Financial Industry Rants & Sins, Vol. 5

I’m telling you, ya can’t make this stuff up. As in, the truth is stranger than fiction. Every week there is a major flaw in a piece of advice that some self-professed personal finance guru gives out over the airwaves or in a newsletter. This week is no different.

This week’s misguidance happened to be about life insurance. A man called a radio show saying that he is 56 years old, and he has 3 kids aged 39 (his teenaged oops), 26, and 24. All finished college with no student loans, his mortgage is paid off, and he has no other debts. He said if he dies, his wife has a pension, retirement savings of about $2,000,000, and she will have social security as well. In addition she will inherit his 401(k) retirement savings of about $2,600,000.

He also said his house on Long Island is worth about $1,500,000, and they have a couple rental properties worth a combined $3,000,000. They also own a small apartment building with 8 units in Brooklyn, worth about $3,500,000 and giving them income of $12,000 a month after all expenses and taxes.

Clearly they were fortunate financially; the estate is worth about $12.6 million, and I wouldn’t be surprised if there’s more to this story, like some gold bullion, paintings, or something else of significant value. No matter how they’ve done their estate planning, there will be taxes. Lots of taxes.

The catch was that the 39 year old child was from his high school girlfriend, and the other two kids were from his wife. Different women gave birth to his three kids, and he wanted to know if he needed life insurance.

The host asked him only one question, “Why do you think you need life insurance?” To which he replied, “My wife thinks I should have it, just in case. But she can’t give a solid reason. She just keeps sayin’ it’s her female intuition.”

“Well let’s take an unbiased look at that female intuition,” replied the host. “You and your wife have amassed enough assets to live comfortably for the rest of your lives, no matter what happens, and she wants you to have life insurance? Her only reason is female intuition. So let me tell you why she can’t give you a solid reason other than her intuition. There is no reason. You don’t need life insurance. That’s for people who will be financially ruined if the breadwinner dies, which is not the case for you. So when you break the news to your wife, you can blame me.”

The guy has 3 kids from different women, and a huge estate that will earn him the noble endeavor of paying estate taxes. If that’s me, I want a large enough life insurance policy to 1) make sure the estate taxes are paid by the policy payout, 2) leave a lot of extra cash for my wife and kids, and 3) add liquidity to my estate so that none of the assets have to be sold in a fire sale and well below their intrinsic market value. I know my wife and kids would want to continue to enjoy the immense cash flow from the assets instead of selling them.

Most importantly, more than the money, the caller has a kid from another relationship, and that kid has legal rights to challenge the estate plan when he dies. Which means the kid can cause legal problems for the wife and siblings, possibly eating away a large portion of the estate in attorney fees, and worse, dividing the family.

A life insurance policy could potentially add enough cash to the estate to level the playing field, and everyone would feel like they are receiving their fair share. While not a guarantee, it dramatically reduces the likelihood of fighting within the family. He worked hard for his assets, and even harder to create a loving, nurturing family that is bonded eternally. Why ruin the family and the estate, if everything could be kept intact?