Plan for a widow with $560,000

[isthisused]

Ok I was just approved for $500,000 term life and I have another $60,000 of coverage through work. I am writing up a plan for her because she has limited education and is intimidated by complicated financial matters, so the plan has to be fairly simple to follow.
I realize the plan will be adjusted every five years or so this first plan assumes I am dead in the next 5 years. She is 40 years old. She will need about $1000 per month to supplement her income. And will need to put away for retirement. Currently we have $20,000 in a 401k. We owe $100,000 on a 30 year fixed mortgage on a house that she would want to keep. We have no other debts..

This is what I’m thinking so far. First, pay off the mortgage. Put $30,000 in a high yield savings account (emergency fund) Invest the remaining $430,000 in conservative diversified portfolio (what kind???) Draw out 4% annually (with a 3% cost of living raise each year) out of that 4% she would put $5000 into a Roth IRA and the rest would be to supplement her income. If she works until 65 and does not lose principle in her investment account, She should have $900,000+ for her retirement assuming 7% compounding. Giving her a $36,000 per year

Please make corrections or offer suggestions or scrap and start over. thanks

[jIM_Ohio]

You don't list enough info as to whether paying off the mortgage would make sense.

I have a letter for my wife with my suggestions in a similar situation.

I tell her that 4% is what you can expect to take from the investment and have most of it still be there.

So if you NEED 12k per year, Put 300k into a bond fund (RPSIX is where my instructions suggest) and that will generate 12k per year and probably leave the principal intact (meaning that 300k might be there for retirement too).
If the other 260k can pay down debts like mortgage, cars and credit card, only you know that for sure.

I don't think retirement is accounted for in your plan. I say this because 20k in a 401k at age 40 is not enough to retire on (for 12k per year, I would suggest around 6X that-72k- by age 40 already saved). So whoever the insurance is providing for, it will help them live, but not retire.

The 30k emergency fund should already be there now, no reason to have that as part of the life insurance plan.

Technically the 5k can only be put into the Roth if she has earned income... and that should be done now even without any life insurance monies needed.

The better plan would be:
1) put 10k into a Roth IRA now (for both spouses)
2) have a 30k EF created now
3) spend less than you earn now
**if you don't do these things on current income, doing them with a lump sum life insurance payout is probably not going to last long, IMO**
4) have a plan to generate the $12k per year needed (300k in a bond fund). Assume 4% yield with no change in principal- reality is the share price of a fund like RPSIX will slowly go up, but might not go up with inflation.
5) have a plan for the remainder of the 200k for retirement.

The longer you live, the less likely the 500k can realistically fund a retirement plan.

[isthisused]

You don't list enough info as to whether paying off the mortgage would make sense.

I have a letter for my wife with my suggestions in a similar situation.

I tell her that 4% is what you can expect to take from the investment and have most of it still be there.

So if you NEED 12k per year, Put 300k into a bond fund (RPSIX is where my instructions suggest) and that will generate 12k per year and probably leave the principal intact (meaning that 300k might be there for retirement too).
If the other 260k can pay down debts like mortgage, cars and credit card, only you know that for sure.

I don't think retirement is accounted for in your plan. I say this because 20k in a 401k at age 40 is not enough to retire on (for 12k per year, I would suggest around 6X that-72k- by age 40 already saved). So whoever the insurance is providing for, it will help them live, but not retire.

The 30k emergency fund should already be there now, no reason to have that as part of the life insurance plan.

Technically the 5k can only be put into the Roth if she has earned income... and that should be done now even without any life insurance monies needed.

The better plan would be:
1) put 10k into a Roth IRA now (for both spouses)
2) have a 30k EF created now
3) spend less than you earn now
**if you don't do these things on current income, doing them with a lump sum life insurance payout is probably not going to last long, IMO**
4) have a plan to generate the $12k per year needed (300k in a bond fund). Assume 4% yield with no change in principal- reality is the share price of a fund like RPSIX will slowly go up, but might not go up with inflation.
5) have a plan for the remainder of the 200k for retirement.

The longer you live, the less likely the 500k can realistically fund a retirement plan.

We are about to open roths for each of us with another $10,000 that is in savings. she has income so she is eligable for the roth. We are getting a late start on saving for retirement. but counting the $10,000 in the roths we will have saved $20,000 in the last year. We are debt free besides the morgage.

If $300,000 in the bond fund can produce $12,000 per year without depleting principle, couldnt $430,000 in the same fund produce $18,400 from which she could fund the roth?

[jIM_Ohio]

We are about to open roths for each of us with another $10,000 that is in savings. she has income so she is eligable for the roth. We are getting a late start on saving for retirement. but counting the $10,000 in the roths we will have saved $20,000 in the last year. We are debt free besides the morgage.

If $300,000 in the bond fund can produce $12,000 per year without depleting principle, couldnt $430,000 in the same fund produce $18,400 from which she could fund the roth?

why would you need to fund roth with life insurance money if you have them funded already with income?

[isthisused]

why would you need to fund roth with life insurance money if you have them funded already with income?

To grow tax deffered for retirment.

[jIM_Ohio]

You missed my point- I think you are wasting the life insurance money.

You already have $10,000 budgeted for Roth contributions.

You die, your widow can still contribute $5000 from same budget- so the IRA budget decreased. The IRA contributions are in the budget you have now, which is derived from an income your wife already has. You would not need the life insurance money to replace this if you were budgeting correctly.

[isthisused]

You missed my point- I think you are wasting the life insurance money.

You already have $10,000 budgeted for Roth contributions.

You die, your widow can still contribute $5000 from same budget- so the IRA budget decreased. The IRA contributions are in the budget you have now, which is derived from an income your wife already has. You would not need the life insurance money to replace this if you were budgeting correctly.

We have scraped the roth $ together but it hasn’t been apart of the monthly budget as it should be in the future. But if we include it in her monthly budget it will just take the amount that she needs to supplement her monthly income up by $400 per month. Either way it affects the life insurance pay out in the same way. Unless Im not understanding you. The reason I separated it was so the people reading the plan could evaluate each of the needs , supplemental income and retirement income, incase they might have a better approach to meet those needs.

[isthisused]

I tell her that 4% is what you can expect to take from the investment and have most of it still be there.

.

Do you tell her to increase her 4% for inflation? Or do you tell her that each year you take 4% of what ever is there?

I think I will start a thread with this because Ive wondered about it.

Example: nest egg is $1000,000 1st year 4% =$40,000 2nd year with drawl is $41,200 3rd year is $42,436 this has her with drawls increasing by 3% to keep up with inflation. without this the standard of living must decline with inflation. Which is no big deal for the first few years but after 10 or 20 she will be eating cat food.

OR Example #2 : Do you tell her regardless of the $ amount, to take 4% and hope that the fund grows enough that her 4% will also grow? I tried to do the math on this and it seams that if your fund gains 6% per year and she takes 4% that her 4% will not keep up with inflation. But will grow the principle.

It seams that example # 1 would provide a stable income that will lag a little behind inflation( I believe it has averaged 3.9%) but mostly keep up. But would eventually begin to erode the principle. Unless some of the principle was in stocks, then the growth might keep pace.

[jIM_Ohio]

Do you tell her to increase her 4% for inflation? Or do you tell her that each year you take 4% of what ever is there?

I think I will start a thread with this because Ive wondered about it.

Example: nest egg is $1000,000 1st year 4% =$40,000 2nd year with drawl is $41,200 3rd year is $42,436 this has her with drawls increasing by 3% to keep up with inflation. without this the standard of living must decline with inflation. Which is no big deal for the first few years but after 10 or 20 she will be eating cat food.

OR Example #2 : Do you tell her regardless of the $ amount, to take 4% and hope that the fund grows enough that her 4% will also grow? I tried to do the math on this and it seams that if your fund gains 6% per year and she takes 4% that her 4% will not keep up with inflation. But will grow the principle.

It seams that example # 1 would provide a stable income that will lag a little behind inflation( I believe it has averaged 3.9%) but mostly keep up. But would eventually begin to erode the principle. Unless some of the principle was in stocks, then the growth might keep pace.

Our personal inflation is not 3%. So a straight 4% withdraw for many reasons:

1) my wife works and has greating earning power. My life insurance is so she can make ends meet. Her salary will go up with inflation, she has a 401k and Roth already in our budget, the life insurance money is so kids have college, house and cars get paid off, and any other loose ends get met (day care, vacations, other).

2) If you take 4% of what's there, the money will never run out (4% of $1000 is $40). The 4% rule lasts for 30 years or less, so by taking only 4% out, the money lasts longer.

3) Kids cost more early and less later. So 4% of 500k now (20k) and 4% of 550k 10 years later (22k) might not have same purchasing power, but 10 years later the kids will need less anyways.

4) This is our plan, I don't know enough about your situation to know if that makes sense for you.

Your best case is get a budget made, then analyze what would happen if the family was down to income from a widowed spouse. The Roth needs to be an "automatic" part of budget- meaning if person makes 50k, they invest 10k for retirement, and that 10k is listed in their half of the budget. If other spouse makes only 20k, they need to contribute 4k (20%) to retirement.

If the budget is not designed this way, then of course there will be issues with fund a Roth now (squeezing it as you suggest) and even more issues later.

If you are not saving 20% to retirement now, I would not plan on a windfall of life insurance money to make up for the time value of compounding. You need to set up your current budget to save 20% now.

[isthisused]

Yes it looks like our situations are a little different. My wife’s earning potential is limited, and it varies depending how many kids she has (child care). But our cost of living is pretty low. However you make a good point that her income would increase with inflation as she raises her prices, so she probably could just do the flat 4%. We got a late start on saving for retirement but last year I saved 15% with an 8% employer match for a total of 23% I have it set to automatically increase by 3% per year at the same time as I would normally get a raise. If we can keep this up and we get an average 8% compounding we should have close to $2000,000 not great but it should keep us in a good brand of cat food.

[jIM_Ohio]

Yes it looks like our situations are a little different. My wife’s earning potential is limited, and it varies depending how many kids she has (child care). But our cost of living is pretty low. However you make a good point that her income would increase with inflation as she raises her prices, so she probably could just do the flat 4%. We got a late start on saving for retirement but last year I saved 15% with an 8% employer match for a total of 23% I have it set to automatically increase by 3% per year at the same time as I would normally get a raise. If we can keep this up and we get an average 8% compounding we should have close to $2000,000 not great but it should keep us in a good brand of cat food.

IMO you should not look at life insurance and how to spend it in a vaccuum. Life insurance is one (necessary) data point on a comprehensive financial plan.

Because the post above gives a bigger indication of the financial plan than the 500k life insurance. I might argue you need MORE insurance now because of what you put above.

Just a guess, you have a 20 year term policy for 500k right? You are about age 38-40, so the policy might have to cover wife (if similar age) for 25 years of working (to age 65) plus 30 years of retirement draw downs (to age 95), so the money needs to last 55 years.

If that is the case 500k won't cut it. But no need to waste money paying for insurance you don't need...

Here is my math.

You suggested you need $2M at age 68? to retire on. I thought I saw a post that you are about 40 now? You used 8% returns (money doubles every 9 years), so I will use the same.

Here's my math for retirement (check points to use to see if plan is on track):
Age 68 $2 M
Age 59 $1 M
Age 50 $500k
Age 41 $250k

If you and wife are same age, you will want $250k set aside by next year to be able to retire at age 68. Retire earlier (younger)?- you will need more than $250k.

Your biggest issue you need to insure against is if something happens to you within next 10 years. I think you could get 500k by age 50 (depends on how much you earn, but putting in 20% of pay for 10 years would be like putting in a full years pay for 2 years and getting interest on that money).

If you live another 10 years, it's probable that you have 300-400k in retirement accounts, and wife making standard 20% contributions will be enough.

Just make sure the 500k can provide her to cover her expenses. You may want an additional 250k policy for 10 years, the need for that 250k goes away once the retirement account is ramped up.

[isthisused]

You are correct that more insurance would be better but I am in good health and I lead a pretty healthy lifestyle. The insurance I got is a safety net; my wife could almost support herself if the house was paid off. She is pretty frugal. I wanted to give her a plan that would provide a cushion and allow her to get health coverage. If I tell her that she can take $1000 per month but its better if she can get by with less, she will make it stretch.
I wish they had an insurance product that starts out with a larger pay out that gradually gets smaller as the term expires. I only got a 15 year term, I wanted to keep the premiums low enough that we could make them even if I lost my job.
The $2000,000 is not based on what we need, its based on what we have and assuming we are able to contribute $23,000 per year for 25 years and get an 8% return.
Your figure of $250,000 that I would need now, negates continued contributions. If I had $250,000 and made no other contributions it would grow to almost to almost $2mil.
I like the idea of a second policy for a shorter term; I wish I had had that idea before I got the policy. I think I can count on my wife’s good looks as a second policy, she says she wouldn’t remarry but after a few years without me she’ll hook up.

I really want to thank you for your imput, you have been very helpful. I welcome any more thoughts you might have.