) If you outlive the level term, you probably won't need as much coverage at this point because you are near retirement. The most logical choice would to pay less premiums and invest more money.
For most families, buying term and investing the difference is the best way to protect the family. Take a look at some of the real life examples below why term insurance is better.
1) Husband dies in a car accident. Prior to meeting him, he had no life insurance. My company gave him a $250,000 policy. His wife and his 2 kids now has $250,000.
2) Husband dies from a brain tumor. Prior to meeting him, he had $150,000 coverage. My company gave him $500,000 coverage. His wife and 4 kids can maintain the same life style, even though the husband is not there anymore.
3) Wife dies from cancer. Prior to meeting her, she had $50,000 coverage. My company gave her $150,000 coverage. Her husband and one child now has $150,000.
I can go on and on of the number of term policies my company paid out. I am thankful to be working at this company and I love that I can help and change people lives for the better. I'm not going to say which company I work at, but many of you can guess which company I represent.
1) You can afford more protection for lower premiums in the beginning.
2) Most term policies contains provision to continue coverage until age 100.
3) Paying less premiums in the beginning allows you to free up money to save money elsewhere.
4) This enables you to find the right savings vehicle to meet your objective.
5) By keeping insurance and investments separate, you have more flexibility on how to spend your money. You can change your life insurance or your investments without either one of them affecting the other. For example lets say you pay $50/month for $500,000 policy and invest $50/month into a Roth IRA. You can lower your coverage to pay less premiums and invest more money or you can stop investing and get more coverage.
6) You control how and where your money is invested.
7) You maintain full access to your savings and investments.
8) If you die during the level term, your family gets the death benefit and all your savings and investments.
9) If you outlive the level term, you probably won't need as much coverage at this point because you are near retirement. The most logical choice would to pay less premiums and invest more money.
For most families, buying term and investing the difference is the best way to protect the family. Take a look at some of the real life examples below why term insurance is better.
1) Husband dies in a car accident. Prior to meeting him, he had no life insurance. My company gave him a $250,000 policy. His wife and his 2 kids now has $250,000.
2) Husband dies from a brain tumor. Prior to meeting him, he had $150,000 coverage. My company gave him $500,000 coverage. His wife and 4 kids can maintain the same life style, even though the husband is not there anymore.
3) Wife dies from cancer. Prior to meeting her, she had $50,000 coverage. My company gave her $150,000 coverage. Her husband and one child now has $150,000.
I can go on and on of the number of term policies my company paid out. I am thankful to be working at this company and I love that I can help and change people lives for the better. I'm not going to say which company I work at, but many of you can guess which company I represent.
Wednesday, March 07, 2007
Investing tip: Dollar Cost Averaging
This is the best investment tip that you should definitely use and share with others when it comes to investing. Dollar Cost Averaging (DCA) is where you invest the same amount of money on a regular schedule, regardless of the price per share. My economic classes talk briefly about this concept but I was never able to see what good this concept is going to do for me. All they tested me on was to calculate some numbers or fill in the missing numbers.
But if you are an investor, you should pay careful attention on what I'm going to show you. Most clients I sit down with have $100 or more to save each month. They don't realize it, but they actually do when I do a budget worksheet for them. So, let’s say you invest $100/month.
MONTH 1, Price per share is $25, so you bought 4 shares.
MONTH 2, Price per share is $20, so you bought 5 shares.
MONTH 3, Price per share is $15, so you bought 6.67 shares.
MONTH 4, Price per share is $10, so you bought 10 shares.
MONTH 5, Price per share is $15, so you bought 6.67 shares.
MONTH 6, Price per share is $25, so you bought 4 shares.
Total shares you own by end of Month 6 will be: 36.34 shares.
The average price per share was ($25 + $20 + $15 + $10 + $15 + $20) divided by 6 is: $17.50
The average cost per share was ($600 divided by 36.34) is: $16.51. You just reduce your cost per share by almost $1 in a 6 month period!
If you were to invest the full $600 in the first month, you will have 24 shares with price per share is $25. With DCA you would of bought almost 12 more shares and reduce your cost per share by $7.50.
Dollar Cost Averaging doesn’t ensure you profits or protect you from short-term or long-term risks, but it does make you a disciplined investor. Most investors in the market don’t know how to invest. They pull out when the market crashes and then come back in when the market does well. There are three things an investor is concern with:
1) Risks, which is the potential that you can lose money,
2) Return, which is the potential you can earn money, and
3) Volatility, which is the day to day fluctuations.
Let’s say you pull out of the market in month 3 with a total of 15.67 shares at $15/share. You will get $235.05 check. Then you come back in Month 6 where price per share is $25 and you put the $235.05 back in the market, so you will now own 9.402 shares. You now own less shares and paying a higher cost per share too. So in reality, you are worse off. This is how many people invest their money and it’s a stupid investment strategy.
If you invested $1000 and you did nothing, you are not accepting any risks or return until you sell them. It’s really a mind-game and even the most discipline investors will be tempted to pull out the market when the stock market crashes. All I have to say if you are investing in the long run, keep where your money is and stay on course.
But if you are an investor, you should pay careful attention on what I'm going to show you. Most clients I sit down with have $100 or more to save each month. They don't realize it, but they actually do when I do a budget worksheet for them. So, let’s say you invest $100/month.
MONTH 1, Price per share is $25, so you bought 4 shares.
MONTH 2, Price per share is $20, so you bought 5 shares.
MONTH 3, Price per share is $15, so you bought 6.67 shares.
MONTH 4, Price per share is $10, so you bought 10 shares.
MONTH 5, Price per share is $15, so you bought 6.67 shares.
MONTH 6, Price per share is $25, so you bought 4 shares.
Total shares you own by end of Month 6 will be: 36.34 shares.
The average price per share was ($25 + $20 + $15 + $10 + $15 + $20) divided by 6 is: $17.50
The average cost per share was ($600 divided by 36.34) is: $16.51. You just reduce your cost per share by almost $1 in a 6 month period!
If you were to invest the full $600 in the first month, you will have 24 shares with price per share is $25. With DCA you would of bought almost 12 more shares and reduce your cost per share by $7.50.
Dollar Cost Averaging doesn’t ensure you profits or protect you from short-term or long-term risks, but it does make you a disciplined investor. Most investors in the market don’t know how to invest. They pull out when the market crashes and then come back in when the market does well. There are three things an investor is concern with:
1) Risks, which is the potential that you can lose money,
2) Return, which is the potential you can earn money, and
3) Volatility, which is the day to day fluctuations.
Let’s say you pull out of the market in month 3 with a total of 15.67 shares at $15/share. You will get $235.05 check. Then you come back in Month 6 where price per share is $25 and you put the $235.05 back in the market, so you will now own 9.402 shares. You now own less shares and paying a higher cost per share too. So in reality, you are worse off. This is how many people invest their money and it’s a stupid investment strategy.
If you invested $1000 and you did nothing, you are not accepting any risks or return until you sell them. It’s really a mind-game and even the most discipline investors will be tempted to pull out the market when the stock market crashes. All I have to say if you are investing in the long run, keep where your money is and stay on course.
Sunday, March 04, 2007
Load fund vs No-load fund
What is the main difference between loaded funds vs no load funds? One word: Commissions! There are two types of load funds you should know about:
1) Class A shares (front end load) usually has a sales charge of around 5% and expense ratio around 1%.
2) Class B shares (back end load) has no sales charge when you buy shares, but when you sell them during the first 5 years. If you redeem your shares in the first year, you will pay a 5% sales charge. In year 2 it drops to 4% and in year 3 it drops to 3% and so on. So after the 5th year, you pay no sales charge on redemption. However, Class B shares have higher expense ratio around 2%. Class B shares automatically become Class A shares in 8 years.
No-load funds has no sales charge, but usually have higher expenses. There is no service, no agent, no manager, so no one is getting paid. Since there is no manager, a no load fund will attempt to copy whatever the S&P 500 does. There are many load funds that can outperform the S&P and there are many that can't.
Are no-load funds always better than loaded funds? The answer is no. Neither one of them have any advantage over the other. Over time, the returns on a load fund and a no-load fund are about the same. However, if a load fund has a historical rate of return of 15% and the no-load fund of the same category has only 9%, then load fund is clearly the one you should pick. But if both load and the no load fund earn 10%, then a no-load fund is the better choice.
In summary, a load fund has a portfolio manager that does the research and find out what companies to invest in. A no-load fund will invest in steady companies (companies that been around forever) and will attempt to copy whatever the S&P 500 does. You really have to compare them in the same category to find out which one is better. For example, if you want high growth in your investments, you will pick mutual funds that is focus on generating high growth. Then you will compare whether a load fund or a no-load fund is better. You can only do this when you obtain a prospectus.
What should you look for in the prospectus?
1) What is it's investment objective?
2) Who manages the fund and how much experience does he/she have? Be careful of companies that advertise how the fund perform in its entire history.
3) Check the past performance over 3-year, 5-year, and 10-year period.
4) What is the expense ratio and management fees?
5) What is the turnover ratio?
1) Class A shares (front end load) usually has a sales charge of around 5% and expense ratio around 1%.
2) Class B shares (back end load) has no sales charge when you buy shares, but when you sell them during the first 5 years. If you redeem your shares in the first year, you will pay a 5% sales charge. In year 2 it drops to 4% and in year 3 it drops to 3% and so on. So after the 5th year, you pay no sales charge on redemption. However, Class B shares have higher expense ratio around 2%. Class B shares automatically become Class A shares in 8 years.
No-load funds has no sales charge, but usually have higher expenses. There is no service, no agent, no manager, so no one is getting paid. Since there is no manager, a no load fund will attempt to copy whatever the S&P 500 does. There are many load funds that can outperform the S&P and there are many that can't.
Are no-load funds always better than loaded funds? The answer is no. Neither one of them have any advantage over the other. Over time, the returns on a load fund and a no-load fund are about the same. However, if a load fund has a historical rate of return of 15% and the no-load fund of the same category has only 9%, then load fund is clearly the one you should pick. But if both load and the no load fund earn 10%, then a no-load fund is the better choice.
In summary, a load fund has a portfolio manager that does the research and find out what companies to invest in. A no-load fund will invest in steady companies (companies that been around forever) and will attempt to copy whatever the S&P 500 does. You really have to compare them in the same category to find out which one is better. For example, if you want high growth in your investments, you will pick mutual funds that is focus on generating high growth. Then you will compare whether a load fund or a no-load fund is better. You can only do this when you obtain a prospectus.
What should you look for in the prospectus?
1) What is it's investment objective?
2) Who manages the fund and how much experience does he/she have? Be careful of companies that advertise how the fund perform in its entire history.
3) Check the past performance over 3-year, 5-year, and 10-year period.
4) What is the expense ratio and management fees?
5) What is the turnover ratio?
Tuesday, February 20, 2007
IRAs: Age 59 1/2 Rule
Lets talk about the Rule 59 1/2, which applies to all types of IRAs. Rule 59 1/2 states that if you make any non-qualifying withdrawals before age 59 1/2, you will be subjected a 10% early withdrawal penalty. You should know that the IRS does not prohibit you from withdrawing money. You can make withdrawals at anytime, but you may pay a penalty and possibly income tax. So, what is considered a "qualified" withdrawal?
1) You may make withdrawals before age 59 1/2 if you become permanently disabled.
2) If you die before age 59 1/2, your estate or your beneficiary will not be affected by the rule.
3) You may make withdrawals to pay for non-reimbursed medical expenses IF AND ONLY IF the expenses exceeds 7.5% of you adjusted gross income (AGI, which means your gross income after all qualifying deductions are made)
4) You may make withdrawals up to $10,000 for purchase, building, or rebuilding of your first home. This can include children, grandchildren, and your spouse if you already bought your first home.
5) You may make withdrawals to pay for higher education expenses. This can include you, your children, and your grandchildren.
6) If you are out of a job and have medical insurance, you may make withdrawals to pay the premium.
In Tradional IRAs, when you start withdrawing money, you will owe income taxes on them EXCEPT on the part where your contributions were not tax-deductible. Remember about the age 59 1/2 rule, if you make non-qualifying withdrawals you will owe 10% penalty tax and income tax on deductible contributions and earnings. Click here to learn more about Traditional IRAs.
In Roth IRAs, when you make withdrawals after age 59 1/2, you may not owe any taxes, depending on when you open the Roth IRA. You may also withdraw your contributions anytime, even before Age 59 1/2 and you won't owe any taxes or penalties! Click here to learn more about Roth IRAs.
1) You may make withdrawals before age 59 1/2 if you become permanently disabled.
2) If you die before age 59 1/2, your estate or your beneficiary will not be affected by the rule.
3) You may make withdrawals to pay for non-reimbursed medical expenses IF AND ONLY IF the expenses exceeds 7.5% of you adjusted gross income (AGI, which means your gross income after all qualifying deductions are made)
4) You may make withdrawals up to $10,000 for purchase, building, or rebuilding of your first home. This can include children, grandchildren, and your spouse if you already bought your first home.
5) You may make withdrawals to pay for higher education expenses. This can include you, your children, and your grandchildren.
6) If you are out of a job and have medical insurance, you may make withdrawals to pay the premium.
In Tradional IRAs, when you start withdrawing money, you will owe income taxes on them EXCEPT on the part where your contributions were not tax-deductible. Remember about the age 59 1/2 rule, if you make non-qualifying withdrawals you will owe 10% penalty tax and income tax on deductible contributions and earnings. Click here to learn more about Traditional IRAs.
In Roth IRAs, when you make withdrawals after age 59 1/2, you may not owe any taxes, depending on when you open the Roth IRA. You may also withdraw your contributions anytime, even before Age 59 1/2 and you won't owe any taxes or penalties! Click here to learn more about Roth IRAs.
Roth IRA
A Roth IRA is where you cannot make tax deductions because your contributions are supposedly be made with after-tax dollars. Usually when you get your paycheck, a portion of it went to taxes. What's ever left over is yours and you can put this in the Roth IRA. Since you cannot make tax deductions, any withdrawals you make after age 59 1/2 are tax free. Tax free withdrawals are generally not allowed within the first 5 years beginning with the first tax year contributions and conversions. For example, lets say you contribute $1000 into the Roth in 2006. The 5 year holding period on the earnings began on January 1, 2006 and expires on December 31, 2010. Lets say that a year later, you convert your Traditional IRA into a Roth IRA on March 1, 2007. The 5 year holding period begins on January 1, 2007 and ends on December 31, 2012 on all earnings from the conversion.
I also heard that you can withdraw your contributions anytime without paying income taxes or penalties. I asked that question to a tax expert at Kiplinger and he said "Roth contributions can be withdrawn at anytime, tax- and penalty-free, regardless of your age." According to IRS publication 590, under subheading Roth IRA, title "Are Distributions Taxable?", it states "You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s)." In other words, you can withdraw your contributions anytime without paying income taxes or penalties.
Not everyone can get a Roth IRA. If you are single and your adjusted gross income (AGI) is above $120,000, you cannot get a Roth IRA. If you are married and filing jointly (or qualify widow(er)) and your AGI is above $177,000, you do not qualify for a Roth IRA. If you are married, but filing separately, and the spouse lives with you, you do not qualify for a Roth IRA if your AGI is above $10,000. (These figures are for tax year 2011. For up to date figures, go see IRS Publication 590).
When you make withdrawals from your Roth IRA, you may or may not pay taxes. You should know that the IRS does not prohibit you from withdrawing money. You can make withdrawals at anytime, but you may pay a penalty and possibly income tax. When you take distributions or make withdrawals, this is how your distributions are paid out in this order:
1) Your annual contributions. You can withdraw this at anytime without penalty or taxes.
2) Taxable portion of first rollover (the conversion). This only applies if your lifetime withdrawals exceeds your lifetime contributions. If you make withdrawals on this portion before age 59 1/2, you will pay a 10% penalty.
3) Non-taxable portion of first rollover. This only applies after the taxable portion of rollover has been withdrawn. You will pay no taxes or penalties on this portion at anytime.
4) Each subsequent rollover, in order, with the taxable portion coming out first and then the non-taxable.
5) And finally, any earnings. If you get to this point, you will pay income taxes during the 5 year holding period. If withdrawn before age 59 1/2, you will pay a 10% penalty, unless it was a qualifed withdrawal. See Age 59 1/2 Rule. After age 59 1/2 and after the 5 year holding period, you do not pay any taxes on the earnings.
Things to remember about Roth IRAs
1) Not everyone can get a Roth IRA. It depends on your Adjusted Gross Income and filing status.
2) None of your contributions are tax-deductible, but when you withdraw your contributions, they are tax-free and penalty-free.
3) Your withdrawals after age 59 1/2 may be tax-free.
4) You must hold the earnings and any conversions in your Roth IRA for 5 full tax years in the beginning.
Some questions I get:
Q1: What if I open my first Roth IRA at age 60, does the 5 year holding period still apply?
A1: Yes, but you can withdraw your contributions at anytime without paying any taxes.
Q2: If I open another Roth IRA somewhere, does the 5 year holding period apply?
A2: 5 year holding period only applies to your first Roth IRA.
Q3: If I convert or rollover my Traditional IRA into a Roth IRA, what should I know before doing this?
A3: One, you will pay income tax on the earnings and any part of your contributions you made tax-deductible. Second, you have to move the entire balance into the Roth IRA within 60 days of receiving receipt. Third, the 5 year holding period will apply on this conversion, whether you previously have a Roth IRA or not.
I also heard that you can withdraw your contributions anytime without paying income taxes or penalties. I asked that question to a tax expert at Kiplinger and he said "Roth contributions can be withdrawn at anytime, tax- and penalty-free, regardless of your age." According to IRS publication 590, under subheading Roth IRA, title "Are Distributions Taxable?", it states "You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s)." In other words, you can withdraw your contributions anytime without paying income taxes or penalties.
Not everyone can get a Roth IRA. If you are single and your adjusted gross income (AGI) is above $120,000, you cannot get a Roth IRA. If you are married and filing jointly (or qualify widow(er)) and your AGI is above $177,000, you do not qualify for a Roth IRA. If you are married, but filing separately, and the spouse lives with you, you do not qualify for a Roth IRA if your AGI is above $10,000. (These figures are for tax year 2011. For up to date figures, go see IRS Publication 590).
When you make withdrawals from your Roth IRA, you may or may not pay taxes. You should know that the IRS does not prohibit you from withdrawing money. You can make withdrawals at anytime, but you may pay a penalty and possibly income tax. When you take distributions or make withdrawals, this is how your distributions are paid out in this order:
1) Your annual contributions. You can withdraw this at anytime without penalty or taxes.
2) Taxable portion of first rollover (the conversion). This only applies if your lifetime withdrawals exceeds your lifetime contributions. If you make withdrawals on this portion before age 59 1/2, you will pay a 10% penalty.
3) Non-taxable portion of first rollover. This only applies after the taxable portion of rollover has been withdrawn. You will pay no taxes or penalties on this portion at anytime.
4) Each subsequent rollover, in order, with the taxable portion coming out first and then the non-taxable.
5) And finally, any earnings. If you get to this point, you will pay income taxes during the 5 year holding period. If withdrawn before age 59 1/2, you will pay a 10% penalty, unless it was a qualifed withdrawal. See Age 59 1/2 Rule. After age 59 1/2 and after the 5 year holding period, you do not pay any taxes on the earnings.
Things to remember about Roth IRAs
1) Not everyone can get a Roth IRA. It depends on your Adjusted Gross Income and filing status.
2) None of your contributions are tax-deductible, but when you withdraw your contributions, they are tax-free and penalty-free.
3) Your withdrawals after age 59 1/2 may be tax-free.
4) You must hold the earnings and any conversions in your Roth IRA for 5 full tax years in the beginning.
Some questions I get:
Q1: What if I open my first Roth IRA at age 60, does the 5 year holding period still apply?
A1: Yes, but you can withdraw your contributions at anytime without paying any taxes.
Q2: If I open another Roth IRA somewhere, does the 5 year holding period apply?
A2: 5 year holding period only applies to your first Roth IRA.
Q3: If I convert or rollover my Traditional IRA into a Roth IRA, what should I know before doing this?
A3: One, you will pay income tax on the earnings and any part of your contributions you made tax-deductible. Second, you have to move the entire balance into the Roth IRA within 60 days of receiving receipt. Third, the 5 year holding period will apply on this conversion, whether you previously have a Roth IRA or not.
Traditional IRA
When you contribute money to your Traditional IRA, your contributions may be fully, partially, or non tax-deductible. This all depends on your filing status, how much income you make, and whether or not you contribute to your employer's sponsor retirement plan such as a 401k.
How much can you deduct?
Before you read on, you should figure out your Adjusted Gross Income (AGI) if you are earning lots of money (somewhere above $50,000). The IRS website in Publication 590 (2005 edition) on page 15 shows you how to figure out your AGI.
If you are currently covered by an employer's retirement plan, your allowable deductions may be further limited. If you or your spouse are covered by an employer's retirement plan, you may be entitled to a partial deduction or no deduction. This depends on your income and filing status. First thing you need to do to figure out whether you can make deductions or no deductions is your Modified Adjusted Gross Income (your final income after all deductions are made). Don't ask me on how to get this number since I never done it before. But if you do figure out this number, determining whether your contributions are deductible or not will be easy.
Rule age 70 1/2
In Traditional IRAs, the Rule Age 70 1/2 applies. This rule say you cannot make any more contributions after age 70 1/2 and must start withdrawing at least the minimum distribution requirement. It also means you can not apply for a Traditional IRA after age 70 1/2. To figure out the minimum distribution requirement, you need three things. 1) Your account balance on December 31 of the previous year. 2) Appendix C of Publication 590 (page 85-100). Find out which table best describes your filing status. For most of you, it would be Table III on page 100. 3) A calculator. Here is the formula to figure out the minimum distribution requirement: (Your account balance on Dec 31 of the previous year) DIVIDED BY (your life expectancy as stated in the appropriate Table, which is usually Table III).
Example: Lets say you become age 70 1/2 in 2006. Your ending account balance on Dec 31, 2005 was $86,000. The minimum distribution requirement is: ($86,000/27.4) = $3138.69. You may start making withdrawals when you become age 70 1/2. If you do not, you must take the minimum distribution by April 1, 2007. This date is called the "Required beginning date." Remember, this is only the mimimum. You can always take more out, but this will not affect the minimum requirement distribution.
Continuing with this example. In 2007, you are age 71. Your account balance on Dec 31, 2006 was: $83,000. The minimum distribution for 2007 is: ($83,000/26.5) = $3132.08. You must take this minimum amount by December 31, 2007 (not April 1, 2008). Failure to meet this minimum amount will result in a 50% tax on the amount you have not taken. Let's say in 2006 you only took $2000 from your Traditional IRA. Your minimum requirement is $3132.08. Since you did not meet the minimum requirement, the amount you will be taxed on is $1132.08 (3132.08 - 2000). You will owe: $566.04 in taxes. And that's as far as I will go with the Rule 70 1/2.
When you make withdrawals from your Traditional IRA, your withdrawals may be subjected to income tax. You will pay taxes on the gains, interests, dividends, and any part of your contributions you made tax-deductible. The only tax-free withdrawals you have is the contributions you didn't make tax-deductible. If you make withdrawals before age 59 1/2, you will be hit with a 10% tax. Click here to learn more about Rule 59 1/2.
Few key pointers you should remember about Traditional IRAs
1) Almost every working citizen can get it, except for people who are age 70 1/2 and above.
2) Your contributions may be fully, partially, or not deductible. This depends on your AGI, your filing status, whether you are covered by your employer's retirement plan, and whether or not you receive social security.
3) Minimum distribution requirement kicks in when you reach age 70 1/2.
4) Your withdrawals are taxable except on the contributions you didn't make tax-deductible.
How much can you deduct?
Before you read on, you should figure out your Adjusted Gross Income (AGI) if you are earning lots of money (somewhere above $50,000). The IRS website in Publication 590 (2005 edition) on page 15 shows you how to figure out your AGI.
If you are currently covered by an employer's retirement plan, your allowable deductions may be further limited. If you or your spouse are covered by an employer's retirement plan, you may be entitled to a partial deduction or no deduction. This depends on your income and filing status. First thing you need to do to figure out whether you can make deductions or no deductions is your Modified Adjusted Gross Income (your final income after all deductions are made). Don't ask me on how to get this number since I never done it before. But if you do figure out this number, determining whether your contributions are deductible or not will be easy.
- If your filing status is single or head of household, and your AGI is $50,000 or less, your contributions to the Traditional IRA is fully deductible. If your AGI is above $50,000 but less than $60,000, your contributions are partially deductible. If your AGI is $60,000 and above, then none of your contributions are deductible.
- If you are married filing a joint return or a qualified widower, and your AGI is $70,000 or less, your contributions are fully deductible. If your AGI is above $70,000 but less than $80,000, your contributions are partially deductible. If your AGI is $80,000 and above, then none of your contributions are deductible.
- If you are married filing separately and your AGI is less than $10,000, your contributions are partially deductible. If your AGI is above $10,000, none of your contributions are deductible.
If you are not covered by a retirement plan at work, then the figures on the previous paragraph changes.
- If your status is single or head of household: AGI does not matter, so your entire contributions to the annual limit are fully deductible.
- If your status is married and filing a joint return or a qualified widower: If your AGI is $150,000 or less, then your contributions are fully deductible. If your AGI is above $150,000 but less than $160,000, your contributions are partially deductible. If your AGI is above $160,000, then none of your contributions are deductible.
- If your status is married and filing separately: If your AGI is less than $10,000, your contributions are partially deductible. If your AGI is above $10,000, then your contributions are not deductible.
Rule age 70 1/2
In Traditional IRAs, the Rule Age 70 1/2 applies. This rule say you cannot make any more contributions after age 70 1/2 and must start withdrawing at least the minimum distribution requirement. It also means you can not apply for a Traditional IRA after age 70 1/2. To figure out the minimum distribution requirement, you need three things. 1) Your account balance on December 31 of the previous year. 2) Appendix C of Publication 590 (page 85-100). Find out which table best describes your filing status. For most of you, it would be Table III on page 100. 3) A calculator. Here is the formula to figure out the minimum distribution requirement: (Your account balance on Dec 31 of the previous year) DIVIDED BY (your life expectancy as stated in the appropriate Table, which is usually Table III).
Example: Lets say you become age 70 1/2 in 2006. Your ending account balance on Dec 31, 2005 was $86,000. The minimum distribution requirement is: ($86,000/27.4) = $3138.69. You may start making withdrawals when you become age 70 1/2. If you do not, you must take the minimum distribution by April 1, 2007. This date is called the "Required beginning date." Remember, this is only the mimimum. You can always take more out, but this will not affect the minimum requirement distribution.
Continuing with this example. In 2007, you are age 71. Your account balance on Dec 31, 2006 was: $83,000. The minimum distribution for 2007 is: ($83,000/26.5) = $3132.08. You must take this minimum amount by December 31, 2007 (not April 1, 2008). Failure to meet this minimum amount will result in a 50% tax on the amount you have not taken. Let's say in 2006 you only took $2000 from your Traditional IRA. Your minimum requirement is $3132.08. Since you did not meet the minimum requirement, the amount you will be taxed on is $1132.08 (3132.08 - 2000). You will owe: $566.04 in taxes. And that's as far as I will go with the Rule 70 1/2.
When you make withdrawals from your Traditional IRA, your withdrawals may be subjected to income tax. You will pay taxes on the gains, interests, dividends, and any part of your contributions you made tax-deductible. The only tax-free withdrawals you have is the contributions you didn't make tax-deductible. If you make withdrawals before age 59 1/2, you will be hit with a 10% tax. Click here to learn more about Rule 59 1/2.
Few key pointers you should remember about Traditional IRAs
1) Almost every working citizen can get it, except for people who are age 70 1/2 and above.
2) Your contributions may be fully, partially, or not deductible. This depends on your AGI, your filing status, whether you are covered by your employer's retirement plan, and whether or not you receive social security.
3) Minimum distribution requirement kicks in when you reach age 70 1/2.
4) Your withdrawals are taxable except on the contributions you didn't make tax-deductible.
Wednesday, February 14, 2007
The dividend in life insurance vs dividend in investments
What is a dividend? To many people, they think its free money. But they don't know the difference between a dividend in a life insurance policy versus a dividend in investments. To them, its all the same. Here, I'm going to define these two types of dividend.
Dividend in a life insurance policy: This is where an insurance company refunds the excess amount of premiums you paid into the policy. That means you are already overpaying your premiums in the first place. So its basically you are getting your change back. For example, let's say you bought something at a store and the total cost is $25. You pay $50, so the cashier returns you $25. Well, in life insurance, they don't return the change back to you immediately, they invest it in their own accounts and then give it back to you later in the year.
Dividend in investments: This is when an investment company makes profits and pay a portion of these profits to shareholders. This is called a dividend. Remember, anything related to investments are not guaranteed. If you do receive a dividend, you have the choice of keeping it in your pocket or re-invest it to buy more shares. You will pay taxes on the dividend, unless your investments are in tax-deferred accounts such as IRAs.
Dividend in a life insurance policy: This is where an insurance company refunds the excess amount of premiums you paid into the policy. That means you are already overpaying your premiums in the first place. So its basically you are getting your change back. For example, let's say you bought something at a store and the total cost is $25. You pay $50, so the cashier returns you $25. Well, in life insurance, they don't return the change back to you immediately, they invest it in their own accounts and then give it back to you later in the year.
Dividend in investments: This is when an investment company makes profits and pay a portion of these profits to shareholders. This is called a dividend. Remember, anything related to investments are not guaranteed. If you do receive a dividend, you have the choice of keeping it in your pocket or re-invest it to buy more shares. You will pay taxes on the dividend, unless your investments are in tax-deferred accounts such as IRAs.
Monday, February 05, 2007
How to borrow money from IRA
"Wait a minute! You can't borrow money from your IRA!" I read an article somewhere that said you can as long as you are able to pay it all back within 60 days. Let's say you are below the age 59 1/2 and you need the money for whatever purposes that doesn't fit the exception rule. There is no loan interest and there is no withholding period when you borrow money from your IRA. So, if you need money right away, you can borrow money from your IRA. How? It's called a IRA rollover.
The IRA rollover can only be done once every 12 months. You withdraw money from your current IRA and you have 60 days to deposit this money into an IRA account. Keep in mind, you don't necessarily have to open a new IRA account to do the rollover. You can put it back into your original IRA. During the 60 day period, you can use the money for whatever purpose, as long as you pay it all back by the 60th day. If you do not pay it back, you will pay income taxes on the earnings and also pay a 10% penalty as well. So, its a double taxation.
You have to be careful with the 60 day rule. The IRS does not accept any excuses or give any extensions if you can't pay the money back. If the 60th day lands on a weekend or on a holiday, it is your obligation to deposit the money before hand. Let's say you get your check from your IRA on April 1. You must deposit the money on or before May 30 (April 1 is the first day of the 60 days. There are 30 days in April and 31 days in May). If May 30 is on a Saturday or Sunday, you know the stock market doesn't do any trading on the weekends. So, you must deposit the money on the Friday before May 30.
The IRA rollover can only be done once every 12 months. You withdraw money from your current IRA and you have 60 days to deposit this money into an IRA account. Keep in mind, you don't necessarily have to open a new IRA account to do the rollover. You can put it back into your original IRA. During the 60 day period, you can use the money for whatever purpose, as long as you pay it all back by the 60th day. If you do not pay it back, you will pay income taxes on the earnings and also pay a 10% penalty as well. So, its a double taxation.
You have to be careful with the 60 day rule. The IRS does not accept any excuses or give any extensions if you can't pay the money back. If the 60th day lands on a weekend or on a holiday, it is your obligation to deposit the money before hand. Let's say you get your check from your IRA on April 1. You must deposit the money on or before May 30 (April 1 is the first day of the 60 days. There are 30 days in April and 31 days in May). If May 30 is on a Saturday or Sunday, you know the stock market doesn't do any trading on the weekends. So, you must deposit the money on the Friday before May 30.
Sunday, January 28, 2007
Debt Repayment: Why Rate doesn't matter.
You seen these ads: "Refinance with 5.05%!" or "Consolidate your debt with a low interest rate of 4.85%." When it comes to paying your debt, interest rates does not matter. What does interest rate really do for you? It just sets the payment. What it really comes down to is how long you are going to be in debt, which in turn determines how much interest you going to pay. The longer you are paying the debt, the more interest you are paying. So, its not the interest rate that matters, its the rate at which you pay.
Take a look at these two people:
Person A
$100,000 loan
$600/month payment
30 years to pay.
Person B
$100,000 loan
$600/month payment
15 years left to pay.
Which person you want to be and why? The obvious answer is Person B because you will be out of debt is 15 years. Keep in mind, both loans are 30 year loans.
Ok, what if the interest rate in Person A is 6% and Person B is 10%? Keeping everything else equal, would you still take Person B? At this point, most people are not sure what to do because they been trained that interest rate is the most important factor when determining a loan, when in fact it should be the least concern. The obvious answer is still Person B because you are still paying $600/month and you will be out of debt in 15 years instead of 30 years.
You are probably thinking why Person B is still better than Person A? Both loans are really 30 year loans. Like many other people, Person A pays his debt once a month, so he will be in debt for 30 years.
But Person B decided that he want to pay his debt every two weeks or bi-weekly. When you pay bi-weekly, you split your monthly payment in half and pay this amount, which is $300, every 2 weeks. This result in an extra month of payment to the year, which all goes to the principal. By lowering your principal, you are getting out of debt quicker. So Person B will be out of debt in 15 years. Even though he has a slightly higher interest rate, he can potentially save tens of thousands of dollars of interest.
Why? As I mention before, its the rate at which you pay that matters the most. You can be like Person A and pay the loan once a month and pay the full total cost of the loan. Or you can be Person B who gets out of debt faster and pay maybe just half of the total cost. Even though his interest rate is slightly higher, his net effective rate is the true interest rate he is paying. Net effective rate = (prepaid cost of the proposed loan divided by original cost) times interest rate proposed loan. You can only get these numbers if the lender shows you various amortization schedule of different payments (a schedule if you pay once a month, a schedule if you pay bi-weekly, a schedule if you add more money toward bi-weekly). The prepaid cost and time you will be in debt will vary between all types of schedule.
For example, lets say you pay bi-weekly and the prepaid cost of the new loan is $100,000 and the original cost of the loan is $200,000. The interest rate of the new loan is 8%. $100,000/$200,000 x 8% = 4%. If you just paid once a month, then the net effective rate will be 8% since you paying for 30 years. But with bi-weekly payment, its 4%.
In conclusion, there are three things you should really be concern with when it comes to repaying your debt:
1) How long are you going to be in debt?
2) How much money are you going to save?
3) And finally, what is the interest rate?
*Please note that all numbers in this post are hypothetical numbers. But the general concept still holds true if you apply it in a real loan to loan comparison.*
Take a look at these two people:
Person A
$100,000 loan
$600/month payment
30 years to pay.
Person B
$100,000 loan
$600/month payment
15 years left to pay.
Which person you want to be and why? The obvious answer is Person B because you will be out of debt is 15 years. Keep in mind, both loans are 30 year loans.
Ok, what if the interest rate in Person A is 6% and Person B is 10%? Keeping everything else equal, would you still take Person B? At this point, most people are not sure what to do because they been trained that interest rate is the most important factor when determining a loan, when in fact it should be the least concern. The obvious answer is still Person B because you are still paying $600/month and you will be out of debt in 15 years instead of 30 years.
You are probably thinking why Person B is still better than Person A? Both loans are really 30 year loans. Like many other people, Person A pays his debt once a month, so he will be in debt for 30 years.
But Person B decided that he want to pay his debt every two weeks or bi-weekly. When you pay bi-weekly, you split your monthly payment in half and pay this amount, which is $300, every 2 weeks. This result in an extra month of payment to the year, which all goes to the principal. By lowering your principal, you are getting out of debt quicker. So Person B will be out of debt in 15 years. Even though he has a slightly higher interest rate, he can potentially save tens of thousands of dollars of interest.
Why? As I mention before, its the rate at which you pay that matters the most. You can be like Person A and pay the loan once a month and pay the full total cost of the loan. Or you can be Person B who gets out of debt faster and pay maybe just half of the total cost. Even though his interest rate is slightly higher, his net effective rate is the true interest rate he is paying. Net effective rate = (prepaid cost of the proposed loan divided by original cost) times interest rate proposed loan. You can only get these numbers if the lender shows you various amortization schedule of different payments (a schedule if you pay once a month, a schedule if you pay bi-weekly, a schedule if you add more money toward bi-weekly). The prepaid cost and time you will be in debt will vary between all types of schedule.
For example, lets say you pay bi-weekly and the prepaid cost of the new loan is $100,000 and the original cost of the loan is $200,000. The interest rate of the new loan is 8%. $100,000/$200,000 x 8% = 4%. If you just paid once a month, then the net effective rate will be 8% since you paying for 30 years. But with bi-weekly payment, its 4%.
In conclusion, there are three things you should really be concern with when it comes to repaying your debt:
1) How long are you going to be in debt?
2) How much money are you going to save?
3) And finally, what is the interest rate?
*Please note that all numbers in this post are hypothetical numbers. But the general concept still holds true if you apply it in a real loan to loan comparison.*
Friday, January 26, 2007
The Debt Crisis of the 21st Century
Debt has become a major issue in the beginning of the 21st century. Today it is the year 2007 and only the past 5 years have I begun noticing that debt is becoming more and more problematic. Bankruptcies filing has been all time high, debt amounts continue to grow every year, and home foreclosures are increasing. Ever year, since 2002 bankruptcy filings continue to break a new record. In 2005, 1.8 million people filed for bankruptcy, setting a new record. I don't know how many people filed for 2006. I wonder how can this happen? America is suppose to be the most educated country in the world, and yet many of us make bad decisions or don't know how to say "no" to these so-called professionals who are trying to sell you something.
1) The Mortgage Industry
When the prices of home plumeted after 2001, many Americans started buying homes. The problem was that many people don't know the different types of mortgages out there and I bet most homeowners today really don't know what kind of mortage they have right now. They think its a fix rate mortgage, but if a mortgage specialist look at it, it may be something else. Do you have fix rate mortgage or adjustable rate mortgage or maybe its an interest-only mortgage? You don't know since they all look the same until you get your next statement that shows a larger mortgage payment than usual. When your mortgage payments start to increase, most people can't afford to pay it. According to MSNBC.com, adjustable rate mortgages accounts for 11% of all total outstanding mortgage debt (Sept 6 2006). Over the next 5 years, about one million people could lose their homes through foreclosures. Take a look at this, if you are paying $1500/month on a mortgage and then next month your mortgage payment jumped to $1700/month, will you be able to pay for it? What if it increases again to $1900/month? Most people can't afford an increase in mortgage payment. The best way out is maybe to refinance into a fix-rate mortgage. Refinancing is a difficult task for the lender and you may or may not qualify to refinance with them. Plus, there will be fees involved to refinance. Some lenders include the fee within the loan so that you don't have to pay it upfront. So, if you are going to buy a home, buy a home that you can realistically afford and always get a fix-rate mortgage. That way you can manage your finance better without the need to guess what is your next mortgage payment is going to be.
*UPDATE 2-12-2007* According to Realtytrac Inc, foreclosures has increased by 25% in January 2007 over January 2006. Total number of homes that were foreclosed in January 2007 was 130,511.
*UPDATE 3-13-2007* According to CBS Market Watch, in the 4th quarter of 2006, delinquency rates (people falling behind their mortgage payments) increased from 4.67% to 4.97%. Foreclosure rates (people who are force to close their homes) increased from 3.86% to 4.53%.
*UPDATE 4-29-2008* According to Associate Press, number of US homes facing foreclosure jumped 112% in first quarter over 2007. Nationwide, 649,917 homes received at least one foreclosure-related filing in the first three months of the year, up 112 percent from 306,722 during the same period last year, RealtyTrac said. http://biz.yahoo.com/ap/080429/foreclosure_rates.html
*March 15, 2010: CBS "60 Minutes" Author Michael Lewis on Wall St's Delusion
2) Credit cards
The first time I got my credit card was at age 18 and it was a joint account with my brother. I rarely used the credit card except when I needed to buy books and supplies for college. My brother paid for it all and I thank him for that. I knew that if you use a credit card, you have to pay it back. Since I didn't have a job, I didn't use it for anything other than for college expenses. But most people are not like me, and so they spend as much as they can or they max it out. Then when they over did it, they see a huge balance on their credit card and so they opt to pay only the minimum, which is usually less than $50. I believe that credit cards brings the "greed" out of people. We are spending freaks. I'm not going to lie. I like to spend too, but I am able to control myself. If I was out of control, I would be buying plasma tvs, the biggest and loudest speakers there is, and the most powerful computers and consoles to play my video games. So, I think credit card is more of a pyschological problem than a financial problem.
Recently, my state started banking awareness week that teach young adults about money such as budgeting, checking and savings accounts, and being responsible on the use of credit cards. Today, the average balance on credit cards nationwide is around $22,000 and it continues to grow.
3) The Solution
If you are like many other Americans, you probably have debt too. Whether its mortgages, student loans, car loans, or credit cards, there are several ways in which you can pay it off. One option is to create a budget worksheet. That way you an evaluate where all your money is going to and which area you can cut or limit your spending on.
A second option is to consolidate all your debt into one payment. Instead of paying to multiple parties, you now pay one bill to one lender. In most cases, your monthly payment is usually lower. What you should do next is use the savings and add it to your principal. For example, lets say you have a mortgage payment of $900/month and credit card payments of around $500/month. You have about 28 years left on your debt payment. That's $1400/month. When you consolidate them, lets assume your new monthly payment will be $1100/month. You saved $300/month, but now you are in debt for another 30 years. Most banks will stop here and let you figure out what to do with the savings. I only know one company that shows you how to get smart with your money and get out of debt sooner. Note: When you consolidate or refinance, interest rate does not matter. Its the rate at which you pay that matters. The larger the loan and the longer it takes you to pay, the more it cost you to pay.
Third option is to start living below your income. That means, don't spend too much. Whatever income you make, save 10-15% of it. By the time you retire, you will be better off than the rest of the country.
Fourth option is to seek professional help if you are unable to control your spending. Spending above your income means that you are not saving anything for your future. If you want to live a happy life when you retire, you better control your spending habits and start saving.
Fifth option is to pay more than minimum amount. That way you are paying off the principal faster.
Sixth option is to utilize some or all the options above and just do it. Don't wait tommorow, or next week, or next month, when then turn to years and years and years and then you forgot about it.
Seventh option is educate yourself of the products and do research about the company. Read all fine prints before signing any documents.
1) The Mortgage Industry
When the prices of home plumeted after 2001, many Americans started buying homes. The problem was that many people don't know the different types of mortgages out there and I bet most homeowners today really don't know what kind of mortage they have right now. They think its a fix rate mortgage, but if a mortgage specialist look at it, it may be something else. Do you have fix rate mortgage or adjustable rate mortgage or maybe its an interest-only mortgage? You don't know since they all look the same until you get your next statement that shows a larger mortgage payment than usual. When your mortgage payments start to increase, most people can't afford to pay it. According to MSNBC.com, adjustable rate mortgages accounts for 11% of all total outstanding mortgage debt (Sept 6 2006). Over the next 5 years, about one million people could lose their homes through foreclosures. Take a look at this, if you are paying $1500/month on a mortgage and then next month your mortgage payment jumped to $1700/month, will you be able to pay for it? What if it increases again to $1900/month? Most people can't afford an increase in mortgage payment. The best way out is maybe to refinance into a fix-rate mortgage. Refinancing is a difficult task for the lender and you may or may not qualify to refinance with them. Plus, there will be fees involved to refinance. Some lenders include the fee within the loan so that you don't have to pay it upfront. So, if you are going to buy a home, buy a home that you can realistically afford and always get a fix-rate mortgage. That way you can manage your finance better without the need to guess what is your next mortgage payment is going to be.
*UPDATE 2-12-2007* According to Realtytrac Inc, foreclosures has increased by 25% in January 2007 over January 2006. Total number of homes that were foreclosed in January 2007 was 130,511.
*UPDATE 3-13-2007* According to CBS Market Watch, in the 4th quarter of 2006, delinquency rates (people falling behind their mortgage payments) increased from 4.67% to 4.97%. Foreclosure rates (people who are force to close their homes) increased from 3.86% to 4.53%.
*UPDATE 4-29-2008* According to Associate Press, number of US homes facing foreclosure jumped 112% in first quarter over 2007. Nationwide, 649,917 homes received at least one foreclosure-related filing in the first three months of the year, up 112 percent from 306,722 during the same period last year, RealtyTrac said. http://biz.yahoo.com/ap/080429/foreclosure_rates.html
*March 15, 2010: CBS "60 Minutes" Author Michael Lewis on Wall St's Delusion
2) Credit cards
The first time I got my credit card was at age 18 and it was a joint account with my brother. I rarely used the credit card except when I needed to buy books and supplies for college. My brother paid for it all and I thank him for that. I knew that if you use a credit card, you have to pay it back. Since I didn't have a job, I didn't use it for anything other than for college expenses. But most people are not like me, and so they spend as much as they can or they max it out. Then when they over did it, they see a huge balance on their credit card and so they opt to pay only the minimum, which is usually less than $50. I believe that credit cards brings the "greed" out of people. We are spending freaks. I'm not going to lie. I like to spend too, but I am able to control myself. If I was out of control, I would be buying plasma tvs, the biggest and loudest speakers there is, and the most powerful computers and consoles to play my video games. So, I think credit card is more of a pyschological problem than a financial problem.
Recently, my state started banking awareness week that teach young adults about money such as budgeting, checking and savings accounts, and being responsible on the use of credit cards. Today, the average balance on credit cards nationwide is around $22,000 and it continues to grow.
3) The Solution
If you are like many other Americans, you probably have debt too. Whether its mortgages, student loans, car loans, or credit cards, there are several ways in which you can pay it off. One option is to create a budget worksheet. That way you an evaluate where all your money is going to and which area you can cut or limit your spending on.
A second option is to consolidate all your debt into one payment. Instead of paying to multiple parties, you now pay one bill to one lender. In most cases, your monthly payment is usually lower. What you should do next is use the savings and add it to your principal. For example, lets say you have a mortgage payment of $900/month and credit card payments of around $500/month. You have about 28 years left on your debt payment. That's $1400/month. When you consolidate them, lets assume your new monthly payment will be $1100/month. You saved $300/month, but now you are in debt for another 30 years. Most banks will stop here and let you figure out what to do with the savings. I only know one company that shows you how to get smart with your money and get out of debt sooner. Note: When you consolidate or refinance, interest rate does not matter. Its the rate at which you pay that matters. The larger the loan and the longer it takes you to pay, the more it cost you to pay.
Third option is to start living below your income. That means, don't spend too much. Whatever income you make, save 10-15% of it. By the time you retire, you will be better off than the rest of the country.
Fourth option is to seek professional help if you are unable to control your spending. Spending above your income means that you are not saving anything for your future. If you want to live a happy life when you retire, you better control your spending habits and start saving.
Fifth option is to pay more than minimum amount. That way you are paying off the principal faster.
Sixth option is to utilize some or all the options above and just do it. Don't wait tommorow, or next week, or next month, when then turn to years and years and years and then you forgot about it.
Seventh option is educate yourself of the products and do research about the company. Read all fine prints before signing any documents.
Sunday, January 21, 2007
Endowment Insurance and Modified Endowment
Prior to Tax Reform Act of 1984, there was a growing popularity of purchasing Endowment Insurance. Like other life insurance, the policy will pay the death benefit if the insured dies within the policy period. What makes it different from other life insurance is that it also pays if the insured lives to the end of the policy period. Like Whole Life, Endowment contracts combine the features of equity growth and protection with more emphasis on the build up of equity in the cash value.
Endowment contracts can mature in either two circumstances. It will pay a death benefit if the insured dies within the endowment period OR it will pay the cash value that is equal to the face amount if the insured lives to the endowment date. Therefore, the cash value must be build at an accelerated rate so that by the end of the policy period, the cash value would equal the face value that is payable to the insured.
Let's say that you bought a 10 Year Endowment policy in 1983 with $50,000 coverage. If you die on or before 1993, your beneficiary will receive the $50,000. If you live after 1993, you will receive $50,000 and no longer be covered.
As you can see, this product sounds very good because there is rapid growth of cash value, your cash value grows tax-deferred, and there is possibility of escaping income taxes if the insured dies and the proceeds were paid as a death benefit. But the disadvantages of having this policy is that you need to pay lots of premiums and you will owe income taxes if you live to the endowment date or age.
Let's say you bought an Endowment at age 65 policy with $100,000 policy. Over the life contract, assume you paid a total of $70,000 of premiums into the policy. When you receive the $100,000, the IRS will tax you the difference between what you paid and what you received, which is $30,000.
In 1984, the marketing of Endowment Insurance ended under the 1984 Tax Reform Act. Since the contract placed more emphasis on accumulation of cash value and relatively little emphasis on death protection, the product was viewed more an as investment contract rather than a life insurance policy. The act says that the cash value in a contract can build no faster than to equal to the face value when the insured reaches age 95. If any policy builds cash value more rapidly than this benchmark, it loses most or all of its tax advantages such as tax deferred growth and no income tax on death benefit.
MODIFIED ENDOWMENT CONTRACT
4 years later after the 1984 Tax Reform Act, Congress pass another act in 1988 called Technical and Miscellaneous Revenue Act. This law says that if a policy creates a cash value faster than that of 7-pay Whole Life Policy, then the policy is a Modified Endowment Contract. Whether its Whole Life, Universal Life, or Variable Life, if the cash value grows faster than a 7-Pay Whole Life policy, then any loan or withdrawal must be made with the understanding that taxable dollars comes out first, then the return premium (which are made with after-tax dollars) dollars. Furthermore, there is a 10% penalty in addition to any taxes due on all withdrawals prior to age 59 1/2.
So if you are trying to accelerate the cash value, don't accelerate too much on what it should be in 7 years. For example, if the cash value is suppose to worth $3000 in 7 years, and you put in more premiums to accelerate the growth, your cash value may be worth more than $3000 in 7 years. If it does, your policy is now a Modified Endowment Contract and it will stay that way for life of the contract.
Endowment contracts can mature in either two circumstances. It will pay a death benefit if the insured dies within the endowment period OR it will pay the cash value that is equal to the face amount if the insured lives to the endowment date. Therefore, the cash value must be build at an accelerated rate so that by the end of the policy period, the cash value would equal the face value that is payable to the insured.
Let's say that you bought a 10 Year Endowment policy in 1983 with $50,000 coverage. If you die on or before 1993, your beneficiary will receive the $50,000. If you live after 1993, you will receive $50,000 and no longer be covered.
As you can see, this product sounds very good because there is rapid growth of cash value, your cash value grows tax-deferred, and there is possibility of escaping income taxes if the insured dies and the proceeds were paid as a death benefit. But the disadvantages of having this policy is that you need to pay lots of premiums and you will owe income taxes if you live to the endowment date or age.
Let's say you bought an Endowment at age 65 policy with $100,000 policy. Over the life contract, assume you paid a total of $70,000 of premiums into the policy. When you receive the $100,000, the IRS will tax you the difference between what you paid and what you received, which is $30,000.
In 1984, the marketing of Endowment Insurance ended under the 1984 Tax Reform Act. Since the contract placed more emphasis on accumulation of cash value and relatively little emphasis on death protection, the product was viewed more an as investment contract rather than a life insurance policy. The act says that the cash value in a contract can build no faster than to equal to the face value when the insured reaches age 95. If any policy builds cash value more rapidly than this benchmark, it loses most or all of its tax advantages such as tax deferred growth and no income tax on death benefit.
MODIFIED ENDOWMENT CONTRACT
4 years later after the 1984 Tax Reform Act, Congress pass another act in 1988 called Technical and Miscellaneous Revenue Act. This law says that if a policy creates a cash value faster than that of 7-pay Whole Life Policy, then the policy is a Modified Endowment Contract. Whether its Whole Life, Universal Life, or Variable Life, if the cash value grows faster than a 7-Pay Whole Life policy, then any loan or withdrawal must be made with the understanding that taxable dollars comes out first, then the return premium (which are made with after-tax dollars) dollars. Furthermore, there is a 10% penalty in addition to any taxes due on all withdrawals prior to age 59 1/2.
So if you are trying to accelerate the cash value, don't accelerate too much on what it should be in 7 years. For example, if the cash value is suppose to worth $3000 in 7 years, and you put in more premiums to accelerate the growth, your cash value may be worth more than $3000 in 7 years. If it does, your policy is now a Modified Endowment Contract and it will stay that way for life of the contract.
Wednesday, January 17, 2007
Whole Life Insurance - Nonforfeiture Options
If you own a Whole Life policy for awhile now, you may be wondering on how to recover your cash value. Before I go on, please note that nonforfeiture really means "surrender" value.
In one point of time in the life insurance industry, if you did not pay your premiums and fail to pay it by the end of the grace period, your policy will lapse and you would forfeit any equity held in the policy. In response to this problem, many life insurance companies adopted the nonforfeiture option, which means you are allowed to stop paying premiums and not forfeit any of the equity in the policy. In simple terms, you have three options on how you want to surrender your policy. The amount of cash value will be reduced by any loans you have taken out of it, whether directly or indirectly. What I mean by directly is that you made a call to the insurance company that you want to borrow the cash value for whatever reasons. By indirectly, you did not pay your premiums, so the insurance company used your cash value to keep the policy active.
These are three different nonforfeiture options you can take:
1) Cash. Simply put, you surrender the policy and take the cash value. If you choose this option, you will not be able to reinstate your policy.
2) Reduced Paid-Up Insurance. This is where you give up the current face value of your policy and use your cash value to purchase a lower face amount. Your policy may be reinstated to original policy within the given time frame that is stated in the original policy (typically 3-5 years).
3) Extended Term Insurance. This is the default option if you do not choose a nonforfeiture option. This is where the face amount in your policy remains the same, but you use your equity to purchase a term policy. The length of this term is equal to number of years you have paid your premiums. For example, if you purchase a policy at age 30 and stop paying at age 50, your policy will last under 20 years and 350 days. You may reinstate the original policy within a given time frame. This option is usually not available in rated policies, meaning your health, habits, or occupation is deemed high risk.
In one point of time in the life insurance industry, if you did not pay your premiums and fail to pay it by the end of the grace period, your policy will lapse and you would forfeit any equity held in the policy. In response to this problem, many life insurance companies adopted the nonforfeiture option, which means you are allowed to stop paying premiums and not forfeit any of the equity in the policy. In simple terms, you have three options on how you want to surrender your policy. The amount of cash value will be reduced by any loans you have taken out of it, whether directly or indirectly. What I mean by directly is that you made a call to the insurance company that you want to borrow the cash value for whatever reasons. By indirectly, you did not pay your premiums, so the insurance company used your cash value to keep the policy active.
These are three different nonforfeiture options you can take:
1) Cash. Simply put, you surrender the policy and take the cash value. If you choose this option, you will not be able to reinstate your policy.
2) Reduced Paid-Up Insurance. This is where you give up the current face value of your policy and use your cash value to purchase a lower face amount. Your policy may be reinstated to original policy within the given time frame that is stated in the original policy (typically 3-5 years).
3) Extended Term Insurance. This is the default option if you do not choose a nonforfeiture option. This is where the face amount in your policy remains the same, but you use your equity to purchase a term policy. The length of this term is equal to number of years you have paid your premiums. For example, if you purchase a policy at age 30 and stop paying at age 50, your policy will last under 20 years and 350 days. You may reinstate the original policy within a given time frame. This option is usually not available in rated policies, meaning your health, habits, or occupation is deemed high risk.
Ways to purchase a Whole Life policy
With whole life, there are several options in which you can purchase this policy. Though, if you read my argument why term is better, you wouldn't bother with whole life in the first place. But, if you are still going to get Whole Life, here are several ways you can purchase it. Please note: Whatever purchase plan you take, you are covered for life!
1) You can make one lump sum payment, which is called Single Premium. Whatever coverage you choose, you can pay all the premiums in one payment. This is the least popular method since most people don't have over $20,000 in their hands. How much you need to pay is calculated on how long you are expected to live (your life expectancy).
2) You can make installment payments, which are called limited-pay. In this plan, you make payments over a given period of time or until a certain age. Limited-Pay Whole Life policies are commonly referred to in terms of their payment period, such as 20-Pay Life or Life Paid at 60. While your policy is paid up at a specific age, coverage continues for the whole life.
3) The final and most popular payment is paying continuously, which is also known as Straight Life or Continuous Premium. In this plan, you make payments until you death or until age 100, whichever comes first. In Straight Life Whole Life, you are not obligated to continously pay until you die or when you reach age 100. You may skip your premiums at anytime and not forfeit your equity in your policy. This is called nonforfeiture option. You may take the cash value of the policy or perhaps continue the full face value protection of your current policy for a fix period of time. To learn more about nonforfeiture option, click here.
In conclusion: 1) The shorter premium payment period, the higher annual premium. 2) The higher the premium per thousand face amount, the faster growth of cash value.
1) You can make one lump sum payment, which is called Single Premium. Whatever coverage you choose, you can pay all the premiums in one payment. This is the least popular method since most people don't have over $20,000 in their hands. How much you need to pay is calculated on how long you are expected to live (your life expectancy).
2) You can make installment payments, which are called limited-pay. In this plan, you make payments over a given period of time or until a certain age. Limited-Pay Whole Life policies are commonly referred to in terms of their payment period, such as 20-Pay Life or Life Paid at 60. While your policy is paid up at a specific age, coverage continues for the whole life.
3) The final and most popular payment is paying continuously, which is also known as Straight Life or Continuous Premium. In this plan, you make payments until you death or until age 100, whichever comes first. In Straight Life Whole Life, you are not obligated to continously pay until you die or when you reach age 100. You may skip your premiums at anytime and not forfeit your equity in your policy. This is called nonforfeiture option. You may take the cash value of the policy or perhaps continue the full face value protection of your current policy for a fix period of time. To learn more about nonforfeiture option, click here.
In conclusion: 1) The shorter premium payment period, the higher annual premium. 2) The higher the premium per thousand face amount, the faster growth of cash value.
Monday, January 15, 2007
Universal Life Insurance and Variable Universal Life
Universal life (UL) combines the flexibility of Adjustable Life with the higher earnings potential of Variable Life. Before I break this policy down, lets briefly mention a few of the benefits:
Universal life is an increasing term policy where the cost of having insurance increases internally and less premiums goes toward the cash value. For example, lets say you pay initially pay $100/month for a $100,000 coverage. $10 of it goes toward the insurance and $90 goes toward the cash value. Next year, the cost of insurance goes up to $12, and $88 goes toward the cash value. Every year, the cost of the insurance goes up and less premiums goes toward the cash value. Eventually, the cost of insurance will equal to $100 and $0 goes toward the cash value. A year after that, the cost of insurance will be $110 and if you don't pay the extra $10, the $10 will be deducted from the cash value. What if you don't want to pay the new premium? Then $110 will be deducted and premiums will continue to rise.
I had a client who had a universal life policy with $20,000 coverage when the premiums were initially $318/year and 25 years later, it jumped to $383/year. It had about $10,600 in cash value after surrender charges. The policy eventually paid dividends that was enough to cover the premiums. It paid dividends every year for awhile. Eventually, something happened and no dividends were paid out. She didn't pay her premiums, so what happen next is the cash value was automatically used to pay the premiums. When I was about to do a 1035 exchange, I found out that there was a loan balance of around $800. So I had her pay the balance off to avoid taxes and moved the entire $10,600 cash value into a variable annuity. 6 months later, the variable annuity was worth around $11,300 and she didn't make any contributions to it. I'm not going to talk about variable annuities, but the main point is that universal life insurance is not that great as it seems. Don't be fooled when an agent says that policy pays dividends because they are not guaranteed. Plus, the cost of the insurance increases internally. You don't notice it because the premiums remain about the same for awhile. Eventually, your premiums will go up too. If you have a universal life policy, you should check it out yourself.
- UL can imitate any of the traditional insurance products - whole life to term insurance to Endowment at age 95
- UL is PERMANENT INSURANCE. Even though the protection element of the policy is ALWAYS INCREASING TERM INSURANCE, the contract can provide coverage until death or around age 95
- As with Adjustable Life, death benefits can be raised (with evidence of insurability) or lowered.
- As with Variable Whole Life, cash value can grow at a much higher rate of interest, but
- unlike Variable Whole Life, there is a minimum guaranteed rate of interest.
- Though policy loans can work just as they do with other cash value policies, it is also possible to make a cash withdrawal (partial surrender) from a UL policy that neither has to be repaid nor requires the payment of interest. Principle comes out first, therefore tax consequences are minimal.
- Premiums are even more flexible than with Adjustable Life as they can be raised, lower, or even skipped entirely. (known as "Stop and Go" feature).
- It is possible to structure UL so that the cash value is paid in addition to the death benefit.
This is how UL work. Each time you pay your premiums, your premium is first credited to a fund, which is call the cash value. Soon, the amount of cash value not only reflects how much you paid, but also what the company has earned. In your cash value, there is a guaranteed minimum of interest, which is usually around 4%. There is also a current rate, which reflects what the company is truly earning on the money. These rates will vary with market conditions. Historically, they have range from 5% to 8% in the past few years. As with other cash value policies, cash value grows tax-deferred. From the cash value, the money is taken to pay company expenses such as commission, premium taxes, administrative costs, on a monthly basis. The money is also taken to purchase term insurance, which is always the protection element of a UL policy.
Unlike traditional policies that force what the cash value should be, you can choose how much cash value you want. The more premiums you pay, the greater the cash value will be. The less premiums you pay, the lesser the cash value. When you purchase a UL policy, you are typically quoted two numbers, a minimum premium and a target premium. If you pay the minimum premium, your UL will closely resemble Term insurance. There will be almost no build up of cash value. If you pay the target premium, the policy will function similar to a Whole Life policy. Based upon interest rates guaranteed in the policy, the cash value would equal the face value when you are between the ages of 95 to 100. If you pay more than the target premium, the policy can work similar to an Endowment insurance. Of course, federal laws dictate that cash value cannot build faster than a Seven-Pay Whole Life contract, which means the growth of the cash value cannot be more than what the value of the cash value should be in 7 years. Therefore, you cannot put bunch of money into the policy in attempt to avoid taxes.
As your cash value grows, you may be able to skip your premiums. This doesn't mean you are not paying it directly. Your cash value is used to pay the minimum premium. Depending on how much cash value you have in the policy and the rate at which the money is earning, it is possible to avoid paying the premiums for quite a long time.
You also have death benefit possibilities. You can decrease your coverage anytime and increase your coverage (with proof of insurability). There are two options on how you want your policy to work.
Option 1 or Option A: Your death benefit remains level and the policy can either pay the death benefit or cash value, not both. As time grows, your death benefit remains level, but your cash value grows. As your cash value grows, you are purchasing less and less term insurance to fund your desired death benefit. And this need for less Term insurance comes exactly at the time when Term begins to get expensive. Remember, cash value cannot grow faster than a Seven-Pay Whole Life policy. If you make any cash value withdrawals and you don't pay it back, your death benefit will be reduced. When the cash value nears the value of the face amount, your cash value will raise the death benefit.
Option 2 or Option B: Your death benefit grows as your cash value grows. You don't know how much death benefit you will have at any given time. All you know that the death benefit will be the face amount plus whatever cash value happens to be when you die. The problem with this option is that the cost of Term insurance gets more expensive as you get older. Most policy owners switch from Option 2 to Option 1 because the cost of Term will be simply too expensive.
Unlike whole life insurance, the death benefit and the cash value are kept completely separate. This allows you to see how much you are paying for Term protection and exactly what is earning in your cash value. In many respects, UL was created in response to "buy term and invest the difference." The UL allows the insurance industry to respond, "Okay, buy our Term and invest the difference with us on a tax-deferred basis."
VARIABLE UNIVERSAL LIFE
There nothing much to talk about here. It contains almost all the same features of a regular Universal Life except: (1) Your cash value is invested in the market, therefore (2) there is no guarantee interest. Variable Universal Life is considered a security and agents selling this product must have a life license and a securities license.
Here is something you should really take a look at if you have a universal life policy:Universal life is an increasing term policy where the cost of having insurance increases internally and less premiums goes toward the cash value. For example, lets say you pay initially pay $100/month for a $100,000 coverage. $10 of it goes toward the insurance and $90 goes toward the cash value. Next year, the cost of insurance goes up to $12, and $88 goes toward the cash value. Every year, the cost of the insurance goes up and less premiums goes toward the cash value. Eventually, the cost of insurance will equal to $100 and $0 goes toward the cash value. A year after that, the cost of insurance will be $110 and if you don't pay the extra $10, the $10 will be deducted from the cash value. What if you don't want to pay the new premium? Then $110 will be deducted and premiums will continue to rise.
I had a client who had a universal life policy with $20,000 coverage when the premiums were initially $318/year and 25 years later, it jumped to $383/year. It had about $10,600 in cash value after surrender charges. The policy eventually paid dividends that was enough to cover the premiums. It paid dividends every year for awhile. Eventually, something happened and no dividends were paid out. She didn't pay her premiums, so what happen next is the cash value was automatically used to pay the premiums. When I was about to do a 1035 exchange, I found out that there was a loan balance of around $800. So I had her pay the balance off to avoid taxes and moved the entire $10,600 cash value into a variable annuity. 6 months later, the variable annuity was worth around $11,300 and she didn't make any contributions to it. I'm not going to talk about variable annuities, but the main point is that universal life insurance is not that great as it seems. Don't be fooled when an agent says that policy pays dividends because they are not guaranteed. Plus, the cost of the insurance increases internally. You don't notice it because the premiums remain about the same for awhile. Eventually, your premiums will go up too. If you have a universal life policy, you should check it out yourself.
Thursday, January 11, 2007
Annuities: Payment or Purchase options
There are three ways to buying an annuity. The first would be called single payment immediate. This means you give the insurance company a lump sum of money and within 30 days or so, you will begin receiving these payments for life. This is most suitable for someone who is near retirement or above age 59 1/2.
The second payment option is called Single Payment Deferred Annuity. That means you give a lump sum of money to the insurance company and the company will invest it for you until the time you choose to begin payout. During this time, your investments grow tax deferred. Most lottery winners choose these payment option. And many professional athletes that earns millions of dollars are given a single payment deferred annuity by their team or employers as a form of future compensation.
The third payment option is called Periodic Payment Deferred Annuity. This is most suited for someone who doesn't has a large sum of money. So, they will elect to put money in the annuity on a monthly, quarterly, or annual basis. Many variable annuities require a minimum balance of $5000 or more. If you don't have that kind of money, you can setup a periodic schedule of payments in which you can put in a minimum of around $250/month or so (depending on what the prospectus says).
The second payment option is called Single Payment Deferred Annuity. That means you give a lump sum of money to the insurance company and the company will invest it for you until the time you choose to begin payout. During this time, your investments grow tax deferred. Most lottery winners choose these payment option. And many professional athletes that earns millions of dollars are given a single payment deferred annuity by their team or employers as a form of future compensation.
The third payment option is called Periodic Payment Deferred Annuity. This is most suited for someone who doesn't has a large sum of money. So, they will elect to put money in the annuity on a monthly, quarterly, or annual basis. Many variable annuities require a minimum balance of $5000 or more. If you don't have that kind of money, you can setup a periodic schedule of payments in which you can put in a minimum of around $250/month or so (depending on what the prospectus says).
Annuities Settlement or Payout Options
What are your settlement options (or payout options)? There are several settlement options you can pick. First one is called the straight life annuity. This is the largest monthly payout option of all three. What this option do is that you want to receive monthly payments for life and don't want anyone else to have it in case you die. If you die before your life expectancy, the insurance company retains the balance of the account. If you outlive the life expectancy, then you have receive more money than what was expected to pay out. It's a high risk scenario for you and the insurance company. You hope to live longer than expected and the insurance company hope you die sooner than expected.
Second settlement option is life annuity with period certain. That means if you die during a certain period of time, your beneficiary will receive the rest of the annuity payments until the period ends. For example, if you elected a life annuity with 10 year period certain and you die during the fifth year, the insurance company will continue paying your beneficiary for the next 5 years. Remember, annuities pay you, the owner, for life. So after the tenth year, you will continue to receive payments, but your beneficiary will not in the event of your death. Periods can be as long as 15 years or 20 years in some companies.
The third settlement option is called Joint and Survivor annuity. That means, you will be paid a monthly benefit as long as you live. Upon your death, a predetermined percentage of your monthly payout will continue to be paid to your beneficiary until that person dies. The percentage varies between companies and can be low as 50% or high as 100%. You may be able to negotiate this percentage. The higher the percentage you pick, the lower the monthly payments you will receive. This settlement option has the least risk to you and therfore, has the smallest monthly payment of all three options. "Lower risk = lower rewards. Higher risk = higher rewards."
The forth settlement option is called Lump Sum Settlement Annuity. As it says, you want to take the whole balance of your account in one lump sum. This puts your investments in your hands and you accept all risks on what you plan to do with it. You will avoid the risk of getting less thatn a full return of your invested capital plus earnings. The drawback of receiving a lump sum is that the IRS will know that you have receive large amount of income and this may push you up in a higher tax bracket.
For example lets say the value of your account at the time you taken the lump sum was $150,000. $65,000 of it was from your own contributions and the other $85,000 was from earnings. If you taken the lump sum of $150,000 you will need to report the $85,000 as ordinary income on your 1040 tax form. Depending on what your normal income was, this may put you in a higher tax bracket than you normally were. Most people will not take the lump sum option because they don't know what to do with all the money. They can put it in a bank account, but they will lose the earning power that the money can generate if it were invested in the stock market.
Another payout option is called installments of designated amounts. That means a specified amount is paid every month until the account is exhausted, after which no further payments are paid. Its similar to a mutual fund withdrawal. Another payout option is called investment income, which the principal is left intact and payments only consist of the earnings. At death, the principal amount is paid in one lump to the beneficiary. Both of these payout options benefits the beneficiaries more than the primary annuitant.
Second settlement option is life annuity with period certain. That means if you die during a certain period of time, your beneficiary will receive the rest of the annuity payments until the period ends. For example, if you elected a life annuity with 10 year period certain and you die during the fifth year, the insurance company will continue paying your beneficiary for the next 5 years. Remember, annuities pay you, the owner, for life. So after the tenth year, you will continue to receive payments, but your beneficiary will not in the event of your death. Periods can be as long as 15 years or 20 years in some companies.
The third settlement option is called Joint and Survivor annuity. That means, you will be paid a monthly benefit as long as you live. Upon your death, a predetermined percentage of your monthly payout will continue to be paid to your beneficiary until that person dies. The percentage varies between companies and can be low as 50% or high as 100%. You may be able to negotiate this percentage. The higher the percentage you pick, the lower the monthly payments you will receive. This settlement option has the least risk to you and therfore, has the smallest monthly payment of all three options. "Lower risk = lower rewards. Higher risk = higher rewards."
The forth settlement option is called Lump Sum Settlement Annuity. As it says, you want to take the whole balance of your account in one lump sum. This puts your investments in your hands and you accept all risks on what you plan to do with it. You will avoid the risk of getting less thatn a full return of your invested capital plus earnings. The drawback of receiving a lump sum is that the IRS will know that you have receive large amount of income and this may push you up in a higher tax bracket.
For example lets say the value of your account at the time you taken the lump sum was $150,000. $65,000 of it was from your own contributions and the other $85,000 was from earnings. If you taken the lump sum of $150,000 you will need to report the $85,000 as ordinary income on your 1040 tax form. Depending on what your normal income was, this may put you in a higher tax bracket than you normally were. Most people will not take the lump sum option because they don't know what to do with all the money. They can put it in a bank account, but they will lose the earning power that the money can generate if it were invested in the stock market.
Another payout option is called installments of designated amounts. That means a specified amount is paid every month until the account is exhausted, after which no further payments are paid. Its similar to a mutual fund withdrawal. Another payout option is called investment income, which the principal is left intact and payments only consist of the earnings. At death, the principal amount is paid in one lump to the beneficiary. Both of these payout options benefits the beneficiaries more than the primary annuitant.
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