Philadelphia Reflections

The musings of a physician who has served the community for over six decades

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Financial Planning for a Long Retirement

How should individual investors ensure they have enough money for retirement?

Such a person is often a professional or entrepreneur who has worked to accumulate the wealth. Legions of "advisors"line up to take this money and manage it or else to sell "products" that promise to solve some problem or other. Without this background, extra savings will be needed, to buy advice. And advice is not invariably reliable.

A person who has created his/her career and its wealth from scratch, can likely manage investments themselves, or at least supervise the process from a position of strength from observation. Reliable advice is not always cheap.

This collection of articles explains to the individual investor how to take control of their wealth. They may eventually decide to look for help from an advisor but they will retain control of their assets and they will know what to do.

Financial Planning videos on YouTube


Insurance is a good-news/bad-news story. On the one hand, "pure" insurance is very important and a very useful part of a person's financial plan. On the other hand, the insurance industry in the United States is a bit of a throwback to the days when financial services and utilities were heavily regulated.

The situation in the insurance industry today is somewhat like AT&T before telecommunications deregulation: AT&T was a regulated monopoly which prohibited competition, limited innovation and set uncompetitive prices. Had AT&T not been deregulated and broken up, it is very unlikely that we would have cell phones or the Internet.

The insurance industry for individuals and small businesses in the United States is actually 50 mini industries (plus a few more for territories like Puerto Rico). The National Association of Insurance Commissioners provides standardization, but the type of coverage you can buy and its cost is determined state by state. In each state the legislators, the regulators and the insurance companies decide among themselves what to allow and what to charge.

{Insurance is important and affordable}

Nonetheless, insurance is very important and it is usually possible to buy insurance that suits the needs of your situation at an affordable price. It's just made difficult by the fact that insurance planning differs so much from state to state and by the fact that information about fees and the operation of the policies is very difficult to get or to understand once you do get it.

What I mean by "Insurance, per se" is insurance that insures you against a risk and does not attempt to serve another purpose as well, such as investment or tax avoidance.

{types of insurance}

A typical person's insurance opportunities fall into five categories: "pure" insurance, health insurance, social security and the investment & estate planning aspects of life insurance. Annuities are also part of the insurance industry.

{definition of insurance}

The fundamental idea behind insurance is that if a group of people who face a similar risk get together and pay a small amount into a pool, those few of them who face a loss can be covered from the pool.

If you don't have a loss, you get nothing for your premium but you are willing to pay it because you know that you can collect if you ever do have a loss which might otherwise bankrupt you.

Over the past century or so in the United States, the Insurance Industry has worked with Congress and the Courts to create tax advantages for itself which have been used to create so-called "variable products" that are sold as investments similar to IRAs and other tax-advantaged savings accounts.

I talk about these products in another presentation. Here, I want to discuss just insurance that helps people to protect themselves from risks. We might call this "old fashioned" insurance. But whether old fashioned or not, this sort of pure insurance is a very important part of everyone's financial planning.

{pure insurance}

Pure insurance for individuals consists of the following:

  1. Term life insurance
  2. Homeowners insurance
  3. Auto insurance
  4. Liability ("umbrella") insurance
  5. Disability income insurance

In each case, you hope the loss (early death, fire, car crash, lawsuit, disabling accident) doesn't happen but because the cost of the loss is so high you are willing to pay something every year to cover yourself in case it does happen.

Sometimes a minimum level of insurance is required by a lender for a mortgage or the like, but that is for the lender's benefit, not yours, so I don't include it here.

{insurance: high deductible, behave yourself, review}

In general, the best advice is

  1. Get a policy with a high deductible and an inflation rider, to keep the premium low and to ensure that the coverage keeps up with inflation
  2. Behave in ways that reduce your risk, like seatbelts and keeping paint cans out of the house; and don't make claims for every little thing
  3. Review the policy every few years.

Most people are inadequately covered:  either too much or too little.

This is an area that is easy to forget once you've made the initial step because most people don't face losses very often, but it is wise to review the details carefully to ensure that you are adequately covered at the lowest cost.

The losses covered by pure insurance can be catastrophic and it is important to be sure that you are protected.

{Group insurance}

Group insurance, provided by an employer, is well worth considering because the qualification process is often easier than for individual insurance and the premiums may be lower. Group Life is frequently offered and many employers offer group health and disability insurance.

On the other hand, group insurance coverage may not be sufficient, which may drive you to consider supplementing it with individual insurance; plus you need to consider the value of independence: being tied to an employer because of insurance coverage or being unable to qualify later in life when you leave an employer are serious considerations.

Sometimes group insurance has a conversion option allowing you to retain the insurance after you leave an employer. This is often not the most cost-effective way to get continuing life insurance, but individual health insurance may not be available any other way and you should look into the requirements for continuing your group health insurance even if you are not expecting to leave because having health insurance is so important.

Group life insurance has two features you should be aware of: first, any premiums paid by the employer for death benefits above $50,000 are treated as income to the employee; second, death benefits paid to the employee's beneficiary become part of the employee's Gross Estate. Furthermore, if the employer's plan is not portable and you want coverage after you leave for any reason, you are likely to pay higher premiums because you are older and you may have to take a medical exam to qualify.

It is well worth taking the trouble to understand the rules of your employer's group policies and to investigate the options available to you as an individual. Call a local insurance agent and ask for advice.

{should you buy insurance on the internet}

The best way to approach pure insurance is to sit down and list all the areas in your life that are at risk, to methodically work through all of your needs and then to investigate your options with the help of a reputable insurance agent, of whom - in these areas - there are quite a few.

This may seem a boring nuisance, but it is always well worth the time and most financial planners will start here when helping their clients because the effect of a loss which could well be catastrophic is often so easily protected against with a little planning.

Increasingly, the Internet is facilitating the creation of discount pure insurance companies in competition to the insurance companies who have commissioned agents.

While the cost of agent-sold insurance is higher because of the commissions, you need to consider the fact that major losses have a significant emotional component and doing business over a number of years with a person in your neighborhood whom you know and who will offer to help is more than just a sales pitch. For pure insurance, choosing a good agent can be as important as choosing a good policy.

{term life insurance}

Term Life Insurance is insurance that provides a lump sum amount to your beneficiary if you die. The word "Term" in term life insurance means that the insurance policy terminates. The policy only covers you for a year or a few years.

This is the way all so-called "pure" insurance works: your auto insurance usually has a term of a year; there is permanent homeowners insurance in Pennsylvania where it was invested by Ben Franklin, but it is quite rare elsewhere.

If you still want life insurance coverage after the policy terminates or expires, you have to buy a new policy, and almost always at a higher price because as you age your chance of dying increases.

{many people should not have life insurance}

The purpose of life insurance is to protect your dependents from financial catastrophe in case you die.

In general, for people without special needs, the need for "pure" life insurance is a short-term need during the period in which they have dependent children.

Low-cost term life insurance that is not renewed once the children are gone is usually the best option. The purpose is to provide an amount of money in the event of your death so that your family can maintain their lifestyle and attain financial goals such as financing a college education. If you are diligent about saving, you will build up an investment portfolio over time. The need for life insurance is likely to decline as your portfolio grows to a size that can support your family; as you approach this point, you will be better off investing the insurance premiums rather than buying insurance with them.

Term insurance, like all pure insurance, only lasts for the policy term and then lapses if it is not renewed. The cost of term insurance goes up every time you renew even if you keep in good health because the number of deaths goes up as the people in the pool get older and their mortality rate goes up.

{permanent insurance}

There is a such a thing as "permanent" life insurance that does not require renewal, but really the only meaningful difference between permanent and renewable-term life insurance is the fact that permanent life insurance policies provide for a level premium that is too high initially for the insurance cost and the difference is put into a fund (called the "cash value account") that is used to offset the higher premiums in later years.

There are two variants of permanent life insurance, whole life and universal life. The twist offered by universal life is a higher interest rate on the cash value which may allow for lower premiums later on, plus an option to have the death benefit increased by any excess cash value in the account at death (which is called "Option B").

The level premiums and the cash value of permanent life insurance may seem an attractive alternative to term life insurance, but you can do better financially if you have the discipline to buy a renewable term life insurance policy plus an index or even a money market fund with the premium difference in the early years.

And, anyway, most people shouldn't get permanent life insurance at all. The need isn't permanent.

{term insurance is not an investment}

The point to remember, the point to stress, is that most people have no reason to own life insurance after their children have become independent. Life insurance is not something that most people should own for life. The need for it goes away at around the time the premium starts to really ramp up.

Of all the pure insurance types, term life insurance is often the least well understood. Not because term life insurance per se is particularly difficult to understand, but because it's "Life Insurance".

For centuries there was only term life insurance. That's all there was. Then in the mid 1970s, largely because of favorable tax treatment, the product began an explosive transformation that continues to this day ... creating a myriad of heavily marketed investment products in which the insurance component is largely incidental.

Let me say that again: life insurance that is sold as an investment actually tries to minimize the insurance part, the insurance is incidental. The advantage of these products is their tax advantage, which is a legislative issue, created by insurance industry lobbyists and has nothing to do with insurance.

But the pure insurance of term life remains a valuable tool for personal financial planning, and the price of term life insurance has been driven down dramatically through the pressure of information & competition brought on by the Internet, primarily, and to a lesser extent because of increased longevity.

{1-year term life rates: 1}

This graph shows how term life insurance rates have fallen as a result of the Internet and also as a result of the fact that people are living longer (3 years longer for every decade since the Second World War in America). The amounts represent the cost per $1,000 of coverage at different ages.

The data is drawn from the IRS which uses it to impute income to people who receive life insurance from their employers.

The top dashed blue line was valid from 1955 to 2001. Essentially, life insurance rates didn't change for 46 years.

By 2001, however, rates had been driven down dramatically, as you can see by the lower red line, in some cases by over 75%.

{1-year term life rates: 2}

This chart simply carries the data out from age 51 to 100. What is most telling about this chart is that in 1955 rates were not quoted beyond age 81, whereas by 2001 the chart was carried out to 100.

These charts should not be used to estimate your own actual policy cost; you can go online to a hundred sites to do that and life insurance agents will be happy to talk to you if you are young and healthy. Or old and rich.

But the charts are representative and they do illustrate (a) the fact that the cost of life insurance rises as you get older, (b) prices have fallen dramatically and (c) they show the populations' increasing longevity.

From the standpoint of the opportunity cost of the insurance policy premiums, the best deal for term life insurance is a single-premium policy with a term equal to the period of need (in other words, one 20-year term policy if you expect to need life insurance for 20 years, rather than two 10-year term policies). Single-premium term policies are unusual and the next-lowest opportunity-cost option is a level-premium policy.

What this means first of all, is buy a policy that covers the entire period that you will need it.

And, second, pay the premium all up front if you can find such a policy; if not, then the next best is a policy for which the premium charged is the same every year for the entire term. This second choice is called level premium.

It should be mentioned that life insurance can play a very large role in estate planning. There are two aspects worth mentioning here:

  1. If you own a policy on your own life, the full amount of the death benefit will be included in your estate. Either your spouse or a trust can own the policy to ensure that it doesn't bulk up the value of your estate (on which taxes will, eventually, be due above a certain - ever-changing - exclusion amount).
  2. The second thing to know is that, because of its special tax treatment, life insurance can sometimes be used to provide the money to pay estate taxes.

Both of these statements gloss over a great deal of complexity ... estate planning requires specialized advice. But you should at least know that the issues exist.

{property, liability, auto, disability insurance}

Pure Insurance, which is insurance that protects against catastrophic loss, includes Term Life Insurance and

Health and Long Term Care insurance are covered separately because they are so different from the other forms of pure insurance. Health Insurance in America is available almost exclusively from large employers, which causes a number of problems; and Long Term Care insurance is quite new.

Variable Life Insurance and Annuities, while sold by Insurance companies, are not really insurance at all and are therefore also covered separately.

{property/homeowners insurance}

The primary consideration with homeowners insurance is to make sure the property is covered at full replacement cost, with a deductible high enough to defray the premium cost, and that the coverage amount increases at least at the rate of inflation.

The alternative to full replacement cost is actual cash value, which is the depreciated value of the house. Do not insure your house for Actual Cash Value; anything less than full replacement cost is tantamount to no insurance at all if you ever have a major loss.

Older homes constructed with materials and techniques no longer in common use are best covered at "functional" replacement cost, which would use asphalt for slate on the roof, plastic rather than copper pipes, and so forth. Unless you live in a historic monument that must be restored exactly and you can afford the premium cost of doing so, functional replacement cost is perfectly adequate.

Expensive personal property is not adequately covered by a standard homeowners policy, and as you get older you accumulate more and more valuable property. If not "scheduled" and explicitly covered for their correct value you will lose nearly the whole amount of any possessions lost or damaged. It's worth a quick glance at the standard schedule for personal property to convince yourself that the standard coverage is almost nil.

Finally, most homeowners policies provide a small amount of liability coverage. It is a good idea to increase it to the maximum as sort of a "deductible" for your umbrella policy because it is not at all expensive and it's hard to have too much liability coverage in our litigious society. In fact, many umbrella policies require higher homeowners liability coverage.

Some people treat their homeowners insurance policies like an ATM to cover relatively minor expenses. In the long run, you're better off paying for smallish items out of pocket to keep the premium at a level that won't motivate you to insure for less than 100% replacement cost with an inflation rider.

It's always important to bear in mind that insurance is intended to cover the infrequent major loss and nothing else.

{auto insurance}

Auto insurance rules vary greatly from state to state, as does the cost.

The generalization that applies everywhere, however, is that the fundamental purpose of automobile insurance is to protect you from liability, not to cover the cost of repairs.

Many states require you to carry some minimal level of uninsured motorist coverage in case you are involved in an accident with someone without insurance; very often underinsured motorist coverage is not required, but it is a very good idea to get a rider for this purpose.

Some states are "no fault" which means that if you are involved in an accident, you are reimbursed by your own insurance company directly. Then, behind the scenes, the two insurance companies settle up between themselves and the driver judged to be at fault will be penalized by higher premiums.

A common but very unattractive alternative in other states is the tort system that requires you to hire a lawyer and sue the other driver yourself to recover damages.

You are well advised to have much more than the minimum level of liability coverage in any jurisdiction. Liability insurance is your only protection against an aggressively litigious system. All too many people, lawyers and plaintiffs, live off of liability suits; protect yourself from this with liability insurance.

{rental car insurance coverage}

Most people know to refuse coverage by rental car companies because their own auto insurance will cover them and this is usually good advice but a few items are worth keeping in mind:

1.  Your collision coverage may not cover the extent of the damage and the rental car company retains exclusive control over the repairs

2.  You policy will pay the depreciated value of the car if it is totaled, but many rental car contracts specify that you must replace their car with a new one.

3.  During the period until the rental car is back on the road, the rental car company will charge you (via the credit card you gave them) an amount that they feel reimburses them for lost revenue. You can be sure your policy does not cover this and you can also be sure that you have a lower estimate of their lost revenue than they do.

{umbrella personal liability insurance}

Your homeowners and auto policies will provide a minimal amount of liability insurance, but not nearly enough. You should carry the maximum liability coverage offered in those other policies, and also get an umbrella personal liability policy for many millions of dollars.

A common rule of thumb is to get an umbrella policy for an amount equal to your net worth. There's no particular rationale for this and ordinary umbrella policies max out well below a high net worth individual's requirement by this rule; my rule of thumb is to get as much as the insurance company will give you. If you feel you are likely to be a target for any reason, you should consider special liability coverage.

Liability awards are made by a court system that is capricious and wholly unpredictable.

An umbrella policy will cost, roughly, one hundred dollars per million per year and it is money well spent, not only for the coverage in the event that you are sued for any reason (other than intentional harm) but also because it covers all legal expenses which often rival the awards themselves.

Umbrella policies often also provide auto coverage outside of America, which is usually excluded from regular auto policies; rules governing foreigners involved in accidents abroad are often very harsh, so this is a handy thing to have. (Better yet, hire a local chauffeur).

{disability insurance}

Disability insurance is often offered by employers as an employee benefit but it is worth looking into the coverage on your own if the coverage is not sufficient. Also, employer disability insurance is sometimes paid for with pre-tax dollars, in which case the benefits are taxable; if paid with after-tax dollars, the benefits can be tax free.

Fewer people buy disability income insurance than life insurance, sometimes expecting to rely upon worker's comp, social security or a successful lawsuit. Disability income insurance is also not as aggressively marketed as life insurance, to which a disability rider may sometimes be added, but disability is more likely than premature death and because of ongoing medical and rehabilitation expenses, disability can be a much greater financial burden.

The deductible of a disability policy is called the "elimination period", which is the period of time that must elapse after you have been medically certified as disabled before benefit payments begin. The length of the elimination period, the length of the coverage period (whether for a set number of years or until retirement age) and the percent of income that is replaced are all options to be investigated.

Investment & Estate Planning With Life Insurance

The attraction of life insurance as either an investment or an estate-planning tool arises from favorable tax treatment:

1.  Life insurance death benefits are income-tax exempt

2.  If the insured is not the policy owner, the death benefits are estate-tax exempt

3.  Cash value (investment) accumulation is income-tax deferred

4.  Tax-free return-of-premium withdrawals from cash value are allowed after 10 years

5.  Essentially-permanent tax-free loans of accumulated cash value are allowed under certain circumstances

 Variable Universal Life Insurance

A Variable Universal Life (VUL) insurance policy is basically a term life insurance policy with an IRA attached. That's a bit glib but it conveys the concept. The reason Variable Universal Life insurance policies are sold is because they are tax shelters. If they weren't tax shelters, there would be no reason whatever to buy them.

For a VUL policy to be a pure tax shelter, the entire premium would go into the tax-deferred investments. The IRS frowns on this, however, and has established very complicated rules to the following effect:

1.  The cash value (investment) cannot exceed a certain % of the death benefit

2.  The premium also cannot exceed a certain % of the death benefit

 Furthermore, since the ratio of cash value to death benefit is a function of market performance, you may find yourself facing a huge assessment in order to avoid negative tax consequences or a lapsed policy simply because of a decline in the stock market.

A VUL that fails the IRS's tests becomes a "Modified Endowment Policy" (MEC) which will always reduce its attractiveness below the threshold used to justify the policy in the first place. Ordinary income taxes will be due on all gains, all at once.

In other words, a VUL policy must be more life insurance than tax shelter and the cost of the life insurance coverage is effectively an additional fee since it is the tax shelter that is of interest, not the insurance (if all you want is life insurance, buy a term policy: " it's much cheaper). Somebody has to keep track of these things, so one of the first questions to answer when looking into purchasing a VUL is who that person will be, how much this special service will cost and how vigilantly it is performed.

Life insurance is a contract, not a security. This means that once you enter into it, you're stuck with it. Aside from the nether world of viatical agreements (in which terminally ill people can sell their death benefits) and 1035 tax-free exchanges (complicated and expensive) once you start paying into a life insurance policy you have to play by their rules to ever get any value out of your investment. VUL is viewed as an investment but you need to keep in mind that the money isn't "yours" except under narrowly prescribed rules.

The safety of your investment depends entirely upon the strength of the insurance company, many of which have gone out of business over the years " at a rate of roughly 50 "- 100 per year. Some states maintain guaranty funds, but you shouldn't count on their protection. A. M. Best rates the credit worthiness of insurance companies and should be consulted. "There are no guarantees, only guarantors" is a clever way of saying that a guarantee is no good if the person making the guarantee goes broke.

Finally, these policies always have very high fees, which are not always fully disclosed, and the investment choices offered for the cash value account (mutual funds called "separate accounts") are controlled by the insurance company and always perform poorly compared to equivalent high-quality index funds.

For some people under some circumstances, the special tax treatment may more than offset these deficiencies and make a VUL policy a viable portfolio choice.  Like municipal bonds, they become more attractive when income tax rates are high. But if ever there was a need for "caveat emptor" it is here. Ditto annuities, discussed below, that are essentially life insurance policies turned inside out, paying until you die rather than when you die.

The basic pitch for why a Variable Universal Life insurance policy is a good lifetime investment is the following:

1.  A young single person in their first job needs no life insurance but they should certainly start investing as soon as they can. To start this process they can take out a small amount of insurance coverage in a VUL policy and pay as much more than the minimum premium as they can, investing the excess in the tax-deferred equity funds of the "separate account".

2.  After marriage, they can add a rider for the new spouse or otherwise convert to joint (1st to die) coverage. Continue funding the equity investment accounts to the maximum extent feasible.

3.  After the first child, increase the amount of insurance coverage and convert the equity investment account to a money market. If the funding and tax-deferred growth in prior years was sufficient, the tax-free investment returns will fund the minimum premium required to keep the insurance policy in force, thereby reducing the family's expenses while providing insurance coverage when it is most needed.

Had the family not funded a VUL in the years prior to this, they would have to pay for term life insurance to protect themselves in their most vulnerable years.

4.  After the last child is out of the home, reduce the amount of insurance coverage, convert the investments back into equities and resume funding the investment accounts.

5.  At retirement, take a series of tax-free policy loans to supplement retirement income, being careful that the policy neither lapses nor converts to a MEC (which requires constant vigilance on the part of the insurance company since an individual can't possibly know when they're at risk). The conversion to income can also be accomplished by converting to an annuity but that would eliminate the last step, plus annuity payments are taxable.

6.  If converted to 2nd to die and transferred to an irrevocable life insurance trust (at least 3 years before the 1st to die), the policy can pass to the family's heirs free of gift, estate and income taxes either providing a legacy directly or else providing the money to pay the taxes on the rest of the estate (bearing in mind that the cost of insurance becomes very high as you move into your 70s and beyond: see the charts in the section on term life insurance).

This is a fairly attractive story, one that has appealed to many people. The first VUL was introduced in 1985, however, so it's too soon to have actual experience with the full lifecycle in practice.

A fundamental issue to bear in mind about life insurance is that its cost goes up very steeply as you age: a $1,000,000 5-year term policy would cost a 25 year old in the neighborhood of $400 per year but might cost a 70 year old $15,000 per year " 38 times more " and an 80 year old could expect to pay upwards of $60,000 per year. This rapid escalation of cost must be borne, from whatever the source, if the policy is not to lapse and become worthless.

The whole story hinges on the net after-tax value produced by the investment account. The key word is "net" because:

1.  Your premium payment is reduced by state premium taxes and any front end loads the insurance company charges

2.  The cost of the insurance, which rises with age, reduces the amount of the remaining premium payment that can actually be invested. The cost per $1,000 of the life insurance in a VUL is higher than in a term life insurance policy because fewer such policies lapse.

3.  Many policies also have back end loads, known as surrender charges

4.  A VUL policy itself has administrative and other expenses

5.  The expense ratios of the separate accounts are higher than other mutual funds

6.  The tax advantage is a function of both

a.   The individual's marginal tax rate, which tends to vary considerably throughout life as the amount of taxable income changes

b.  The general level of taxes in the economy, which at the time of this writing is quite favorable making tax-advantaged investments in general less attractive

The math to determine whether the net benefit is positive is complex and must be done separately on every policy considered since every policy is different, which tends to discourage comparison shopping. Since so many variables are at play over the entire period of a family's lifetime, even the most sophisticated analysis is at best an estimate. Ben Baldwin's excellent book, The New Life Insurance Investment Advisor, devotes a separate chapter to the problem of figuring out if a VUL is a good investment, and it ends inconclusively. The fact that computer programs perform these analyses quickly does not improve their accuracy.

Very often, a buyer's motivation is the insurance policy's characteristic of "forced saving". Many people know they should save but they also know about themselves that the desire to consume for today always wins out over the need to save for tomorrow. This rationale actually shows a level of maturity but if at all possible, alternative tax-advantaged opportunities should be taken fully before considering a VUL:

a.   401(k) or other employer provided (and matched) savings plans

b.  IRA

c.   HSA

d.  529

Given the current tax environment, a taxable discount brokerage account which supplements the other tax-deferred accounts with low-cost index funds will often provide a much better long-term return than a VUL. However, it does seem likely that the US government debt is going to rise significantly to fund Social Security, Medicare and the general increase in the role of government in American society. Therefore, the likelihood of increased taxes in the future seems high, which will make all tax sheltered opportunities more attractive than they might be today; it will also make them more expensive, so the best time to consider them is when tax rates are low.


While there are many options available, annuities, like life insurance, essentially have a "pure" form and a tax-sheltered investment form.

The pure form of an annuity is a Single-Payment Immediate Annuity, possibly with an inflation rider, which will pay a fixed stream of taxable income for life in return in return for a lump-sum payment. The return on investment of such an annuity is not as good as the long-term return of a diversified investment portfolio, but it is guaranteed for life. It is very comforting to many people to have their basic expenses covered in this way and it is often well worth giving up some theoretical return for peace of mind.

The issue is getting such an annuity at the least cost: no-load annuities from Berkshire Hathaway and USAA are worth looking into if the security of a life pension is something you're interested in.

A hybrid option is an Inter Vivos Charitable Remainder Trust, a sort-of a do-it-yourself annuity which gives whatever money is left at your death to a designated charity (rather than to an insurance company as in the case of an annuity). Broadly speaking, an Inter Vivos Charitable Remainder Trust operates like this:

1.  You give a lump sum gift to the trust, designating a charity to be the recipient of the funds at your death. You get an immediate one-time charitable tax deduction.

2.  You retain the right to invest the funds inside the trust, and the investment activities of the trust are tax exempt.

3.  The trust is required to distribute an amount not less than 5% but not more than 50% of the value of the trust to you (or other beneficiaries) every year. These distributions are taxable.

This description glosses over quite a few details that must be well understood before establishing such a trust, but is should give a feel for why such structures are very attractive to many people.

A Variable Deferred Annuity (VDA) is the tax-deferred investment vehicle.

To invest in a VDA, you pay premiums that go into one or more of the mutual funds offered by the annuity company. There are two phases: accumulation, during which you put money into tax-deferred investments, and liquidation, during which time you receive taxable annuity payments. "Annuitization" is the conversion from accumulation to liquidation.

In fact, a majority of existing VDAs have never annuitized, apparently because people are content to allow the principal to grow tax free. However, VDAs are not efficient vehicles for transferring wealth to non-spousal beneficiaries because they must arrange for a taxable payout of the value within the VDA within one year of the annuitant's death.

As with VUL, the only appeal of a VDA is as a tax shelter. Variable annuities are notorious for their fees, which in most cases more than eliminate whatever benefit the tax deferral provides. Vanguard and Fidelity offer no load VDAs, however, if a VDA seems to be of interest.

{social security}

There is a huge debate about Social Security funding brought on by the fact that there are more retirees than the system anticipated and they are living much longer than expected.

Social Security is called the Third Rail of American politics because it is so sensitive. Let's ignore the politics and just talk about the facts.

{social security is a success and is going broke}

First of all, Social Security has been a huge success. It was intended to supplement the income of retirees, disabled people and their families to keep them out of poverty. It has done this quite well and therefore is a much beloved program.

Second of all, if demographics and taxes remain as they currently are, Social Security will start paying out more than it takes in around the year 2040, technically it will be bankrupt.

{social security will not fail, everyone covered will receive benefits}

Those are facts and I don't believe they are worth arguing about. Furthermore, I think there is an obvious conclusion we can draw from these facts, namely that the system will not fail. The Baby Boom generation simply will not allow their elected officials to do anything but support the system. Period.

Lots of people say that they don't expect to receive any Social Security benefits because the system is in trouble. Well, that's just nonsense. Every person in America who has contributed to the system (via the so-called FICA taxes) will collect Social Security benefits.

They will; they just will.

{social security must take in more money or pay out less money}

Obviously, some changes must be made to prevent the system from going bankrupt and the only useful changes are to either increase the money going in or to decrease the money going out. Or both. Both of these choices are taxes and both are already happening.

Since the Greenspan Commission in the early 1980s took a look at this problem, the taxes on wages have been increased and the age of eligibility has been pushed out.

The tax on wages is a direct tax on workers and the increase in the age of eligibility is an indirect tax on retirees. In both cases, people have had to give up some money to the government, and that's called paying taxes.

The Greenspan Commission pushed off the day of reckoning to 2040 and some new commission will push it out even further. This new commission will do it the same way the Greenspan Commission did, by raising taxes.

This is a fact. Everything else is politics.

So, as a current or future Social Security recipient, relax: you will get paid and, in fact, you will get more than the generations who preceded you. You will just have to pay a little more up front and have to wait a little longer at retirement.

The one caveat I would add to this is that the populist pendulum swings back and forth in Washington and the burden of the inescapable tax increases may be skewed toward higher net worth individuals.  But even so, I stand by my prediction that everyone who has paid into the system will receive benefits at retirement.

{the components of social security}

When most people think of Social Security, they think of retirement benefits. In fact, the Social Security Administration oversees six broad benefit plans.

First is retirement for which people initially become eligible at age 62 with reduced benefits which increase about 8% per year if retirement is delayed up to age 70.

Disability Benefits covers people of any age who have paid into the system who have a severe physical or mental ailment.

Family benefits provide support to certain members of the families of either retirees or disabled persons.

Survivor benefits go to the families of eligible workers who are deceased.

Medicare provides hospital and medical insurance coverage to retirees or to people who have received disability benefits for two years or more. I cover Medicare in another presentation.

Supplemental benefits are available to retired or disabled persons who also qualify for Medicaid and food stamps.

{fica components}

Except for the Supplemental Benefits, the money for Social Security comes out of taxes on wages, the non-deductible, non-refundable taxes that appear on a W2 form, below the Federal income tax withholding line.

The so-called FICA taxes are a total of 15.3% of a person's wages, with 12.4% of the first $97,500 going to Old Age, Survivor and Disability Insurance - OASDI is the acronym - and 2.9% of total wages going to Medicare.

The employer pays half and the employee pays half. This applies to W2 income employees as well as self-employed persons.

{social security eligibility}

So, who's eligible? Currently, you are probably eligible.

Anyone who paid FICA taxes for ten years on $4,000 per year adjusted for inflation is eligible and is "fully insured". Adjusted for inflation means that the amount was smaller in previous years; each year the amount you must earn in each quarter is adjusted upwards for inflation.

This probably means that anyone listening to this presentation is eligible as a "fully-insured" participant. The only broad class of people who might not be eligible are certain government employees with an equivalent pension.

{social security statement}

The rules are complicated and guaranteed to change, so here's what you do:

go to or else call 1-800-772-1213

and request a copy of your benefits statement. The Social Security Administration is supposed to mail a copy to every eligible person every year around the time of their birthday but if you've misplaced your most recent copy, just get another one.

If you haven't looked at your statement recently, look at it now and make sure all the information is correct. If it isn't, start raising a fuss until whatever is wrong is fixed.

{social security full retirement}

The next thing to do is to decide when to start receiving retirement benefits. This depends entirely on how long you expect to live.

If your family has a short life expectancy and/or you are not in such great shape yourself, take it early. You can start receiving a reduced benefit at age 62. You will receive less per year than if you wait, but you may receive more in total if you are not in good health.

The age at which you can receive full retirement benefits is called the "full retirement" age. The Greenspan Commission recommended making this age later than 65 for younger people and this table shows the ages of eligibility; it's actually broken down by moth, so as you get close you will want to look up your specific case on your statement.

Broadly speaking, if you live more than 12 years beyond full retirement age, you will receive more money by waiting until then.

In fact, your benefit will increase 8% per year more than that if you wait until age 70; less, if you were born before 1943, the idea being to provide people with an incentive to delay.

{average social security retirement benefits payments}

How much will you get? Well, here again, the calculation is so complex that the only way to really get a handle on this question is to look at your Social Security statement.

However, for talking purposes, for people reaching their full retirement age in 2007, in other words for those people born in 1941 choosing to wait until they are 65 years, 10 months old to receive retirement benefits, the national average is a bit under $17 thousand dollars per year and the maximum is just under $26 thousand dollars.

The amount is indexed for inflation every year to keep up with the rising cost of living.

You won't get rich on this amount of money and as the politicians struggle with fixing the system the numbers may change; nonetheless, this is a very comfortable amount of money you can add to your retirement income calculation.

When you think that during the Depression, elderly people were literally starving to death, this is a very generous safety net that America provides to its elderly citizens.

This is why the system is so much beloved and that is why politicians suggest changes to it at their peril.

All of which adds up to why I don't think it's going away. This is a democracy, and when tens of millions of the Baby Boom generation, who protested the Vietnam War and changed so much of our society are looking forward to receiving Social Security benefits,  well, what they want, they will get because that's how the system works.

{taxes on social security benefits}

Finally, there's the question of whether you can work and receive Social Security retirement benefits.

If you decide to receive benefits prior to full retirement age and you earn outside income, your benefits may be reduced. The earnings limitation for people who choose to retire early was $12,960 in 2007. Earn more than that and your retirement benefits will be reduced $1 for every $2 earned above that amount.

Following full retirement age your benefits are not reduced by any other income you receive.

However, if your Modified AGI, the bottom line on the front of your 1040 tax form with a few additions, plus 50% of your retirement benefits exceeds certain levels, then between 50% and 85% of your benefits will be subject to tax.

{medicare and medigap}

Medicare is a Federal insurance program that covers health care costs for people aged 65 and up. Some people with disabilities, others with renal disease are eligible earlier than 65 and for low income beneficiaries dependents can sometimes be covered, but for the most part, this is health care coverage for Seniors; for people 65 and older.

Medicare is partly funded through a 2.9% tax that is levied on wages as part of FICA along with the rest of Social Security. But Medicare also has deductibles, co-pays and premiums for some of its coverage, so Medicare is not free coverage.

In general, eligibility rules are the same as for Social Security in that you must be fully insured, meaning - essentially - that you must have paid into the system for at least 10 years during your working life. Most people qualify and so are eligible.

{contact social security and medicare}

Medicare is part of the Social Security program. The Social Security Administration sends out a pamphlet to every person covered by the system every year at around the time of their birthday which contains information about your eligibility and benefits.

If you don't have a current copy, go to


And request a new one.

Medicare has two useful websites of its own run by the Center for Medicare and Medicaid Services which is part of the US Department of Health and Human Services, and often goes by the initials, CMS.


Contains a lot of very useful information about the program in general, and

MyMedicare DOT GOV will allow you to look up specifics of your own participation.

{medicare eligibility}

By and large, eligibility for Medicare begins at age 65, whether you are still working or retired.

It is a good idea to have your plan for what type of Medicare and other insurance you will want complete well before your 65th birthday because it is complicated and you really have only six months after your 65th birthday to apply without penalty.

So plan ahead.

{medicare benefit periods}

Medicare's deductibles and co-pays are based on a concept of Benefit Period, rather than on a calendar year as is common with individual health insurance policies.

A Benefit Period begins when you enter a hospital or nursing home and ends after you have been discharged for 60 consecutive days. There is no limit to the number of Benefit Periods and each one is distinct.

The chart shows the charges as of 2007 for coverage under Part A, which we'll get into more later. If you enter a hospital, there is a $992 dollar deductible but none for a nursing home.

After 20 days in a nursing home, you have a co-pay of $124 dollars per day up to day 100 when the benefit runs out. Medicare does not cover long-term care. It is often a very good idea to have your own individual Long Term Care policy because if you need to remain in a nursing facility for more than 100 days, Medicare pays nothing. Medicare was not intended to provide long term care and all-too often people run through all their assets paying for long-term nursing care and then must rely on Medicaid, the health insurance program intended for very low-income people.

In a hospital, a $248 dollar-per-day co-pay kicks in at day 61 and lasts until day 90.

For hospital care, there is a lifetime allotment of 60 "reserve days" that can be drawn upon only once with a co-pay of $496 dollars per day.

Thereafter, you must rely on other forms of insurance, although 150 days, which is roughly 5 months, is a very long time to spend in a hospital and the chances are good if you are in the hospital that long, you will have to be discharged into a nursing facility.

{medicare options}

You have two choices when considering Medicare: the original program which consists of Parts A, B and D; and the Medicare Advantage program, called Part C, which acts rather like an HMO or PPO.

Part C, Medicare Advantage is somewhat more restrictive than the Original Medicare in choosing which doctors to vast and so forth, but it is often less expensive and may have more options.

{original medicare}

In the original Medicare, part A is the basic coverage provided as part of Medicare; the other parts are optional, extra cost choices.

Part A covers inpatient hospital, skilled nursing care services, home health care and hospices.

For a fully-insured person, there is no premium for Part A, although there are deductibles and co-pays.

Part A limits hospital stays to 90 days per spell of illness with a lifetime reserve of an extra 60 days. Nursing home coverage is limited to 100 days per spell of illness.

Spells of illness or benefit periods must be separated by 60 consecutive days not in a facility. The deductibles and co-pays are indexed for inflation and were shown in the previous section for 2007.

Part B covers physicians, outpatient services, equipment and rehabilitation.

Part B is optional and in 2007 requires a payment of $93.50 per month premiums which are deducted directly from Social Security retirement benefits, if any. The premium is higher for people with incomes over $80,000 on a sliding scale up to $161.40 per month, in 2007.

There is also a $131 deductible and a 20% co-pay. If you don't signup for Part B within six months of becoming eligible for Medicare at age 65, the cost goes up 10% if you subsequently decide to join Part B.

Part D is Prescription Drug coverage. To be eligible for Part D, you must have signed up for Part B, also. However, enrollment is restricted to November 15 to December 31, so careful planning is required.

Part D has a $32 dollar per month premium, a $265 dollar deductible and a 25% co-pay up to $2400 dollars.

You are responsible for 100% of the costs between $2401 dollars and $5451.25, after which there is a co-pay of 5%. The part for which you are responsible for 100% is often called the donut hole.


Finally, Medigap Insurance is offered by private insurance companies to pay for donut holes and other areas that are not covered by Medicare and sometimes also to pay for the deductibles and co-pays.

It is usually a good idea for most people to get some form of Medigap insurance but careful research is required because there are many choices as well as unscrupulous operators.

Medigap policies are standardized to the extent of coverage but not as to cost, so first you must decide which of the standardized coverages you want and then you must shop around for the best cost.

Medigap policies usually require you to be enrolled in Part B and Medigap does not cover prescription drugs, so you need to consider whether you will also enroll in Part D.

A legitimate Medigap policy must state that it is a Medicare Supplement Policy. Except for the three states of Massachusetts, Minnesota and Wisconsin, all Medigap policies must offer 12 standardized coverage options called Plans A thru L. They do not need to offer all of them, however.

The MEDICARE DOT GOV website has a booklet on choosing a Medigap policy and it is well worth your time to read it, perhaps more than once.

The best time to buy a Medigap policy is in the Open Enrollment period which is during the six months after your 65th birthday and after you have enrolled in Part B. You really don't have much time, so you are well advised to know exactly what you want to do before your birthday so that you can be as efficient as possible.

During this open enrollment period you are guaranteed Medigap coverage and you are guaranteed to get the standard rates. If you wait beyond this period you may be denied coverage or charged considerably more than the standard rates for pre-existing conditions.

{medicare advantage plan}

Finally, Part C is like an HMO or a PPO and is the alternative you have to the original Medicare plan of Parts A and B.

Medigap insurance is not an option under Part C, so you must assure yourself that you are comfortable with all that is provided by the program itself.

{medicare: enroll within 6 months of your 65th birthday}

In summary, I would advise you to begin researching your numerous options long before your 65th birthday;

First of all because they are complicated

and second of all because you really only have the six months following your 65th birthday to enroll in all of the health care plans that will cover you for the rest of your life.

MEDICARE DOT GOV has publications that provide a good place to start and the Social Security Administration has lots of people to help if you avail yourself of the opportunities.

Will Medicare change between now and when many people reach 65? Yes, very likely, but the better informed you are, the better you can adapt to any changes that come along.

Is Medicare running out of money? Yes, technically it is; and at a rate that makes the Social Security problem look quite small in comparison.

But that does not mean you won't be covered; you will be. There will inevitably be changes to the system but it simply will not fail.

Once you reach 65, or perhaps a little older for younger folks, your health coverage will largely be in the hands of the US Department of Health and Human Services, and it well behooves you to prepare yourself in advance for this.

This series of topics is drawn from narrated presentations that can be found here: Risk Management

This page is

Financial planning utility functions:


Please see the Disclaimers

As far as Medicare is concerned, Part A (hospital) is entirely paid for out of the general fund, derived from everybody's taxes -- to the individual, it is essentially free. Medicare Part B, paying doctors, is 75% subsidized by taxes, so it is a no-brainer to sign up. Part D is not a bargain for me, because I have one of those sweetheart deals from a University. However, for an ordinary citizen it comes close to breaking even, and should be regarded as a budgeting device for an age period in life when you probably do want to smooth out your expenses.
Posted by: G3   |   Feb 19, 2008 12:05 AM
There is an age, beyond which an insurance company will not sell term insurance. That means you have to accept the rather low returns on permanent coverage. Somehow, it seems to me you ought to be doing your own investing toward that eventuality, possibly with term insurance in the early years, to get started.
Posted by: G3   |   Feb 18, 2008 11:59 PM

Thank you for your comment.

You are right that I have not mentioned a number of types of insurance. I feel badly about this and hope to fill in the gaps as time goes on.

In the situation you describe, might not life insurance help? If the surviving, non-participant spouse prefers an annuity to a lump sum, such an option could be arranged.

George 4
Posted by: GRFiv   |   Feb 16, 2008 4:48 PM
Very good article. For insurance you don't mention insurance to protect loss of income from a pension when the major pension owner dies. e.g. I expect to receive a sizable pension and when I die my wife only gets 50% of it. This would be a significant hardship if I die young
Posted by: Alan   |   Feb 16, 2008 2:30 PM
The McCarran Act was part of the long fall-out from the Roosevelt court-packing uproar. The Court had held that the Constitution limited federal involvement to interstate commerce, as "commerce between the several states". It reversed itself when FDR threatened to keep adding more Justices until he had a majority that would get rid of the interstate commerce limitation, Within six weeks of the decision, Congress responded to insurance lobbyists by saying that no federal regulatory agency was to interfere in the business of insurance. All of the states then passed laws regulating insurance, so the effect was to single out this one industry and shift its regulation to the state level. That was clearly the idea of the founding fathers -- for all commerce, except commerce between the several states. The resulting experience with insurance regulation at a state level has been very unsavory, perhaps because all of the corruption was focused on a single industry. In 1973, ERISA was passed because big corporations were driven crazy by the multitude of regulators for pension plans. As an afterthought, the health insurance benefit was tacked onto the ERISA bill, essentially saying everything we said about pensions also applies to health insurance. I don't know about life insurance as a company benefit, but I wouldn't be surprised if it got included in some way. The overall consequence of all this has been gridlock, and the wide-spread assertion that this mess is not amendable because everybody is scared they will lose some particular loophole that has been created by accident. However, if anyone wants to do something useful, the place to begin is with McCarran Fergusson.
Posted by: G3   |   Feb 16, 2008 2:12 PM
Well, I'm not one to advocate Federal regulation but the fractured state of insurance in America serves only the interests of Boss Tweed; not the consumer.

As for Princess Diana, I don't know where things stand; those sorts of people occupy a different dimension from me.
Posted by: G4   |   Feb 16, 2008 7:58 AM
I'm about half way through and have to go. My first suggestion is you allude to the McCarran Fergusson Act that reversed the Supreme Court decision that the business of insurance could have federal regulation, especially antitrust regulation. And second, I wonder how the litigation about Princess Di turned out; there was a chauffeur, but he was acting as an agent for billionaires in the back seat.
Posted by: GRF3   |   Feb 15, 2008 5:38 PM

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