The most underused tax-savings vehicle: the Health Savings Account (HSA)

In summary

Health Savings Accounts (HSAs) let you save on taxes (like a 401k) when you contribute to them. They grow tax-deferred (also like a 401k/IRA), and if you use them for approved health costs*, the earnings are also tax-free! Unlike an FSA, the account is yours to take with you and the money never ‘expires’ (think of it like a healthcare spending IRA), and best of all, if you don’t use it for healthcare by the time you’re 65 years old, you can take it out with no penalty and just pay income taxes on it as those it were a 401k/IRA!

You must have an HSA-eligible health insurance plan to contribute (but not to use) an HSA, so check if your employer provides one and if the coverage makes sense for you (for most healthy people it does!)

Either open the HSA through your employer, or if you need to roll over an old HSA or you want to open one on your own, I highly recommend (and use) Lively, which has no fees, great customer service & website, and great investment options via a linked TD Ameritrade brokerage. (Yes, you can invest your HSA balance so that it can grow tax-free just like a retirement account! I keep a couple thousand for just-in-case health expenses in cash and invest the rest to grow for future needs for me or my family, since they can also use ‘your’ HSA.)

*out of pocket expenses, including on over-the-counter stuff like aspirin or feminine products, dental, and vision like contacts & contact solution). Generally you can’t pay for insurance, but if you’re on unemployment benefits or continuing your employer insurance with COBRA, you CAN pay for those premiums with your HSA.

Details

As health care costs in America continue to soar, so do health care insurance premiums.  The fortunate ones have access to quality, affordable, employer-sponsored group health insurance.  Those that are not so lucky?  Well, let’s just say your affordable options are somewhat limited (assuming you’re not independently wealthy and don’t want to “self-insure.”)

What does a “normal” health insurance policy cost for an individual?

A quick search on ehealthinsurance.com returns several plans with a wide range of premiums, coinsurance percentages, out-of-pocket maximums and coverages.***  The search I performed assumes that the policy holder (the person who’s buying the insurance) is a male non-smoker who lives in North Seattle and is 25 years old.  (Premium prices for a person who is 55 are in parentheses right next to our sample 25 year-old’s monthly premiums.)

Our sample person would pay $226 ($431) per month for a policy with a $500 deductible, 20% coinsurance after the deductible, and an out-of-pocket maximum of $4,500 (including deductible.)  The first 1-5 per year office visits to a primary doctor or specialist are exempted from the deductible.  All our person would have to cover is the $30 copayment (or “copay”, a typically small payment towards your health care per office visit.)  Also, prescription drugs are covered at a $20-$40 copay.

Health insurance is expensive!  How can I lower my premiums?

If that $226 ($431) monthly premium sounds pretty hefty to you (adding up to $2712 ($5172) per year), there are alternatives.  The easiest way to lower any kind of insurance premium is to increase your deductible.  This means that if you do use your insurance, more of the upfront costs will be born by you.  The benefit is that if you’re relatively healthy, you may not pay much out of pocket for health care, saving yourself the difference in premiums.  High-deductible health insurance is also referred to as “catastrophic” health insurance.  I.e: this type of insurance doesn’t pay much if anything for the small stuff, but if something terrible happens to you and you wind up in the hospital for a few days, you won’t be wiped out financially.

If we run our male 25-year old (55 year-old) search for high-deductible plans we find one with a $2,000 deductible, 10% coinsurance after the deductible, and an out-of-pocket maximum of $5,100 (including deductible.)  However, we don’t find any deductible exemptions for office visits on this policy.  Also, prescription drugs aren’t covered at all (which may be a consideration for our sample 55 year-old person.)

What’s the upside to the higher deductible (and out-of-pocket maximum) and the reduced benefits on this catastrophic policy?  Premiums are less than 30% (40%) of the lower-deductible policy at $65 ($168) per month.  Comparing our lower deductible and high-deductible policies, those premium differences amount to $1,932 ($3,156) per year in savings.  If you rarely go to the doctor, that could make a pretty big difference to you over the years, especially if you’re investing the difference and earning returns on that money each year.

Health Savings Accounts – how HSAs can help those considering high-deductible health insurance

The government has created a tax-advantaged device that might make high-deductible health insurance even more attractive to you.  This vehicle is called a Health Savings Account (HSA.)

The idea behind a Health Savings Account is fairly simple:

Step 1) An individual or family purchases a high-deductible (greater than $1,400 for individuals in 2021; $2,800 for families) health insurance option from any carrier they like (including your employer.)  The minimum deductible does NOT apply to preventative services.  Thus, you could have a plan that waives its deductible for routine office exams and immunizations that still qualifies for an HSA.  Also, the out-of-pocket maximum for an HSA-eligible plan must be less than $7,000 (for an individual in 2021;  $14,000 for families.)

Step 2) The same individual or family opens up an HSA, into which they can contribute up to the annual amount stipulated by the IRS.  For 2021, those annual limits are $3,600 & $7,200 for individuals & families respectively, with an extra $1,000 ‘catch up’ contribution for those who are 55 and up.

Note that a family can never contribute more than the family limit with all their combined employee + employer contributions. For example, if each spouse has their own HDHP + HSA, and one spouse is covering children on theirs, they can NOT contribute $7,200 to the kids+spouse plan and $3,600 to the individual. Each spouse can only contribute the $3,600 to each HSA.

Benefits of an HSA – Triple tax-advantaged!

– You can deduct contributions that you make to the HSA from your taxes** (without having to itemize.)  Also, you can invest in whatever you want, similar to an IRA.  In theory, any provider of IRAs is eligible to offer HSAs.  In practice, however, I haven’t heard of any brokerages or mutual fund houses that offer HSAs directly (but hopefully that will change as the HSA becomes more popular and widely known.)

** State tax treatment of HSAs varies. Depending upon the state, HSA contributions and earnings may or may not be subject to state taxes.  See THIS for information on your state.]

– Your contributions remain in your account from year to year until you use them (unlike Flexible Savings Accounts which are often “use it or lose it” for a given year.)

– The interest or other earnings on the assets in the account are tax free.

– Distributions are tax free if you pay for documented qualified medical expenses.  These expenses can include medical/dental/vision/chiropractic services, over-the-counter and prescription drugs, medical hardware like eyeglasses and hearing aids and long-term care insurance premiums (however, generally you cannot treat insurance premiums as qualified medical expenses for HSAs.)

Who’s covered?

The qualified expenses can be for you, your spouse, or any of your dependents (i.e.: children.)

What’s covered?

From the IRS, “the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body. These expenses include payments for legal medical services rendered by physicians, surgeons, dentists, and other medical practitioners. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes.

Medical care expenses must be primarily to alleviate or prevent a physical or mental defect or illness. They do not include expenses that are merely beneficial to general health, such as vitamins or a vacation.”

A large list can be found HERE, and includes all the ‘normal’ medical expenses one might think of (exams, hospitalization, treatment, lab fees, vaccines, surgery (NOT cosmetic!, medicine), as well as acupuncture, dental treatment & hardware (dentures, braces – but teeth whitening is NOT covered),  birth control, chiropractor bills, contact lenses (including saline solution), glasses (for vision correction), eye exams, laser eye surgery, hearing aids, and nursing homes & services.

There is also a list of things NOT covered, which includes cosmetic surgery, hair removal or transplant, funeral expenses, gym memberships, nonprescription medicine (e.g.: aspirin), and nutritional supplements (e.g.: vitamins).

What about insurance premiums?

In general, insurance premiums (the cost you pay to maintain your insurance) are NOT covered, since they aren’t direct payment for medical care.  However, you CAN use HSA money tax & penalty-free if you’re paying for 1) Long-term Care insurance (up to certain limits), 2) health care continuation coverage (COBRA), 3) insurance while you’re receiving unemployment benefits, and 4) Medicare premiums once you (or you AND your spouse if you’re covering your spouse) are 65 or older.  See Pub 969 for details.

What if you DON’T use the money for qualified medical expenses?

If you use the money for something else, you will pay a 20% fee on the money and income taxes (so DON’T do that!)  However, if you are 65 or older or disabled, you can withdraw the money for whatever you like and only pay regular income tax (avoiding the extra penalty, making the HSA similar to a Traditional IRA or 401k.)  After 65, you continue to withdraw your HSA money tax-free to pay for medical expenses.

Additionally, unlike Traditional IRAs and 401ks, there are NO Required Minimum Distributions (RMDs) for HSAs, so the money can continue to grow tax-free while you’re in retirement.

Furthermore, if the policyholder ends their HSA-eligible insurance coverage, he or she loses eligibility to deposit further funds, but funds already in the HSA remain available for use (1).  Your HSA is also “portable” in that it stays with you if you change employers or stop working.

In order to qualify for an HSA, you must be enrolled in a high deductible health plan (HDHP), you can’t be enrolled in Medicare, and you can’t be claimed as a dependent on someone else’s tax return for the year you enroll/contribute.  In 2014, a HDHP must have a MINimum annual deductible of $1,250 for an individual ($2,500 for a couple) and a MAXimum out-of-pocket maximum (INCLUDING the deductible) of $6,350 ($12,700) for ‘in-network’ coverage, if your plan is a in/out-of-network plan.  HDHPs MAY cover preventative care without requiring the deductible.

Your health insurance provider, and health care search engines like ehealthinsurance.com, can tell you whether your plan qualifies as a HDHP so that you (or your employer) can contribute to an HSA.

Conclusion

Health insurance can be tricky and somewhat complicated.  Besides looking at the financial side of things (premiums, coinsurance, out-of-pocket maximums) you need to be especially careful at reading through a potential policy to understand everything that’s covered, and more importantly, what isn’t.

HSAs are one way that a person might be able to save on health care costs.  However, to benefit you should be healthy (i.e.: need the doctor rarely in the future), in a tax bracket where the tax savings will give you a nice benefit, and making enough money and have the discipline to invest in your HSA.  Doing so successfully could result in significantly lower health insurance premiums, while allowing your HSA to grow tax-free until you either need it for medical expenses down the line, or you use it like a 401k/IRA after you turn 65.

Regardless of which health care option you choose for yourself or your family, make sure you understand it and make sure you enroll in one of those options!  Due to the high cost of health care, and the likelihood that something can happen to you at any moment, you can’t afford NOT to buy health insurance.  You may feel young and invincible (I sure do!), but all it takes is a car wreck or a sports accident to lay you up.  Often times these circumstances are completely beyond our control.  Your entire savings and assets could be wiped out (and you could accrue significant debt) by a few days stay at a hospital.

So, stay healthy (both physically and financially)!  Eat right, exercise, invest early and often and make sure you have health insurance to protect yourself and your family.

[To learn more about HSAs, check out the IRS’s Publication 969.]

***”Coinsurance” is the % of your covered health care costs that YOU will pay for AFTER you pay costs up to the amount of the deductible. (Therefore, if your coinsurance is 15%, you pay 15% of the costs after you pay the deductible amount and your health insurance company pays the balance of 85%.)

The policy’s annual “deductible” is the amount of health care costs that you will have to incur (per year) before your insurance company will help pay some of them.

The annual “Out-of-pocket maximum” is the total amount of money that you might be liable for, in one year, should you have to pay that much in health care costs that year.  This number sometimes includes the deductible and sometimes does not.

The monthly “premiums” equate to the amount you must pay to maintain your health insurance coverage.  For a given policy, premiums generally go up as you get older, as it becomes more likely that you will incur health care costs that your insurance provider will have to cover.

Here’s an example to show how all these parts of your health insurance policy work together: Let’s say Joe N. Shured has a policy which features a $1000 deductible and 20% coinsurance after that, with an out-of-pocket maximum of $5000, which includes the deductible.

In 2008, Joe goes in for a routine checkup which costs $250.  Since this amount is below his annual $1000 deductible, Joe pays for the whole $250 out of his own pocket.  Later in the same year, Joe breaks his arm skiing and has to go in for X-rays, a cast, etc.  His total bills for the broken arm are  $6750.  Since Joe had already paid $250 towards his deductible, the first $750 of his broken arm bills also goes towards the $1000 annual deductible (which he pays all himself.)  Now that Joe has paid health care costs in 2008 equal to his deductible, the coinsurance of 20% kicks in.  Joe therefore pays 20% of the remaining $6000 balance, which equals $1200.  His insurance company picks up the tab for the remaining $4800 (assuming his policy covers those types of medical expenses; always read your policy carefully!)

To date, in 2008 Joe has paid $1000 for the deductible plus $1200 after the coinsurance kicks in for an out-of-pocket total of $2200.  His insurance company has paid $4800 (for a total of $7000 in medical bills in 2008.)  Let’s say that Joe, the clumsly being that he is, falls down a flight of stairs later in 2008 and breaks both legs.  These leg bills come to a total of $20,000, after a couple days stay in the hospital.  At 20% coinsurance, you might think Joe would have to pay $4,000, but notice that Joe already has paid $2,200 out-of-pocket medical expenses this year.  Because Joe’s policy has an out-of-pocket maximum (including deductible in our example) of $5,000, Joe only has to pay $2,800 of the leg bills out-of-pocket.  (Because $2,200 + $2,800 = $5,000.)  His insurance company must pay the remaining $17,200 of bills.

Joe finally makes it out of 2008 without anymore scrapes.  However, on Jan 2nd of 2009, Joe celebrates State U’s touchdown a little too violently and gives himself a hernia.  His hospital bill for this is $225.  Since Joe is in a new calendar year, his deductible has reset to $1000 again, so Joe must pay the whole $225 himself.  (Joe’s annual out-of-pocket maximum is also back at $5000 for 2009.)

(1) http://en.wikipedia.org/wiki/Health_savings_account

How to buy life insurance without getting ripped off

Quick life insurance takeaways up front

1) AVOID buying ‘cash value’ life insurance policies (whole, universal, variable).

2) Instead, buy TERM life insurance with guaranteed level-premiums for you and anyone else in your family who’s income your family depends on (e.g.: your spouse. Never buy life insurance for your child unless they’re a movie star who’s income you depend on.)

3) Buy a term of 20 – 30 years. The term you choose should be long enough to make sure all of your dependents will be financially independent when the term expires and you are no longer covered. This means your kids should be out of college & gainfully employed, your house paid off, and your spouse & yourself should have plenty of retirement money socked away by the end.  Err on the side of a longer term than you think you’ll need: it’s usually not much more costly than a shorter term. Policies are cheap when you’re young and healthy (so quit smoking/don’t smoke.) If you are a good saver and estimate that you’ll have a lot more in savings in, say, 15 – 20 years, you could go shorter on the term to save a few bucks, but it’s a riskier strategy if your savings goals don’t proceed as planned.

4) Get a death benefit of $1,000,000. The ‘death benefit’ should be large enough to pay off your family’s debts and provide at least 5 – 10 years’-worth (or more, especially if your spouse doesn’t work/earn much) of living expenses. Make sure to factor in any outstanding mortgage + HELOC debt, college costs for your children, your spouse’s student loans (yours would be forgiven on death; not much consolation if you ask me), any home help your spouse might have to pay for to make it as a single parent. Subtract from this need any investments your family would inherit + any life insurance you already have from, say, your employer.

If you make a lot and live life relatively high on the hog, you might want $2,000,000. If you’re strapped for cash and used to living on less/have few debts, $500,000 might do it.

5) Go get a quote now at Quotacy. Quickquote is also fine, but I like the speed and interface and lack of entering an email address at Quotacy. Check also with your employer to see what coverage they offer and compare rates.  Many employers offer a little coverage for free (say, 1-2x your base salary), and give you the option to buy more. Their rates might be better or worse than what you can find on your own, so check around.

6) Make a decision and buy coverage from a company with an AM Best or Moody’s financial strength rating of at least A or A- to protect your family!

Feel free to stop here and get a quote. I’ve already covered the main factors to consider above, but if you want more background, keep reading.

Why I hate insurance, even though I need it & buy it

If there’s one thing I hate, it’s high-fee financial products.  Insurance products are often some of the worst offenders.  The main perpetrators are ‘cash value’ life insurance and annuities (although there are plenty of other useless types of insurance to avoid.)

Anyone with dependents (those that depend on your income) needs life insurance.  That being said, Ward’s rule #1 when buying insurance is ‘DON’T!’  I only buy insurance for things that can’t be planned & paid for by my own savings.  If you were relatively wealthy/lived cheaply and had already saved, say, 25 times your family’s annual spending needs, then you probably don’t need any life insurance at all, because your family can just use your assets to live on at the time of your death.

Alternately, even if you aren’t rich: if you don’t have any significant debt, have no dependents, your spouse makes enough money to live off by themselves, and you have other savings, you may not need any life insurance either (or at least no more than the paltry amount offered by your employer as part of your standard benefits package.)

For most of us, especially when we’re young, starting a family, and relatively low on the net worth totem pole, we need life insurance to protect our families in the unlikely-but-possible event of our early demise.

The only life insurance you’ll ever need

Most insurance companies will try to sell you some type of ‘cash value’ life insurance policy.  These include ‘whole life’, ‘universal life’, and ‘variable life’ policies.  Cash value policies all have an investment component to them as well as a ‘death benefit’ (a lump sum paid out to your beneficiaries when you die, regardless of your investment amount in the policy.)  The catch is that these policies are awful because they hit you with high fees (often in the form of the terrible investment choices with high expense ratios that come with your cash value life insurance policy.)

My general rule of thumb (and by ‘general’, I mean you should nearly always do this!) is to keep your insurance and investments strictly separate! Therefore, say it with me, “I will NEVER buy cash value life insurance no matter what an insurance agent or financial salesperson (sometimes disguised as an ‘advisor’) tells me!”*

Okay, so what life insurance SHOULD you buy?  Term life!  Term provides one thing, a death benefit, and that’s it.  Fortunately, that’s exactly what you need.

How term life insurance works

When you buy a term life policy, you pay an annual premium.  The older or more unhealthy you are, the higher the cost (since there’s a greater probability that you’ll die, forcing the insurance company to cough up the dough to your heirs.)  If you die within a certain period of time (the ‘term’, often 20 or 30 years), the insurance company pays the beneficiaries listed in your policy a ‘death benefit’ of some fixed amount of money that you’ve specified when you buy the policy (typically in $100 K increments, the most common amounts being $500 K or $1 million.)

Example: You’re a 28-year-old non-smoking person in good health.  You determine that your spouse and child would need $500 K to live on if you were to die.  You figure that in 30 years your kid will have graduated from college and your spouse will be doing fine, so you buy a 30 year term policy with a $500,000 death benefit.  You would likely pay a premium of around $400 – $500 per year, less than the price of a cell phone plan!

Make sure you buy a ‘guaranteed level-premium’ policy.  This means you are essentially renewing the policy each year and paying the same price to do so.  Without this your rates can fluctuate and/or you can be denied coverage if your health changes for the worst.

You can always cancel your policy if, say, you strike it rich and no longer have a need for the insurance.  (Although, it may pay to keep the policy anyway if you’re deep into the term since the premiums are relatively cheap compared to what it would cost you to buy new term life insurance at your decrepit old age.)

How big of a death benefit do you need?


This is a tricky question, but some general rules of thumb are helpful. If you don’t want to go through this exercise and you can afford it, just get $1,000,000 and call it good.

To be more precise, consider your family’s annual expenses, your outstanding debts, and your assets.  Most people want enough so that their spouse can pay off the mortgage, cover the kids’ college, and pay for any funeral expenses and other miscellaneous debts you leave behind, as well as have enough to live on to make up for your loss of income for the next few years, and any necessary single-parent help like childcare for the kids.

For most families, somewhere between $500 K to $1 M should do it.  The more assets you already have, such as your 401k, stock accounts, any social security death benefits accrued, the more money your spouse makes, and the closer your kids are to being financial independent, the less life insurance you need.  If you’re young, term is cheap, so err on the high side for the death benefit.

A sample calculation might go like this: 10 years of annual family expenditures: $60,000/year x 10 years = $600,000 + mortgage and other debt of $300,000 + today’s cost of 4 years of college at Your State University for 1 child ($100,000) = $1,000,000.

How long of a term should you get?

If your spouse works and could support themselves (not including the costs of raising children), then I would recommend getting a term policy to get your kid’s through college.  Estimate when your last child will graduate college and be self-sufficient (the two are not necessarily synonymous) and get a policy that will last at least that long.  Again, err on the safe side, so if you or your wife is pregnant with what you expect to be your last child, round up to a 30 year policy.

Get a quote and buy a policy from an A-rated company


I like Quickquote.com for getting comparable online term life insurance quotes**.  You can play around and get a feel for premium costs when varying term length and death benefit amounts.

Compare these quotes to the prices offered by your employer for life insurance (and check to see what they might already give you as part of your standard benefits package.)

Lastly, make sure that the insurance company you buy a policy from has an AM Best or Moody’s financial strength rating of at least ‘A’ or ‘A-‘, which means ‘excellent’.  This helps insure that the company is stable enough to still be around if and when your family needs the payout. The quotes you get from the above sites will tell you the rating.

Tip: I’ve found that round number periods like 20 and 30 years seem to cost much less than one would think given the relatively expensive 15 or 25 year periods.  Also, the more benefit you buy, the cheaper it is per dollar of premium; another reason to err high on the death benefit.

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* The only situation where you MIGHT consider cash value life insurance is the following: you’re wealthy and in a high tax bracket AND you’ve already maxed out ALL of your tax-advantaged retirement savings (401k, IRAs, HSAs if applicable, college savings plans if you need those for someone.)  Not only that, but you must have AT LEAST 15 – 20 years until retirement in order to offset the fees with the marginal tax benefits from cash value life policies.

SO, if you are within 15 years of retirement, STOP, don’t buy cash value life.  Similarly, even if you ARE 15+ years from retirement, max out all of your (far superior) tax-advantaged retirement savings options before even considering cash value life.  Even if you pass these two criteria, give this some serious thought with a fee-only financial advisor.

** I also used selectquote.com, but I DON’T recommend them because you don’t get instant results online (instead, some insurance agent will call you up to give you your ‘free’ result, which is really just an excuse for them to sell you a policy.  I hate being sold to!) I also struck accuquote.com from the list because they called me (twice! by two different salespeople!) to give me the ‘hard sell’ after I got the online quotes.  This really irritates me.

Avoid these 8 common financial mistakes

TL;DR – Avoid buying these things:

  1. cash value aka Whole/Universal Life insurance (buy term life instead),
  2. annuities
  3. credit card debt (pay it off now & set up autopay)
  4. car leases
  5. time-shares
  6. a new car before your old one is completely done for.
  7. Generally avoid buying vacation property or
  8. expensive remodeling your home, at least until you have $1+ million in the bank or are otherwise ready to retire comfortably and have extra money to burn.

Having advised a lot of people financially, I see the same mistakes holding them back over and over again. These bad decisions don’t seem to be bad moves to people at the time they make them, which is why they are so dangerous. The combination of friendly salespeople serving their wicked corporate overlords + our consumer culture makes wealth-destroying behavior seem ok and normal to us. It’s not ok, and it’s harmful, so let me help you recognize it so that you can avoid it and grow wealthy. Your future self will thank you.

Financial mistakes ordered from ‘Absolutely-Do-Not-Do’ (1 – 5) to ‘Be Careful’ (6 – 8)

  1. Buying ‘cash value’ life insurance like Whole or Universal Life insurance. 99.8% of people only need Term Life insurance, and that is what you should buy. If you think you’re in the 0.2% that could benefit from a cash value life insurance, you are almost certainly wrong, even more certainly if you’ve been convinced of this after talking to a salesperson who might be thinly, or thickly, disguised as an ‘advisor’ or some other financial person deserving of your trust. Most are absolutely not. Trust no one. Not your bank, not your credit union, not your mom, not your co-worker, and definitely not anyone who works for a financial institution or gets any type of payment from them. Trust no one. Except us, we’re the good guys.
  2. Buying an annuity. Life insurance companies are again the villains here. They push annuities to people who are afraid of ‘losing/running out of money’, which is… everybody. In reality, only 0.0001% of the population would probably ever truly need an annuity, and even this tiny fraction could find a better one than being offered by your particular salesperson. Pricey annual fees sneakily included so you don’t see what they cost you combined with all kinds of heinous other fees to prevent you from getting out of the product will steal a ton of your money over time. To illustrate, $100,000 invested in 0.1% fee stock index fund over 30 years will generate income of $508,000. In a typical 2%-per-year money-stealing annuity (it’s often even worse), you’ll only get $247,000 over the same 30 year period with the exact same investment risk, less than half as much! Where did the missing $261,000 go? Straight into the saleperson’s and the insurance company’s pockets. They’ll be quick to emphasize how wonderful it was that your gained $247,000, and if you hadn’t read this you would have never known that you actually lost $261,000 thanks to their evil machinations.
  3. Not paying off credit card debt when you have the cash on hand to do so, and not setting up autopay. This one baffles me a little since everyone ‘knows’ that credit card debt is ‘bad’, and yet even when they have cash in a checking account making nothing they sometimes don’t take it to pay off credit card debt costing them 12+%. This behavior is correlated with people who don’t enroll in autopay to always pay off their credit cards in full every month. The best way to avoid this problem is to log into your credit card account(s) RIGHT NOW, and turn on automatic payments for the full balance. Seriously, do it now. Here are the links for Chase, Capital One, Bank of America (instructions here), American Express, Discover, and CitiBank. If you’re carrying debt, transfer any cash you have on hand to pay off the balance right now (the same links above probably get you close to the right place to make a one-time payment. Do this now too!) With autopay, you’re not losing any control or risking a bounced payment because you’ll still get all the same notifications of a bill about to be paid and can always log back in later and turn off/reduce your autopay to a less-than-full amount if needed. You can still check your statement 20-something days prior to your bill being due in case there’s some charge you want to dispute, which there won’t be, because yes, it turns out that the suspicious SAM’S SUPER DUPER 1000 COMPANY charge for $38.93 that you don’t remember and are positive was fraud was just some gas station somewhere that you did indeed fill up at. One urban legend I’ve heard is that it’s “good for my credit score” if you run a ‘small’ balance. This is 100% false. On the contrary, paying your bills on time every time without fail is the best way to maintain a high credit score, so again, set up automatic payments for the full balance amount right now! There’s no danger, and much goodness, in scraping together all cash you have on hand to pay off an outstanding balance now. In the worst case scenario, if you need cash later, you can simply run up the debt again back to where it was.
  4. Buying a time-share. This is another ‘sold-not-bought’ product that you will almost certainly not get enough value from. They come with annual fees, are difficult to sell, especially for any kind of money close to what you paid for it, and make you feel forced to use them even if you’d rather do something else with your vacation time. Just rent a hotel/AirBnB like everyone else and you’ll enjoy more freedom, and almost definitely more wealth.
  5. Leasing a car. Unless you absolutely must have a new model all of the time, or can wangle some business tax deduction that your accountant has actually run the numbers on and assured you it’s worth it vs buying (it’s probably not even then), leasing a car is a wealth-destroying move. Instead, buy a reasonably priced, reliable car and drive it into the ground.
  6. Buying a new car before your old one is used up. Like leasing, buying another car before running your current one into the ground is a very costly thing to do, especially if you repeat this process many times during your life. Whether you choose to buy used cars as I recommend, or if you must have a new car, always drive your current vehicle into the ground before upgrading. This saves you a lot of money by driving your car long after you’ve paid it off. Switching cars every few years is a good way to burn through a lot of disposable income that you otherwise could have invested and become wealthy with. One simple rule to avoid temptation is always paying cash for your next car. This forces you to save for it in advance, and also to reckon with the true cost of upgrading as opposed to fooling yourself into thinking it’s not that financially painful by financing it in little bits each month. Rule of of thumb: Spend less than $10,000 for your next car, and only upgrade when your current vehicle has > 200,000 miles on it or would cost more than half its value to keep driving it.
  7. Buying vacation property. After time-shares, this is another popular way to sink money into something that you will never ever get enough value out of. Anytime you consider buying a vacation property, take the purchase price, and multiple by 5%. Write down that number, and decide if this annual ‘opportunity cost’ is close to the annual value you’d get out of your property. Consider a $300,000 remote lake-front cabin. Sounds nice and peaceful right? Well, 5% * $300 K = $15,000 per year, which is $1,250 per month. That’s roughly how much more you’d make over time on that money if you invested it in a low-fee stock index fund instead. Let’s say you spend a month per year at this resort of yours, which is pretty darn optimistic for most working people. 30 days divided into $15,000 = $500/day. For that price, you could rent a room in the Bellagio in Las Vegas and order champagne room service every day. You are not getting a good deal on your vacations spent at Lake Woebegone. Plus, if you buy a vacation place, you’re gonna feel obligated to ‘get your money’s’ worth and feel pressured to go there every time you have vacation. Maybe you’d rather go somewhere else instead! $15,000 per year can buy a lot of hotel or AirBnB stays, or an annual multi-week European vacation, or anything else you can think of, including a very nice lakefront resort property that you don’t have to own and can instead rent as you like! Vacation property is almost never worth it from a financial perspective. Even if you plan to rent it out part of the time to get some money back out of it, the math usually doesn’t work when you subtract the cost of the mortgage, taxes, insurance, property management and other fees, and maintenance from the revenue you expect (which always ends up being less than you think.) There’s also the headache associated with managing and maintaining property of any kind, which is even worse if you’re also a landlord. If you must buy vacation property, try to get it so cheap that even if you only use it a few weekends out of the year (the most likely scenario), your per-night/annual costs are still reasonable. For example, getting a few acres of raw wilderness land for $20,000 that you could camp on, or even erect a cheap tiny mobile home for another $20 K, might be worth it. 5% * $40,000 = $2,000 per year. 10 nights a year = $200/night, not bad, and the land might even someday increase in value if you buy it in a nice area that is experiencing population growth (but don’t hold your breath.) Rule of thumb: Spending less than $100,000 for vacation property, maybe it’s ok. More than $100,000, DON’T DO IT!
  8. Remodeling your home. People love to spend on their homes by telling themselves ‘it’s an investment’. Every single remodel/addition listed here shows that the value of your house will increase by less than the cost of the remodel. Think about that. As soon as you’ve spent $20,000 remodeling your bathroom to your unique tastes, maybe your home value when you finally sell the place has increased by $10,000, so you’ve instantly destroyed $10,000 in wealth. If that $10,000 loss was worth it to you because you love your new bathroom by that much over the life of the time you spend in the home, that’s fine, but don’t fool yourself into thinking you’re gonna recoup anywhere near the spending in a future home sale. Of course, there are some price-effective home improvements that you should do like adding insulation to save on energy costs, but these tend to be few-hundred dollar DIY projects that no one sees, vs $10,000+ projects that you pay other people to do and then show off at parties. Houses do not build wealth anywhere close to stocks, and the same goes for remodeling them. If you are skilled and can do a lot of the costly labor yourself and scrimp on materials costs, you might be able to add some ‘sweat equity’ to your property as well as enjoying the results of your labor. That said, even skilled people in my experience end up spending much more than the value they create. Rule of thumb: If your home improvement projects total less than less than $10,000, go ahead, otherwise DON’T DO IT!

Any other common financial mistakes that you’ve made, or seen other people make, that you think should be added to the list? Let me know in the comments.

Optimize your auto insurance and save hundreds a year

The Author’s 2002 Toyota Corolla aka ‘The Babe Magnet’, purchased used in 2006, and still going strong with over 200,000 miles! (Optional carrying capacity shown on roof racks.)
Checklist to optimize your auto insurance
  1. Increase your Collision + Comprehensive deductibles to at least $1,000, and preferably $2,000 or as high as you can comfortably pay for.
  2. If you car is worth less than ~$5,000 – $10,000 AND you can replace it with cash today, drop Collision & Comprehensive altogether.
  3. Decline Underinsured Motorist Property damage since your Comprehensive/Collision already takes care of that.
  4. Protect yourself with high liability limits: Carry at least $50,000 / $100,000 for Bodily Injury Liability and $50,000 for Property Liability. If you have more than $100,000 in assets, increase your limits at least as high as your net worth, or to the max allowed by your insurer.
  5. If you and your family already have health insurance, you don’t need and should drop Personal Injury Protection and Underinsured Motorist coverages.
  6. Drop rental car coverage. Drop roadside assistance if you already have your own service, or decide you don’t need it. If there are any other small dollar coverages, you probably want to drop them too. Self-insure small financial risks yourself!
Step-by-step instructions to pare down your auto insurance to save hundreds per year

Most people carry coverages they do not need on their auto insurance, or simply pay too much for insurance because they haven’t shopped around in years. Let me show you how I optimize auto insurance coverage to save money while protecting myself from financial risks.

First, shop around for the best coverage by at least getting a quote at GEICO (they often offer the best prices) and Allstate/esurance. These guys offer insurance directly to consumers without brokers as middlemen, and thus often offer the best prices. Compare their rates to your current insurer and see if it makes sense to switch.

Next, let’s take a look at your current policy online, either after switching carriers or before. As an example, I’ll use my GEICO auto insurance to show you before and after cost savings.

Companies with good online interfaces like GEICO let you play around with coverage limits and types to see cost differences in real-time. If you carrier doesn’t let you do that, you’ll need to call them up and talk through the differences over the phone. (Another reason I like GEICO.)

Navigate to where you can see the coverage broken out something like this:

My post-optimization coverage. Note that I carry very high bodily injury + property damage limits to protect myself to the maximum extent possible, but I’ve pared down all other unnecessary (for me) coverage.

Now, find a button that says something like ‘Edit coverage’. So long as you don’t save the changes, you can hopefully play around with the limits and see the dollar differences. Let’s do this at GEICO, and explain how to determine what you do and don’t need.

Auto insurance has four basic components to it:

  • Injury Liability: this protects YOU financially by paying for physical injury to another person in an accident. I.e.: you hit them and they end up in the hospital.
  • Property damage liability: this protects you financially by paying for damage you cause to someone else with you car (e.g.: you hit their car, or, god forbid, their house.)
  • Injury protection: this pays you/your passengers some (usually small-ish) amount for medical bills that you incur as a result of the accident. Most people don’t need this IF they already have health insurance and can pay their insurance deductible.
  • Property damage protection: this pays you if your car is damaged. If you can afford to fix, or replace your car if it’s totaled, you’re better off ‘self-insuring’ by keeping cash on hand and declining this coverage. My car is worth less than $5,000, which is an amount I’m totally comfortable self-insuring.

Let’s say I had a fairly typical set of coverages that looks like the below, including collision + comprehensive with deductibles of $500.

The first and most important thing to look at is your liability limits. You generally want these as high as you can afford to protect you from large financial losses.

As a rule of thumb, get as much as will be equal to or greater than your total net worth if possible, but get at least $50,000 / $100,000 for Bodily Injury Liability and at least $50,000 for property damage liability. (I.e.: if you wreck someone’s $50 K car, you’re safe. If you total their $200 K Ferrari, you’ll still be on the hook for more money…)

Next we have coverage for your losses. This is where you can save some dough. I always decline Medical Payments (above), Personal Injury Protection, and Underinsured motorist (below) because these cover my or my passenger’s medical bills, which I don’t need because I already have health insurance that would cover those. If you also have health insurance, and so do the people who ride with you (your family, say), then you almost definitely to not need any of these coverages, which will save you big bucks!

Eliminating these three things will save me $58.90 + $123.30 + $43.40 = $225.60 every 6 months, so $451.20 per year ( = $37.60 per month.)

Next are Underinsured Motorist Property Damage (above; this covers my car) and Comprehensive + Collision. Collision pays for damage to your car resulting from a car crash if you’re at fault, or in a no-fault state, or if it’s the other guy’s fault and he doesn’t have insurance or is never caught. Comprehensive is for non-crash damage to your car like from theft, vandalism, or natural disasters.

I drive a cheap, reliable car, and keep plenty of cash on hand, so I decline all of these coverages completely and pocket the savings (to save & invest if I ever need to pay for any such damage, or to replace my car.) If you can afford to pay cash to replace or fix your car, waive all of these. A general rule of thumb might be to waive them if your car costs $10,000 or less, and certainly waive if it’s only a few thousand or less.

Check Kelly Blue Book to estimate your car’s replacement value, since that’s all an insurance company will give you (they won’t pay you more than the car’s worth! That’s why even a minor-but-expensive-to-fix ding will ‘total’ your car from the insurance company’s perspective.)

For those of you with more expensive/newer cars, even if you need this coverage, you should definitely increase the deductible to the highest level you can afford to pay without losing sleep over it. For more people, that’s probably in the area of $1,000 – $2,000. If you haven’t saved at least that much in an emergency fund, get busy!

If I dropped these property coverages completely, I’d save $11.30 + $12 + $49.20 = $72.50 per 6 months = $145 per year.

If I upped my deductible from $500 to $2,000 and dropped the Uninsured Motorist one (I don’t need it since I’d have my own Comprehensive + Collision coverage to use in that event), I’d still save about $61 per year. (Your savings might be much greater if you have a more expensive car.)

Dropping rental car coverage saves me $30/year. Ask yourself: if your car is in the shop, are you really going to need to rent a car, or could you just borrow one, get a ride with a friend, work from home, ride the bus/public transit/bike/walk, or take Uber/Lyft? And even if you DID need a rental car, it’s not expensive to rent one yourself; you don’t need to insure against the risk.

If you already pay for AAA or another roadside service, you definitely don’t need to pay for duplicative roadside assistance from your insurer. However, if you don’t have it, it’s only $20.60 per year from GEICO, and is probably worth it, so you decide there. Here’s what GEICO’s covers:

Okay, now you’ve eliminated coverage you don’t need, raised your deductibles, and upped your liability limits to protect yourself. Way to go!

Tell me in the comments how much you saved, and whether you also increased your protection by raising your limits.