(As published in April 2016 Smart BIZ)
If you still haven’t dropped by McNally’s to pick up “THE END OF WORK – financial planning for people with better things to do”, or downloaded it from Amazon for your kindle, you can continue to read it for free in your monthly Smart BIZ.
So far, we have covered taking responsibility for maintaining a positive cash flow in the management of your income and expenses. You have a personal Business Plan to work towards your goal of financial independence, with your scarce resources allocated to your priorities. You are managing your money through planning, taking actions and, most important, by measuring the results, to stay on track to achieve your objectives. This month we turn to the proactive management of the risks that can ruin your plans.
“Whatever can go wrong, will go wrong. (at the worst possible time, in the worst possible way)” – Murphy’s Law
What can end your work, and thereby interrupt or stop your income? You could lose your job in a merger, or get outsourced. But you have kept up your skills and networked so you will most likely be able to replace the lost income from this kind of “end of work” fairly quickly.
What other life events could cut off your income? Premature death will certainly do that So long as there is no one depending on your income, like a spouse and children, this risk is not too serious; whichever way you are going, you will not need an income. But if there are others depending on your pay cheque, you may need to provide capital to generate the income that you no longer can.
The risk of a disability, whether by illness or accident, is actually greater than premature death. Now you are not just worried about the spouse and kids, you need to worry about a roof over your own head and food in your fridge, along with the cost of retraining for a new field. Employment Insurance provides a short term disability benefit for up to seventeen weeks, enough time to get the cast off your leg from the skiing accident. You may have long term disability insurance as a benefit with the group insurance where you work. But careful consideration is still needed in your financial planning to ensure your coverage is adequate, not just for the cost of living but to keep up the payments your debts. Creditor disability is often included as part of mortgage insurance.
Other risks may not directly cut off your income but can impose major costs that have the same net effect. The cost impact of a critical illness, even when you survive, can eat up your savings, drive you into debt, or ruin your retirement. The best motive for buying CI insurance can simply be to provide the resources that will greatly improve your odds of beating the critical illness.
Life risks compound as well. A 35 year old male non-smoker only has a 6% chance of dying before age 65. But the risk of a disability is 34% and of a critical illness is 26%. The combined risk of one of these events occurring by age 65 is 50%!
Another “cost” event that will almost certainly impact your cash flow is long term care. If you are alive at 65, you have a 50% chance of still being alive at 90 and 25% of reaching 95. If you are worried about your quality of life in your last 10 or 20 years, you may want to purchase long term care insurance. Do you want to spend it in a seniors’ warehouse or in a pampered upscale residence?
The really big and certain risk to your continuing income, and the lifestyle it supports, is retirement. When you “retire” should be your choice, but for every professional that keeps working to 75 because they love their vocation, there is a 55 year old who has been out-sourced and can’t get a new job – age discrimination is very real. Income when work ends is the ultimate destination of financial planning. Keep the priority of choices for when you are 64 in mind and you may decide to postpone the new car so that you can max out your RRSP contribution. Maintain your allocation of resources to pay yourself first in your diversified investments, using dollar cost averaging with the magic of compound interest.
Your retirement income plan needs to meet the risks of aging. You need to accumulate some wealth beyond what you need for your retirement cost of living, to provide resources to cope with third trimester risk events like critical illness or long term care. Insurance for these things in your 70’s costs way too much, so you need your own extra resources to self-insure these risks. And some extra resources over your pension may just supplement your retirement income for holiday treats, not to mention making up for inflation.
Safety Management Systems provides a risk management framework for your financial planning. SMS was first developed for risk management in the nuclear industry, where the consequences of risk events can be somewhat catastrophic. Fifteen years ago, the Director General of Civil Aviation introduced SMS into civil aviation. While civil aviation by any measure or comparison is very, very safe, the only means to even greater safety is in the proactive recognition of the risks in your operating environment, to explicitly take steps to minimize the risk of an occurrence, while pre-planning how to mitigate the impacts should the risk occur.
This is where thinking like Mr. Murphy can be helpful. Pessimism can be a tool to anticipate negative occurrences, and guard against them, even before they happen. You may decide to buy critical illness insurance, not out of guilt, but due to healthy pessimism.
The final element of your financial risk management is emergency planning: how you will respond, not if, but when an actual emergency occurs. That begins with having a Will, one that addresses how you or your partner will respond should something happen to one of you. The Will is not just about how your assets are to be dispersed. It includes a living will for when you are not able to make decisions for yourself, as well as choosing an executor to look after your affairs and a guardian for your children. It is a lot easier to deal with a crisis when you have a plan set out in advance. Not a happy subject perhaps, but it is reality. Dealing with these questions in advance through your own “emergency plan” will lessen the impacts of a tragedy, for yourself and the people you care about. GET YOUR WILL DONE NOW.
Fredrick Petrie, author of “THE END OF WORK: financial planning for people with better things to do”, practices financial planning at Mortgage Logic, 1793 Portage Ave., Winnipeg MB. (204) 298-2900