CD? No thanks…

By Brad Thomason, CPA

 

A quick run by BankRate.com this afternoon shows that CDs still aren’t paying much.  One-year certificates are about a point, and even if you agree to go out as much as 5 years you still won’t get the rate up to 2%.

Most people need to hold some cash for liquidity purposes and the unexpected.  And a bank is a good, safe place to keep it.  But all too often we see people put money in the bank because they don’t have any ideas for a better place to put it.  When that happens, they become de facto CD investors, whether they meant to or not.  Even at today’s slowed economic pace, 1% a year is still not enough to keep up with the erosive effects of inflation.  In economic terms, putting your money in a CD is a money-losing exercise.  So once basic liquidity needs are met, it’s wise to limit the amount of money that is exposed in this manner.

Here are a couple of themes that we see people following for money that they don’t have an immediate need for.

 

Health Concerns?

Many retirees have cleared most of the major big-ticket expense items:  House is paid for, kids are educated and married off (the fact that weddings often cost enough to be considered a major financial event is probably a topic for another post some other time…), toys are accumulated, already have the car they want, etc.  But the question mark that’s still out there is the medical one.  Even if costs for illness, medication, doctor visits and hospital stays are covered, there’s a whole other category of costs that deal with ongoing care for chronic conditions.  These have to be paid for out of a separate bucket, and realistically speaking there’s no good way to budget for them ahead of time, simply because there’s no way to know how big the cumulative number will end up being.

Many people chose to “shift” this risk on to an insurance company in the form of buying a long-term care policy.  Even if the costs can’t be budgeted, premium payments can, they reason.  Going this route provides a level of protection and peace of mind.  But for some people, the cost of doing so is tough to take (even if they can afford it in a fiscal sense) because there’s always the chance they are paying for something they’ll never need (no one seems too upset that they wasted their money on car insurance when they don’t have a wreck, nor on homeowner’s when a tree doesn’t fall through the roof; but with LTC it seems to be perceived differently).

One alternative is a policy that’s set up to make available a pool of money if you need it for LTC purposes, but if not, the benefit gets paid out upon your death just like a conventional life insurance policy.  That way the coverage is there if you need it, but your family gets something back if you don’t.

 

Money you don’t need

Once you get the LTC piece covered, what if you still have money that you don’t expect to need; you know, the money that you will eventually leave to your family or favorite charity?  You may not want to put it at risk by investing it in something volatile, but maybe you don’t want it stuck in a CD either.  Is there anything you can do to keep it safe and get a better yield than what the bank pays.

For this situation we sometimes see people going to an insurance company for what’s commonly known as “single-pay life.”  The set-up is pretty simple.  Instead of making lots of premium payments over many years to fund a permanent life policy, they do it in a single lump sum.  The money they put in buys some set amount of death benefit (e.g. $100K payment might buy $175K of death benefit, depending on the age and health of the person being insured).  Then when the purchaser passes away, the larger sum goes to the beneficiaries.  To provide options if circumstances change, there are usually provisions available for accessing the money paid in if it turns out you need some of it for something else along the way.

In many instances the difference between what is paid in and what gets paid out is markedly greater than what would have accumulated if the money had simply been sitting in the bank all that time.  In the example case mentioned above, it would take about 70 years to get that kind of growth in a CD, at today’s short-term rates and after accounting for taxes.

Speaking of taxes, the single-pay route has an advantage on that front too:  While the owner is alive the “accumulation” in the life policy isn’t being taxed currently (as it would be in a CD), and the death benefit is generally going to be tax free to the heirs (unless the policy is purchased through a business or some other advanced method).

 

Insurance companies have long been derided by the mutual fund industry as a bad place to save and grow money (though with the collapse of the mutual fund industry’s track record over the last decade, that’s a much tougher argument for them to win today than it once was).  But using insurance companies as a place for storing money you’ve already made is a whole other matter entirely.

If you have money you expect to need to spend, especially within the next year or so, keeping it handy at the corner bank makes a lot of sense.  But for money that’s not needed right away, but still needs to be kept safe from market volatility, more and more folks are saying “no thanks” to CDs and looking for better options elsewhere.

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