Putting Your Savings on Auto-Pilot Can Be a Great Idea (but Usually Not Via Complicated Life Insurance)

Friday, February 15, 2013 at 2pm
By John Friedman

I’ve often said that your savings rate is the primary numeric fact underlying your overall financial health. See here, here, here and here, to just link a few. In the next breath, though, I usually have to add that, quite unfortunately, many of us are quite rotten at saving money, while just about all of us are quite excellent at spending it.

So I often recommend to clients that they set up some sort of automated savings plan — something that takes the day-to-day decision-making out of the will-I-save/won’t I save daisy-petal-pulling conundrum.

This sort of plan siphons off, on a regular basis, some of your money and puts it out of spending’s reach. You can call these things auto-pilot savings plans or forced savings plans or auto-dings (as in, “please auto-ding my account and take the money you grab out of that account via auto-ding and put it into this other account over hyere) or auto-snags (as in, “please auto-snag some money out of my account and plop it in over hyere where I cannot get my little mitts on it”).

And in John Friedman Financial parlance, when we design a plan which auto-dings and auto-invests for the long run, we call it a Rip Van Winkle plan, and we call the method of investing embedded within that plan Rip Van Winkling.

Call it what you will. But please do consider setting up an auto-pilot savings plan.

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Auto-pilot savings plans work well for almost everyone and they likely can do you a world of good for you.

For Exhibit A, your honor, I present to you any employer-provided retirement plan you might be able to use, which would typically have you auto-saving some money out of every paycheck without you ever having to trouble yourself with thinking about it. Those little dabs’ll do ya — those auto-dings will be less noticeable to you than actually writing out a check and transferring the money to some account other than your day-to-day checking account, and they’ll happen like clock-work, as in: no further nudges necessary.

And they will, fer-sher, result in you having a good-sized dollop of savings that you otherwise would have . . . spent away (we keep it clean in here).

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It’s important, though, that you not pay a bunch of money for any auto-savings plan you use.

Most auto-savings plans are 100% free. In fact, most financial services providers (FSPs) are only too happy to help you set up a bridge between your account with the FSP and your day-to-day checking account, and they’re also only too happy to then help you set up a weekly or biweekly or monthly (or whatever) auto-snag where, without you lifting a finger of clicking a thing, that FSP goes and grabs, say, $100 (or $1,000 or $10,000 or whatever other number works for you) out of your day-to-day checking account and plops it into your account with the FSP.

Remember: just about all FSPs are asset gatherers. Gathering dollars is their main, once-removed objective (the non-once-removed objective is to make money).

So you could dial in something like, “Please, FSP, go grab $250 every other Tuesday out of my checking account and then please put that money into the account I have with you” and then you could also tell the FSP something like, “Please, FSP, when the $250 gets there, please invest one-half of it into ABCDE mutual fund and one-half of it into VWXYZ mutual fund until I direct you otherwise.”

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So which auto-savings plans cost money?

The main type that comes to mind are complicated life insurance policies — those that do something other than simply pay a death benefit if the insured person dies before his or her time. Those complicated life insurance policies usually have some sort of forced savings component built into them — and you betta believe that you will pay for that forced savings component, over and above the cost of the actual life insurance itself.

So pretty please, all you human beings out there: pretty please do not confuse the good that can come from setting up an auto-pilot savings program with the good and not-so-good and the sometimes-terrible that can come from setting up an auto-pilot savings program wrapped in an expensive, complicated life insurance policy.

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And how do you know which life insurance policies are which?

That is a topic for another day.

But generally the kind that are good are very simple and not at all complicated: e.g., they usually (a) insure against the unexpected, too-soon death of a person who financially supports little ones or other folks not capable of supporting themselves, and (b) send you nice simple documents that you can easily understand, as opposed to the sort of documents that complicated life insurance policies send, which contain lots of numbers you don’t understand (e.g., numbers labeled cash value and surrender value and contract value) and/or lots of columns of figures that you can’t understand without getting help from your friendly neighborhood life insurance salesperson.

For instance, life insurance policies that last 20 years, say, and cover a father or a mother with young ‘uns at home, and cost the same amount each year no matter what — those are usually the good kind.

And then when it comes to forced savings look to some financial services provider that simply wants to auto-ding your account and put it into an account of your own choosing that is way simple to understand. And don’t bundle the two things together into one hybrid forced-savings/life-insurance thang.

OK?

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That’s the general advice — the conventional wisdom. As always, specific exceptions to the general abound.

For those who make lots of money each year and have retirement needs that are way bigger than can be accomplished via standard employer-based retirement plans, or for those who have estate tax planning needs that are gargantuan, when you start looking at complicated insurance, please (a) be sure that you 100% trust your insurance salesperson and are happy to help him or her put his or her kids through school, and (b) get a second opinion from someone who is not going to earn a commission on the sale of that policy, and (c) be sure you are capable of understanding the documents you’ll receive when you own the policy, and (d) measure twice/cut once, because these things are sometimes not easily unwound.

And if you really want to test your salesperson’s mettle and approach, see what s/he says when you ask these three questions: (1) What is the amount of compensation you will receive if I purchase any of these products from you, and (2) How is your compensation calculated for each product you are having me consider, and (3) What sorts of pushes and pulls are there on you that could impact what you are recommending to me?

So, please: careful boss.

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And one last thing: if you are a great saver — you save money all on your own without any problem whatsoever — then you probably should never, ever pay for an auto-pilot savings program. You do not need the training wheels, you do not need the forcing and the precommitment: you are good to go as-is. Kudos to you.

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