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Editor’s Note: For the latest developments regarding federal student loan debt repayment, check out our student debt guide.
If you’re a new dentist, you have plenty of reasons to smile about your profession. You can start practicing soon after completing dental school, and you stand to earn a healthy salary right off the bat. The average entry-level dentist in the U.S. earns $189,979 a year, according to ZipRecruiter.
At the same time, you also need to figure out how to pay off your student loans. According to the American Dental Association (ADA), the average dental school graduate leaves school with nearly $300,000 in education debt. By comparison, medical school graduates owe an average of $243,483 in total educational debt, according to the Education Data Initiative. That’s where budgeting for dentists comes into the equation.
Key Points
• Consider disability insurance to protect income.
• Establish saving and investing strategies early, leveraging a pay-yourself-first mentality.
• A good budgeting rule of thumb: Set aside 30% of income for savings, with 25% for retirement and 5% for other savings.
• Think about diversifying your investments and including HSAs, IRAs, and after-tax brokerage accounts.
• When tackling student loans, consider aggressive repayment strategies, as well as refinancing.
How Budgeting Helps
Starting a career with a six-figure loan debt may feel overwhelming, but budgeting for dentists can help. In fact, now is an ideal time to establish your saving and investing strategies, says Brian Walsh, CFP®, Head of Advice and Planning for SoFi. “When you’re right out of school and your lifestyle is already lean, you can more easily build a pay-yourself-first mentality without making any drastic adjustments,” he explains. “It’s significantly easier to do it at this point instead of when you have a house, a car, and a family and then need to start making cuts.”
Here are some strategies to help you create your budget and plan for the future.
Protect Your Income
With its repetitive motions and constrained work area, dentistry can be physically taxing work, especially on the back and joints. According to the ADA, dentists have a one in four chance of becoming disabled. To mitigate your risk, you may want to consider disability insurance, which covers a percentage of your income if you become unable to work due to an illness or injury.
If you purchased a policy during dental school, you have the option to increase your coverage now that you’re making more. If you don’t have a policy, you can buy one as part of a group plan or as an individual. Find out if your employer offers it as part of your benefits package; some do. Monthly premium amounts vary, but in general, the younger and healthier you are, the cheaper the policy.
Recommended: Budgeting as a New Doctor
Don’t Overspend
Dropping a bundle on meals out? Clicking “add to cart” more frequently? Enjoy your hard-earned income, but don’t go overboard on splurges.
To help you focus on where you put your money, consider prioritizing your financial goals — saving for a home, for example, or paying off your debt. This is an important strategy in budgeting for dentists. Walsh also recommends that early-career professionals use cash or debit cards for purchases to build up good spending habits, and automate their finances whenever possible. For example, pre-schedule your bill payments and set up automatic contributions to your retirement account.
Kick-Start a Savings Plan
Tackling student loans is likely a top priority for you right now, but just as important is creating a savings plan.
Walsh recommends early-career dentists set aside 30% of their income for savings. Of that, 25% should be for retirement and 5% for other savings, like building an emergency fund that can tide you over for three to six months. The remaining 70% of your income should go toward expenses, including monthly dental school loan payments.
The sooner you start saving and investing, the sooner you can enjoy compound growth, which is when your money grows faster over time. That’s because the interest you earn on what you save or invest increases your principal, which earns you even more interest.
You may even want to consider buying a dental practice at some point, so that’s another reason budgeting for dentists makes sense.
Explore Different Ways to Invest
As a high earner, you may need to do more with your money than max out your 401(k) or 403(b), though you should do that, too. Walsh suggests new dentists leverage a combination of different investments. This strategy, called diversification, can help shield you from risk. Here are some types of investments to consider:
• A health savings account (HSA), which provides a triple tax benefit. Contributions reduce taxable income, earnings are tax-free, and money used for qualified medical expenses is also tax-free.
• An individual retirement account (IRA), like a traditional IRA or Roth IRA, can offer tax advantages. Contributions made to a traditional IRA are tax deductible, and no taxes are due until you withdraw the money. Contributions to a Roth IRA are made with after-tax dollars; your money grows tax-free and you don’t pay taxes when you withdraw the funds, provided certain requirements are met. However, there are limits on how much you can contribute to an IRA each year.
• A Simplified Employee Pension IRA (SEP IRA) can be a good option if you’re a solo practitioner. “Total contributions can be just like those with an employer-sponsored plan, but you control how much to contribute, up to a limit,” Walsh says. Contributions are tax-deductible, and you don’t pay taxes on growth until you withdraw the money when you retire.
• After-tax brokerage accounts offer no tax benefits but give you the flexibility to withdraw money at any time without being taxed or penalized.
Two investments to consider bypassing are variable annuities and whole life insurance. Neither is a suitable way to build wealth, Walsh says.
Whatever your strategy, keep in mind that there may be fees associated with investing in certain funds. Those can add up over time, Walsh points out.
Determine a Student Loan Repayment Strategy
Since new dentists tend to start earning money more quickly than other health care professionals, they are often better positioned to tackle loan repayments more aggressively.
But your repayment strategy will depend on a number of factors. To start, consider the types of student loans you have. Federal loans have safety nets you can explore, like loan forgiveness and income-driven repayment (IDR) plans, which can lower monthly payments for eligible borrowers based on their income and household size.
Once you’ve assessed the programs and plans you’re eligible for, figure out your goals for your loans. Do you need to keep monthly payments low, even if that means paying more in interest over time? Or are you able to make higher monthly payments now so that you pay less in the long run?
If you have multiple loans and/or other debts, there are two approaches you might consider for paying them down. With the avalanche approach, you prioritize debt repayment based on interest rate, from highest to lowest. With the snowball method approach, you pay off the smallest balance first and work your way up to the highest balance.
While both have their benefits, Walsh often sees greater success with the snowball approach. “Most people should start with paying off the smallest balance first because then they’ll see progress, and progress leads to persistence,” he says. But as he points out, the right approach is the one you’ll stick with.
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Consider Your Refinancing Options
Paying down debt has long-term benefits, like lowering your debt-to-income ratio and building your credit. In order to help do this, you may want to include refinancing your student loans in your student loan repayment strategy.
When you refinance, a private lender pays off your existing loans and issues you a new loan. This can give you a chance to lock in a lower interest rate than you’re currently paying and combine all of your loans into a single monthly bill, which can be easier to manage. Some lenders, including SoFi, also provide benefits for new dentists.
The refinancing process is straightforward, yet some common misconceptions persist, Walsh says. “People overestimate the amount of work it takes to refinance and underestimate the benefits,” he says. A quarter of a percentage point difference in an interest rate may seem inconsequential, for instance, but if you have a big loan balance, it could save you thousands of dollars.
That said, refinancing may not be right for everyone. If you refinance federal student loans with a private lender, for instance, you lose access to federal benefits and protections, such as forgiveness programs and forbearance. Consider all your options and decide what makes sense for you and your financial goals.
The Takeaway
Dentistry can be a rewarding career with the potential to earn a healthy salary right from the start. However, you’re likely to have a significant loan debt when you graduate from dental school. Fortunately, balancing your goals with some smart saving, investing, and loan repayment strategies can help you get your finances on firm footing.
Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.
With SoFi, refinancing is fast, easy, and all online. We offer competitive fixed and variable rates.
Photo credit: iStock/5second
SoFi Student Loan Refinance SoFi Student Loans are originated by SoFi Bank, N.A. Member FDIC. NMLS #696891. (www.nmlsconsumeraccess.org). SoFi Student Loan Refinance Loans are private loans and do not have the same repayment options that the federal loan program offers, or may become available, such as Public Service Loan Forgiveness, Income-Based Repayment, Income-Contingent Repayment, PAYE or SAVE. Additional terms and conditions apply. Lowest rates reserved for the most creditworthy borrowers. For additional product-specific legal and licensing information, see SoFi.com/legal.
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This content is provided for informational and educational purposes only and should not be construed as financial advice.
If you’re on TikTok or Reddit, it’s likely you’ve come across a tenacious rumor: That it’s better to invest in life insurance than a 401(k) for retirement. So, is it true?
Life insurance vs. 401(k)
Life insurance isn’t an investment, while a 401(k) is a type of investment account offered through your employer. Permanent life insurance (which offers lifelong coverage) isn’t an investment, and its exorbitant fees erode the money you pay into your policy and any earnings you might make for the first decade.
“It was very strange to me that there were so many life insurance salespeople all over TikTok, basically soapboxing about life insurance, like it was the next big thing like it was the most amazing investment on Earth,” says Vivian Tu, founder of Your Rich Bff, a TikTok channel that focuses on financial education, based in Miami Beach, Florida.
Can life insurance grow like an investment account?
In some cases, yes. There are some types of life insurance, such as whole life insurance or universal life insurance, that have the ability to increase in cash value. But how do some of those policies earn money like an investment return? By tracking market indexes.
One of the features touted by TikTok influencers is that returns made on insurance policies aren’t affected by the overall stock market, but that isn’t necessarily true. The insurance companies may invest in the stock market with part of their portfolio, which is technically a portion of a policy owner’s premium. Though some policies provide fixed returns, some depend on current interest rates and investments. Some policies have you pick the stock or bond indexes for your policy to mirror, such as the S&P 500, and the insurance company pays you interest based on how those indexes perform.
Life insurance vs. 401(k): Fees
If life insurance can earn stock market interest in a way similar to that of a 401(k), what’s the issue?
The issue is that, depending on the policy, the staggering fees insurance policies charge often wipe out the amount you would get back from those premiums and any investment returns.
For example, if you pay the premium for seven to 10 years, most of those premiums go toward the cost of providing that insurance. In addition, there are administrative fees and the agent’s commission, though you may not see a commission listed on a statement and it may be difficult to figure out exactly how much those commissions are. Those commissions aren’t a one-time payment: You may continue to pay them for seven to 10 years, or as long as the policy is active.
The premiums you pay that cover fees don’t sit in an account waiting for you to cash them in. If you pay into a 401(k) for a decade, you get to keep all that money less any fees and investment losses. With an insurance product, it’s only after a decade (again, depending on your policy) of monthly payments that you actually start accruing premium money and interest in a cash value account the insurance company holds for you.
That interest percentage is less than you can get in a high-yield savings account and far less than the stock market’s long-term average of 10% (not accounting for inflation).
Insurance policies also have significant surrender charges, which are fees you have to pay if you withdraw money from your policy early. These charges are often so large that they can dramatically reduce the net value of your policy until the first few years pass.
For example, if you wanted to take money out of your policy after the first two years, your surrender charge would likely be so high that there would be little to no money to take out. These charges eventually reduce to zero, but it can take 10 to 16 years.
While 401(k)s do charge a 10% penalty if you want to take money out of your account before you’re 59½, that 10% is likely to be far less than a surrender charge. Plus, there are lots of exceptions to the 401(k)’s 10% penalty, including disabilities, the birth of a child, medical expenses and emergency personal expenses.
If you were to invest in the stock market through a 401(k), you wouldn’t lose 10 years’ worth of investment dollars to the cost of insurance, and your management fee would likely be less than 1%.
“The idea that 401(k) fees are higher than an insurance product that would be serving as an investment, I don’t even know how you support that idea,” says Georgia Lee Hussey, a certified financial planner and founder of Modernist Financial, a wealth management firm in Portland, Oregon.
Insurance fees are complex
In addition to paying commissions and exceptionally high fees, you may not even know how much you’re paying because insurance fee structures are so complicated.
“Whole life policies are basically called the black box of insurance policies. You can’t really see what’s happening inside them,” Hussey says. “You can understand the internal expense ratio sometimes but you usually have to go deep into the disclosure documents to understand what the insurance company is really getting paid.”
If you purchase insurance through an agent or broker (or a TikTok influencer), it’s possible that that person will be making a commission, and that’s on you to figure out.
“When you actually look into it, you realize that all of these people are, in fact, life insurance brokers. They don’t even work at life insurance companies that provide the policies,” Tu says. “The vast majority of them are not fiduciaries, so they are not legally obligated to do right by you financially.”
On the topic of using insurance to invest, it’s good to remember two cardinal rules of investing: If it sounds too good to be true, it probably is. And if you can’t explain it clearly to a friend, you probably don’t understand it, which could be a sign to steer clear.
As Tu says: “It’s insurance. It’s not an investment.”
If you have a whole life insurance policy that pays dividends, you may have the option of purchasing paid-up additions. Paid-up additions in life insurance are small additional amounts of coverage bought with your life insurance dividends.
Paid-up additions let you increase your death benefit — the payout your beneficiaries could receive if you die — without raising your premiums, because your dividends pay for the additional coverage in full. The extra coverage can help your life insurance keep up with inflation.
You’ll need a participating life insurance policy to earn dividends. Participating life insurance policies are available through mutual life insurance companies, which are owned by policyholders rather than shareholders. Dividends are never guaranteed, though some mutual life companies have a long track record of paying them.
If you use policy dividends to purchase paid-up additions (PUAs), you won’t need to provide new proof of insurability. This means you can get the extra coverage even if you’ve developed health problems. The additional insurance you can purchase is based on your age at the time the dividend is issued.
Alternatives to paid-up additions in life insurance
There are several alternatives to using dividends to purchase paid-up additions in life insurance. For example, you could choose to:
Receive the dividend payment as cash.
Use it to reduce your life insurance premiums.
Pay down outstanding policy loans.
If you’re shopping for life insurance and want the flexibility to increase your death benefit, there are several other ways to do so without a paid-up additions rider.
Inside: The answer is so obvious! Stop the assumptions with the 3 percent or 4 percent rule of retirement. Learn how much money to save for retirement today.
We all know that saving money for retirement is something we should do.
Maybe you are contributing the minimum to your 401K through work to get the match. Possibly saving money in a Roth IRA.
But, are you truly saving enough for retirement?
More than likely not.
Don’t feel like you are alone. According to a new study, only half of households actually have money saved in retirement accounts. The good news for those who have saved is the dollar amount saved for retirement has been increasing in the past 10 years.
Here is the real reason you don’t save for retirement… you have absolutely no clue how much money you need to be saved to retire.
You have tried to use all of the online retirement calculators from all of the big companies. Your results are millions of dollars different. You have no clue where to start, or what to believe.
And then you just get unmotivated because you’re like there’s absolutely no way I can make that dollar amount work.
So, What is Our Retirement Number
Personally, I completely get it this is a conversation. My husband and I have had it for years.
What is our retirement number?
What amount do we need to retire with?
And honestly, even can I actually save that much before I am too old to work?
It is all a complete unknown, it is a best-guess scenario.
There is absolutely no way for you to truly understand how much you need because there are so many things that go into it, including inflation, your savings rate, your withdrawal rate, and your anticipated expenses. So there’s a lot of variables and that’s when the variables get too confusing you don’t know which way to start.
One Guaranteed Truth…
The financial advisors believe they are the know-all-be-all with their calculations while charging you an asset management fee that is putting a drag on your overall portfolio.
And then October 27, 2020, Bill Bengen announced that instead of using the 4% rule is outdated, and now you can use a 5% rule. (Bill Bengan is a financial advisor who made the 4% rule of thumb famous 25 years ago.) So, this latest information just throws a curveball into everything that has previously been used for the past 25 years, and now you’re left wondering…
Well, I have no idea what is the proper amount I need to save for retirement.
Do you know what the amount that you need to save for retirement is?
So, let’s dig in for a little bit and we’re gonna talk about the three different percentages that are talked about the most. It’s the 3% rule, the 4% rule, and the 5% rule is one better than another. We’ll debate that and shortly.
How does Withdrawal Rate work?
But first of all, you have to realize that not everything works the way you want, so let’s show some examples before we dig into the specifics of the different rules.
Basically, the whole concept is if you save $1 million and you start withdrawing either 3%, 4%, or 5%. That withdrawal amount is the amount of income that you would live on each and every year, while the rest of your portfolio is continuing to grow and increase in value.
The ultimate, perfect-scenario goal is that you would withdraw as much as you possibly could without depleting the portfolio.
Withdrawal Rate Example:
Here are the assumptions:
Plan to spend $50,000 a year
7% rate of return on your money
Age doesn’t matter and not accounting for taxes or inflation (we want to keep this simple)
The amount you would need to save based on each of the withdrawal rates:
3 percent rule, you would need: $1,666,667
4 percent rule, you would need: $1,250,000
5 percent rule, you would need: $1,000,000
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The Withdrawal Rate Confusion
In our example, we used simple calculations that don’t account for age, taxes, or inflation and the amount you need to save for retirement is $666,667 different.
The numbers are too much for the average person to understand and have faith in.
This is why the confusion on how much to save for retirement and what model and which retirement calculator is the best.
Shortly, we are going to give you the simple answer of how much to save for retirement. But, first, a little background on the various percent rules for retirement.
3 Percent Rule
The 3% rule has gotten very popular with the FIRE movement.
The FIRE movement is Financial Independence Retire Early.
Because most of these people aren’t looking at retiring in the normal typical retirement age of 60s, they’re looking to retire in their 30s or 40s. They feel like they need to be super conservative because they are trying to estimate how much they need each month to live off their money for possibly the next 50 years.
That’s a lot of variables that you have to take into account.
The good news is you can always learn and figure out ways to make money in retirement so it’s not a complete waste, you can always go back to work because you are younger, and have youth on your side. So, is 3% a safe withdrawal rate?
The golden advice is you want to plan for the worst but hope for the best. The goal is that 3% would cover all of your necessities and basic expenses.
4 Percent Rule
Is the 4 percent rule viable?
The 4 percent rule of retirement was made famous by Bill Bengen 25 years ago (and just recently he said that number is outdated.)
The assumptions were if you withdraw 4% of your investment account every year, you will still have enough to live on throughout retirement.
This was based on what has happened in the markets, accounted for inflation, and the age you want to retire. He conducted many possible case scenarios and concluded that by only withdrawing 4 percent will make sure your money lasts. That is why it has been what is called a golden rule for retirement.
How long will my money last using the 4% rule? If you do all the calculations, it should last for at least 30 years. Obviously, you are looking at many variables of the stock market doing well and your living expenses staying low. Once again, the other big factor is what inflation will do in the future.
So, is the 4% rule that much better?
5 Percent Rule
And then, October 2020 rolls in. The breaking news is that Bill Bengen announced the 4 percent rule for retirement is too conservative and now you can actually use 5%.
So, that leaves the average person going… Okay. My head is spinning. I’m not sure how much I need to save for retirement. What is a good number?
Can I safely withdraw 5% of my investment accounts and still have enough money? That means I need less money to retire.
Can you Overcome Why Most People don’t save for Retirement?
There are too many variables, there are too many unknowns, and they don’t understand how it all works.
That is the real reason people don’t save for retirement.
I get it. I’m there with you. I feel it. I hear it from readers. But, we are going to break down some of the key items so that way you know how much you need for retirement.
And just remember, even if you messed up your numbers, the market went down, or you want to spend more in retirement than you are, then you could always go back to work. Even better, learn how to make money online for beginners, pick up a side hustle, make a little bit of extra money, and actually do something that you truly enjoy doing.
Learn how much money should I have saved by 30.
How Much do I need to Retire?
The simple answer… aim for $1,000,000 in investment accounts.
You may be able to aim lower depending on some variables which we cover shortly.
Investment accounts can include any of the following:
401K
Roth IRA
IRA
HSA (health saving account)
Brokerage Accounts
High-interest bank accounts
Real estate
You want accounts with liquidity. Things that can be bought and sold for cash. Those are the assets we are counting on how much to retire with.
Don’t use equity in your house because you need a place to live. If you want to use equity, that is fine, but your calculations just become slightly more difficult. We want simplicity.
Right now, your money goal is to reach $1,000,000 in investment accounts. Specifically in liquid net worth.
(Of course, this number may be lower if you live in a low cost of living area, plan to move with overall lower costs or another country, or have good options with lower health care costs. There have been plenty of people who retired with less and love life.)
Based on these variables, you may just need $500,000 to retire. Or somewhere in that range.
Realistic Retirement Savings for Motivation
We shared what a realistic retirement savings amount of $1 million dollars is. Is your first reaction – yikes, there is absolutely no way I can reach that amount.
However, you can!
Just break it down into smaller chunks.
For instance, make your next goal to save $100,000. You do that 10 times and you hit that realistic retirement savings amount.
If that seems like a stretch, then break it down even further. To stay motivated you can strive to save $50K or even $20K.
Break it into bite-sized manageable pieces to help you save for retirement and stay on track.
Learn what happens if you don’t save for retirement.
Best Ways to Save for Retirement
This is the basics to start saving for retirement.
You already know much should you really save for retirement. Now, you just to need to do it.
Here is the safest way to save for retirement. First, open up one or all of these accounts (pending where you are on your money journey). Then, look at investing in S&P 500 Index funds. The most highly recommended index fund for beginners is VTSAX.
1. Contribute to 401K
This is the simplest way to start saving.
Make sure you are contributing at least the minimum to your employer’s 401K.
Every year you can contribute up to a maximum amount. In 2023, an employee can contribute $22,500 to their 401k (the employer is eligible to contribute as well for a combined amount not to exceed $66,000 or 100% of your compensation, whichever is less). For the latest contribution limits, check out the IRS site.
Each year, increase your percentage by 1%. A simple way to reach maxing out your 401K.
Pro Tip: Check if your employer offers a ROTH IRA option. These are becoming more and more popular with companies. A Roth 401K will let your money grow tax-free because you pay taxes when you contribute money. If they don’t offer one, pester the human resources department.
2. Open Roth IRA
The next best option is the ROTH IRA. You want to contribute to a Roth IRA because you pay taxes upfront rather than at withdrawal like a traditional IRA.
Since ROTH IRAs have tax advantages, there are also contribution limits set by the IRS. The contribution amounts have remained the same for a couple of years now. The annual contribution limit is $6,000 per year, or $7,000 if you’re age 50 or older.
The downside to Roth IRAs… the amount you can contribute may be limited based on your income and filing status. However, for the average American, you should be able to max out the amount you can save each year.
Learn if can you have multiple Roth IRAs as it may be a smart financial move.
Pro Tip: Even if one spouse is a stay-at-home parent, you can still contribute to a Roth IRA for the non-working spouse.
3. Health Savings Account
Say what? Yes, a health savings account is on the list as a way to save for retirement. It is a great way to grow your money tax-free going in and on withdrawals.
You must have a High Deductible Health Insurance Plan to open a health savings account.
This is something you want to do and contribute the maximum amount each year. For 2023, you can contribute $3,850 for individuals and $7,750 for family coverage. Typically, the limits go up $50 each year, which helps you save more every year.
Pro Tip: This account will stay with you even when you leave your current employer and insurance. Plus you can use the HSA funds forever – even to pay Medicaid premiums. (Hopefully, nothing changes on these tax-advantaged accounts).
4. Traditional Brokerage Account
The last avenue has no tax benefits, but you are still saving money to be used later. That is what really matters.
Since there are no tax advantages to these basic brokerage amounts, there also are no limits on how much you can contribute.
This is where you would save the remaining money after you exhausted all the other methods listed above.
Side Note…
Yes, there are other ways to save for retirement. For this post and the average investor, the above-mentioned accounts are a great place to start. Once you become savvier and want to invest more money, then you can look at back door IRAs, 529s, or whole life insurance.
Saved $1 million for retirement, Now What?
Once you reach that 1 million dollars retirement mark, congratulations!!
That is a huge milestone that many people never reach. So, what is the next step?
Now, that you are closer to finally being able to live off your investments, you must start to look at the retirement calculators more seriously and factor in all of those variables (age, taxes, and inflation). It is much easier to predict the future once you have built a solid nest age and are closer to living off your investments.
Everyone started the financial independence journey at a different age and will reach their million-dollar mark at different times.
For the average person, you know learned how to save for retirement. You know what you need to do and where to start.
In this post, we took out all of the confusion on how much to save for retirement. Don’t worry about is the 4 percent rule is viable – or if it should be the 3 percent rule or the new 5% rule. The assumptions and variables will hold you back from starting. You know the dollar amount to start with, move on with that.
This simple advice for hitting your first milestone is the motivation to keep you going. Along the way, you will become savvier with finances and investing.
When it is time to move to the question of “can I retire” at such and such age, you have already taken out many of the variables, and the decision becomes more and more clear.
Take steps to reach that $1000000 mark today.
Get ahead now…
Know someone else that needs this, too? Then, please share!!
Did the post resonate with you?
More importantly, did I answer the questions you have about this topic? Let me know in the comments if I can help in some other way!
Your comments are not just welcomed; they’re an integral part of our community. Let’s continue the conversation and explore how these ideas align with your journey towards Money Bliss.
Extended term insurance is a way to use the cash value of a permanent life insurance policy to buy a term policy that lasts for a set number of years and has the same death benefit
. It can be useful if you can no longer afford your life insurance premiums but you still need the coverage.
Most permanent life insurance policies, like whole life insurance, charge higher premiums than term life and use part of this money to build cash value over time. These policies typically contain a “nonforfeiture” clause, which means you won’t lose the cash value that’s accumulated if you cancel the policy or allow it to lapse.
Extended term insurance is a nonforfeiture option that lets you keep your life insurance coverage for some amount of time, even though your permanent policy ends. It replaces your permanent policy with a term policy, typically of the same face amount, paid for by your accumulated cash value.
The length of the term depends on how much cash value the policy has, as well as your age when you stopped making payments. If you have an outstanding policy loan, your insurance company will deduct the amount from its cash value first. The insurer will use the remaining amount to determine how much term life insurance you qualify for
.
Pros and cons of extended term life insurance
The advantage of extended term insurance is that you can stop paying premiums and keep some coverage in place. If you die during the policy’s term, your loved ones will still receive a death benefit, which is the payout from a life insurance policy.
The downside is that you’re replacing permanent life coverage — which is typically meant to last your entire lifetime or until an advanced age — with short-term coverage. If you outlive the policy’s term, the policy will expire and your survivors won’t get a payout when you die.
If you decide you no longer need coverage or you can no longer afford premiums on a permanent policy, you’ll also typically have the option of trading in the policy for its cash surrender value.
A term conversion rider in life insurance is a feature that gives you the option to convert a term life policy into a permanent life policy without new medical underwriting. Some term life policies automatically include a conversion option. Others require you to pay extra for this life insurance rider, and some policies may not offer it at all.
Term life insurance covers you for only a specific period of time, usually between 10 and 30 years. If you outlive the policy’s term, your coverage expires. Permanent life policies like whole life insurance often provide lifelong coverage, extending to a maximum age such as 100 or 121. But these types of policies are usually far more expensive than term life insurance because in addition to permanent insurance, they have a savings component called cash value.
A term conversion rider lets you lock in the ability to buy permanent coverage in the future, while allowing you to pay lower term life premium rates. You may want to secure the option to obtain permanent life insurance in case your health or financial obligations change. Or perhaps you can only afford term insurance now, but you’re hoping you’ll make more money and will be able to buy permanent life insurance later.
How much does it cost to convert a term policy?
Usually there’s no fee for converting your term policy to a permanent one, but you can expect your premiums to increase significantly. Since a term conversion rider doesn’t require new underwriting or a life insurance medical exam, your health status won’t affect your premiums. Your age will be a factor in how much you pay, though.
You may have a limited window for converting your policy. For example, some policies require you to exercise your conversion option before you turn 65, at least 18 months before the end of the policy, or in the first five or 10 years of your policy’s term. With other policies, the conversion provision remains in force until the policy expires.
Many insurers allow for a partial conversion, which leaves you with two separate policies: your remaining term policy (with a lower life insurance face value) and your new permanent policy.
Be aware that when you convert, you typically can’t choose from all the permanent policies an insurer may offer. You’ll probably have only one conversion option, and it may not be the right policy for you. It’s a good idea to check out other permanent life insurance options on the marketplace, especially if you’re in good health.
A term conversion rider can give you additional flexibility in case you need to purchase permanent coverage in the future. If you’re interested in a policy that includes this rider, consult with a life insurance agent or broker.
Preneed insurance is a small whole life insurance policy that you purchase through a funeral home to prepay your final expenses. Unlike a standard life insurance death benefit, which goes to your survivors when you die, a preneed insurance payout goes to the funeral home you’ve selected.
People often buy preneed insurance because they’re worried about burdening their loved ones with funeral costs. The median cost of a funeral with a viewing and burial was $8,300 in 2023, according to the National Funeral Directors Association
. Some typical expenses that preneed insurance covers include:
Funeral home costs.
Embalming, preparing and transporting the body.
Casket or urn.
Death certificate fees.
How much does preneed insurance cost?
Preneed insurance allows you to lock in today’s rates for a funeral and burial and pay for these expenses in monthly installments. Plus, it’s usually easier to qualify for than a standard life insurance policy. However, you’ll often pay higher premiums for less coverage than you would for life insurance. You could even wind up paying more in premiums than the funeral actually costs
Washington State Office of the Insurance Commissioner. Funeral Insurance. Accessed Apr 9, 2024.
.
Not all prepaid funeral plans fall under the preneed insurance umbrella. Some funeral homes offer the option of paying expenses in an upfront lump sum. When funeral costs are paid with a single premium, the funds are deposited in a trust account rather than being used to buy a life insurance policy.
The cost of preneed insurance will vary based on your age, where you live and what type of final arrangements you want. Typically, premiums cost between $125 to $300 per month and are paid over three to 10 years.
If you’re considering preneed insurance, read the details of the contract carefully. Some services may be guaranteed, which means the funeral home will cover the expense regardless of how much it costs when you die. Other services are nonguaranteed, which means your loved ones may have to cover the difference between the cost of the service and what your plan covers.
Alternatives to preneed insurance
If you’re considering preneed insurance, there are a few alternatives you should be aware of. Final expense insurance, also known as burial insurance, is designed to cover your funeral and other end-of-life expenses, but nothing else. The death benefit is often higher than you’d get through a preneed policy, and it goes to your survivors instead of the funeral home.
If you have enough money to cover funeral expenses, you could also set up a savings account with a payable on death designation and make a loved one the beneficiary. The money will automatically transfer to the person you designate when you die, and they can use that money for your final expenses.
Learn more about life insurance for final expenses
A term insurance rider adds temporary coverage to a permanent life insurance policy for a set amount of time, usually 10, 20 or 30 years. Life insurance riders offer additional coverage to complement standard policies and the options vary among insurers.
Adding term insurance to a permanent policy
Term life riders can typically be added to permanent policies, such as whole life insurance or universal life insurance, often for an extra fee. The payout from a term life rider can be used to cover temporary or short-term costs in the event of your death. For example, you may want to add a term life rider that lasts as long as your mortgage or until your children finish college so these larger expenses are covered if you die unexpectedly.
Let’s say you take out a permanent life insurance policy worth $100,000, which may be sufficient to cover your beneficiaries if you die after retirement or with fewer financial obligations. Adding a 20-year term life insurance rider worth $100,000 could help fulfill financial needs and bridge gaps if you die within that time frame.
It’s often cheaper to add a term life insurance rider to a permanent policy instead of buying a term policy now and a permanent life insurance policy later.
🤓Nerdy Tip
Most life insurance riders can’t be added to an existing policy. If you’re in the market for life insurance, explore all the riders and opt in to the ones you want or need when you buy a policy.
Types of term and permanent insurance riders
There are two main types of life insurance: term life insurance, which offers coverage for a fixed number of years and pays out if you die during the “term,” and permanent life insurance, which typically covers you for your entire life.
While the names can be confusing, a term life rider generally refers to temporary coverage added to a permanent life insurance policy. Some companies allow you to add a term life rider to a term life insurance policy to bump up your coverage even more, though this is rare.
Some of the most common life insurance riders include:
Alternatives to a term life rider
Assessing your needs can help you determine whether you need a permanent life insurance policy with a term life rider, or a different type of life insurance altogether. For many people, a standalone term life insurance policy is enough to provide their beneficiaries’ with a financial cushion.
Since the premiums for a term policy are usually cheaper than a permanent policy, you could save and invest the difference to plan ahead for yourself or your loved ones after the term ends. If you want to leave the option for permanent coverage open, consider adding a term conversion rider to your term life policy. This allows you to upgrade your policy to a permanent life insurance policy before a deadline specified by your insurer.
Frequently asked questions
What is a term insurance rider?
A term life insurance rider adds coverage to a permanent life insurance policy for a set number of years. This rider can help cover time-boxed or short-term financial responsibilities like a mortgage or care for young children.
Is a term insurance rider worth it?
It depends on your financial needs and situation. A term insurance rider can give you the flexibility to add coverage based on your current and future financial obligations. If you’re interested in permanent life insurance, adding a term life insurance rider to your coverage will likely leave you with cheaper premiums than if you were to buy the full amount as permanent life insurance.
How do I add a term rider to my existing life insurance policy?
Most companies only allow a term life rider to be added to the base policy upfront. However, some insurers may let you add a rider later for an extra cost. Contact your insurance company or agent to ask about adding riders to an existing policy.
How much does a term insurance rider cost?
The cost of adding a term life rider to a permanent life insurance policy varies based on factors like your age, amount of coverage and lifestyle. Adding a term life rider will typically increase your monthly premium on a permanent policy, but is likely to be cheaper than having two separate policies.
Around half of Americans have a life insurance policy. Financial advisors recommend having life insurance coverage that’s 10 to 15 times the amount of the insured’s annual income.
But additional insurance may be recommended to cover costs such as outstanding debt, children’s college education costs, or lifetime support of a disabled family member. Perhaps it’s no surprise that about one in five people who have insurance think they don’t have enough.
Getting to that life insurance protection point may be made easier by purchasing multiple life insurance policies. How many life insurance policies can a person have? There is no legal limit, and each person has unique life insurance needs, which will influence the number of life insurance policies held. There are also upsides and downsides to buying multiple insurance policies.
Why Have Multiple Insurance Policies?
Time is a big influencer on having multiple life insurance policies. For instance, a financial consumer may still have a whole life insurance policy that was taken out in childhood.
As the policyholder grows up and has a family, they may decide to take out a second life insurance policy to cover those financial dependents.
Or, an existing life insurance policy holder may need additional coverage for specific needs. Consider a homeowner with a family and a home mortgage. The homeowner may need a second life insurance policy to cover the mortgage owed on the home in the event he or she passes away.
Even smaller expenses can trigger the need for an extra life insurance policy. For example, the head of a household might consider buying an extra life insurance policy to cover the cost of funeral expenses, so the grieving family will have one less thing to worry about.
Recommended: 8 Popular Types of Life Insurance for Any Age
How Multiple Life Insurance Policies May Work
Since buying a home or starting a family has such a big impact on a family’s finances, adding more life insurance is certainly understandable.
In that context, adding extra life insurance in the form of an additional policy may make good sense. Using a policyholder with a mortgage and a family as an example, here’s how having multiple life insurance policies might work.
Term Life Policy: Enough life insurance to cover the cost of a home mortgage in the event the policyholder passes away.
Let’s say the head of household needs to cover a $300,000 mortgage. They buy a $300,000 term life insurance policy that expires in 30 years, when presumably the mortgage will be paid off.
If, in the event the policyholder dies sometime during those 30 years, the term life insurance policy pays $300,000, which the family can use to pay off the mortgage and remain in the home. If the policyholder is still alive after the 30-year term ends, the term life insurance contract ends with no more premiums owed on the policy, but no death benefit either.
Additional Term Life Policy
The head of household wants to leave his or her family in good financial shape after passing on. That means not only covering the costs of a mortgage, but also household bills, health care expenses, and the cost of college education for the children. A 20-year policy for $200,000 might ensure the family’s ability to cover necessary expenses, should the policyholder die during the policy term.
In the above example, the policyholder “doubles up” by purchasing one term life insurance policy to cover mortgage protection, so the family can continue living in the home without fear of having to cover mortgage costs and a separate term life policy meant to cover basic household and life expenses .
Life Insurance Laddering
Another approach is buying three life insurance policies and possibly paying less than a large single life insurance policy might cost.
The strategy is called “laddering.” Instead of buying one large life insurance policy for $1 million, for example, the policyholder might buy three smaller, term life insurance policies that equal $1 million, each for a different term. For example:
• A 10-year term life policy for $500,000 worth of coverage. • A 20-year term life policy for $300,000 worth of coverage. • A 30-year term life policy for $200,000 worth of coverage.
By stacking, or laddering, life insurance policies over different timetables, the policyholder is getting the exact financial coverage he or she needs at different stages of their life.
The laddering concept could give the policyholder some financial leverage with their insurance strategy. Typically, as a policyholder grows older, the need for life insurance declines, as the mortgage is paid down and children are grown and financially responsible for themselves.
Note that each person’s insurance cost will be different based on age, gender, health, hobbies, and other factors, so laddering may not be the right choice for everyone.
Pros and Cons of Having Multiple Life Insurance Policies
A person’s unique coverage needs will influence any decision to expand a current policy, add a new life insurance policy, or simply keep their current life insurance as it currently stands.
Pros:
Adding to a group life policy. Those with group life insurance subsidized by their employers may not have adequate financial protection. Coverage through an employer may not follow the employee, either, so if a person changes jobs, typically that coverage will no longer be in effect. Buying additional coverage could give a policyholder the life insurance protection they need.
Providing extra protection for life stages. Big “life stages” events like buying a home, having children, or launching a business may increase the need for more life insurance. As more value is added to a person’s net worth, the need for adequate life insurance to ensure their family is protected after they’re gone increases. An extra life insurance policy may provide that extra cushion of financial support. Term life insurance places a limit on the policy’s length based on insurance protection needs
Curbing risk. It doesn’t happen often, but insurance companies can go out of business. While an extra life insurance policy might add another layer of financial protection in the event of this worst-case scenario, consumers do have some protection through insurance guaranty associations. These guaranty associations provide benefits to policyholders and beneficiaries of policyholders in the case of an insurance company becoming insolvent. Insurance companies are legally required to join guaranty associations in the states where they do business.
Cons:
Coverage denial. Applying for multiple life insurance policies may signal companies that you’re attempting to purchase more life insurance than you actually need.
Insurance companies can and do share encrypted customer data, including the existence of multiple life insurance applications, via an industry organization known as the Medical Information Bureau (MIB).
Insurance providers rely on the MIB to ensure they’re not providing more life insurance coverage to a consumer than is necessary. Thus, having two or more life insurance applications under consideration by different companies could draw attention and end up in a denial of coverage based on a consumer’s intent to purchase more life insurance coverage than is necessary. Generally, during a life insurance interview, insurance companies will ask about other coverage an applicant already has in force or has pending. This double checking is to make sure a person will not be overinsured. The MIB also helps prevent fraud by proposed insureds because the MIB includes previous denials that could be left off of an application.
More complex record keeping. Multiple policies means multiple payments and more paperwork to keep track of. A missed payment could mean termination of a policy. For people who have a difficult time keeping track of household records and payments, multiple policies may not be a good idea. It can be easier to manage everything if all policies are through the same insurer.
Possible increasing premiums. Want to keep the cost of life insurance in check? Premiums are generally less expensive for young, healthy people. Purchasing one larger policy at a relatively young age may cost less overall.
Alternative to Having Multiple Policies
One possible strategy for maximizing life insurance benefits without taking out multiple policies is the use of insurance riders, which can add benefits to a policy without having to take out a new one. An insurance rider is supplementary coverage to an existing policy.
Some examples of riders are conversion of an addition of long-term care insurance to a basic life policy or accidental death and dismemberment for someone with a particularly dangerous job or hobby.
Policies may include conversion privileges, but riders can extend the amount of time the policyholder can convert. The cost of an insurance rider varies depending on the type of rider and the insurer. Each person’s insurance needs will determine which, if any, rider is necessary, and if the cost is affordable to them.
Recommended: What Is Life Insurance and How Does It Work?
The Takeaway
By purchasing multiple life insurance policies, policyholders can have extra coverage that pays out on a specific debt, like a mortgage payment, after the policyholder passes away. Additionally, multiple policies can help consumers get the exact life insurance coverage they need — when they need it most.
If you’re shopping for life insurance, SoFi has partnered with Ethos to offer competitive life insurance policies that are quick to set up and easy to understand. You can apply in just minutes and get an instant decision. As your circumstances change, you can easily change or cancel your policy with no fees and no hassles.
Complete an application and get your quote in just minutes.
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