Sunday, July 02, 2006

Money Sense


I got a call from my accountant the other day. (I say, "accountant," like he's spending all his time crunching numbers and figuring out how to save us money and expand our vast empire when in fact he's just a friend who does our taxes. Sorta like calling the guy who cuts my grass my "gardener.")

Anyway, he called to remind us that we need a will and also to suggest a couple of other things that he thinks we should be doing. I didn't agree with him on the other things and since my friends run away from me screaming whenever I start talking about money, I'm going to tell the you instead.

First, he wants us to sign up for the Florida College Pre-pay Plan. The way the plan works: you pay a set fee now ($12,000) and your child is guaranteed 4 years tuition at a Florida state college or community college. You can also pay monthly, about $88 a month for 18 years. If, for any reason your child doesn't go to a Florida State school, you get the principal back ($12,000).

Here's why it's a shitty deal:
Invest your money in the stock market for 18 years and you will get at least an 8% return per year. So, when they give you back your $12,000 because little Johnny is dumb as a stump, they get to keep the $36,000 in interest you would have earned outside the plan. They also keep that money if your child goes to school out of state or goes to a private school.... goes to a vocational school... gets a scholarship and doesn't need the tuition... you get the point. It's a great deal as long as your kid definitely goes to college and goes to a Florida State school. Otherwise, they get 18 years of interest off of your money.

Instead, I have a 529 plan. This is an education account that grows tax-free and is tax-free when you take the money out as long as you use it for education. You can use the money for any school in any state and some abroad. You can use it for vocational school or technical school. You can use it for school supplies like a computer or even a car. You can use it for anyone in your family at any time and it's transferable (if your kids don't use it it can sit and collect interest for their kids.) Sure, I'll put more in this plan than I would have to put in the Florida plan but the 509 account can be used anywhere by anyone at anytime. If you have the Florida plan and your child skips college you get $12,000 back. The same amount invested in a 529 will be worth $48,000 (at least) and can be passed down to future generations. Theoretically, the account could put generations through college. The average annual return for my plan over the last 3 years is 15%.

Again, it will cost me more money than the Florida plan but if my child wants to do anything other than attend a Florida state school, I'll be in a position to help. If my children don't go to college or vocational school at all they will never have to save a penny for their children's education.

Second, he wants us to get Universal Life Insurance.
Now, Universal insurance is a good deal if you want life insurance for the rest of your life. You pay one premium and it never changes. Plus, you can over-fund the policy by putting more money in than is needed and that money grows tax-free and is tax-free when you take it out. Sounds like a great deal but it's really not.

You see, you don't need life insurance for the rest of your life. You only need it for about 30 years. Just long enough for your children to be grown and out on their own. Sure, it's nice to get a shit-pot of money when your parents kick-off but is it worth them paying all their life so that you can get a bundle when you're 40? No.

So, you buy term insurance at half the cost and you invest the difference. That's the crucial part.

Let me spell it out for you:

Let's say you have $250 a month to put toward over-funding your Universal Life Insurance Plan. What you are really doing is buying an insurance policy and letting the company invest the rest. So, the policy (we'll say it's a million dollars) cost $100 a month and the other $150 gets invested. At the end of the year you've invested $1800. let's say you get a 10% return on your money, that's $180 (tax-free!). So, you have a million dollar life insurance policy and $1980 in savings. Not bad.

But wait! Let's say, instead, that you buy a 30-year term policy. Because the policy will expire before you are likely to die, it's much cheaper. Bobbi has a million dollar policy and it's less than $50 a month. When it expires, our children will be 30 years old. So, start with $250, spend $50 on the policy and invest the other $200 every month. At the end of the year you have $2400 invested, plus your 10% return of $240. You have to pay taxes on the $240 so let's assume you're rich and have to pay 35%.... that's $84. So you make $2400 + $240 - $84 = $2556.

$1980 vs. $2556. The only benefit to the $1980 is that you still have life insurance when your kids are in their 30's. Even after taxes you will make $30,000 more over the 30 years of the term!

Whenever someone tries to sell you Universal insurance or an annuity or anything of that sort remember this: They will take your money, invest it and keep some of the profit. Why not invest it yourself in mutual funds and keep it all?

Keep in mind that my figures aren't exact but you can be sure of these things:
1. The insurance portion of your Universal plan costs more than a term plan.
2. The tax savings of the Universal plan will never exceed the extra profit you make by investing the money you save with a term plan.
3. Any decent mutual fund can beat the return on a Universal plan.
4. There's a reason that people are always trying to sell you Universal insurance, they make a lot of money off it.

That concludes our lesson for today.

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