Unless you really want to leave a mess for your heirs when you die (maybe you do, in which case you can close the article), there are some potentially catastrophic estate planning mistakes you will want to avoid to make things much easier for your family in what will already be a stressful and emotional time.

1. Wrong beneficiary on accounts

Did you intend to leave the entirety of your 401(k) to your ex-husband? Didn’t think so! But that’s what can happen if you don’t regularly check and update beneficiaries on bank accounts, retirement accounts, life insurance policies, trusts, and other assets. Assets with beneficiary designations typically pass outside of the probate process, which means even if you update your will and other estate planning documents, assets with beneficiaries may not reflect your current wishes. It’s a good idea to regularly log in to your accounts and check who the beneficiaries are and update as necessary. You may never need to change beneficiaries, which is great, but it’s always better to be safe than sorry.

2. Giving assets away before you die

There is absolutely nothing wrong with being generous while living and giving assets to your heirs, but in some cases giving assets away before you die can be a huge mistake. Investments, real estate, and other property can receive what is called a step-up in basis at death. 

Let’s say a nice couple, Bobby and Bobbina, want to give their favorite son Bobbo their treasured family vacation home. Bobby and Bobbina bought the home for $10,000 and a silver dollar in 1958, but now the home is worth almost $3 million. If they gave Bobbo the home while they are living, their basis of $10,001 carries over to Bobbo. That means if or when Bobbo sells the home, he will owe taxes on the entire sale price over $10,001 (minus any exemptions if the home becomes his primary residence).

If Bobby and Bobbina instead leave the vacation home to Bobbo in their will, he will receive a step-up in basis when he inherits the home. That means if or when Bobbo sells the home, he would only owe taxes on the amount the home has appreciated in value since he inherited it. The difference between giving assets away before you die or after you die may seem small, but it can have huge tax consequences for your heirs.

3. Not having any or enough life insurance

A large number of Americans don’t even have health insurance, much less life insurance. Not everyone needs life insurance, but if others are financially dependent on you to live, chances are you should consider your need for life insurance. A need for life insurance often exists when your assets aren’t large enough to cover your debts (like a mortgage). Life insurance can also be used to replace your income if you are worried about taking care of your family financially if something were to happen to you. If you are older and have done a great job investing for retirement, you may be able to self-insure. This means you have enough assets to pay off your debts if you were to die and your family would be taken care of. There are many different types of life insurance available, but we believe term life insurance is the best and most cost-effective solution in most situations.

4. Not having estate planning documents

Wills typically don’t cost a lot of money, and if you don’t have children or many assets, a simple will may do the job. If your estate is more complex, it would be smart to use an estate attorney to prepare your will. Dying intestate, or without a will, means the laws of your state will decide how your property is distributed upon your death. This might not be a huge deal if you don’t leave behind anything worth fighting over, but the more assets and potential heirs you have, the greater the need for a will.

Wills aren’t the only way to express your wishes when you are no longer able to do so. An advance healthcare directive gives instructions for your medical care if you are no longer able to make your own decisions. There are several different types of power of attorney that can be used to allow a person or organization to manage certain affairs on your behalf. There is medical power of attorney, financial power of attorney, and durable, limited, or springing power of attorney. Like the names suggest, a power of attorney can handle your estate, financial, and even medical decisions.

5. Worrying (or not worrying) about estate taxes

Not worrying about estate taxes can be a catastrophic mistake, but I would argue that for most people, at least with the current federal estate tax exemption, worrying about federal estate taxes is a much more common mistake. The current federal estate tax exemption is $13.99 million, or $27.98 million for married couples, which means you must have a very substantial amount in assets to be impacted by federal estate taxes. If you think you will or could be impacted by federal estate taxes, consider reaching out to a fee-only financial advisor to develop a plan for minimizing or eliminating the impact of estate tax.

Some aspects of managing your financial life can be pretty tolerable and even enjoyable. My wife enjoys managing our household budget and I really like contributing money to our retirement accounts and watching them grow. Unfortunately, I can confidently say that estate planning is rarely enjoyable and, at its best, somewhat tolerable. However, it is a vital part of planning for your financial future, and something that must be taken seriously and considered a priority.

Whole life insurance policies may not be the optimal way to protect against risks. What should you do if you have a whole life insurance policy that you’ve paid on for years? Cancel it or keep paying it?

Want to know what to do with your next dollar? You need this free download: the Financial Order of Operations. It’s our nine tried-and-true steps that will help you secure your financial future.

You may have heard of life insurance or annuity products that track the market – maybe you even have a family friend that sells them. In this Q&A, we analyze a real policy and show you the real returns so you can see how it stacks up against investing in the stock market!

You may have heard of life insurance or annuity products that track the market – maybe you even have a family friend that sells them. In this Q&A, we analyze a real policy and show you the real returns so you can see how it stacks up against investing in the stock market!

When does it make sense to self-insure instead of using term life insurance? Or does it ever make sense to no longer use life insurance? Want to know what to do with your next dollar? You need this free download: the Financial Order of Operations. It’s our nine tried-and-true steps that will help you secure your financial future.

Infinite banking, also commonly called “bank on yourself,” is a way to use whole life insurance to build savings and leverage cash values for self-financing. It seems like the name of this concept changes once a month. You may have heard it referred to as a perpetual wealth strategy, family banking, or circle of wealth.

No matter what name it’s called, infinite banking is pitched as a secret way to build wealth that only rich people know about. Those practicing infinite banking use it as an alternative to keeping money in the bank or investing in the stock market. How does infinite banking actually work and is it worthy of your time and money?

How infinite banking works

Infinite banking requires a dividend-paying whole life insurance policy, which can be over 20x more expensive than term life policies. You can use other types of permanent insurance, but dividend-paying whole life works the best because premiums do not go up and cash value whole life policies have a guaranteed rate, which is a minimum percent the cash value grows each year. Because of this component, infinite banking is often pitched as something that is “guaranteed” and “can’t lose money.”

The flow chart below shows the basics of how infinite banking works. You, the policyholder, put money into a whole life insurance policy through paying premiums and buying paid-up additions. This increases the cash value of the policy, which means there is more cash for the dividend rate to be applied to, which generally means a higher rate of return overall. Dividend rates at major providers are currently around 5% to 6%. Paid-up additions, or PUAs, have no ongoing premiums but one-time loads of between 5% to 10%, typically.

The entire concept of “banking on yourself” only works because you can “bank” on yourself by taking loans from the policy (the arrow in the chart above going from whole life insurance back to the policyholder). There are two different types of loans the insurance company may offer, either direct recognition or non-direct recognition. Direct recognition loans are subtracted from the dividend-earning portion of your cash value and you pay interest on the loan. Direct recognition loans don’t really work for infinite banking. Taking loans from the policy is such a big part of infinite banking that it doesn’t work if taking out the loans takes away from your cash value and costs you money to interest.

Non-direct recognition loans are loans where the amount is not subtracted from the cash value earning dividends. While you continue to earn dividends on the loan amount, you do have to pay interest on the loan still, and your interest rate could be higher than the dividend rate. One feature called “wash loans” sets the interest rate on loans to the same rate as the dividend rate. This means you can borrow from the policy without paying interest or receiving interest on the amount you borrow.

Is infinite banking a good idea?

The draw of infinite banking is a dividend interest rate and guaranteed minimum rate of return. It’s pitched as something that can never go down, unlike investing in the stock market.

The drawbacks of infinite banking are often overlooked or not mentioned at all (much of the information available about this concept is from insurance agents, which may be a little biased). Only the cash value is growing at the dividend rate. You also have to pay for the cost of insurance, fees, and expenses. Whole life insurance policies can have administrative costs, loads/commissions for the agent, loan fees (in addition to the interest you pay on the loan), and surrender fees. Companies that offer non-direct recognition loans may have a lower dividend rate. Your money is locked into a complicated insurance product, and surrender fees typically don’t go away until you’ve had the policy for 10 to 15 years.

Every permanent life insurance policy is different, but it’s clear someone’s overall return on every dollar spent on an insurance product could not be anywhere close to the dividend rate for the policy. The costs – expenses, fees, commissions, loads, interest – are just too high in aggregate.

To give a very basic and hypothetical example, let’s assume someone is able to earn 3%, on average, for every dollar they spend on an “infinite banking” insurance product (after all expenses and fees). This is double the estimated return of whole life insurance from Consumer Reports of 1.5%. If we assume those dollars would be subject to 50% in taxes total if not in the insurance product, the tax-adjusted rate of return could be 4.5%.

To be clear, in a very generous example, someone may be able to make about 4.5% doing infinite banking. We assume higher than average returns on the whole life product and a very high tax rate on dollars not put into the policy (which makes the insurance product look better). The reality for many folks may be worse.

This pales in comparison to the long-term return of the S&P 500 of over 10%. Right now, in September of 2023, many savings accounts are paying over 5%. Infinite banking is a great product for agents that sell insurance, but may not be optimal when compared to the cheaper alternatives (with no sales people earning fat commissions).

What are the benefits of infinite banking?

Here’s a breakdown of some of the other purported benefits of infinite banking and why they may not be all they’re cracked up to be.

1. Control

The simple idea behind infinite banking is that you can be your own banker without taking loans or relying on a normal bank. However, you don’t actually have more control over your own money. Your cash is locked into a complicated insurance contract with limited access. If you want to leave, like you can at almost any time with a savings account or Roth IRA custodian, there are substantial surrender fees involved for typically the first 10 to 15 years. It is common to see surrender fees 10% to 35% of the cash value.

2. Protection

At the end of the day you are buying an insurance product. We love the protection that insurance offers, which can be obtained much less expensively from a low-cost term life insurance policy. Unpaid loans from the policy may also reduce your death benefit, diminishing another level of protection in the policy.

3. No market volatility

Permanent insurance products may seem attractive to investors with a low risk tolerance that like the idea of never losing money. While your cash value may not decrease in value, you can lose money by surrendering your policy early. The table below shows real numbers from a real policy that a friend of the show was kind enough to let us analyze – notice that you would not break even by surrendering the policy until over 15 years in.

How much do you need to start infinite banking?

The amount of money you need to do “infinite banking” is another huge drawback. The concept only works when you not only pay the substantial premiums, but use additional cash to purchase paid-up additions. The opportunity cost of all of those dollars is tremendous – extremely so when you could instead be investing in a Roth IRA, HSA, or 401(k). Even when compared to a taxable investment account or even a savings account, infinite banking may not offer comparable returns (compared to investing) and comparable liquidity, access, and low/no fee structure (compared to a high-yield savings account).

Congratulations on the new baby! When determining life insurance coverage, a common rule of thumb is 10 times your annual income, based on your current income, but consider additional factors such as future income potential, debts, health, and family needs to ensure adequate coverage.

Want to know what to do with your next dollar? You need this free download: the Financial Order of Operations. It’s our nine tried-and-true steps that will help you secure your financial future.

In this highlight, we discuss when it makes sense to start thinking about getting life insurance and which types of life insurance you should consider.

In this highlight, we discuss some things you may not know about permanent life insurance.