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The Biggest Mistake Most People Make in Choosing a Pension and The Best Opportunity to Save Hundreds of Thousands of Shekels
A long time ago, when Daniel Kahneman, future nobel laureate in economics, was teaching a group of Israeli Air Force officers about effective training and positive reinforcement, he was challenged by one officer. “On many occasions, I have praised flight cadets for their clean execution of some aerobatic maneuver. The next time they try the same maneuver, they usually do worse. On the other hand, I have often screamed into a cadet’s earphone for bad execution, and in general he does better on the next try. So please don’t tell me that reward works and punishment does not, because the opposite is the case.”
A powerful challenge, no doubt, and one I think we can all sympathize with in some of our personal and business relationships.
But the truth behind this challenge is explained by Kahneman using statistical principle called regression toward the mean. In various situations where luck is present, you are always more likely to go toward your average. If a variable is extreme on its first measurement, it will tend to be closer to the average on its second measurement—and, paradoxically, if it is extreme on its second measurement, it will tend to have been closer to the average on its first.
Take these pilots for example. Let’s say that one a scale of 1 to 5, a pilot named Yosef flies a 3 on average. Yosef flew a 2, for which his commander screamed at him. Since Yosef on average flies a 3, the next time he is more likely to do better, irrespective of the yelling. Similarly, if Yosef flew a 4 and was given a hearty shkeyach from his commander, the odds are still that he will do worse next time, since he flies a 3 on average and 3 is worse than 4. Positive reinforcement is proven to work in the long run, but in the short run, specifically in a situation where luck is a major factor, regression toward the mean is king.
I bring up this to demonstrate what is in my opinion is the biggest mistake people make when choosing a pension, or making any investment for that matter. People I have met tend to focus on the past performance of a fund or company to choose the right investment. But if there is one thing that past performance has shown, it is that it is a never good indicator of future returns. Also, due to regression toward the mean, people who choose the better performing funds are almost always disappointed within a year or so since, as regression analysis proves, the next year is more likely to be more toward the average return, which for anyone starting from a point above average, is worse.
Now that the year has ended, you will likely be bombarded by company after company showing off their past performance, as if it means anything. Their salesmen and agents will admit that past performance doesn’t guarantee future returns, but they’ll end the sentence while pulling out a nice graph showing how well they did over the past five years. They’ll jokingly admit that their stock pickers are no better than chimps with darts, but still find a way to make them look prophetic. You need to ignore these people and follow the science.
What does matter in choosing a pension is (1) getting a significant discount for the rest of your life and (2) that the company has the proper range of options available for investments for the rest of your life. When you are young, or at least in good health, pension funds are more likely to offer discounts and if you succeed in getting a discount for life. But when you get older, and especially if your health deteriorates, most pension companies won’t want you since your being in the fund will cause damage to the actuarial balance all pension funds must maintain. And even if they do accept you, the chance of you getting a huge discount on fees is very slim since, as far as they’re concerned, you’re no longer a long term investment for them. Remember, in your 50s and 60s you have the most money in your pension you’re ever going to have and having a significant discount on fees during this time will likely save you hundreds of thousands of shekels, on accumulation fees. It’s up to you to take advantage of your youth, health, and work connections to make sure you save this money before it’s too late.
Focusing on options is also important since you will need to solidify your investments as you reach retirement and unless the company that has given you a discount has the proper investment options, you could be left with the terrible choice of either settling on having too much risk or else moving your money to a new fund, potentially forgoing any discount and losing tens of thousands of shekels in fees.
Concentrating on investment options and fees doesn’t mean you should ignore פנסיה נט completely; you should have an idea how your fund is doing compared to the market and how it is performing and invested. It means that you should take such information with a grain of salt and be less concerned with statistically insignificant issues such as how well the fund performed over a single year and more concerned with issues that will save you hundreds of thousands of shekels such as the investment options available by the company and the fees you’re paying.
Jonathan Degani is a licensed pension consultant by the Ministry of Finance. If you’re looking for help choosing or reviewing a pension, please feel free to call 052-790-6824.
The anecdote at the beginning of the article above is taken from Daniel Kahneman’s book, Thinking, Fast and Slow. The definition for regression toward the mean is taken from wikipedia.
Shomer Shekalim offers free workshops to help freelancers understand and take control of their fiances. If you’re interested in organizing such an event for a small group of freelancers (4–10 people) please e-mail me at firstname.lastname@example.org or call me at 052-790-6824.
Unlike salaried workers, freelancers (עצמאים) have no minimum they must set aside for their pension. Unfortunately, this leaves freelancers with the responsibility of making sure that they have money for retirement in addition to the appropriate level of life and disability insurance.
But there is some good news. Freelancers have significant tax benefits to saving through a pension and keren hishtalmut.
Pension: An עצמאי can deposit up to 16% of his salary into a pension. Of this 16%, 5% gets you a 35% tax credit and 11% is tax deductible. OK, now in English: Lets say you make NIS 100,000 a year. If you deposit NIS 16,000 in your pension, you get back 35% of NIS 5,000 = NIS 1,750. Also, the other 11% is tax deductible, so at the end of the year, you’ll pay taxes on NIS 89,000 instead of NIS 100,000.
In addition, a freelancer can give himself a keren hishtalmut, a mutual fund that grows tax free and becomes liquid after six year. A freelancer can set aside up to 7% of his salary, 4.5% is a tax deduction.
This is a link to a calculator from beinleumi that calculates how much you can put aside for a keren pensia and keren hishtalmut and the subsequent tax breaks you’ll receive. To be clear: a זיכוי is a credit which means 35% of it is money back in your pocket. ניכוי means a tax deduction, which means that it is as if you never made that money for the purposes of your paying taxes. For your convenience, I translated the calculator in the image here (click to enlarge).
In my next post, I’ll make sense of the barrage of insurance offers that atzmaiim receive from insurance companies and agents and discuss what is more important, what is less, and what should be completely ignored.
I recently updated my tax calculator. The latest version includes the new tax brackets and credits according to 2014.
The Israeli Tax Calculator allows you to check your paycheck and see that the correct taxes were deducted correctly. If too much money is being taken out for taxes or insurance, then you should demand back your money through a tax alignment (תאום מס) or an insurance alignment (תאום ביטוח לאומי). If you need to get money back through an alignment see this post for more details.
Note: While the amount for insurance should match your paycheck perfectly, the amount you pay for taxes may not. There are other factors besides the ones mentioned in this spreadsheet that can affect the amount of taxes you pay (how much you got paid over the past 6 years, how often you get paid.)
Use the guide as follows:
If you are paying less in taxes than what is calculated on the sheet: Find out what kind of benefits you are receiving and how to continue receiving them.
If you are paying more in taxes than what is calculated on the sheet: Odds are you need to do a tax alignment. Speak to your HR person and fix up your tax record and then file the appropriate paperwork at מס הכנסה.
As always, if you find any flaws in these excel sheets or have any ideas for improving them, please feel free to contact me.
Are there any financial tools you would like to see? Please feel free to either leave some ideas in the comments below or e-mail me at email@example.com
As an American Jew, I have an aversion to paying retail; as an Israeli, my biggest fear is being a friar. So I was particularly thrilled when I found infomed’s insurance price comparison tool. One of the most common questions people ask when buying insurance is “how do I know I am getting a good deal?” This tool allows you to compare various prices for insurance plans, listed according to the breakdown I offered in my last 2 posts about seudi insurance and the different kinds of health insurance in Israel.
The site is pretty close to perfect. It obviously doesn’t include any extra you’d pay for a preexisting condition, nor does it update according to the CPI every month, but it’s a great reference to use before you buy insurance. Unfortunately, this site is only in Hebrew, so if you don’t speak the language very well, you may need to knock on your neighbor’s door for some assistance.
Remember, you won’t get a discount unless you ask for it. So next time your insurance agent shoots out a number, take a minute to find out what the retail price is and insist on paying less.
Speaking of which, if anyone needs health or seudi insurance, please feel free to contact me at firstname.lastname@example.org for a quote. I am not an agent (yet) but my boss works with just about everyone and gives a discount to whoever I send his way.
The first time I was offered to buy health insurance in Israel, I pushed it aside. Isn’t everyone covered for everything here? Well, kind of, but not exactly. This post seeks to explain the different levels of insurance in the country and what kind of coverage each layer provides.
Level One: Bituach Leumi (through your Kupat Cholim): Thank God, Israel is a first rate western country that provides an extraordinary level of medical care for all of its citizens. If an emergency comes up, you can go to the hospital and pay nothing. When you need to see a doctor, you can just sign up online and the cost is very small co-pay. Most medicines are subsidized, as are surgeries and other treatments. But there are still some things that aren’t covered. Instead, they are covered by the next two layers:
Level Two: Additional Health Insurance through Kuppat Cholim: If you have something like Magen Zahav of Meuhedet Adif, you have what is called shaban (שב”ן – שירותי בריאות נוספים). Shaban covers you for additional medicines that affect quality of life (ie treating a kidney stones in a way that hurts much less). Shaban cannot offer any additional protection for anything that can save your life. For that, you’ll have to turn to…
Level Three: Private Health Insurance: Almost all the insurance companies in Israel (not kuppot cholim) offer private health insurance. There are usually three levels: The lowest level of this insurance covers you for a certain amount towards transplants and surgeries abroad in the case of emergency. The next level offers a slightly higher level that covers a wider range of emergencies not covered by kupat cholim, as well as certain quality of life treatments as well. This level is usually called something like mashlim shaban – since it complements (להשלים) the insurance offered by the shaban – where the shaban pays for a part, the private insurance picks up the rest of the tab. The highest level covers a large plethora of emergencies and illnesses and pays you irrespective of whatever is covered by kupat cholim and the shaban (in fact, sometimes it will pay you extra for having gone through something, even if the shaban paid for it as well). Just to be clear, while almost all insurance company have the three kinds of programs above laid out above, there are variations; some cover more of X, some exclude Y, but the structure still holds.
In addition to the basic insurance laid out above, there are several kinds of “riders” or mini-policies which you can stick on your medical policy. Below is an outline of the five most common types and which ones I think are worthwhile:
1) Ambulatory – this covers preventative medicine, including check-ups, CTs and MRI. Of all the riders, I consider this to be the most worthwhile. It does cost a bit more, it does not cost nearly as much as…
2) Alternative medicines – if you’re a naturalist or hippy, go for it. If not, you can skip it. Of all the riders, this is usually one of the most expensive (because the client will probably use it for every sickness).
3) Personal doctor – this means that if you are suffering an illness, you have a personal case file and a doctor from the insurance company who monitors the progress so you know where you stand day or night. Some people consider this worthwhile, while others do not. It is a fairly inexpensive rider.
4) Expedited medicine – this rider is a hypochondriac’s dream. In the event of something wrong, you get to go to some facility or specific hospital where a team headed by someone like House MD finds what’s wrong with you and gets back to you within a few days. This rider isn’t so expensive, but most people opt to skip it.
5) A lump sum in case of contracting a specific kind of sickness (ie NIS 100,000 in case of cancer). The cost depends on how much you want the sum to be. When opting for this, and I recommend you do, opt for a sum that will allow you to get yourself and your family in order as the chaos of a sickness begins. For example, NIS 100,000 is a good amount for making sure that you are covered until disability insurance kicks in and for your family to adjust as you go through a crisis. To be clear, this money will not cover the cost of treatments abroad, as they usually cost much more than what is provided by these policies; you need to make sure the insurance covers the medical need and that this ride only covers the transition period for you and your family. If you’re wondering, this is a kind of teunot ishiyot – personal injury – insurance. In fact, the reason I am very critical of personal injury insurance generally (see last post) is that I think it should be bought in a policy like this rather than as a standalone. Buying it with this puts it in the specific context which helps the client choose the proper coverage he or she needs and doesn’t buy any unnecessary insurance.
There are dozens of other riders. Some are simple add ons, like a rider that provides a personal doctor for cancer, or a rider that ensures that all of your medical files are on a disc-on-key for immediate use when going to the hospital. There are also elaborate riders such as one that pay for a TV in the hospital, allows the sick person to order take away once a day, have his or her spouse stay at a nearby hotel and even pay for a temporary secretary to reschedule all of the person’s meeting while he or she is in the hospital. Every insurance company has its own specific riders and can choose to only allow certain riders with certain policies.
A final word on this subject. Some of you have the option of opting for additional health coverage through your work. This is usually a great idea and the cheapest way to get a good policy at a fraction of the price. A group policy includes at least 50 people at a single workplace – so you can’t just make a group out of you and your neighbours. The only downside to a group insurance policy is that you can’t add any riders that aren’t in it – you either take or leave the package.
If you have any questions about the various policies or are interested in getting some insurance for your family or a group policy for your business, feel free to contact me at email@example.com.
If I were to die tomorrow, my family would suffer financially; it is therefore imperative that I ensure that my salary could be replaced and my family could continue to live the kind of life we live today. But if I were disabled, things would be much tougher. Not only would my family have to replace my salary, but they would have to pay more to have someone take care of me. This is where seudi insurance comes in.
A person becomes “seudi” (in need of long term care) in one of three ways:
1 – A person has a mental affliction (ie alzheimers)
2 – A person cannot control his or her ability to go to the bathroom, plus he or she cannot do one of the following five things: (a) eat and drink (b) get up and lay down (c) be mobile (d) shower and (e) dress and undress
3 – A person cannot do three of the following five things: (a) eat and drink (b) get up and lay down (c) be mobile (d) shower and (e) dress and undress
The insurance guarantees that if you qualify as seudi, you’ll get a certain amount of money (ie NIS 5,000) every month for 3 years, 5 years or life (FYI like disability insurance, this usually kicks in after a few months). I personally do not understand why anyone would buy it for 3 or 5 years; if you’re disabled as outlined above, you need a caretaker for life.
Some of you are probably already saying “hey, don’t I have that from my Kupat Cholim?” Well, yes and no. Kupat Cholim offers its members to sign up for a collective policy with a different insurance company, which keeps the person insured for 5 years and insures the member in case of disability above for payments for 5 years (usually, as always, some exclusions apply).
The other option is to buy this insurance privately. And here there are two options. You can choose to buy it at a rate that will change every year (start out cheaper and pay more as you age) or buy it at a fixed rate (that only rises with the CPI, not due to your age). The fixed rate also allows you to have a reserve amount set up, so if you stop paying in one day, you’ll still be covered, but not as much. For example, if you’ve been paying in from ages 30 to 50 and then stop paying, but get injured at 51, you’ll still be covered, but instead of getting NIS 5,000 a month, you’d get NIS 4,000 (this is an example, not exact).
If you have the kupat cholim policy, you can buy a private policy that complements it. For example, kupat cholim will pay you for 5 years; you can buy a policy that pays you every month for life after 5 years.
A similar insurance with very important differences is teunot ishiyot.
Teunot Ishiyot offers the insured a sum of money in the case of an accident. There are five types: K1: a certain amount of money for death from an accident (from an accident means within 12 months). K2 allows for the sum in case of disability as well. K3 gives a weekly amount for disability for up to 2 years. K4 expands accident to include a particular list of sicknesses (ie cancer). K5 expands the list to include all illnesses unless stated otherwise (ie all illnesses except Lou Gherig’s Disease.)
Personally, I don’t see why I’d need to insure myself in the case of an accident any more than in the case of any other kind of death. Does my family suffer less financially if I drop dead than if I get hit by a car? And the same goes for disability and sickness (I’ll get to the other kinds of health care soon for extenuating circumstances).
Those who sell this will tell you that that this insurance offers you a big payoff in the case of an accident and illness, which you may like. But insurance isn’t roulette; insurance is about covering you in the case of financial threat; you shouldn’t be playing it to hit the lottery as you, God forbid, get cancer. There may be some cases when this is necessary, but your agent better have a very good reason specific to your case.
The primary advantage this insurance offers over others is that unlike seudi and disability, which generally carry a three month waiting period, this insurance kicks in after 7 days (14 if only K1 and K2). So in short, if you have three months expenses on hand (which is an important goal), then you can save money and skip this insurance. If not, then it may be worth to buy this insurance until you compile the money.
In summary, this insurance isn’t like health, life, disability or seudi. This is the one kind where you really have to look with a good eye and ask yourself if you need this kind of coverage. For many people, this coverage is superfluous and sold in place of seudi, which provides support the real support needed in the case of a long term disaster. For others, particularly those without any savings, this may be helpful.
A while ago, I posted about the insurance in your pension, discussing how much insurance you’re already paying for, and therefore do not need to purchase. In this post I plan to review the common misconceptions that people have about insurance and what is and is not necessary to buy in addition to the insurance in your pension:
Life insurance: Before I even discuss how much life insurance you need, one thing must be made clear. Life insurance allows the insured to take care of his dependents in the case of his or her demise: no dependents no need for life insurance. If you have no children, parent, spouse, sibling etc. that would suffer financially in the event of your death, there is no need for insurance. If you set up your pension correctly, you should have your spouse getting 60% of your salary and each child getting 20% until age 21 or 18. You only need to purchase additional life insurance if this will not be enough. Similarly, if you do not make a full time salary (for example, a housewife), then you would need to get life insurance. I want to stress this, because most people think the opposite is true. If Dad makes the bucks and Mom stays at home with the kids – Dad doesn’t need additional life insurance but Mom does.
When you buy life insurance, you usually buy a set amount (ie 500,000) that the beneficiaries will receive upon death. The best way to decide how much you need it to purchase insurance for the amount of money you’re going to need for 10 years. For example, let’s say a housewife allows the kids not to be in tzaharon (saving 2,000 a month) and watches the kids while the husband is at work and prepares dinner (another 5,000 a month). This means that you’d need 7,000 x 12 x 10 = 840,000 to replace her in the event of death. I obviously oversimplified this, but as a general rule, writing out the cash flow you would need will help you determine how much you need to buy.
If a spouse works part time or only pays in a pension from some of his salary, then insurance should be bought to cover the rest. For example, let’s say I make 10,000 but only pay a pension on 6,000 (the rest is a bonus that I get every month). Or let’s say I only work a 60% job and earn 6,000. Either way, I’d need to get additional insurance for 4,000 x 12 x 10 = 600,000.
Disability: Your insurance can cover up to 75% of your salary, which is probably enough to get by. Like life insurance, your pension should cover this if you set it up right, and like life insurance, it is the stay at home spouse who will need an arrangement made to cover her in the case of disability. When setting this up in your pension it is called nechut (נכות). When purchasing it on your own it is called ovdan kosher avodah (it is also called that if you have bituach menhalim). Usually, this insurance only kicks in after three months, so you should still have three months expenses put away in case something happens.
In my next post I’ll cover probably the most important insurance you don’t have, seudi, and the much less useful that too many Israelis are sold, teunot ishiyot.