Get Financially Fit!

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We make a living by what we get, but we make a life by what we give.
-Winston Churchill

While few of us want to think about the possibility of dying, none of us want to consider dying without a solid estate plan.  Imagine the fate of your children, pets, and wealth being decided by the courts.  According to the US government, half of Americans die without completing a will. My challenge to you this month is for you to either start or improve your estate plan.

Here are the essentials to establishing a solid estate plan:

1. Carry adequate life insurance for your survivors
2. Update your beneficiary information on your retirement and investment accounts.
3. Compete a will
4. Complete a medical directive and assign your healthcare proxy
5. Give while you are alive.

Let’s review these points one at a time.

Carry adequate life insurance for your survivors.
Inadequate life insurance is one of the most unfortunate scenarios for a surviving family. Not only do the survivors have to grieve the loss of a loved-one, but also face the long-term financial stress of making ends meet. It’s important to have the right amount of life insurance, the right type of life insurance, and to shop competitively.

Determine the amount of required life insurance by considering the money needed to pay off the house, pay for childcare, pay for college education, and replace missed wages. A general guideline is to buy 10 times your annual income.  This would mean that a person earning $50,000 per year would consider a $500,000 term policy. Also recognize that a life insurance policy on a non-working spouse makes sense to provide for care of children. The bottom line question is, how much money would the family need if there is an unexpected death of a parent?  If nobody is dependent on your income then life insurance is not needed.

I recommend the purchase of level term life insurance. Level term life insurance means that the death benefit remains the same during the life of the policy. A 40-year non-smoker male can purchase 20-year level policy with a $500,000 life insurance benefit for about $450 per year. The actual price will change with age, health, and the number of policy years. Avoid whole life insurance products that combine life insurance with investments. Whole life investment insurance is very expensive and aggressively sold by sales people seeking large commissions. Better to buy level term life insurance and do your own investing. Recognize that you won’t need life insurance once you achieve retirement security or financial independence. Good places to start your search are Insure.com and termassistant.com. These companies competitively shop among life insurance companies for you. Make sure to purchase from a life insurance company that is rated A or higher.

Update your beneficiary information in your retirement accounts.
Did you know that your beneficiary designations in your retirement accounts (401K, 403b, IRA, pension, etc) take priority over the wishes of your will? It’s therefore important to review and update your beneficiary information annually. Updating beneficiary information is quite easy today, especially with online accounts. I recommend that you take 30 minutes today and review your beneficiary designations.

Complete a will.
What happens if I don’t complete a will? The courts will appoint an executor who will assign guardianship for your children and distribute your wealth within the limits of the law. Therefore the most important reason to complete a will is to insure that your wishes are executed in a timely manner. Here are examples of important instructions that you can have within a will.
• Naming an executor who will carry out your wishes.
• Naming a guardian to care for your children
• Instructions for distribution of wealth and possessions.
• Instructions for care of your pets.

I recommend a two-step process to setup your will. First complete a will (one for each spouse if married) on your own using an Internet site or standardized legal forms. Completing a will online is easy and quick - the most difficult part is making decisions about your wishes. This will save you money since you will not be paying an attorney by the hour to ask you questions. In my search for a simple and inexpensive online will, I discovered Build A Will. Their process is intuitive and you can complete a will for any state for under $30. Once your will is complete, then have it reviewed by an attorney to both insure that you aren’t missing something significant and to insure that it’s legally binding.

You may also consider setting up a trust if you have significant wealth, have a complicated situation such as a blended family, or want to avoid the risk that your will may be challenged. A trust can’t be challenged as it avoids the court probate process. A trust is best created and maintained with the services of an attorney.

As you can imagine it’s important that a copy of your will is assessable to your attorney (if applicable), your executor, and other close family. It’s also a good idea to review your wishes with your executor to further insure your wishes are carried out.

Complete an advanced directive and identify your healthcare proxy
In addition to your financial wishes, it’s important that your medical wishes are followed. This is best done by completing an advanced directive and naming your healthcare proxy.

You can obtain an advanced directive application at the National Hospice and Palliative Care Organization (NHPCO).  After you have completed the forms it’s important provide a copy to your physician, spouse, close family, and friends. Also review your advanced directive with the person who you assign as your healthcare proxy.

It’s advisable to assign a healthcare proxy. This is also known as your durable medical power of attorney. Use a durable medical power of attorney form to identify the person who will make medical choices for you in the event that you cannot.

Give while you are alive
The title is self-explanatory. Giving while you are alive is great way to insure that your wishes are fulfilled. You may also choose to invest in your family legacy by investing in education for your children or grandchildren, contributing to your favorite charities, or creating memories for your heirs by taking them on a vacation.

One key advantage of giving while you are alive is that you can see first hand the benefits. Additionally you can adopt and modify your giving based on the results that you observe.

Life Application
Now is the time to start or improve you estate plan. Completing an estate plan will give you the peace of mind knowing that your wishes will be followed.

 Little things done well over and over are far more important
than spectacular achievement done every once in a while.
-Richard Quick

What are the best and worst financial decisions that you’ve made?  I’m sharing my best and worst financial decisions to encourage you to focus on your next improvement step. 

The best personal finance decision that I have made was contributing to my 401k from a young age.  The worst personal finance decision was not putting down 20% on a real estate purchase.    

In my last year of college, I took an engineering economics course.  In this class I learned about the importance of investing early for retirement.  For example, if you invest the same amount of money over time into the stock market, half of your final portfolio will come from the contributions that you made during the first 7 years.  This is because after 7 years your portfolio will earn returns equal to your contributions. 

When I started working I worked with an engineer who was 10 years older than me.  He educated and coached me on the importance on starting 401k investment.  He regretted  that he didn’t start his 401k contributions immediately.  I pass along the challenge to everyone to both start retirement savings as early as possible and contribute as much as you can.  At this point in my life I can see the benefits of starting retirement savings from a young age.   

The worst decision that I ever made was purchasing real estate without putting down a 20% down payment.  I wanted to own real estate so bad that I purchased a condo with only 5% down.   A key lesson that I learned is to be patient and save sufficiently.  I wish I could have learned my lesson from reading about it versus paying expensive tuition.   

Whatever your best and worst personal financial decisions,  I believe we can all make significant improvement by by focusing on continuous improvement.  I encourage you to focus on the following question:  What next action can I take to day to improve my personal finances?   To help you get started in improving your personal finances, I am sharing worksheets and templates from my book, Get Financially Fit! 

Goal Setting Templates  Goal-Setting-Template.pdf
   Related article:  Write down your goals
 
Financial Steps Financial-steps.pdf
   Related article:  Create a financial plan

Financial Fitness Survey  financial-fitness-survey.pdf
    Related article: Take the financial fitness test

Debt Elimination Debt-Elimination-Worksheet.pdf
   Related article: Eliminate Debt

Follow your dreams, Achieve your goals!

Question:
I just received some unexpected money, what do your recommend that I do with the money?

A Roth IRA is a great retirement savings vehicle. Money is invested with after tax dollars and grows tax-free. When you withdraw your money in retirement you do not pay taxes. Let’s review income limits, contribution limits, and the easiest way to get started.

Individuals are allowed to invest $5000 in 2008 (if you are over 50, you can add an additional $1000) as long as their adjusted gross income is less than $101,000. The adjusted gross income is shown on line 4 on a 1040EZ tax form, it’s on the bottom of page 1 for a regular 1040 form. If you make between $101,000 and $116,000 the allowed contribution is gradually phased out. Above an adjusted gross income of $116,000 a Roth IRA contribution is not allowed. A married couple can invest $5000 each as long as the combined adjusted gross income is less than $159,000. Above an adjusted gross income of $169,000 the allowed contribution is phased out. If you exceed these income limits then you can invest in a traditional IRA.Starting a Roth IRA is easy.

The easiest investment option for starting your Roth IRA is to use a lifecycle retirement fund.  All that you need to do is identify the year that you want to retire.   For example if you want to retire in 2035, you would invest in a 2035 lifecycle retirement fund.  Lifecycle retirement funds automatically transitions from a high percentage of stock market investments  (typically 80% stocks for young investors) and transition to a balance of 50% stocks and 50% bonds.  Your main job is to add money, the fund automatically takes care of the asset allocation (the mix of stocks and bonds).  Recently most lifecycle funds have added a small percentage of international investments.   

To get started simply contact a low expense no-load mutual fund company (such as Vanguard or Fidelity) by visiting their web site or by telephone.  I like Vanguard and Fidelity because they use low cost index funds in their lifecycle retirement funds.  Vangaurd calls their lifecycle retirement funds Target Retirement Funds and Fidelity call their the Freedom Funds.  

I really like and recommend lifecycle funds for retirement because I think it’s most important for people to get started with retirement savings.  The next most important tasks are increasing the savings rate and then evaluating if you want to take a more proactive role in choosing index and no-load mutual funds.

Follow your dreams, Achieve your goals!

A small house can hold as much happiness as a big one.
         –Chinese Proverb

Purchasing and owning a home is a cornerstone of the American Dream.  This dream is poignantly captured by a recent quote that I heard from a woman,  “My dream is to own a small yellow house with a blue door; every other Sunday I will have my family and friends over for dinner.”  The fulfillment and benefits of owning a home can be significant. For example, when you own a home, you experience an increase quality of life from both having housing stability and having your own safe retreat from the stresses of life.  Buying and owning a home does have its risks and pitfalls though. For example, it’s important that you don’t overstretch yourself with too much house.

I recommend that you implement the following strategies to maximize your success with buying and owning a home:
1. Be patient and selective in your home choice.
2. Make a significant down payment.
3. Finance with a fixed mortgage.
4. Purchase a home appropriate for your income.
5. Build increasing equity in your house.

Let’s review these points one at a time.

Be patient and selective in your home choice.
Most people desire to minimize the frequency of buying and selling houses to minimize both transactions costs (real estate and mortgage fees) and the significant amount of work required to move. I recommend that you treat buying a house as a significant project. When making any significant purchase it’s best to clearly list out your requirements and preferences and take adequate time to make a wise purchase.

Clearly defining your purchasing musts and wants will prevent you from buying a house that doesn’t meet your needs. List out important factors such as the number of bedrooms, number of bathrooms, single or double story, proximity to your work place, size of garage, and of course price. Then define each factor as a must or a want. If you are married, I recommend that requirements and preferences are listed individually and collectively.

When you are in the process of buying a house, you will likely experience pressure from both real estate agents and mortgage brokers to proceed quickly. You may hear comments such as, “This house won’t last long at this price” or “You should move to lock in these interest rates.” This occurs when these people prioritize their interest of making money ahead of your interest of making the right purchase. I recommend that you ignore these pressures and take the time to be confident in your purchasing decision. When my wife and I purchased our house we took nine months to buy. By the time we purchased we knew exactly what we wanted and the fair market value of homes for sale.

Make a significant down payment
We are currently going through a national housing price correction that reminds us that putting no-money-down is a bad strategy. No-money-down mortgages are appealing because the enables people to get into a house, but can be painful when real estate values decline and people need to sell their house. I recommend that you make a 20% down payment on your house. At 20% you do not have to pay mortgage insurance (mortgage insurance is insurance paid by the borrower but provides protection for the lender). Of course, another advantage of paying 20% down is that your mortgage payment is lower. This is important because, many people underestimate increased expenses associated with owning a house. For example, you may need to pay for landscaping your yard, you may purchase furniture, and you may make home improvements.

Finance with a fixed mortgage
Traditionally most mortgages were sold with a fixed interest rate. This means that the interest rate charged (and thus the payment) was the same over the loan period. There has been a dramatic increase in the sale of adjustable rate mortgages. There are a wide variety of adjustable rate mortgage, but the most common ones have a period of time where the interest rate is fixed (five years for example), and then the interest rate changes annually based on the prime interest rate. If you are confident that you will be in a home for only five years, an adjustable rate mortgage may be appropriate. People are attracted to adjustable rate mortgages because the initial low interest rates enable them to purchase more house. The dilemma with adjustable rate mortgages is that if interest rates increase then your payments increase accordingly. Given that the majority of people don’t get a pay raise when interest rates increase, it’s more prudent to buy with a fixed interest rate. I recommend purchasing a house with a 15 or 30 year fixed mortgage. Be sure to compare the costs and rates of a mortgage from three different lenders.

Purchase a home appropriate for your income
Owning a home should bring fulfillment into your life; not increased stress. Banks and mortgage companies evaluate two ratios to determine your maximum mortgage. If you have no debt then the mortgage payment can be 28% of your gross income. The limit of your mortgage payment plus other consumer debts is 36%. For example, for a monthly income of $3000 the maximum mortgage would be $840 per month. If your income is $3000, you have an auto loan for $250, and a student loan for $200; then the maximum mortgage would be $630.

It’s important that you don’t take on too large of a mortgage. You will want to have incremental money for retirement savings, building up your rainy day fund, and sustaining a desirable quality of life. Before you purchase a home, mimic making a mortgage payment by saving the difference between your rent and the anticipated mortgage payment.

Build increasing equity in your house
In time, you will likely build equity in your house from the value of your house increasing, from improvements that you make, and from your mortgage principal decreasing in time. I recommend that you resist the temptation to take out home equity loans. I think that it’s a good idea to continuously improve your home over time. If you are energetic and skillful you may choose to make many improvements, if you hire professionals then you may initiate an occasional improvement. Home improvements provide an immediate increase in your quality of life. The long-term benefit of making improvements is that you should be able to sell your house easier if necessary. Home improvements typically don’t have full immediate payback, thus it’s best to limit the amount that is financed by a home equity loan.

Life Application
The next time that you purchase a home: slow down, enjoy the process, and make a great decision for your household. I recommend that you put down 20%, use a fixed interest rate mortgage, and limit your mortgage payment to 20% of your take home income. Once you own a home, continuously build equity by both avoiding equity loans and continuously improving and updating your home.

Follow your dreams, Achieve your goals!