Article: To act like the rich, be frugal

Posted By Paul

I'm a big fan of the book 'The Millionaire Next Door' as you can see by the previous posts:

The Millionaire Next Door Pt 1: Big Hat No Cattle

Millionaire Next Door Review Pt. 2: UAW or PAW

Millionaire Next Door Review Pt. 3: Economic Outpatient Care

There is an article with the author where they ask him about trends in purchasing of certain "status" items. His findings and opinions are interesting. Here is an interesting excerpt from the article:

"For example, most prestige makes of cars -- 86 percent -- are driven by nonmillionaires. Yes, people with very high incomes, high levels of wealth are more likely to drive status automobiles. But in sheer numbers, the largest consumer segment for pricey cars, vodkas and homes is not the millionaire population, it is the aspirationals. These are people who think they are acting rich via their adoption of prestige brands, but in most cases they are only acting like each other."

Here is the link for the full article:

To act like the rich, be frugal

HSA? HRA? FSA?

Posted By Paul

So just when you thought medical insurance couldn't get more confusing they added even more types of health related accounts for you to puzzle out. I've been trying to figure out what they all are so I thought I would share what I found.

Let's start with the FSA. For that I'm going to refer people to an earlier post which describes them in detail:
Are FSA's worth doing?

So then what is a Health Reimbursement Account (HRA)?
An HRA is an account setup by your employer that you can use for medical expense reimbursement. It's essentially your company telling you: "We're going to give you X dollars to help you pay for your health care costs this year."

Generally you have to submit proof of medical expenses to your company for reimbursement.

So what's the downside? As near as I can tell there really isn't one. However, the HRA might not be for everyone. For example, one thing I've seen are things where a company has two plans that you can choose from:

Plan A: Costs you $1000 a year and you don't get an HRA.
Plan B: Costs you $2000 a year and you get an HRA of $1500.

If you assume Plan A and Plan B have the same coverage, which one should you choose?

Well, if you are healthy Plan A might be better since you might have health care expenses that are so low that you might never even USE your HRA. However if you have some known health issues that makes you certain that you'll end up using that $1500, then Plan B becomes the better option.

Okay, so then the final account to cover is the Health Savings Account (HSA)

The first thing to know is that not everyone is ALLOWED to get an HSA. You only qualify for an HSA if you are in what is considered to be a High Deductible Health Plan (or HDHP...sigh all these abbreviations). If you are enrolled in an HDHP (your employer should let you know) then you are allowed to open an HSA.

So what does an HSA do? Well first lets cover how money goes INTO the HSA. Contributions come from YOU (not your employer like in the HRA), and contributions go in pre-tax (which is cool).

While in your account your money can be invested (the investment vehicles depend on the financial institution that holds your account usually a typical set of funds and a money market).

So how does money come out? You use it for reimbursement of medical expenses (by submitting paperwork to whoever is administering your HSA).

Now one cool thing about the HSA is that the money doesn't "expire" at the end of the year like it does with an FSA, it remains yours so if you have a lucky year you have that money saved up for the following year.

If you withdraw money from your HSA that isn't for a medical expense then you take a penalty, but from what I've read, this penalty disappears when you turn 65, so if you whatever money you don't use become yours without penalty when you turn 65, so in a way you can consider it part of your retirement funds.

Also, if you leave your job or change health plans such that you are no longer in a HDHP then your money doesn't disappear. If you leave your job your account remains yours. If you end up switching to a health plan later that ISN'T an HDHP then you're not allowed to contribute to your HSA any more, but you can still withdraw money for qualified expenses.

It seems to me that an HSA can be a good choice for people who are in a situation where they don't have many health expenses currently, but expect to in the future. They can put money in their HSA and if they are lucky enough to have a year without any significant medical costs then they have those contributions saved in case it happens the following year. If you manage to go several years without any significant medical costs then you could build up a pretty nice little rainy day fund for when something does happen.

I found a link to a pdf that did a nice comparison between the three accounts:

HRSFSAHSA.pdf

I also recommend the wikipedia entries as they all do a good job of explaining the accounts in further detail:

Wikipedia Entry - FSA
Wikipedia Entry - HRA
Wikipedia Entry - HSA

Tips For Open Enrollment

Posted By Paul

If you're like me then November means open-enrollment. It can be a hard to squeeze in enrollment along with the holiday season, but the choices you make now are some of the most important ones that you'll make for the year.

Here are some tips I thought I'd share on navigating the open enrollment process:

1) Go to the informational sessions - companies almost always host some sort of meeting where they give an overview of your choices, be sure to go to this meeting.

2) Come to the session informed - this can be a tough one since it's easy to want to come to the session and get the information you need there, but I've found that it's REALLY helpful if you can at least try to understand your options BEFORE you go to the meeting. That way you can listen in the meetings to see if your understanding of the plans jives with the info the presenter describes. You can even come prepared with questions, which is a great way to clarify the ins and outs of your various choices.

3) Understand your choices - often with healthcare plans it's not as simple as "the plan that costs me the most is the best". Often the "best" plan is a matter of the size and health status of your family. Which brings me to item 4...

4) Have an honest understanding of the health care needs of your family for the year - it's hard to predict what kind of health issues you will face in the upcoming year but you can at least make an effort to identify things that you KNOW will be coming up.

5) Discuss with your family - The decision you make will have an impact on all of them for the year, so bring them into the discussion early. Go over the information with them. Not only does it make them more informed about their health care plan but going through the pamphlets and literature with someone else makes the process slightly less mind-numbing.

7) Discuss with coworkers - For me this is often the most useful thing to do. Your coworkers are making the same sort of choices you are so it's a great way to discuss pros and cons of plans and maybe learn something from a coworker that you missed or misunderstood.

8) Consider the worst case and prepare for it - One thing I like to consider when comparing plans is the "worst case for the year" by that I just mean the annual out of pocket costs for a plan. If a plan says that the most you'll have to pay in the year is say....$10,000 then if you have that amount in your rainy day fund it helps me sleep a little better. If the maximum out of pocket for a plan you are considering is $10,000 and you only have $2000 in the bank then I might want to rethink your plan choice or try to add more to your rainy day fund.

9) Check the networks. There are so many plans that only pay benefits when you go to a health care provider in a particular network. It's easy to just assume that your doctor is in the network, but definitely take the time to check, it usually only requires a quick phone call or web page search.

It seems like health care choices are getting more and more complicated each year, so use every information resource available to you when making your decision.

Links: Good info sources for annuities.

Posted By Paul

As I did my research on annuities I found some links that I wanted to pass on:

AnnuityTruth.org - specializes in info for annuities for seniors

Ultimate Guide to Retirement: Annuities - A great page from CNNMoney with all kinds of info about the different types of annuities. A must read for anyone thinking of purchasing an annuity.

Useful info to find out more about annuities.

What the heck is an annuity part 4: Variable with Life

Posted By Paul

This is going to be my next to last posting in the annuity series (my final posting will be a collection of useful info sources I found on annuities). I'm going to talk about the most controversial member of the annuity family, the variable annuity with life.

This is a very strange investment vehicle in that it is a mix of life insurance and fund investment. Essentially you put money every month into the variable annuity, part of that payment goes into the insurance component of your account (essentially like a life insurance premium) and the other part goes into "sub accounts" (mutual funds that you can choose from a family).

So what is the appeal? Well a common argument is that you get life insurance AND a retirement vehicle. You often hear of the idea that down the road you borrow against the cash value of your annuity which means you get your money tax free. I've heard of financial advisers presenting this idea as if it were something they had thought of.

What is the downside? Here are two of the most basic arguments against variable annuities with life insurance:

1) If you want life insurance, just go and buy life insurance - my research into this mentions that generally if you compare the money you pay for life insurance through a variable annuity to just getting a normal life insurance policy you'll discover that the life insurance through the annuity is MUCH more expensive.

2) Just as with regular variable annuities, watch out for fees. Brokerage fees, fund fees, commissions, maintenance fees. They can eat up your investment quickly.

I also found in my research that when you hear about "life insurance scams" that most often it is in the form of a variable annuity with life insurance product. This doesn't surprise me since the whole variable annuity with life insurance is a great product if you want to confuse and deceive someone since you have a variable annuity (which is already a complicated and poorly defined product) and you toss in life insurance (which is a complicated thing unto itself). A variable annuity with life insurance takes these two complicated things and mashes them together into a product that is almost impossible to understand, and makes it VERY easy to hide fees.

To give a personal slant to this, I had a variable annuity/life insurance policy for a short time. I opened it and then later closed it and luckily I didn't lose much.

So what did I learn from my brush with variable annuity/life insurance policies?

-They are confusing. When I first invested I THOUGHT I knew how it all worked but only after watching it closely did I see the fees and how the affected my return on investment.

-There is inertia and psychology involved. For example when I opened my annuity I put in a small amount of money and I watched it closely. I shudder to think what would have happened if I had put my whole nest egg in there and just stopped checking it and figured it was doing fine.

-They have all kinds if little ways to keep the money rolling in. With my annuity I would get a letter every few months saying that I had been offered an increase in my life insurance death benefit, and that for just X dollars more a month I would get an additional coverage of Y dollars in death benefit. The worst part was that the letters said that unless I contacted them they would assume I wanted the increase in benefit (and premium). It got to be annoying to have to write or call them every few month and tell them NOT to raise my premium. Imagine if I had just ignored the letters? Then every few months my premium would have gone up a little and who knows where it would have ended up.

It sounds like I'm pretty down on this type of product, and I would have to say that for the most part I am.

If you read my previous article on variable annuities you may recall that I suggested going into it ASSUMING it's a bad investment and then see if you can be convinced otherwise. For the variable annuity with life insurance it's so complicated and easily prone to hidden fees and catches that I would take my warning even further.

For a variable annuity/life insurance product I would suggest the following rules:

1) If you aren't taking full advantage of 401k/Roth IRA options then don't even think of looking at this product.

2) If someone offers you an annuity life insurance product, find out what it would cost to get the equivalent death benefit with out the annuity part.

3) Take some time to find the fees. They are in there, so see where they are and how much they are, ask about broker commissions, fund fees, maintenance fees and so on.

4) Do not invest in this product unless you can get an impartial knowledgeable person to think it's a good idea. When I say impartial I mean someone who is not making or losing money based on whether or not you invest in this product. This is NOT the type of product where you should trust the person who is selling you the product.

5) Do the research. This is also NOT the type of product where you should think: "well my aunt has one and she likes it, so mine's probably okay". There is so much variety among these products that your aunt could have a totally different TYPE of product, and maybe your aunt has one but doesn't really understand how it works either.

6) If anyone suggests that you invest in this type of product, ask yourself: "Would this person make money off of my investment?" If the answer is yes, then take EVERYTHING they say with a huge grain of salt.

There might be people in situations where this type of product is a good idea, but I would predict that this type of investment is probably the most commonly owned "bad" investment.

If you are someone who has this type of product and you don't really understand it I would do some serious research into your product, just some basic things like:

1) Find out what your death benefit is and do a little research to see what it cost you to get the same benefit from a reputable insurance company without all of the annuity stuff.

2) Check your subaccounts, find out what their maintenance fees are, compare them to mutual funds at Vanguard.

If you are at all worried after doing the above, then consider finding a financial adviser that is paid by the hour and seeing what they think, or perhaps just find a trusted friend or family member that is "into investing" and have them look over the account and see what they think. The worst thing to do is to be in a bad investment and continually paying month after month.

What the heck is an annuity part 3: Variable

Posted By Paul

As I go through the various types of annuities I seem to be gradually moving towards the more controversial types of annuities, and that brings us to one of the more controversial members of the annuity family, the variable annuity.

So what's a variable annuity? Here are the basic characteristics of a variable annuity:

1) Tax deferred - gains are only taxed when you withdraw them.

2) Fund based - your money is going into some sort of mutual or bond fund that you select (generally an annuity offers 6-12 funds that you choose from).

The variable part just means that your money is going into an investment, your return is based on how well those investments do. There is no guaranteed return.

I'm guessing that a lot of you are thinking: "This sort of sounds like a 401k." and you're right. It is SORT OF like a 401k, but that SORT OF is important.

In my research the main thing to watch in this sort of annuity is the fees. There are often high management fees, commissions for the agent who sold it to you, and other little fees like that. The fees may seem like a minor thing, but imagine if the fees end up being 2% of your total investment, you need to make 2% to just break even, and even more to beat inflation.

It seems that these fees are what typically give these types of investments a bad name. Even if you don't see any specific up front fees, the funds themselves might have a very high expense ratio. To see what that means go to my earlier post:

A Few Quick Tips On Mutual Funds

The question now is, are variable annuities something to avoid at all costs? Well I'd say that you should ONLY look at a variable annuity if you are already taking full advantage of your allowed contributions for your 401k AND Roth IRA.

If you decide to look into a variable annuity I would be VERY careful. I hate to recommend paranoia but this is one of those situations where I would suggest going into the situation with a very skeptical eye. Assume that the variable annuity is of the "bad" type (high commissions, high fees, etc.) and only invest if you are convinced this isn't the case.

Also, I would suggest that you observe the agent you are dealing with very closely. If they seem to be trying to conceal or downplay various fees and commissions, I would be VERY careful.

Finally, if anyone tells you that you should take your IRA or 401k and roll it into a variable annuity, consider this a HUGE RED FLAG! I found several articles that said that this sort of suggestion is essentially like saying:

"Hey let's take your big pile of money in a low fee environment and roll it into an investment with high fees and commissions without any added tax benefits."

If you have money in a variable annuity, I would suggest that you take a very hard look at it and see just how much you are paying in fees and then see how that is affecting your investments.

What the heck is an annuity part 2: fixed deferred

Posted By Paul

I came across another major annuity type called the "fixed deferred" or "fixed interest deferred" annuity that I wanted to talk about.

A fixed interest deferred annuity is kind of like a savings account, so I'm going to assume we all know what a savings account is and describe the annuity in contrast to that.

1) Like a savings account a fixed annuity gives you a known return on your money. In fact with fixed annuities you generally "lock in" an interest rate for some amount of time (like 5 years) and then after that interval has expired you "lock in" a rate again. One example is that Vanguard has a fixed annuity where if you open today you get a rate of 2.65% for the next 5 years. Note that this isn't a bad rate, in fact it's better than most CD's you can find right now.

BEWARE: I read about places where you get some awesome rate for the first year and then after that it resets to something lame, only now they have your money and you have to go through all kinds of hassle to move it.

2) Unlike a savings account, any interest you get is tax deferred. You don't pay taxes on it until you take it out.

3) Unlike a savings account, you can't just deposit and withdraw money whenever you feel like it. They vary, but it seems like most places have rules about how and when you can withdraw your money. The one through Vanguard for example says you can take out 10% of your savings in a year without penalty (but be careful, as with all tax deferred vehicles there can be tax consequences for getting your money out early). From my research it also seems that in most cases to add money you have to open a whole new annuity.

The above points generally capture what this type of annuity is. It's sort of like a 401k (you get the tax deferred part) and kind of like a savings account or CD (guaranteed interest).

So what are the pros and cons? Here is what I was able to come up with:
Pros: You get all the perks of a savings account PLUS tax deferral.
Cons: This is money you shouldn't plan on touching until the terms of the annuity are met. If you needed to "break open the piggy bank" early then tax and penalties could eat in to your money fast.

Overall, I think that this sort of annuity isn't a bad thing to consider if you've already given all you can to your 401k AND Roth IRA and still have money to sock away. When considering this sort of annuity BE SURE TO READ THE FINE PRINT and make sure you know what you're getting. Key questions to ask are:

1) What is my rate and how long does it lock in?
2) Is this rate an introductory rate?
3) How can I withdraw my money and what kind of withdrawal limits/penalties are there?
4) Is there any way to deposit additional money?

One interesting point is that when you compare this to my previous post:

What the heck is an annuity? Part 1

You'll see that this type of annuity is VERY different from the type I describe in my earlier post. As I mentioned before (and will mention again) that's one thing I REALLY don't like about annuities, it's such a broad term.

Once again I'll close with a quote from Warren Buffett about business investing, but it applies just as well to investment vehicles:

"Never invest in a business you cannot understand. "