My (Financial) Living Will #illumedati 3

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Like I said in my previous post, I lost my original post about creating a Financial Living Will. So, it’s Finance Fridays… but on Saturday!

I’ve decided to try to replicate the post to the best of my ability today while the content is still relatively fresh in my mind. Maybe this is even a blessing in disguise to allow me to distill down my thoughts further and make this post better (although probably not shorter).

Stock Photo from Pixabay.

Wait… what? What is a “Financial Living Will?” Does that even exist?

Haha! You’re right. It isn’t a legal document like an advanced directive or power of attorney is. However, I still think it’s important.

Ok… what is it?

By my own self-created definition, it’s a written statement of what you would advise your beneficiaries to do with the insurance payout (or any other assets) they would receive in the event of your untimely death. For me, I have very little in terms of assets. However, I do carry a term life insurance policy of $2 million, as I advise all physicians to do.

If you haven’t already read them, read these two posts to catch up: Why do I need insurance? and Life Insurance

Additionally, if you are the sole physician earner in your family, then $3 million is probably the safer bet.

Why does it matter what they do? I mean.. you’re dead… why do you care?

You’re right, I don’t gain anything personally from creating this document. However, I own that life insurance policy to make sure that my family is taken care of should I pass earlier than expected. As such, I feel I have a responsibility to advise them on what to do with it. Whether they take my advice (or not) is up to them.

C’mon Sensei, you worry to much… What’s the worst that could happen?

The biggest concern would be if my beneficiaries squandered the payout. It’s difficult to understand how to handle a large windfall of money if you’ve never had to deal with it before. Prior to writing this post, I’ve never actually sat down and devised a plan on what to do if I received a windfall of $2 million. But that’s kind of the point. It’s an exercise to express my wishes.

Squandering a payout is not an uncommon phenomenon.

This has happened many times before, if you just Google “broke lottery winners” you’ll see a bunch of news stories:

8 big lottery winners whose money and luck ran out – Bankrate.com

Why So Many Lottery Winners Go Broke – Fortune.com

Why do 70 percent of lottery winners end up bankrupt? – Cleveland.com

The most interesting parts of these articles are:

“Indeed, the Certified Financial Planner Board of Standards says nearly a third of lottery winners declare bankruptcy—meaning they were worse off than before they became rich.” – Fortune.com (emphasis mine)

“In fact, about 70 percent of people who win a lottery or get a big windfall actually end up broke in a few years, according to the National Endowment for Financial Education.” – Cleveland.com (emphasis mine)

So one study says that 1/3 of lottery winners declare bankruptcy. The other study says ~70% of lottery winners OR those who receive a big windfall become broke. What’s interesting is that it isn’t necessarily because the winners were spending all the money on themselves (although that is part of it), it’s because:

“The biggest problem, several finance advisers agreed, is that lottery winners give away too much money to family and friends.” – Cleveland.com (emphasis mine)

I think the biggest problem these people face are that they don’t have a plan. If you don’t have a plan, then this is one of the times to speak with a financial advisor, accountant, and lawyer.

Wait… You think your beneficiaries will squander the life insurance payout?

No, of course not.

However, at the time of my death, my beneficiaries – namely my wife, will be taking care of crazy amount of other things. Relaying the news to my family, organizing the funeral, etc. She will also need to consider whether she should stay in Hawaii or move closer to other family since the major reason we moved to Hawaii was my job.

Now, I love my wife. She’s a beautiful woman, outstanding mother, and excellent psychiatrist, but despite my best efforts, any and all talk about finance puts her to sleep. Like literally if she needs help falling asleep I just start talking about compound interest, index funds, staying the course, and throw in some basic math and she falls sound asleep. But with all these other things that she will need to take care of, she may forget some of our conversations regarding investing, retirement, index funds, etc.

If I didn’t write this post, she would probably do just fine, but it would cause her undue stress to have to deal with all this without any kind of plan written down. These are all reasons for me to write this post… and am also now re-writing it because I think it is so important.

I see… so what’s your plan then?

Well, first things first.

There are two potential heavy hitting expenses to a windfall (for my beneficiaries). They are: How much tax will they have to pay and Do they have to pay off my loans?

So, regarding taxes:

“Generally, if you receive the proceeds under a life insurance contract as a beneficiary due to the death of the insured person, the benefits are not includable in gross income and do not have to be reported.” – Source: IRS.gov (emphasis mine)

However, please note:

“Any interest you receive is taxable and you should report it just like any other interest received.” – Source: IRS.gov (emphasis mine)

If you have term life insurance, you shouldn’t be receiving any interest and won’t be taxed on it. However, if you have whole life insurance, any interest you have accrued on the payout will be taxed. As such, I have term life insurance and won’t be taxed, and this doesn’t affect me. If you listened to me, you should also have term life insurance, so this shouldn’t affect you either.

Now, regarding my loans:

In general, all federal loans are forgiven on death. This is called a “Death Discharge” – Source: Studentaid.ed.gov

Some private loan companies also have a “Death Discharge:

“Some lenders of private (non-federal) student loans offer a death discharge if the borrower dies. These include Sallie Mae, New York’s Higher Education Services Corporation, Wells Fargo, and Discover. With other lenders, the borrower should ask about the lender’s compassionate review process. Some lenders will waive the cosigner’s obligation on a case-by-case basis if the cosigner is on fixed income and does not have the resources to repay the debt or if the student was killed in action while serving in the U.S. Armed Forces or in a public safety position.” – Source: Edvisors.com

However, some private loans can potentially go after your estate after you die, which may include your life insurance payout.

My loans are all handled by Sallie Mae. So they should be discharged on death. However, even if they weren’t discharged on death, I acquired my loans before I was married, and they are completely mine alone as I have no co-signer. For this reason, I think it would make it very difficult for any private loan company to go after my wife. This may be different for you if you live in a community property state, such as Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin. Sources: Studentloanhero.com and Nolo.com

I see, so the payout won’t be taxed and your beneficiaries shouldn’t have to pay for your student loans. So then what?

Well, the $2 million payout should essentially be $2 million.

The next consideration is, will my wife stop working? Well, she talks about early retirement a lot, but I really doubt she would do it. She spent 4 years of pre-med, 4 years of med school, and 5 years of residency/fellowship to acquire the skills to be an excellent psychiatrist. It would be a shame to have that go to waste.

So, I doubt she will stop working. However, she won’t need to work full-time and she would have the flexibility to do whatever she wanted. If she wanted to work part-time or start a small low volume private practice, then both of those options would be open to her. Nonetheless, I will structure my advice with the assumption that she will keep working at least part-time, only needing some money from the payout to supplement her income (if necessary).

Here is my advice:

  1. Pay off all her student loans.
    • Just make them all gone and forget they exist. Their interest rates aren’t huge, but just get that monkey off your back.
  2. Pay off mortgage to reduce the monthly payment to a comfortable amount.
    • By comfortable amount, I mean <10% of her net income per month would be the mortgage.
    • The interest rate on our current house isn’t horrible, so probably no need to pay it off completely.
    • She may also consider downsizing or just selling your house and buying a house outright in a lower cost-of-living area, if she decided to move closer to family/friends.
  3. Put $50,000 each into the 529s for the kids. I’ve talked about 529s before:
    • What is a 529?   /   Choosing a 529    /   Let’s Talk About 529s
    • $50,000 into a 529 right now is a healthy jump start to the account. She could continue to add $100 or $200 a month to it without too much trouble.
    • $50,000 principal, $100 a month, 15 years to grow (for a 3yo), @ 6% interest = $147,759.07
  4. Keep $50,000 in an emergency fund in bank account.
    • This should already be there anyways… $50,000 is just a round number, but it should be 6 months of “monthly expenses”
  5. Keep $100,000 in a No Risk CD.
    • In case she needs to supplement her income, or pull out money for other reasons, such as starting a private practice.
    • Some might say that this is a waste of compound interest as it is better utilized in stock/bonds. However, I think it is worth it to have as a security blanket in our situation.
    • If she feels comfortable and has established a new equilibrium later, she can just reinvest this into the funds below.
  6. Dump the rest into these index funds:

That all seems reasonable… anything else she needs to do?

Yes, she will most likely need to look into estate planning… ie. creating a trust.

Estate Tax for 2017 starts at $5,490,000. – Source IRS.gov

That is for an individual. For a married couple, it would be double that, or $10,980,000. If we assume the estate tax stays the same, it is unlikely my wife and I would hit ~$11 million to leave to our children. However, with a ~$2 million headstart and 30+ more years of compound interest, the likelihood of my wife hitting the estate tax for our children increases, especially if you include any assets she would own (like our house), or however much our 401ks had compounded as well.

For the sake of this post, if you received a $2 milllion and didn’t contribute anything else to it — but just let it compound @ 6% interest for 30 years… what would you guess the total would be?

$5 million? $7 million? $10 million?

If you said $10 million, you’re close… because it’s $11,486,982.35. (use compound interest calculator, and enter $2,000,000,  $0 contribution, 30 years, 6%, compounded annually)

However, the creation of a trust is outside the scope of this post and there are multiple ways to do it. In the event of my death, my wife will probably want to meet with an estate planner to establish a trust for our children, especially if she follows the plan I outlined above. We had discussed this previously, so she has a general idea of what the plan was.

Another consideration would be to start giving our children monetary gifts up to $14,000 a year. – Source: IRS.gov

Note: In the event that the estate tax changes (ie. dips down to $2 million or so), I may need to revisit estate planning again.

I see. I see. Any other advice?

Yes.

Don’t be afraid to spend a little money, but buy experiences, not things.

Be happy. Money isn’t happiness. Family is happiness.

TL;DR

A Financial Living Will is a good financial exercise.

It’s also something to keep around for your beneficiaries in the case of your untimely death.

Everyone’s Financial Living Will will likely be a little different, even if their ideals are the same.

I’ve left mine here for your reference, along with my thought process.

-Sensei

What does your Financial Living Will look like?

Agree? Disagree? Questions, Comments and Suggestions are welcome.

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