6 Homeowners Insurance Mistakes

Homeowners insurance isn’t complicated – but lots of people lose track of their coverage needs, because they’re in the same home for so long. That policy that you bought five or ten or 20 years ago may well no longer be adequate to protect you. A fire, flood, wind event, sinkhole or other catastrophic event could still leave you financially devastated, even with homeowners insurance.

Here are some common mistakes people make with their policies.

Inadequate coverage amount.

Although it’s been a rough five years for homeowners, financially, the fact remains that real estate historically appreciates over time, along with inflation. The same is true for construction materials and labor. If your home were to be destroyed, would your insurance coverage cover the cost of rebuilding today? Or is it still based on what it cost to build a home a decade ago?

Remember, too, that the cost of rebuilding a home in place, new, can be very different from the market value of your existing home. Your existing home may have been built with materials and specifications that are no longer available or even legal. It frequently costs much more to rebuild a home in place than to buy the identical home next door. If you want to be able to rebuild, insure for replacement value, not market value.

Inadequate inventory of personal goods

Your homeowners insurance needn’t just protect you against loss or damage to your home’s structure. If your home is destroyed, you may also need to replace its contents, as well: Furnishings, antiques, musical instruments, jewelry, art and collectibles all need to be replaced or compensated for in order to make you financially whole after a catastrophe to your home.

Unfortunately, too many people accumulate valuables for years, but never take an inventory of their property – to be stored offsite – and never update their insurance policies to reflect the value of their property that they have at risk.

They stand to lose tens or even hundreds of thousands of dollars if disaster strikes.

To address this, you may consider using one of several websites available to help you document your property, log the serial numbers, if applicable, and/or photograph your belongings and store it off site, where your inventory list cannot be destroyed by the same hazard that destroys your house. One good example is knowyourstuff.org. Don’t have time? Too busy with work?There are many businesses that will do this job for you, at an affordable cost.

Assuming floods are covered.

They almost never are, in a basic homeowners’ policy. The vast majority of times, hazards that are not roughly equally common across the state are excluded from homeowners’ policies. You have to buy separate flood insurance, either from your carrier or via the National Flood Insurance Program.The same generally applies to sinkholes.

Business Property at Home.

Do you have a home office? Do you use your home to store business inventory or supplies? Check your coverage. Your homeowners policy may not cover these items. In some cases, business operations out of your home could even invalidate your homeowners policy. You might need to plus up your commercial insurance policy to cover business property.

Liability Limits are Too Low

Jury awards are much higher than they used to be. If you haven’t adjusted your homeowners’ insurance liability coverage in a while, you might need to either increase this limit, or buy an “umbrella” insurance policy that covers liability over and above your coverage from other basic insurance policies.

Not owning coverage when you’re renting

Renters can be damaged by fires, floods, thefts and other hazards, too. You could lose everything you own. If a fire starts in your apartment or rented home and you are found negligent, your neighbors or property manager could sue you for damages, too. If you are renting, but don’t have renters’ insurance, you probably need it. It costs less than a pizza, for most basic policies, for a month of coverage.

One of the first things we do with new clients is a review of insurance coverages. Life insurance is vital, of course, for most people with youngsters, and for many older folks, too. It depends on the situation. But homeowners insurance, or renters insurance, and other forms of liability protection apply to just about everyone.

Retirement Income Tools: Lifetime Income Annuities and Reverse Mortgages Explained

That’s all well and good – but you need to be able to keep food on your table and a roof over your head now, and not at some theoretical point in the future (that may never arrive, since growth stock companies occasionally do go bust!)

If you are relying on your investment portfolio to generate income to live on, though… and an income that’s going to be reliable, no matter what the stock market does. The consequences of a bear market early in a retirement, when you have no choice but to pull your living expenses out of a stock-heavy portfolio even when prices are low – can create a devastating chain reaction from which your portfolio many never recover.

I’m not speaking so much to those with tens of millions of dollars to your name. I’m sure you’ll muddle through somehow – and tax mitigation is a big part of your strategy, anyway, in many cases. You may not want to maximize income.

But for the lower-to upper-middle classes, who’ve had to try to save money for retirement through the bear markets of the 1970s, 2000 and 2008, and are now faced with the lowest interest rate, lowest-dividend environment in living memory, you’re going to need every break you can get.

So what tools are out there to maximize income?

The Lifetime Income Annuity

The lifetime income annuity is the pure income play. You give a chunk of your nest egg – or the whole thing, in some cases – to an insurance company. In return, you get a contract saying the insurance company will pay you X amount per month or per year for as long as you live. You can also elect to spread the payments out over the lifetime of yourself and one other person. Normally, it’s the spouse (though I’ve seen grandparents set up a lifetime annuity to give a small check to a beloved grandchild or grandchildren every year at Christmas time for as long as that child lives, long after grandma is gone. Which is neat to be able to do!)

The income is partially taxable – you pay income tax on the fraction of the income attributable to the growth of whatever you put in – and you spread that tax out over your expected natural life.

Advantages

The big advantages to the lifetime income annuity are the guarantees – you are guaranteed not to run out of income for as long as you live (as long as the insurer remains solvent, that is!). There’s nothing else that will provide you that guarantee and put it in writing.

The other advantage, from an income point of view, is the concept of mortality credits. These credits enable older annuity buyers to get a much higher payout on a given lump sum than interest rates would allow.

Here’s how it works:
Imagine four elderly women in a knitting club. They make a pact: They’ll each put $100 in a cookie jar, and vow to get together in one year and enjoy the money. This they do, except that one of the ladies dies. Each of the three ladies now gets $133.33. That money didn’t make a penny of interest, but all the survivors got a 33 percent return on capital! For not doing anything except being alive!

Lifetime income annuities work the same way: Those who die ahead of actuaries’ expectations subsidize the incomes of those who survive.

Typically, these annuities will often come with a return of principal guarantee – if you die before you receive back an amount equal to what you paid in, your heirs will receive the difference in an annuity death benefit. You can also buy an inflation benefit, though it will reduce your starting income level substantially.

Disadvantages

Lifetime income annuities always seem to be going on sale – next year. All things being equal, the payout on LIAs increases with age – since, on average, your premium contribution plus interest gets paid back to you over a shorter period of time. So if you commit to a large lifetime income annuity, you’re committing yourself to a lower payout for life.

This is particularly disadvantageous in todays’ low interest rate environment. Yes, you get paid a payout rate, not strictly an interest rate. Every payment back to you contains a partial return of principal (non-taxable.) But with interest rates so low, you are locking yourself into a very modest return – one that could improve markedly if you hold on for a year.

Lastly, assets in a lifetime income annuity don’t get passed on to your heirs. Once you commit to a lifetime income annuity, it’s pretty much lost to your family, except via any return of premium at death guarantees.

Reverse Mortgages

This is pretty much the real estate equivalent of the lifetime income annuity. Except that instead of sending an insurance company cash, you transfer to them the title to your home. You go on living in the house, and they send you income. How much? That’s a function of how long you are expected to live and the value of your equity in the home.

These are similar to LIAs, in that you do have a guarantee of lifetime income. The insurance company gets its money after you pass on, when they sell the house. Normally, you need to be at least age 62 to qualify.

More on these in an upcoming post. Before you commit to one of these, though, look carefully at the precise terms of the contract. If you have to live in a nursing home temporarily, can the reverse mortgage company come in and seize your home while you’re not living in it? The AARP and the Department of Housing and Urban Development have both put out useful consumer guides.

Both the LIA and the reverse mortgage are powerful options for increasing or maximizing income – without taking on market volatility. For some people they are just the ticket. But there are significant downsides and caveats to each of these products as well.

Tips: Read the fine print on these contracts before you sign. Both lifetime income annuities and reverse mortgage programs are commitments, and are very difficult or impossible to unravel later if you change your mind.

Be careful about changing any plan in which income is guaranteed for a plan in which your income is not guaranteed.

Consider the needs of your heirs and dependents, too, after your death. If they are entirely dependent on your wealth and your ability to earn, then you’ll want to look at some alternatives.

One technique: Just buy a lifetime income annuity big enough to cover your basic expenses. That way, you can reap the benefits of long term investment, avoid committing your entire portfolio to a low-interest rate environment and less-than historically-average payouts, and you can sleep well at night knowing that no matter what the market does, you still have the basics covered.

Remember that these products are sold, not given away. The salesman almost always gets paid if you buy and doesn’t get paid if you don’t. A good fee only planner can go over the advantages and disadvantages for each plan in your case, without any conflict of interest.

Tax Diversification

Congress has a mountainous struggle ahead with debt. We’re already borrowing 40 cents for every dollar of federal outlays. Structural and demographic issues hardwired into the Social Security program since the baby boomers were born are about to make themselves felt – overwhelming payroll tax receipts. And Medicare is in even worse shape. Meanwhile, Congress stripped 500 million from Medicare over the next 8 years to fund ObamaCare, which we now know will cost about $800 billion more than advertised over the next ten years.

One way or another, taxes are going to go up.

What we don’t know is how. Will Congress raise taxes on Social Security income, as the Clinton Administration did in 1993? Will they raise the retirement age to 70 and beyond to balance Social Security cash flows? Will they get out of the Medicaid business and leave it in the hands of the states? Will they move to nationalize 401(k) and other pension assets, or tax their growth? Will they make Roth IRA income taxable?  Take away the homeowners mortgage interest tax deduction? Raise income tax rates or lower exemptions? Tax life insurance cash value accumulation and/or death benefits? Raise the estate tax or slash the current exemption of $5 million?

We don’t know.

You’ve heard of investment risk and inflation risk. In the bond world, you have default risk. Well, all investors in America must also deal with the presence of legislative risk: The possibility that Congress will pass laws that substantially change the present or future value of your assets, and present changes to the set of assumptions that guide your investment and savings decisions.

Tax Diversification

That’s why it’s important to spread your legislative risk among many different types of assets: Tax deferred retirement accounts, pensions, home equity, savings in taxable accounts, municipal bonds, dividend paying stocks, cash value life insurance – all have an important role to play in building a tax-diversified retirement portfolio.

We believe it’s important to divide assets among at least three “buckets,” the taxable bucket, the tax-deferred bucket, and the tax-free bucket

Taxable Assets

These are assets that don’t present an income tax bill after the year in which you receive them – at least, under the current set of laws. Instead, Congress levies capital gain taxes on any profits you make – though they may charge income tax of some kind on dividend income these sources generate.

The main benefit here is the favorable rate accorded to long-term capital gains – that is, profits on assets you held more than a year.

You can also mitigate your tax liability through techniques such as tax loss harvesting – that is, selling some losers to generate capital losses, to offset your gains (and up to $3,000 of income in any given year).

Examples of assets in the taxable bucket include most things you hold outside of retirement accounts, including rental real estate, your own home (you do get a $250,000 or $500,000 capital gains exemption on your personal residence, depending on whether or not you are married, though Congress can modify this at any time as well). CDs, bank accounts, money market accounts, bonds, mutual funds, stocks, and investment property, including collectibles, tends to fall in this category unless you put it in a retirement fund.

Tax-Deferred Assets

Tax deferred assets include things like deferred annuities, 401(k)s, SEP IRAs, SIMPLE IRAs, 403(b)s, and traditional IRAs. These assets are most vulnerable to an increase in income tax rates in future years. Congress could also begin charging for transactions within them, to some extent, though they would have some difficult questions to explain to the public about why they were changing the rules after investors had committed these funds.

Tax Free Assets

Tax free assets include assets you already paid taxes on, which current law allows to grow tax free, and generate tax free income to you. This works for you very well if you front-loaded your income taxes when rates were comparatively low – as they likely were during the Bush Tax Cut era. Congress is quite likely to repeal the Bush cuts at some point – perhaps after the economy has recovered somewhat and the Democrats retake control of the House.

Examples of assets currently inhabiting this bucket include Roth IRAs, designated accounts in 401(k)s, and cash value life insurance (funded under modified endowment contract limits).

By dividing your assets among each of these tax buckets, you can go a long way towards avoiding a severe shock to your retirement income or plans to pass on assets to the next generation.

Part of our process is looking beyond your assets and asset classes to help ensure you are diversified against acts of Congress as well as acts of God and acts of neurotic stock market players and bond players.