Archive for April, 2012

The stock market crash of October of 2008 devastated nearly everyone’s 401k plans; many have not fully recovered or are back to pre-crash levels only because workers have continued to contribute additional money. How did we get here and how to prevent it from happening again?

Until 1978 when tax code 401(k) was added to the U.S. tax code annuities (defined pensions)were the normal and preferred way of funding worker’s retirements.  Wall Street equity firms successfully lobbied the regulators to implement rules excluding all other types of investments and savings.  Today the vast majority of 401(k)s allow only equity market based funds with one or two fixed cash account options.

All kinds of safe investments which are allowed in IRAs are excluded from 401k plans.  Perhaps if workers had safe money options to choose from in their 401ks they would not be facing underfunded retirements.

The U.S. Treasury Department in 2007 started studying the advantages that would result to workers if annuities were an option inside 401(k)s.  Finally the government appears to be concluding the rules need to be changed. 

Here is an excerpt from a Bloomberg interview with J. Mark Iwry, senior advisor to Treasury Secretary Timothy Geithner. 

Q: You’ve introduced proposals to make it easier to offer annuities and other income products in retirement plans. What problems do these address?  

A: Helping manage longevity risk. Let’s say you’ve reached retirement age. You’ve got your pot of money accumulated in a 401(k) or IRA. For many people, figuring out how to manage that pot of money is an unprecedented challenge. What’s a prudent withdrawal rate, and how do I use it to replace my former paycheck?  

You start with the fundamental uncertainty about what lifespan to plan for. At age 65, a man has about an even chance of living to age 84 and a woman has about an even chance of living to age 86. For a married couple, there’s a good chance that at least one of them will live into their 90s. Given uncertain investment returns and the possibility of outliving your life expectancy, many financial planners explain it’s not prudent to withdraw more than about 4 percent of one’s savings every year. (That assumes you make no adjustments over time in response to changing circumstances.) A typical reaction is, “Gosh, I’ve got a quarter of a million dollars in my account. That feels like a lot of money. But 4 percent of $250,000 is only $10,000 a year to add to Social Security. That’s not enough.”  

 

Q: How are you trying to change the current retirement system to solve that       dilemma?

A: One solution is to provide for a predictable lifetime stream of income, such as an annuity provided under a retirement plan or IRA. By pooling those who live shorter and longer than average, everybody can essentially put away what’s necessary to reach the average life expectancy, and those who live longer than average will be protected. The longevity risk pooling means that an annuity might provide an annual income of more like 6 percent or 7 percent, rather than 4 percent, depending on interest rates and the terms of the annuity. 

 

Q: So if this goes according to plan, our readers are going to see more chances to buy annuities through their 401(k)s.  

A: That’s right; the range of choice in those plans should expand. We’re also focused on defined benefit pension plans, which often offer the choice of an annuity — which will last your whole life — or a lump sum. If framed as an all-or-nothing choice, too often people pick the lump sum. We’re trying to encourage plans to get away from an all-or-nothing “choice architecture.”

Had annuities been utilized as 401k investments no one who chose a fixed annuity option would have lost any of their funds in the 2008 market crash. Nor would they have lost any additional money during the ongoing Global Financial Crisis (GFC) or Great Recession.

Hopefully the rules will be changed sooner rather than later. 

You may ask questions in the comments or contact me privately Tim Barton, ChFC

Make a mistake now and there is a good chance you will have to be satisfied with a meager lifestyle for the rest of your life or worse your money will run out before you die.  You have worked long and hard to save for your retirement.  Now you are hoping it is enough to maintain your lifestyle and last the rest of your life.    Up until the point of retirement the emphasis is on accumulation of dollars and getting the highest return.  Managing money during the distribution phase is a skill few people or even money managers have been taught. 

The 2 most common retirement distribution mistakes are not considering the effect on your money of the sequence of returns and negative compounding.  

Many money management people will tell you that you cannot control the sequence of returns; this is certainly true if your money stays in a market based portfolio.  No one can provide an accurate prediction of future market returns, making it critical to move retirement income money out of these volatile investments and into safe money instruments.  

Negative compounding is the loss of principal when stocks or bonds decrease in value (brokers say don’t worry this only a paper loss) combined with having to sell the asset for income while it is worth less than you paid for it.  (to view table click here)

With your money in safe places negative compounding is easy to control because losses do not occur making it easy to maintain your income and budget which in turn leads to a stable fulfilling lifestyle. 

These are new problems previous generations did not face because they had guaranteed pensions making it unnecessary to self-fund all their retirement years. Even in these incredibly uncertain times running out of money is not an option.  

You may ask questions in the comments or contact me privately Tim Barton, ChFC

You just won the lottery jackpot  $100,000,000!  Most of us dream of this happening and imagine all the fabulous things we would buy and do.

But first you must decide how to receive the money, no doubt a perplexing decision for many winners.  The rest of us see them on TV gleefully accepting & displaying the “big check” with their smiling advisers looking on.

It should go without saying winning a big sum is an emotional experience with a decision to make soon.  This decision comes down to “Cash Option” or “Annuity” with no in between choice allowed by the lottery. 

The government assesses taxes at the rate of 7.75% Wisconsin state tax and 25% Federal tax  making the total tax 32.75% which is deducted/withheld from your winnings immediately.

 Cash Option – Winner receives about 50% of the advertised jackpot amount.  In our $100 million example that leaves the winner with $50 million to subtract taxes from. The net jackpot after taxes is $33 million; not too bad.                                                            

 Annuity – Wisconsin Megabucks winner receives the full advertised jackpot $100 million in 25 annual installments. In our $100 million example the winner gets $4,000,000 per year minus current taxes, nets $2.7 million per year for 25 years.  Nice yearly paycheck.  

The annuity option pays out twice as much, $67,250,000 after tax, this is the equivalent of earning a guaranteed 8.6% rate of return per year.   

Yet nearly every winner picks the cash option. Unless they are going to spend all the winnings right away; and if that’s what they want to do – I hope they enjoy their moment.  

If on the other hand they want the moment to be larger and last a lot longer; the annuity is the way to go.   Later if there is a change of heart all or part of the annuity’s future annual payments can be sold to investors for lump sums. Savvy investors recognize the value of annuity payments solid investments.  In today’s market enviroment an 8.4% guaranteed rate of return is a very good. 

It is unfortunate some advisers steer their clients away from annuities.  They either do not understand how annuities operate to achieve high returns for clients. Or perhaps the reason is once an annuity is setup there are no ongoing fees or commissions paid to representatives. 

My advice – If you win the big jackpot don’t settle for the one time “small” payout. Take the big payout over time with the annuity option. After a year or so when your emotions settle down. You can think logically and clearly again, you can change your mind and sell all or parts of the annuity payments for that upfront cash.

You may ask questions in the comments or contact me privately Tim Barton, ChFC

Forever, now that is a long time. If you could; would you choose immortality?  What would you do in exchange for immortality?  In a poll done by YouGov an online polling organization found out that not everyone wants to go on with life forever. 

Less than half of Americans 42% would choose eternal life.  Surprising to some folks, men are more likely to want continued life 48% whereas only 36% of women would choose indefinite life. 

When asked if living forever would require them to-

• Live in extreme poverty 13%
• Give up all human contact 18%
• Perpetual nakedness 30% 

Perhaps this is just a silly entertaining poll but long life is worth thinking about.  The largest growing segment of the U.S. population are those folks over the age of 100.  Medical technology is advancing rapidly and many diseases that would have resulted in sure death a few years ago now thankfully now have very high survival rates.

According to several studies the biggest fear of retirees is not death rather it is running out of money.

If you could choose today–

Would you live forever?

Would money you have affect your decision?

You may ask questions in the comments or contact me privately Tim Barton, ChFC

Have you noticed some anxiety among those looking to retire in the next few years or among those who have already retired?   

Perhaps these nuggets from recent surveys hold some answers- 

Are the pensions like many of our parents had still available?

The number of large companies offering traditional pension plans hit an all-time low in 2011.  Now only 13 Fortune 100 companies sponsor a traditional pension plan open to newly hired workers, down from 17 in 2010 and 89 in 1985.

Source: Prevalence of Retirement Plan Types in the Fortune 100 in 2011, Towers Watson (07.2011)

What is the average retirement age?

For men is 64 and for women 62.

Source: What Is the Average Retirement Age? – Center for Retirement Research (August 2011) 

Is there fear of becoming unemployed?

42% identify job uncertainty as the most pressing financial issue facing most Americans today.

Source: The 2012 Retirement Confidence Survey, ebri.org (March 2012)

Are Americans confident they can retire comfortably?

Just 14 percent are very confident they will have enough money to live comfortably in retirement. This finding has been stagnant at historically low levels since 2009.

 Source: The 2012 Retirement Confidence Survey, ebri.org (March 2012)

How much money does it take to retire?

Households earning $50,000 and over need about 80% of pre-retirement earnings to maintain the same level of consumption in retirement; Households earning less need an even higher percentage.

Source: How Much to Save for a Secure Retirement, Center for Retirement Research (11.2011)

What has happened to retirements savings?

 Nearly a quarter of adults age 50 and older exhausted all of their savings during the economic downturn.

 Source: Income Security: The Effect of the 2007-2009 Recession on Older Adults, U.S. Government Accountability Office (10.18.11)

Do men and women feel the same?

Women are less confident than men that they will have enough money to live comfortably throughout their retirement; 34% of women express confidence, compared to 41% of men.  Half of all individuals with at least $500,000 in investable assets are women, 50% of all women feel they need assistance in some areas of managing their finances.

Source: Women, Retirement, and Advisors: Concerned About Meeting Retirement Expectations, Female Boomers Seek Expert Advice, Insured Retirement Institute (09.26.11)

How did this happen?  

Due to massive economic changes the old pre-2008 market based retirement income withdrawal models have proven to be unreliable for actual income needs.  If a retiree draws their budgetary income needs from a fund during market down turns negative compounding begins to take its toll.  Leaving those retirees at risk of running out of money.

What can be done now?

As tax season approaches, I wanted to take a moment to remind you of some unique benefits that are available to the brave men and women serving in our Armed Services.

Heroes Earned Retirement Opportunities (HERO) Act:

On May 29, 2006 President Bush signed into law the Heroes Earned Retirement Opportunities (HERO) Act. The HERO Act allows members of the Armed Forces serving in a combat zone to include nontaxable combat pay as compensation for purposes of determining traditional IRA or Roth IRA contribution amounts.

Prior to this act, because combat pay is nontaxable and excluded from gross income, a serviceman or servicewoman with only combat pay was unable to make an IRA contribution.

Additional time to make traditional IRA or Roth IRA contributions:

Generally, traditional IRA or Roth IRA contributions are due by the tax filing deadline (April 17, 2012 for the 2011 tax season), not including extensions. However, military members and their spouses may qualify for a deadline extension of up to 180 days after the last day served in a combat zone, hazardous duty area, or certain other deployments, plus the number of days that were left to make the IRA contribution at the time service in the combat zone began. The extension doesn’t just apply to traditional IRA or Roth IRA contributions, but also to filing tax returns, paying taxes, and claiming a tax refund.

Heroes Earnings Assistance and Relief Tax Act (HEART) Act:

On June 17, 2008 President Bush signed into law the Heroes Earnings Assistance and Relief Tax (HEART) Act. One of the major provisions of the HEART Act relates to the ability to roll over Service members’ Group Life Insurance (SGLI) payments to a Roth IRA or a Coverdell ESA.

The Act permits an individual who receives a military death gratuity or SGLI to contribute the funds to a Roth IRA and/or one or more Coverdell education savings accounts. In addition, the contributions would be treated as rollover contributions and not subject to normal income or contribution limits. The contribution must be made within one year from the date the taxpayer receives the military death gratuity or SGLI payment. This provision is generally effective for payments made on accounts of deaths from injuries occurring on or after June 17, 2008.

 You may ask questions in the comments or contact me privately Tim Barton, ChFC

If you have any questions, talk to your financial or tax professional.