Jonathan Clements's Blog, page 408

Taking Your Lumps

READ THE MEDIA and you’ll likely be convinced that health care costs in retirement will be overwhelming. One example: The Motley Fool says the average couple will need $400,000 for retirement health care expenses—if they’re healthy.

Pretty scary stuff. But let’s be realistic: Every ongoing living expense stated as a lump sum looks scary. For instance, my total property taxes over my retirement will come to $435,000, excluding annual increases.

Not reassured? Consider this from a recent study by the Employee Benefit Research Institute: “For the majority of surveyed people, out-of-pocket health care expenses are not as high as commonly believed. For those who die at age 95 or later, the median cumulative out-of-pocket expense after age 70 until death is slightly above $27,000.”

On top of those out-of-pocket (OOP) costs, you’ll also need to pay various insurance premiums. These two expenses will vary based on one’s income in retirement (Medicare premiums are income-based), coverage selected (traditional Medicare or Medicare Advantage, plus any Medigap plan and Part D prescription drug benefit), individual health care needs and, to some extent, location.

Many people will find that their monthly premiums in retirement will be higher than during their working years, especially if they had received benefits through their employer. But that’s a reason to plan, not to panic.

In 2018, the majority of Medicare beneficiaries pay the standard Part B premium of $134 per month and the average but variable premium of $35 for the Part D prescription drug benefit. For those individuals with incomes above $85,000 a year, these premiums will be considerably higher. Be happy: You’re considered wealthy.

On top of this, you may have a premium for a Medicap plan, which helps insulate you from potentially high OOP costs. While costs vary widely, figure $225 per month for Medigap coverage. If you’re married, you’ll need to double all of these various premium amounts. Result? Unless you have a high income, total premiums should average $788 a month for a couple, equal to $9,456 per year. A 30-year retirement gets a couple to the scary number of $283,680.

Meanwhile, coping with OOP expenses requires some planning. I’d advise setting up a “health expense risk” fund. If you’re enrolled in a qualified high-deductible health plan, the best tool is a Health Savings Account (HSA). You can set aside funds pretax during your working years, invest them for growth and then use the proceeds tax-free in retirement for health care expenses. In the absence of an HSA, simply setting up an account earmarked for OOP expenses will ease your financial stress in retirement.

The last risk is long-term care (LTC). If you don’t have LTC insurance, you’re on your own—unless you deplete almost all your assets, at which point Medicaid kicks in. Those concerned with protecting assets from LTC expenses should seek specialized financial and legal advice that’s customized to their financial situation and to the state where they live.

How much risk is there? About 69% of seniors will need some type of long-term care. But that includes both in-patient and at-home care—and both paid care and care provided by family and friends. An estimated 42% of  seniors will require paid in-home care, 35% will need nursing home care and 13% will require care in an assisted living facility, with care typically lasting one year or less. Still, make no mistake: There is a significant financial risk—and, if you’re unlucky, the dollars involved could be large.

Richard Quinn blogs at QuinnsCommentary.com. Before retiring in 2010, Dick was a compensation and benefits executive. His previous blogs include Pain Postponed, Sharing It and What Motivates Me. Follow Dick on Twitter @QuinnsComments.

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Generating Interest

TWO DECADES AGO, I read an article in The Atlantic magazine about building a home bank for small children. But this wasn’t a bank that would sit on a shelf or table. Its home was in an Excel spreadsheet—with a phenomenal interest rate of 300%.

If real, that kind of return would end the debate on index vs. actively managed funds. Fortunately for banks and mutual funds, the Belwick Bank—named after the street we live on—only had one customer: our four-year-old son and his weekly allowance of $1.

With a little help from a spreadsheet guru in the accounting department at work, I built the spreadsheet, so it would make new interest calculations each day and automatically deposit his allowance each week.

Our hope was that this bank would instill a fun lesson: that saving money and compounding interest can lead effortlessly to more money and a bigger Belwick Bank account. It just takes time, patience and an appreciation of delayed gratification.

One of the beautiful features of the spreadsheet was that our son could gaze into the future by scrolling down and seeing what would happen to his money three or six months later—if he didn’t touch it. But if he was thinking about spending some, he could plug in a withdrawal and see how that would influence his total today and six months later.

It’s hard to say with certainty how this exercise influenced him and whether it made him more careful with money. But my memory is that he didn’t withdraw much, didn’t buy much—and was happy to see his money grow. My firm belief: The Belwick Bank helped our four-year-old develop an early understanding of the power of compound interest and of delaying gratification.

Alan Cronk retired after spending 32 years in the newspaper industry as a marketer, editor and writer at the Winston-Salem Journal. This is the third in a series of blogs about his and his wife’s experience educating their child about money. Previous blogs: Baby Steps and No Laughing Matter.

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Moving Costs

I HAVE A CLIENT I’ll call Irene. She became a widow in April when husband Henry died.

Like most married couples, they held title to their home in joint ownership with the right of survivorship. In plainer language, this means that co-owner Henry’s death results in his loss of all ownership in their dwelling. Surviving co-owner Irene automatically acquires all ownership in it.

Irene is uncertain what to do with her highly appreciated home. One option is to quickly sell it and move to where her daughter lives. But I agree with the daughter that Irene should go slowly when it comes to major decisions like home sales. Other options are to wait several years and then sell or just stay put, in which case the residence eventually winds up with her heirs.

Irene wants to know the tax consequences of selling or staying. I start by explaining the tax breaks for individuals who sell their principal residences.

The law authorizes “exclusions” that allow home sellers to sidestep income taxes on most of their profits when they unload their principal residences. The exclusions are as much as $500,000 for couples filing joint returns and as much as $250,000 for single persons. Sellers are liable for taxes on gains greater than $500,000 or $250,000.

If Irene sells, can she exclude $500,000 or $250,000? The answer depends on the sale date and whether she remarries. Though she’s no longer married, recently widowed Irene still qualifies for the higher amount—as long as she sells within two years of Henry’s death. It’s the lower amount if she sells after the two-year deadline.

What if Irene remarries? If new husband Harry then lives in the place as his principal residence for at least two years out of the five-year period that precedes the sale date, the exclusion will once again be $500,000.

Usually, a seller also has to own the place for those two years. That requirement doesn’t apply to Harry. That means his name doesn’t have to be on the title.

Moreover, the IRS says that Irene and Harry needn’t be married for all of the two years that precede the sale date. What do they need to do before the sale occurs? Just marry. This holds true even if their wedding precedes the sale by just one day.

Even if Irene doesn’t remarry—and even if she doesn’t sell within two years of Henry’s death—her taxable gain may be smaller than she fears. Suppose, as is likely, that Irene’s long-term capital gain from her home’s sale exceeds her exclusion ceiling.  She calculates the tax on the gain by following the rules introduced by the Tax Cuts and Jobs Act (TCJA) that Congress passed in December 2017.

For most sales, the capital gain’s tax rate is 15% (income between $38,600 and $425,800 for single persons). It increases to 20% (income above $425,800) and goes as high as 23.8% for those who are in the top income tax bracket of 37% and subject to the Medicare surtax of as much as 3.8% on income from certain kinds of investments, including profits from home sales.

On top of Uncle Sam’s take, state income taxes may also be owed. I caution Irene that she might not be able to deduct all of those taxes; TCJA imposed a $10,000 ceiling on write-offs for state and local income and property taxes. Another snag: Irene forfeits any write-off for state income taxes if she’s subject to the alternative minimum tax.

While my recitation of federal and state tax rates dismays her, she positively beams when I pivot to tax laws that authorize exceptional condolence gifts for Irene and other bereaved individuals who sell inherited homes, stocks and other assets that have appreciated in value.

In tax lingo, the basis (the starting point for measuring gain or loss) of inherited assets “steps up” from their original basis (the cost upon purchase, in most instances) to their date-of-death value. It’s as if the inheritors had bought the assets that day.

On Henry’s death, a step-up in basis for their home benefits Irene when she sells her dwelling. What happens if she never sells? On Irene’s death, there’s a second step-up in basis that benefits her heirs.

The first step-up is only for Henry’s half interest. There’s a step-up of his adjusted basis (typically, half the original purchase price and half the cost of any subsequent home improvements) to what that half-interest is worth when he dies. If the couple lived in a community property state, the step–up is for the entire basis.

On Irene’s death, there’s a step-up of her adjusted basis (previously boosted by the step-up for Henry’s half interest) to what the entire home is worth when she dies. When the heirs sell the home, they’re liable for capital gains taxes only on post-inheritance appreciation.

The bottom line for Irene and her heirs: Whereas a sale by Irene of a home that has appreciated immensely can trigger sizable federal and state taxes, a sale by the heirs dramatically shrinks or even erases those taxes.

J ulian Block writes and practices law in Larchmont, New York, and was formerly with the IRS as a special agent (criminal investigator). His previous blogs include Anti-Social Security, Execution Matters and Taking Shelter. Information about his books is available at JulianBlockTaxExpert.com. Follow  Julian on Twitter @BlockJulian.

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Not My Thing

NOT LONG AGO, I ran into my friend Martin, who works as a cardiologist at a local hospital. In the course of our conversation, I commented on the construction equipment outside his facility and asked what they were building.

His answer: “Building? No, they’re actually un-building.”

He explained that recently his hospital had been sold and the new owner was a for-profit company. As part of the transition, the new owner had evaluated the hospital’s facilities and discovered that a group of older buildings was largely unused. Unlike the prior owner, which was a nonprofit, the new owner was subject to real estate taxes, saw no sense in paying taxes on empty buildings—and determined that it would be worth the expense to take them down.

This got me thinking about how tricky it can be to make financial decisions. In this case, two different owners of exactly the same buildings came to opposite conclusions simply because of a difference in their tax status. Moreover, in addition to tax considerations, there are a thousand other ways in which each of us is unique: our age, health, children, lifestyle and much more. Each of these factors must be considered when making financial decisions. On top of this, with so much information coming at us—from radio, TV, podcasts, blogs and more—it can feel more difficult than ever to make sense of it all.

As the hospital example illustrates, what works for one person may not work for the next. How do you figure out what financial advice will work for you? Whenever you come across financial information and are wondering what to make of it, try asking yourself these three questions:

1. Does this information actually matter? On my shelf, I have a book titled Guide to the 50 Economic Indicators That Really Matter. This book is only lightly read and probably ought to be thrown away, since most of the 50 indicators really don’t matter. For ordinary people, there is very little relevance, and debatable predictive value, in obscure statistics like the Baltic Dry Index or the Tankan Survey.

I would put recent concerns about trade tariffs into the same category. Yes, this issue matters, but the impact is far from certain. If you have a diversified portfolio and take a long-term view, it really shouldn’t cause you to lose sleep. As William Bruce Cameron (and not Albert Einstein) once said, “not everything that can be counted counts.”

2. Is the information accurate? In recent years, there’s been growing concern in academic circles about a phenomenon called the “replication crisis.” The worry is that it’s very difficult to reproduce the results from a large portion of studies published in academic journals. While scholars are still working to understand this, I view it as yet another reminder that you should think critically about everything you read. Before making financial decisions, always evaluate the credibility and the track record of the source, and always look for counter-arguments.

3. Is the information universally applicable? Some advice does indeed fall into this category: Avoid credit card debt, for example, and avoid high-cost investments like annuities. But some advice will apply only in specific cases—to people in certain tax brackets or, alternatively, to people who hold specific investments, such as high-yield bonds or a concentrated position in a particular stock.

The upshot: As you come across financial advice, always ask yourself whether it is generally applicable. If not, ask yourself whether it applies to you. There are lots of good ideas out there. Just be sure that any given idea will be good for you.

Adam M. Grossman’s previous blogs include Nothing to Chance,  In the Cards  and  You—But Better . Adam is the founder of  Mayport Wealth Management , a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter  @AdamMGrossman .

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When I’m 64

AS WE AGE, our perspective on money slowly shifts. How so? Below are 11 changes I see in myself and my contemporaries, those also in their 50s and 60s. Admittedly, some of these changes are more aspirational than actual. We don’t behave quite as wisely as we imagine—but we are, at least, trying to be wise.

We’re less confident we can beat the market, but more confident we know what we’re doing.
We are freer with our money—but more calculating with our time.
We care less about what others think and more about what we value.
We’ve stopped buying possessions for their lasting value and started purchasing experiences for the happiness they can deliver.
We are less physically courageous, but braver in the face of market declines.
We pay more heed to what today’s decisions mean for tomorrow—which is ironic, given that time is now in shorter supply.
We’re less bothered by life’s nonsense—unless you’re a telemarketer or sender of spam, in which case we think you deserve to fry.
We used to think the rich and famous were to be admired, but now we see their foibles and view them as flawed—just like the rest of us.
We are less likely to listen solely to our gut and more likely to pause long enough to let the contemplative side of our brains have its say.
We’re quicker to concede we simply don’t know—and less certain we have the precise right answer.
We no longer imagine we’ll leave a significant mark on the world, and yet we’re more anxious than ever to do work we think is important.

Follow Jonathan on Twitter @ClementsMoney and on Facebook.

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Economy Class

ARE YOU NERVOUS about college costs? You should be. According to the College Board, the average cost to attend a public four-year university as an in-state student in 2017-18 was $20,770. Private four-year universities averaged a whopping $46,950. Ouch.

Lucky for you, the system can be beat. Here are four great ways to cut college costs:

1. Scholarships and Grants. Thousands of dollars in scholarships and grants are available—but you have to apply. The application process may seem daunting at first, but by using a strategy I call “templifying,” the task is simple.

During my high-school and college years, I applied for more than 100 scholarships. If you think I typed out over 100 individual scholarship essays, you’re wrong. From my experience, 80% of scholarship prompts can be answered by a pre-built arsenal of five or six “template” essays.

These prompts include questions like: Why did you select your major? What are your future goals? What is your biggest failure and what did you learn from that experience? Why do you deserve this scholarship? What is your greatest accomplishment?

After building several essay response templates, an aspiring college student can apply for hundreds of scholarships in a fraction of the time. What scholarships should you apply for? Check out sites such as Scholly.com, Scholarships.com, StudentScholarshipSearch.com and ScholarshipPoints.com.

Meanwhile, the first step in qualifying for grants is to fill out the Free Application for Federal Student Aid, or FAFSA. Even if you don’t think you qualify for needs-based aid, fill out the application anyway. According to a NerdWallet study, an estimated $3 billion in federal Pell grants go unclaimed simply because college entrants failed to fill out the FAFSA.

2. AP and CLEP Exams. Advanced Placement (AP) and College Level Examination Program (CLEP) exams are the best nonmonetary ways to cut college costs. Qualifying scores on these exams count as college credits. With the average college course costing around $1,800, these exams can potentially save tens of thousands of dollars.

Most high schools offer AP courses as part of their curriculum, while CLEP courses typically aren’t offered. What’s driving this? The AP program is heavily promoted in schools because of its alignment with the Common Core curriculum.

Both AP and CLEP exams can be attempted without taking an accompanying course. Sure, this is slightly more difficult and requires more motivation. Still, there are hundreds of free and paid resources online to help prep for these exams.

3. Dual Enrollment. This is when a high school student takes college courses at a nearby university, on top of their regular course load. An ambitious student can enter college with dozens of credit hours completed by enrolling in these types of programs.

The best part is that most participating universities allow high school students to take the courses for free or close to it. To receive college credit for a course, a student must typically achieve a grade of C- or better.

Similar to the AP and CLEP exams, this strategy can eliminate costly semesters from a student’s college career. One advantage of dual enrollment is that the student actually gets to participate in a college-level course, instead of just taking an exam on the subject. Check with your local high school to see what dual enrollment options are available.

4. Community Colleges. These are often shunned because of their lack of prestige. But there are four sound arguments for attending a two-year community college.

First, community college courses cost a fraction of those offered at public or private four-year universities. Second, students can commute from home, thereby saving on housing and food costs. Third, at many institutions, the first two years of coursework are typically “general education” requirements—meaning the courses don’t necessarily pertain to a student’s all-important major. Finally, if a student studies for two years at a community college and then transfers to a more prestigious university to complete his or her degree, it’s the university that bestows the degree. Employers care about the final destination, not the beginning of the journey.

There’s a fifth potential reason to attend community college first: Some state universities have scholarship programs for community college attendees. These programs are typically based on achieving a minimum grade point average—and they may cover the full cost of attending the state university.

Cody Berman blogs at FlytoFi.com. For more on holding down college costs, check out his Ultimate College Guide. Follow Cody on Twitter @FlytoFi.

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Telling Tales

WHEN YOU WERE growing up, did you ever hear stories like these?

“If you swallow gum, it will stay in your stomach for seven years.”
“If you keep making that face, it will freeze that way.”
“If you drink coffee, it will stunt your growth.”
“If you watch too much TV, your eyes will turn square.”

In hindsight, these stories are funny and harmless. But problems can arise if, as adults, we make important decisions based on misinformation. Within the world of personal finance, the topic that seems most susceptible to tall tales is Social Security. I regularly hear people attack it, arguing that it’s a Ponzi scheme or that it’s going to go broke.

While the program isn’t perfect, I believe it’s far better than its reputation suggests. Below are five common myths about Social Security, along with my views.

Tall Tale No. 1: Social Security is going broke.

Fact: It’s true that there are special trust funds that hold Social Security’s surplus tax revenue. Those funds, however, are not Social Security’s only source of funding. The reality is, Social Security is an obligation of the federal government. Unlike a private company’s pension plan, the government will have to continue making payments, whether or not there’s any surplus remaining in those trust funds. Yes, in the future, Congress could vote to reduce benefits. But the system cannot truly “run out of money.”

Tall Tale No. 2: It’s just a retirement plan.

Fact: While Social Security is best known for its retirement benefits, it also provides two other important programs: disability insurance and life insurance, in the form of survivor benefits. With a few exceptions, all three programs are available to every American.

Tall Tale No. 3: Since Social Security provides disability benefits, there’s no need for private disability insurance.

Fact: While Social Security provides a disability program, I still recommend private insurance. That’s because the bar is much higher to receive benefits from Social Security than it is from a private insurer.

Tall Tale No. 4: If I haven’t worked, I’m not entitled to any benefits.

Fact: Social Security was designed in an earlier era, when households typically had only one breadwinner. For that reason, the system will pay retirement benefits to both a retired worker and to that worker’s spouse, even if the spouse never worked. This is a separate benefit, on top of the worker’s own benefit, and does not reduce the worker’s benefit. Benefits are also available to ex-spouses.

Tall Tale No. 5: I should sign up at my earliest possible opportunity.

Fact: Most likely not. Again, Social Security was designed in a different era, when life expectancies were shorter. As a result, the benefits get much more generous if you can wait. Your monthly check will permanently increase by eight percentage points per year, plus inflation, for each year that you wait beyond your “full retirement age” of 66 or 67, up until age 70, at which point the benefits don’t increase further.

Adam M. Grossman’s previous blogs include Nothing to Chance, In the Cards and You—But Better . Adam is the founder of  Mayport Wealth Management , a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter  @AdamMGrossman .

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Looking Forward

I WAS LISTENING recently to a Bob Dylan song, From a Buick 6. One of the song’s lines is, “I need a dump truck, baby, to unload my head.” That’s how I sometimes feel about the churning in my own mind concerning retirement.

I turned 67 this year. This is probably one of the most critical periods for me as a retiree. There are things in my life I need to sort out, so I can develop a more accurate financial plan that will support my retirement. The following are some of my thoughts about my life moving forward.

I don’t want to die where I currently live. This might sound morbid. But it’s the truth. I spend the majority of my time taking care of my elderly mother. When I’m not with her, I stay with a friend at her house. I’m only home one day a week and it no longer feels like home.

When I was younger, I thought it was a great location for me. As I grow older, I’m not so sure. It would be difficult to walk in the neighborhood because of the traffic and the uneven sidewalks. The building I live in is not very accommodating for an older person.

The new home I’m considering is in an area that is walkable, has good medical facilities, and is located close to stores and restaurants. The home would be easier to navigate and has a small yard. This, however, would also increase my housing costs. Until I make a decision, I have decided to use those costs when calculating my future expenses.

I have a close friend. I want to make sure she is financially secure. I decided to wait until I’m age 70 to claim Social Security, so I receive the maximum possible benefit. As a result, if we decide to get married, she would be eligible for a larger survivor benefit after my death. She should outlive me. I like her odds because she is a female and six years younger. Also, I think delaying my Social Security is a smart thing to do. If one of us lives a long life, the larger payment would be extremely helpful.

I have a mother who will be 95 years old this year. I have power of attorney over her finances. I use the “do no harm” approach when managing her finances. I decided this year to move her remaining money from stocks to bonds. I believe her money should be in liquid assets because of her age and short time horizon. I don’t want her withdrawing from her portfolio in a bear market. If she doesn’t need long-term care, I believe she will have enough money to last the rest of her life. If she needs additional money, I will step in and help her as much as I can. This could be a major expense.

That brings me to my thoughts on how I will fund my own retirement. I’m not comfortable with current stock market valuations. At this point, I’m not trying to grow my portfolio. Rather, I’m trying to preserve it and protect it from inflation. My portfolio has approximately 75% in bonds and 25% in stocks. The bonds plus my Social Security should fund my projected living expenses during retirement. The stock side of my portfolio will be used as a hedge against inflation and for funding possible long-term-care needs.

When I’m 70 years old, I plan on using the IRS’s required minimum distribution table as the percentage I will withdraw each year from my overall portfolio. That will force me to be conservative with my spending, with small percentage withdrawals, especially in the early years.

How will I know my portfolio is performing well? I’m using the Vanguard Target Retirement Income Fund as a benchmark. It isn’t a perfect match, but close enough. As of June, my portfolio was slightly ahead of the Vanguard fund for the year to date.

Dennis Friedman retired at age 58 from Boeing Aerospace Company. He enjoys reading and writing about personal finance. His previous blogs include More Than Money, Leap of Faith and Lessons Learned.

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Pain Postponed

RAISE YOUR WALLET if you think taxes won’t be going up.

Is there much doubt that the federal government will seek additional revenue, given its ballooning debt and future spending on Social Security, Medicare and other federal programs? If so, should retirement savers really be deferring taxes—or, instead, should we be taking advantage of tax-free retirement savings?

The IRA was first introduced in 1974. At that time, there was a 38% tax rate on individual incomes of more than $20,000, with a maximum 70% tax rate on incomes above $100,000. Fast forward to 1980 and the launch of 401(k) plans: You had a maximum tax rate of 70% on incomes above $108,300, and a 39% rate that started at $23,000. Back then, saving on a tax-deferred basis made sense. But today, we have—I suspect—the lowest tax rates we will see for decades.

Some experts—including Prof. Larry Kotlikoff of Boston University—estimate that the unfunded liability for government entitlement programs is $210 trillion. Yup, that’s trillion. That is the difference between anticipated benefit payments and anticipated revenue to support them.

Don’t buy those very long-term projections? Consider instead the very real and growing federal debt of $21 trillion. With that kind of debt, the top tax rates won’t be the only ones going up. There simply isn’t enough money among top income earners to get the revenue needed.

Moreover, it isn’t just higher income tax rates that can hit workers and retirees. Consider that one of the federal government’s largest single revenue losers is the tax-free status of employer-provided health benefits. On top of that, in many cases, even employee contributions are made on a tax-free basis. Could this low-hanging tax fruit tempt the politicians—potentially affecting most middle-class Americans, including millions of retirees?

Despite the likelihood of higher tax rates, we still see employers encouraging their employees to fund tax-deductible retirement accounts, such as traditional 401(k) and 403(b) plans. Those traditional retirement accounts are also where any matching employer contribution ends up. Are employees being set up for steep tax bills in retirement?

The tax situation has changed greatly since 1980 and is likely to change again—and not for the better. For many folks, the chances of being in a low tax bracket in retirement are waning, especially once they factor in not only the taxes owed on required minimum distributions from retirement accounts, but also the growing taxation of Social Security benefits.

What are the implications of all this? Putting some money in tax-deductible retirement accounts still makes senses. During your working years, those tax-deductible contributions will save you taxes at your marginal tax rate—but in retirement, much of your retirement account withdrawals will likely be taxed at lower rates, because these withdrawals might account for the bulk of your income.

Bu if you’re saving more than, say, 10% of your income for retirement, you may want to rethink which account you use for those additional savings. The obvious choice: a Roth 401(k), Roth 403(b) or Roth IRA. You won’t get a tax deduction for your contributions. But once retired, everything withdrawn from your Roth accounts should be tax-free—potentially a huge plus if tax rates are indeed headed higher from here.

Richard Quinn blogs at QuinnsCommentary.com. Before retiring in 2010, Dick was a compensation and benefits executive. His previous blogs include Sharing It, What Motivates Me and Benefits Lost. Follow Dick on Twitter @QuinnsComments.

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Nothing to Chance

IN THE SUMMER of 1789, George Washington got into a dispute with his Postmaster General—a fellow named Ebenezer Hazard—and removed him from office.

Looking for a new profession, Hazard decided to start an insurance company. He called his new firm the Insurance Company of North America and specialized in providing life insurance to ship captains. The business was a perfect fit for the times and quickly prospered. Still, I’m sure that even Hazard would be surprised to see his company still in business more than two centuries later. Today, Insurance Company of North America is the “i,” “n” and “a” in the company’s new name, Cigna.

Ordinarily, insurance companies would not be the most interesting topic, but there is one thing about them that is worth your attention: They are disproportionately represented among the world’s oldest surviving companies. In addition to Cigna, several other American insurers date back 150 years or more. And outside the U.S., many go back as far as the 1600s.

In my opinion, it is no coincidence that so many insurance companies have survived for so long—and I believe it’s worth taking the time to understand the secret to their longevity. Once you do, you may be able to apply their playbook to your own finances.

So what is their secret? It’s not any of the most obvious explanations for business success: None has monopoly power. None possesses unique technology. And none has a Steve Jobs-type visionary leader.

Instead, the strategy that they all employ is something that, in industry jargon, is called “liability matching.” In plain English, that means that they plan very, very carefully to be sure they can meet their future financial obligations. For example, suppose that hurricane season typically results in $2 billion worth of claims each year. If you looked at the internal books of any homeowner’s insurance company, they all would be able to point to a set of dollars that are specifically earmarked for hurricane season 2018, another set for 2019, and so forth. Similarly, a life insurance company will have funds set aside to meet the claims they expect this year, next year and every year into the future for which they have sold policies.

In short, insurance companies leave nothing to chance. They don’t hope and pray that there will be enough cash available to meet future claims. Quite the opposite: They have teams of actuaries who spend their days preparing risk models to ensure that there will be enough cash (or investments expected to produce cash) to match every single projected future obligation of the insurer. That is why it is called liability matching.

As individuals, none of us has the resources of an insurance company. We don’t have our own team of actuaries and we don’t have the ability to increase our own household incomes in the way that insurance companies can raise rates on policyholders. Still, the principle of liability matching is a powerful technique that anyone can employ.

What would this look like in practice? Insurers maintain hundreds of individual accounts—one for each group of future claims. Clearly, you don’t need to go that far. But I would think about it in the same way. Start by asking yourself how many different major obligations you have in your future. For virtually everyone, retirement is a consideration. In addition, some of the following might apply: private school or college tuition, a home down payment or renovation, a wedding and perhaps a major charitable gift. If you are just getting started, you might be focused more on student loans you want to pay off. These are just examples. Take some time to write out your own list of major obligations, being sure to attach an estimated dollar value and timeline to each.

In drawing up your list, I have found that it makes sense to stick to five or fewer individual goals. Go much beyond that and things can become too unwieldy. Indeed, if you focus on funding a small number of very specific and quantifiable goals, I think you’ll find it enormously helpful. You’ll have a yardstick against which to measure your progress. And with that yardstick in hand, you’ll likely find yourself making progress more quickly than you otherwise would, as you strive to accumulate assets to match your future liabilities.

Adam M. Grossman’s previous blogs include In the Cards, You—But Better and Happily Misbehaving. Adam is the founder of  Mayport Wealth Management , a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter  @AdamMGrossman .

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