What is financial pyramid? The first time I heard the word, I thought they were talking about one of those pyramid schemes. I knew it was time to dig deep and figure it out.
According to Maslow’s theory, you have to meet your most basic level of human needs before you can meet your higher-level needs. Like a pyramid, the most fundamental needs are at the bottom and the self-actualization and self-transcendence needs are at the top. More on Maslow here.
To piggy back on that, I will assume that you have enough to take care of your basic needs. That means you have food, shelter and clothes. If you have those, then continue reading.
This is a very broad topic, I will try my best to use as many headings and subheadings as possible to make it palatable to the eye.
From the pyramid picture above, the stronger the foundation, the bigger the structure it can support.
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Wealth foundation – Financial pyramid base
Good foundation is the bare minimum for a good financial planning.
Would you build a house without a solid foundation? I’ll assume no. Why then build your financial house on a bad foundation? Without a solid foundation, it does not matter how awesome the house is, it will eventually collapse.
The most important thing to remember in the foundation of finance is Insurance, Insurance, and more Insurance.
I cannot stress this enough. Many people do not insure against catastrophe. They justify it by saying, “ I don’t get the money back if I don’t use it.” That very statement shows a lack of financial maturity. Yes, some will get lucky and never experience the consequence of not having insurance. But, why take that chance and risk everything you’ve worked for?
In many developing countries, the population hardly insure themselves. The result is what you see when the breadwinner dies. The kids cannot complete school and the other partner’s financial life is changed drastically. Sometimes the family is left with no choice than to depend on extended family or beg for food.
We will talk about the important foundations to have. These are not in a particular order of importance. Ultimately, you need most, if not all of them.
This is one thing that I can guarantee everyone needs. In fact, modern basic needs include health insurance. Here are few of the many reasons to have a health insurance.
- The uninsured receive less medical and less timely care – Health is wealth. Literally! For many of us, our best asset is ourselves. If we breakdown, there goes the income too.
- Preventative Care – Neglecting to receive regular checkups will eventually catch up to you. It is a missed opportunity for early diagnosis. Be wise, prioritize your health. Maybe I am biased too as a doctor but hey! Don’t say I didn’t tell you.
- Lack of insurance causes a financial burden for you and your family- The number one cause of bankruptcy in the United States is medical bills. Don’t be a statistic!
Thankfully, this one is mandatory. If you can afford a car, then you must insure it. Due to the legal ramifications of not having car insurance, I don’t think you need much convincing. I don’t want to have to write a post on how to pay your exorbitant ticket. Moving on!
The best way to visualize this is to think carefully, who will suffer when you die. I know! I know! Many of us don’t like to think of our mortality. However, this is an important matter to handle as soon as possible. The earlier you get it, the cheaper it is. You are less likely to be as healthy as you are right now. If you are married, this is important to have. If you have kids, this is a must.
How much life insurance?
2 million dollars should be plenty for most people. You can always start with less and increase, but having it is a must.
What type of life insurance?
Term life insurance is ideal. Do not get suckered into whole life insurance. It is better to separate investment and insurance. Whole life insurance has a very high premium and they try to invest your insurance money for you. Unfortunately, the return on these investments is mediocre. You are lucky if you get 4% average yearly. Instead, invest your money separately and have it under your control. You are likely to beat their interest rate. Also, my own reason for going against whole life insurance is that if the company goes belly up, now you have lost both your investment and your insurance in one fell swoop. Who will save you now?
How long should you have life insurance for?
I currently have 30 year term life insurance. My thought process is that I will be financially independent in 30 years and would no longer need a life insurance. I actually think, we would achieve our goal in 20 years or less. Talk about being an optimist. The reason for life insurance is to make sure your family is secure in your absence. In 30 years, the kids would be old enough to survive on their own. Well, if they are anything like their dad and take their finance seriously.
Where to get life insurance?
Like most of these insurances and investments, make sure to take advantage of whatever is offered at your job first. In this case however, I advise you to have a personal one that goes with you. When and if you leave your job or get fired, you will still have some coverage.
Life insurance is one of those insurances you cannot get without an agent. You will have to do your research for an agent to use.
Similar to the concept above, what will happen if you are unable to work any longer? If you have not reached financial independence, this is the end of your financial journey. Some people are able to pick up a different job or re-purpose themselves, but who are we kidding? Can you predict what kind of disability you are going to have? No. The only way to take control is to know how much you will be entitled to receive if you become disabled. Look into your job disability policies. I will advise you to have your personal disability insurance, in addition to what’s offered by your employer. If you get fired from your job, your workplace disability insurance ends there. when you have your personal insurance, you can take it with you anywhere you go. Even better, your personal policy is tax free. So the money you see is what you get.
How much disability insurance?
Decide on your monthly lean budget. Lean budget is basically the bare bones essentials. In our case, we will cut the traveling budget, soccer, gymnastics, preschool, dance and swimming classes for the kids. It’s basically your budget minus the extracurricular activities. Then get at least enough insurance to cover your lean budget.
More about disability insurance here.
Where to get disability insurance
This is one of those financial product that you need an agent for. The company I used for my disability insurance is Set for life insurance. I became a partner with them because I had a good experience during my transaction with them. Feel free to ask for a quote at no obligation to you.
It seems like all of my post touch on emergency fund. This is a coincidence. Or is it? Repetition drives the concept into even the hardest skull. Think of emergency fund as a form of insurance too. An emergency fund is extra cash that you set aside for unforeseen circumstances. The recommended emergency fund is 3-6 months of living expenses.
Read more about another post touching on emergency fund here.
Homeowners insurance will pay to repair or replace your house if it is destroyed or damaged by natural disasters, such as fires, tornadoes, hurricanes, etc. They won’t cover you with human-made disasters. You can also protect your possessions with homeowners insurance. While it does not cover everything it is still important to have. In many states, this is a requirement. Even while renting, consider rental insurance.
No such thing as death insurance. There is nothing to insure you against death. I am talking about having a WILL. Everyone should have one. I use the excuse, that I don’t currently have any significant asset. Therefore, I haven’t made it a priority. I have added it to my list of things to do in the next one year.
If you die without an estate plan or a will, your assets will be distributed based on the law of intestacy. Intestacy is basically leaving it to the law to decide how to distribute your assets. This might not be what you had in mind for your assets.
Components of a will
You can decide which property to distribute to who
You can appoint a legal guardian for your children in your absence.
Will gives the opportunity to nominate someone you trust to execute your will
Here are some more reasons to have a will.
The most important part of will for me is the peace of mind that my affairs will be taken care of after my death.
Apart from making your wishes known, a will allows you to provide for those who you choose. For example, If you are in a relationship and are not married, you will not be able to give your partner your inheritance without a will.
You can also strategically craft your will reduce or even eliminate inheritance tax.
Now we go on to our next layer of the financial pyramid
Wealth accumulation – Financial pyramid next layer
To invest, you have to save first. The recommendation of the percentage of your income you should save continues to increase. Dave Ramsey talks about 15%. I have also seen one third. Challenge yourself and increase your savings yearly. Start at 15% and then move up every year. Make it like a game. You want to win right? Time to save up! My personal goal is to improve my income to a level in which I can save more than 50%.
The rule is really simple. Spend significantly less than you make.
As discussed in our how to start investing post, the earlier the better with investments. Once you have all your foundation taken care of, then it’s time to invest. Don’t just keep your money in a savings account, inflation will eat it up. If you save your money, without investment, it won’t have half the purchasing power it has 30 years ago.
Posts about investments are here for your reading pleasure
This whole blog really is catered towards saving and investing , so stay tuned for more on this segment of the pyramid in the future.
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Now, we move to the next level of the financial pyramid which is wealth preservation.
Wealth preservation – Financial pyramid top layer
Now that you are becoming wealthier, you have the confidence of a Jujitsu grand master. Don’t start summer salting yet. Its time to preserve that wealth. After that, you can do couple of flips.
Insurance again? Yes. Same way we cannot avoid death and tax, add insurance to that list.
This one is a new one for many folks. It means exactly what the name implies. It covers you on a rainy day, and also helps you cover what other parts are not covered by anything else.
Just like an umbrella, it is better to have it and not need it, than to need it and not have it.
The other name for umbrella insurance is excess liability coverage. I like Umbrella better. The umbrella policy adds additional or extra liability coverage on top of your auto and home insurance policies. The coverage limits usually starts at around 1 million dollars and go up from there.
Let’s say your auto liability insurance is capped at 250,000 dollars, you then get involved in a law suit that require you to pay 500,000 dollars. Umbrella policy is here for the rescue. It will pay the excess 250,000 dollars.
It is important for the truly worst case scenarios.
In a very unfortunate situation of a loss of life
The court will calculate how much that person would be making to provide for her family, had she not tripped in your front porch and died.
In the unfortunate situation of severe disability
You remember that person who tripped on the snow in your driveway? He is not dead but is now permanently disabled. Even more common is involvement in an auto accident.
I am sure you get the point now. So I will stop the doom and gloom.
How big should my umbrella be?
According to how big you are of course. A 300 pound man needs a bigger umbrella than a 100 pounds man. So in financial term, have an umbrella at least equal to the amount of your assets. Umbrella insurance is one of the cheapest, so you can go bigger if you like.
Long term care insurance
Statistics showed there is a 70 percent chance that someone in the USA would need some form on long-term care after the age of 65. A home health aide cost close to 40,000 dollars a year at a bargain. Nursing home is even twice more costly.
The problem here is that health insurance, medicare and Medicaid either does not pay for long-term care or say you are too wealthy to qualify for it. Last time I checked, medicare pays up to 100 days of long-term care only.
Here is the deal
If you are ultra wealthy, you can afford to pay for this expense by yourself.
If you are poor, really poor, you will likely qualify for the government benefit
For most of us, we would be in the middle; this will likely deplete our retirement savings. That is the curse of the middle class.
As physicians, I would expect that we should be able to pay out of pocket when the time comes.
How can you get long-term care insurance?
You can get it through your job – This is the method I am using currently. It is cheap and does not require a medical exam to enroll in the benefit.
You can also do your personal one too, but I have not explored that personally.
Now that you are rich like the richest man in Babylon. Solomon in the bible ring any bell? Its time to know how to distribute the wealth.
Wealth distribution – The mount Everest of the financial pyramid
Now, if you have made it this far, you feel pretty good about yourself. You are wealthy. But we are not done. You need an estate plan
We already talked about the first part of the estate planning, the will. Scroll up to re read at any time.
This is to dictate your end of life wishes. You have the chance to write it all down exactly how you want it. If you don’t want to be on life support when the end result will not lead to a meaningful quality of life, then write it down. Now is your chance when you still can.
This person would make decisions for your health when you can no longer make the decision. It is important because your wife or first child might not be the closest person to you. As a doctor, if my patient does not have a health care proxy, we follow the state defined rules. We usually go to the wife first, then the children from oldest to the youngest.
Power of attorney
This is the trusted individual who manages your financial affairs when you die. This is not automatic. Don’t assume your spouse will automatically be awarded this. Write it down!
This is a matter of trust I tell you. Can I trust you to follow the financial pyramid properly?
Trust in this case is actually a legal concept. This I will say is important if you have many assets. Most doctors, if they are wise enough with their finances will fall into this category. Once you die, your assets can be passed on to a specific person called your trustee.
This helps in two ways
Minimize your estate taxes
You can avoid probate.
What is probate – probate is the process of proving to a court that the document presented is the last will of the deceased. It also decides what goes where.
Each state has its own probate process. Just know that this is a painful process. Although I have seen some videos and some articles who made some exceptions to when to avoid probate. As far as I am concerned, don’t leave your assets up to the state to distribute. Believe it or not, some of your relatives can actually contest or object your will in court.
Of course, if you don’t care where the assets go, you don’t need a trust. After all, you are gone.
How to plan retirement income distribution
Knowing which retirement income to take out first and how much to take out makes a big difference when it come to tax time.
There are also different withdrawal rules for different accounts. This is another reason to have a bag mix of retirement accounts.
At retirement, you would have different money buckets
Tax free money – This would be your Roth IRA. You already paid the tax before investing it, it grows tax free and now at a ripe age of 60, you are ready to take out the money. Tax deferred money – Example of this is the 401k. You avoided tax when you invested the money which is all nice. Now is the time to pay up. Taxable account – this is where almost all other investment falls in. Don’t forget social security. If it is still there when we retire that is.
I am a fan of the 4% rule. Here is review from the master himself, Mr Money Mustache. However, there are some people doubting the wisdom of that recently. Two of them are listed below.
One more thing you can do to help you maximize your retirement income. Move to a retirement friendly income state. You are retired anyways; don’t be afraid to move if possible. It might be worth your while.
Gifting is at the top of the financial pyramid
Plan how you aim to distribute your assets apart from your family. I have heard of many billionaires who left all their wealth to charity. If that is your cup of tea, you have to plan for this.
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