Ask Liz Weston

Get smart with your money

Insurance

Should you hide assets to get more financial aid?

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Dear Liz: We have a son who is a high school junior and who is planning on going to college. We met with a college financial planner who suggest we put money in a whole life insurance policy as a way to help get more financial aid. Is that a good idea?

Answer: Your “college financial planner” is actually an insurance salesperson who hopes to make a big commission by talking you into an expensive policy you probably don’t need.

The salesperson is correct that buying a cash-value life insurance policy is one way to hide assets from college financial planning formulas. Some would question the ethics of trying to look poorer to get more aid, but the bottom line is that for most families, there are better ways to get an affordable education.

First, you should understand that assets owned by parents get favorable treatment in financial aid formulas. Some assets, such as retirement accounts and home equity, aren’t counted at all by the Free Application for Federal Student Aid or FAFSA. Parents also get to exempt a certain amount of assets based on their age. The closer the parents are to retirement, the greater the amount of non-retirement assets they’re able to shield.

Consider using the “expected family contribution calculator” at FinAid.org and the net cost calculators posted on the Web sites of the colleges your son is considering. Do the calculations with and without the money you’re trying to hide to see what difference the money really makes.

Most families don’t have enough “countable” assets to worry about their effect on financial aid formulas, said college aid expert Lynn O’Shaughnessy, author of “The College Solution.” Those that do have substantial assets have several options to reduce their potential impact, including spending down any custodial accounts, paying off debt and maxing out retirement plan contributions in the years before applying for college.

Another thing to consider is that most financial aid these days comes as loans that need to be repaid, rather than as scholarships or grants that don’t. So boosting your financial aid eligibility could just mean getting into more debt.

Meanwhile, it’s generally not a good idea to buy life insurance if you don’t need life insurance. The policy could wind up costing you a lot more than you’d save on financial aid.

If you’re still considering this policy, run the scheme past a fee-only financial planner—one who doesn’t stand to benefit financially from the investment—for an objective second opinion.

No spouse, no kids. Time to cancel life insurance?

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Dear Liz: I am 43 and divorced. I have a mortgage and an auto payment. I fully fund my 401(k) each year and am funding a Roth IRA. I also have emergency savings of $30,000 and a term life insurance policy for $350,000. What I don’t have is children or a spouse. I am thinking of canceling the policy, but is this a good idea?

Answer: The most important question to answer about life insurance is whether you need it. If no one is financially dependent on you, the answer is probably no.

Then again, canceling your policy is a bet that your life isn’t going to change — that you won’t someday have a partner who may need your income to pay the mortgage or other expenses, for example. If you’ve canceled your policy, you may find it difficult — not to mention more expensive — to get similar coverage later.

Term insurance is typically fairly cheap. Current quotes for a $350,000 30-year level term policy for a woman your age are typically between $40 and $60 a month. You’ll have to weigh whether the savings is worth what you’d be giving up.

Should life insurance be renewed in retirement?

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Dear Liz: My life insurance policy of $500,000 will end in four years, when I’m 63. My wife’s policy ends at age 62. Our kids are 28 and 25 and successfully launched with careers. I also have a $180,000 life insurance policy through my job that expires when I plan to retire, also at age 63. My wife and I have long-term-care insurance policies. We have $170,000 in an active investment account plus $1.4 million in our 401(k)s. Our kids also have trust funds that they will get when they turn 30 of about $80,000 each. Should I buy more life insurance for 10 to 15 years? Our estate, which is in a living trust, will pass to the kids. Our house is worth about $1 million.

Answer: The first question you must ask when it comes to life insurance is whether you need it. If you have people who are financially dependent on you, you typically do. If your wife has sufficient retirement income should you die, and vice versa, then you probably don’t.

So-called permanent or cash-value life insurance is often sold as a way to pay estate taxes, but again, it doesn’t look as if you’ll need that coverage. Congress increased the estate tax exemption limit for 2012 to $5.12 million, and that amount is tied to inflation going forward.

Still, this is a good question to pose to a fee-only financial planner, and you should be seeing one for a consultation before you retire in any case. Retirement involves too many complicated, irreversible decisions to proceed without help.

“Cheap” insurance could cost more in the long run

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Dear Liz: My homeowners insurance just went up 25%. I’ve made no claims and made no changes. I want to get quotes from other providers, but I’m afraid I’m going to get some type of “teaser” rate. I tried changing companies a few years ago and the rate was good, but when it came time for the renewal, they doubled the price! Again, I made no changes nor had any claims. So, now I want to change, but I’m afraid of falling into the same trap. Any suggestions?

Answer: You can’t assume you’re locking in a low rate for life when you buy homeowners insurance. Companies that want to expand their market share may lower their prices awhile to lure customers away from their competitors, then raise premiums when their claims costs go up or they simply want to cut their risk.

The company’s reputation for customer service should be at least as important a factor as price in your decision-making. Check the complaint surveys that many state insurance departments maintain on their websites to see which companies have the best (and worst) reputations.

One way to reduce your homeowner premium is to increase your deductible. Raising the amount you pay out of pocket from $250 to $1,000 can lower your premiums 25%. You should be paying small damages out of pocket anyway, since filing small claims can cause your rates to rise.

You also should shop around every few years, even if a company doesn’t dramatically raise your rates, to make sure you’re getting a decent deal. But again, chasing the lowest-cost insurance could be only a short-term win — an insurer that charges slightly more could be the more stable, and consumer-friendly, choice.

Advice not to fund 401(k) is a red flag

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Dear Liz: You recently suggested an insurance salesman be reported to state regulators because he suggested a reader stop funding a 401(k) and instead fund an insurance contract with after-tax dollars. You were way out of line. It’s very likely tax rates will be going up, so it may make sense to trade a tax benefit now for a better one in the future.

Answer: You might have a valid point if the reader were wealthy enough to be funding a life insurance policy or annuity in addition to his 401(k) contributions. Wealthier people are already facing higher tax rates, and they are more likely to be in the same bracket, or perhaps even a higher one, when they retire.

The fact that the insurance salesman suggested the reader redirect his retirement contributions to the insurance contract indicates the reader didn’t have the cash flow to do both. So it’s still quite likely that the reader will drop into a lower tax bracket in retirement, in which case he’s given up a valuable tax break now for a less valuable one in the future.

A red flag should go up anytime an insurance salesperson recommends you stop funding a tax-deductible retirement plan or that you tap home equity to buy whatever he or she is selling. That indicates the product was designed for someone wealthier than you. At the very least, you should run the purchase past a fee-only financial planner — someone who doesn’t earn commissions on product sales — to make sure you’re getting the whole story.

Get second opinion before buying cash-value insurance

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Dear Liz: I think you missed one of the possibilities when a reader wrote to you about a pitch he received from an insurance salesman. The salesman wanted the reader to stop funding his 401(k) and instead invest in a contract that would guarantee his principal but cap his returns in any given year. You thought the salesman was pitching an equity indexed annuity, but it’s possible he was promoting an indexed universal life policy, which would offer the same guarantees of principal and offer tax-free loans.

Answer: You may be correct — in which case the product being pitched is just as unlikely to be a good fit for the 61-year-old reader as an equity indexed annuity.

Cash-value life insurance policies typically have high expenses and make sense only when there’s a permanent need for life insurance. If the reader doesn’t have people who are financially dependent on him, he may not need life insurance at all.

Furthermore, the “lapse rate” for cash-value life insurance policies tends to be high, which means many people stop paying the costly premiums long before they accumulate any cash value that can be tapped.

Before you invest in any annuity or life insurance product, get an independent second opinion. One way is to run the product past a fee-only financial planner, who should be able to analyze the product and advise you of options that may be a better fit for your situation. If you just want a detailed analysis of the policy itself, you can pay $100 to EvaluateLifeInsurance.org, which is run by former state insurance commissioner James Hunt.