Understand Your Insurance Policy Effectively

As a product, insurance has evolved dramatically over the past 50 years. There are so many different types that it can be difficult to know where you’re getting a great deal and when you’re being sold on something you don’t really need. When I was growing up my mother taught me something that would become the mantra upon which I would live my life: “Frustrations only come from unrealized expectations”. In an effort to set appropriate expectations, you need to know a few things about me.

1. I don’t sell insurance products
2. The way I view insurance is the way a typical tax advisor would, by the numbers
3. I believe that in part, insurance products exist to address emotions
4. I believe that insurance can be one of the lynch pins to financial success

Now, let’s dive into some of lowest hanging, most helpful fruit!

Why Buy Insurance?

As a Tax Advisor, you can imagine that I’m mostly rooted in facts and logic. Let’s first use logic to determine our motivation for buying insurance:

1. You’re legally required to have it
2. You must have it to satisfy the needs of a contract
3. The cost/benefit ratio is clearly in favor of carrying it
4. You’re using it as a tool to hedge against risk

Okay, now that pesky logic is out of the way, we’ll get our Freud on and consider some of the psychological reasons for purchasing insurance:

1. Fear (honestly, we could stop here)
2. Peace of mind – #1 and #2 may seem similar, but one is to keep you from feeling bad, the other to help you feel good. An important distinction!
3. Love – to protect and help your loved ones. You may carry life insurance for your heirs, so they don’t have to experience the same financial hardships you endured.
4. A friend or the internet told you that you needed it
5. You got sold (yuck!)

Work with someone you trust

I once worked with someone who retired after over 30 years with their employer. Through their own contributions and those of their employer, they had a significant retirement package. After meeting with a financial advisor, they rolled their entire retirement into a variable annuity, which is essentially a financial investment product with an insurance wrapper. Since this investment is rooted in insurance, these products can sometimes use the word “guarantee”, unlike most other financial investments regulated by the SEC which are barred from using that term. Following this purchase, my client then came to me, not fully understanding what they bought, and wanted some further clarification. After answering what I could, my client went back to the financial advisor and was very upset with what they were sold.

After another meeting, this financial advisor convinced them to surrender their insurance product, resulting in a fee of over $70,000, to then just go and buy a slightly different variable annuity, resulting in another commission for the advisor. When my client returned to me and explained what happened, I literally threw my hands up in the air in frustration.

Make sure you work with, or at least talk with, someone you trust when making important financial decisions!

Moving on from my soap-box moment…

Some insurance, depending on what state or country you live in, is required by law. For example, auto insurance is required to drive legally in the United States. Mortgage companies may require you to have an active homeowner’s insurance policy to borrow the funds when purchasing a home. Reasons to purchase insurance are easily found. The primary question is which reasons are the right ones? I’d love to just answer that seemingly simple question for you and wash my hands of the subject, but alas any simple answer addressing this question would be an oversimplification.

Some general, rule-of-thumb tips on buying insurance:

(disclaimer: I don’t sell insurance, I’m giving you tips from a financial perspective!)

1. If you are insurable, you should generally carry life insurance (how much to carry is another blog post entirely)
2. Work with someone you trust, or at the very least that someone you trust trusts
3. Keep records of your purchase that are accessible to your loved ones
4. Make sure to carry health insurance
5. Carry auto insurance if you own or consistently drive a vehicle
6. Know the value of your primary assets and insurance them
7. Know your medical history and plan accordingly. Short-term and long-term disability plans can take tremendous burdens off your loved ones.

Insurance and Taxes – Why Tax Advisors Love Insurance

Generally speaking, most pay-outs of insurance plans are not taxable. There are niche cases of course, such as business insurance that is deducted as a business expenses, which pays out and is then taxable income to the business. The more common forms, health, life, homeowner’s, disability, auto, and liability, are generally tax-free forms of insurance. Again, there are niche cases, so I’m speaking in general terms.

Term-Life  and Whole-Life

There are two primary types of life insurance, term-life and whole-life. Term-life insurance is a contract covering a period of years and is generally cheaper than the alternative. Whole-life insurance builds up a cash balance as you pay your premiums, which under certain plans can be drawn upon for tax-free distributions. It’s worth noting here that someone working as an insurance professional who has read this far has cringed at least once on a generalization that I’ve used. As a tax advisor I see so many similar oversimplifications regarding the tax code that can be very bothersome. I urge you again to work with a competent professional that you trust when determining your insurance needs.

Due to the tax advantages of many insurance products, you can imagine why tax advisors see tremendous value in certain types of insurance and how they fit into your tax and financial plan. To either have a financial plan that doesn’t include insurance, or not have a financial plan at all, is to set yourself up for future financial failure (try saying that five times fast). You cannot accidentally set yourself up for financial success, you have to get there through deliberate action. It doesn’t have to be hard either, with the help of competent, trustworthy professionals you can make small, consistent changes to help improve your financial health.

Let us know how we can help by reaching out to us directly at info@molentax.com.

You can learn more about personal financial health here: https://molentax.com/services/personal-family-budgeting/.

We also produce a podcast that’s perfect to listen to during your daily commute or when you’re looking for practical financial direction.

Give us a listen and submit your questions!

Kevin Molen, E.A.
Advisory Services Manager