Category: Income Planning

“I Would Never Put My Money in an Annuity”

“The last thing I want to do is lose some of my hard-earned money to the stock market”. And so it goes. People have strong opinions about both. When I do ‘Income Planning’ I make it very clear that the most important requirement for a good retirement plan is that the clients have peace of mind. They should do what they want with their money. After all, they worked for it. Risk it, protect it, a combination of both… Whatever you decide is right for ‘you’.

160202155232-annuity-780x439I have been a financial professional for 35 years and seen it all, what works and what doesn’t. There are many different types of annuities and a lot of unnecessary confusion. But, since their inception in 1995, I have thought that Fixed Index Annuities can play a critical role in many retirement plans. My conviction gets stronger all the time.  I’d like to share some different perspectives that may help you decide.

A Fixed Index Annuity is a contract typically provided by an insurance company to an “annuitant” (often a retiree).  It can be used to mitigate longevity risk, outliving our retirement savings as well as a potentially great growth opportunity that also protects your principal against loss. The public has been deceived about the returns too. I have clients doing better over time by risking less.

The insurance company invests your investment in the annuity in bonds. It also uses premiums paid by annuitants who don’t live a long time to help pay annuitants who do live a long time using what are referred to as “mortality credits.” The payouts you receive come from bond interest, from increases in an underlying market index as well as from a partial return of your own capital, the money you worked for.

One the greatest objection to annuities is the you must give up your principal to get income. This is NOT TRUE for a Fixed Index Annuity. You do not give up any principal to get income, as it is provided via a ‘rider’. You principal will continue to be added to, even after you turn on lifetime income, in any year there are gains in the underlying index. They can earn money when the market goes up and NEVER LOSE when the market goes down. The remaining value of your account is available to you, subject to a predesignated free withdrawal schedule, known in advance.

imagesHERE ARE SOME OF THE REASONS I LIKE FIAS FOR SOME OF MY ASSETS:

  • It is a ‘protected’ asset outside of the Wall St (Red Money) bucket
  • I can make money when the market index increases but I never lose if it goes down
  • They don’t lose principal providing a source of money that has not (will not) go down in value because of market loss
  • They provide longevity insurance by GT’ing income for one or both lives
  • Remaining principal, interest, & bonus paid to heirs
  • Liquidity ranges from 7% to 100%
  • Account value credits gains even after income is started
  • Guaranteed income cost is fixed, typically 1%
  • Income continues even if account value goes down to zero

Risk selling advisors sometimes try to make you feel stupid if you consider an annuity. But here are just a few prominent, figures who have owned annuities: Benjamin Franklin(no dummy) assisting the cities of Boston and Philadelphia; Babe Ruth avoiding losses during the great depression, and O. J. Simpson (Hey, I did not say you had to be a good person to own an annuity) protecting his income from lawsuits and creditors. Ben Bernanke (the previous Fed Chairman who knows as much as anyone or more about money, insurance companies and protection as well as Wall St and their risk strategies… in 2006 disclosed that his major financial assets were annuities. —THINK FOR YOURSELF!

 

401(K) BECOMES A 201(K). NOW WHAT?

Warren Buffet has been quoted as saying, “My 2 top rules for investing are, #1- Never Lose and #2- Never forget rule #1.” Retirees who watched in horror as their account balances plunged along with the stock market in 2008-2009 had to face a bitter challenge: how to generate enough income to pay their bills for the rest of their lives with the assets, the money they had left. Retirement in all about income.

The tired, stale but widely accepted rule of thumb retirees they could take 4% of their assets per year and increase the amount for inflation by 3% each year and their money would last 30 years. Not! In some cases, you could be 50% or more off.

ikThen they suggest, depending on the extent of your losses, you may want to freeze your withdrawals at current levels, skipping the annual inflation adjustment until the market rebounds. Or, if you suffered significant losses of 30% or more, you may want to restart your 4% withdrawal schedule based on the new, lower balance. But that can take a big bite out of your income. Say you started with a $1-million retirement stash and had been withdrawing more than $40,000 a year. If your savings shriveled to $700,000, you’d now have to get by on just $28,000 a year. This is a ticking time bomb that will blow up.

There is, however, another way to stretch your income and increase your annual withdrawals to 8% or more of your savings. And you can still be assured you won’t outlive your money. A study by the University of Pennsylvania’s Wharton Financial Institutions Center found that you could create a stream of secure lifetime income for 25% to 40% by using an immediate annuity. What I don’t like though is with an immediate annuity, you give up control of the money. And although you get the maximum monthly income with a single-life annuity, it stops paying out when you die. If you die prematurely, you forfeit a chunk of your initial investment (which is then returned to the investment pool to pay the benefits of other annuity holders). Therefore, a Fixed Indexed Annuity is likely better for most retirees. You do not give up your money, or the future growth and you still can provide a guaranteed lifetime steam of income.

lklHow much to invest in an annuity strategy for income can best be determined by working backwards to figure out the appropriate amount to allocate to an annuity strategy.  First, add up your regular expenses and then subtract any guaranteed income you already receive, such as a pension and Social Security benefits. If there’s a gap, consider filling it with an annuity. Getting lifetime income illustrations to review from a non-biased retirement income planner can be very helpful to determine how much future guaranteed income you will need. Remember, once retired you do not have time to wait for the market to get your money back. You are likely to need some before that.

I look at only companies that are B+ or higher. For an extra layer of protection, it can be an added measure of security to diversify among companies, none to exceed the $250,000 limit covered by California’s guaranty association, which protects investors if an insurer becomes insolvent. (Some states have higher protection limits; see http://www.nolhga.com for links to each state.)

Securing a guaranteed stream of income for the rest of your life may bring peace of mind, but it does not guarantee that you will maintain your future buying power unless properly planned and possibly laddered in some form. Getting the extra money when you’re older is much more important than having the extra cash early in retirement. To me, it fits with the logic of annuities — that you’re worried about living a long time and running through the rest of your savings. An annuity is an insurance contract, and it should be about future guarantees and certainty.

Although most retirees like the idea of guaranteed income, many balk at the idea of giving up control of their money with an immediate annuity. As a result, an increasing number of retirees have been turning to another type of insurance product, called a Fixed Index Annuity, that allows you to earn money based on the increase of a market index but never lose as a result of a declining market. They provide much more flexibility in addition to the income certainty they provide. They also provide guaranteed compounding for income even if the market goes down.

Can Annuities Mitigate Inflation Risk?

Inflation has averaged about 3%. That means if you need $5,000 to live on when you retire, you will need $10,000 if you live 25 years. Inflation is the silent [retirement] killer because you never get a statement showing how much spending power you have lost to inflation. Annuities alone cannot protect you from inflation. But it is a big and integral component of a strategy to beat inflation.

rtBy having a foundation of guaranteed, pension-like income as a foundation, you can take more risk with other money for better potential growth. The annuity income ‘foundation’ increases your time horizon on the money at risk and… it provides a base of certainty to live on which prevents you from ever having to spend money that has gone down in value—a BIG NO-NO for retirees!

The ‘risk’ associated with loss is that you might need it to live on and will not be able to wait for the market to return to new highs. Having guaranteed annuity income can decrease or eliminate this loss. This decreases or ‘mitigates’ your exposure. One pile of money cannot provide lifetime guaranteed income, and expect to increase in value at the same time. It would be like expecting a sailboat to also perform as a speed boat. You can have a boat that conserves gas or one that goes fast, but not both. This gets to the heart of our approach, namely, to put yourself in a position of strength by building a foundation of guaranteed income to cover your essential expenses.  Then the rest of your assets can be more aggressively invested, yet your overall risk profile is quite safe.

Wall Street’s solution is to own more bonds as you get older, for safety and income. This is quite risky! When interest rates go up the value of your bonds goes down. That means you LOSE PRINCIPAL in an investment that was sold as safe. Also, if you have that money in bonds, it is not available for growth, which you will need unless you have way more money than you will ever need. If you follow this ‘conventional’ old advice it could very well be at your own peril. Take control of your retirement. Think for yourself. Ask questions. Just because something has been taught for 30 years does not mean that it is right or best.

df.pngConventional advisors tell retirees to avoid annuities due to inflation fears. Of course, that means you must buy bonds from them (hmmm). But, either they do not know or they don’t want you to know that guaranteed income from an annuity really frees up other assets to be invested for growth to keep up with inflation because you do not have the pressures of safety and income on those assets. Income from an annuity is actually a very important part of an optimal inflation protection strategy.

Don’t be the Retired Frog in the Proverbial Pot of Boiling Water

sdsOur ability to make important financial decisions declines with age. It is better to admit it. Your financial future may depend on it. A study from two Texas Tech professors shows an alarming decrease in financial awareness among Americans of retirement age.

No one wants to admit it but our ability to manage our money decreases as we age, but our confidence does not. It is important to be aware of this.

A study, form by professors Michael Finke and Sandra Huston of Texas Tech University and John Howe of the University of Michigan from the Department of Personal Financial Planning found our ability to make good financial decisions declines at a consistent rate as we age, and I am not talking in our 80s. The ability to answer basic financial questions decreases in line with the gradual erosion of memory and problem-solving abilities later in life.

Since fewer employers provide pensions than ever before, people are more dependent on their retirement savings coinciding with decreased abilities. What is more concerning, is older respondents didn’t report a loss of confidence in their ability to make financial decisions, a compounding issue.

“This was originally one of the most surprising and alarming findings from the study,” Finke said. “As we get older, our ability to answer basic financial questions that include knowledge, and the ability to apply that knowledge, gets worse. But we have no idea this is happening. It’s very like the research on driving skills. Since it happens so gradually, we’re not aware our abilities are getting worse over time.” It is like the frog put into the pot of room temperature water, warming slowly. He gets cooked before knowing he is in danger of doing so.

sdfgIn “Old Age and the Decline of Financial Literacy,” published in the journal Management Science, the researchers found average financial literacy scores fell by half between the ages of 65 and 85. Characteristics like education, gender and wealth did not matter. They found older Americans were significantly less likely to correctly answer basic life insurance questions.

They report scores on problem-solving and memory can explain the age-related decline in financial literacy, which involves both the ability to remember financial terms and concepts and the ability to process this information. Though it is likely a natural part of aging, don’t minimize the issue.

Decreasing financial literacy opens the door to abuse from less principled advisers, numerous and always new financial scams. as well. Retirees whose financial literacy skills have declined may be particularly vulnerable to the sale of unsuitable investments.

One solution is to make sound decisions while you can. The more income certainty you can put in place that will last for the rest of your life, the less financial decisions you will need to make as you age. Retirement is the ‘spending’ years. The ‘earning’ years are over. Protecting principal and providing income is key.

Ignore ‘THIS’ and it will be at your own FINANCIAL PERIL.

dssdIn retirement, the sequence of returns is much more important than rates of return. The timing of gains and losses, or ‘sequence of returns,’ as it is referred to, is much more important than the rates of return. During the working years, when you are investing to accumulate money for retirement, gains and losses are anticipated and part of the accepted ‘deal’. But when you retire and begin the de-cumulation or spending down of those assets you saved, a single negative year can create a big problem, if you need some of that money to live on. It can leave you coming up short, sometimes very short… of sufficient money to live on later.

Portfolio risk is compounded or magnified in the years leading up to and throughout the retirement years. Even a small loss of 10% can potentially deplete many years of assets down the road. You save money for retirement so you have money to live on, to spend when you retire. When you spend money that has gone down in value due to market loss, that money is gone forever. You cannot get back the losses. This is what is referred to as Reverse Dollar Cost  Averaging. This is expertly explained by retirement expert Moshe Milevsky in his 6 page whitepaper, Retirement Ruin And The Sequencing Of Returns. It is valuable to read it and understand it. In case you want the short version, here it is.

If you have a 401k at work, you may be familiar with the term Dollar Cost Averaging. For example, let’s assume you set aside $300 a month in your 401k. That $300 goes into your investment strategy no matter what, every month, like clockwork. That means in periods when the market is up, your $300 buys less shares. In periods when the market goes down your $300 buys more shares. The idea being, over time you have a lower average cost of all your investments because you kept buying even when things were going down and were cheap. It can be a reasonable strategy when you are in your 20’s, 30’s, 40’s, and [maybe] even early 50’s to accumulate money over time. Reverse Dollar Cost Averaging is the exact opposite. Now you are taking money out, on a systematic basis, for income to live on and the fluctuations in the market work against you, instead of help you. Imagine you are now 65 and retiring.

Here is an example. You retire at age 65, planning to live to age 90, with $500,000 in saved assets to supplement your social security. You have heard it is OK, and you feel confident spending 4% per year. The market losses 20% in year one and you took out $20,000 (4%) to live on. You have ONLY $380,000 of your $500,000 at the end of year 1. A whopping 24% of your assets are gone and you have 96% of your retirement years left to live. B I G PROBLEM! Taking withdrawals in years that your account is down in value, accelerates the decline.  This puts you on a path where your only options are; continue your withdrawals at an even higher percentage now, because if you need $20,000, it is now 5.26% of the $380,000 you have left. Your only other options are to reduce your income and your lifestyle, or significantly reduce your lifestyle by taking no withdrawals until your money returns to the pre-loss values. This can and has taken 10 years or more in some periods of market turmoil. Not a fun retirement to say the least. By the way, without income guarantees, some experts are now recommending that you take only 2% withdrawals, not 4%. This MorningStar Report suggests a 2.8% rate.

ghghUsing a personal pension instead, created from some portion of your assets, your 401(k) and or IRAs is a much safer, more certain way to set yourself up for success and peace of mind. These are not affected by declining markets because you get a contractual guarantee that provides steady income for life. This gives you confidence because you will not run out of money, you have steady income no matter how long you live, market declines will not decrease that income, and your principal is protected from market losses.

When it comes to Retirement Planning there are NO REDOs.

You have been disciplined, saved for retirement. That may have seemed like the hard part but the harder part is just beginning. You are on the 80-yard line but you have not scored! You must understand how to make that money last. The earning years are ending and new focus is… SPENDING. The goal is different. The philosophy is different. The strategy is different. You need a plan that is different.

You have worked, been disciplined and saved your whole life to get to where you are. You have arrived and you should feel proud of that. But arrived where? At the end of your ‘savings’ journey. I wish I could say it is over. It isn’t. You now start the ‘spending’ part of your trip. Unfortunately, mistakes at this point are very unlikely to be corrected.

We imagine getting to this point many many times in life, but almost no one thinks about what to do once you get here. We think about saving, saving, saving but not s p e n d i n g. It is common to picture that day when we’ll have stashed away enough money to call it quits. Some of us get good at the accumulation phase – but rarely are we prepared for what comes after that: making the money last for the rest of our lives.

That’s the concern I hear most often hear from the people I meet through my workshops or in my office. They worry is, and rightly so, that they’ll outlive their savings. There are several things that can derail you’re your retirement.

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If you are going to make your money last, unless you a lot more money than you will need, you cannot afford to lose any of it. I am often shocked by how much risk pre-retirees – people who are just five to seven years away from their goal retirement age, retirees- already retired, will keep in their portfolio.

Most people think their only option is to lose to inflation by having their money in the bank or take risk. They have been brainwashed to think they must take risk to keep up with inflation, using risk oriented investments –stocks, bonds, gold, traded real estate trusts, mutual funds, ETFs, etc. I know it sounds counter to everything you think you know but, you can risk less and spend more. Take this easy 11 question Risk Analysis, to see where you are.

The little known good news is, there is a middle-ground financial vehicle, where you can mitigate risk and still keep up with inflation. For instance, fixed index annuities can provide protection of your principal from market volatility while still allowing for potential gains based on market performance. Did you know you can get 50% of the market gains without ever experiencing a loss? When you have a solid foundation of assets that provide safety and guaranteed income, you can sleep at night even with the risk you take with ‘other’ assets.

The point is to focus on your retirement income, not just your net worth. If you’re only looking at your statement balances, you could be missing a big part of the picture. Remember, the focus is different for retirement. It doesn’t matter how much you have saved on any given day – it only counts if you’ll have that money when you need it… for the rest of your life.

wqeqwIn Dave Vick’s book, Bat Socks Vegas and Conservative Investing, he likens your financial professional to  a Sherpa. You need someone to get you up the retirement mountain, help you to accumulate enough money. But you’ll also need help during the preservation and distribution phase of your journey that is just as important. I think the Sherpa analogy is a good one. The Sherpa cannot get you up or down the mountain without you doing your part. Your part is getting educated, understanding what most people never will, it is all about preservation and income. BTW, most financial ‘sherpas’ only focus on the climb, the earning years. They are unknowledgeable about how to get down the mountain safely, in the spending years. Make sure your Sherpa knows how to get you down the mountain.

The Retirement Choices We Make Are Often Irrational…

It is no shocker that research proves we are not very rational about the way we make key decisions on when and how to retire. And a few new, fascinating studies just presented at the annual Retirement Research Consortium meeting in Washington, D.C., prove it.
By “not very rational,” I don’t mean that our choices are nutty. We’re just not doing what economists say we should be doing. The economists typically say retirees should convert their savings into these monthly-income-for-life products — but most people don’t. Another is taking social security too early. Problem is these choices are made psychological as they are financial. “Is a good decision one that gives you the best economic outcome or what makes you the happiest or most comfortable? Hmmm?

One irrational decision made by too many retirees is Taking Social Security Too Early. Fifty percent of Americans start collecting Social Security at 62 or within two months of leaving the labor force; 80 percent or more claim benefits before their full retirement age based on “Hey, it’s my money, I better get it before I die” mentality, even though they could double their Social Security payments by waiting until age 70.

Why Retirees Snub Annuities

After surveying 5,000 Americans age 50 to 75, John Beshears, an assistant professor of the Harvard Business School, and four co-authors discovered that although older Americans like the idea of a steady income stream in retirement, they hated annuities’ lack of flexibility. This is based on a significant lack of understanding. You cannot assure your money last forever and simultaneously expect keep it all liquid to spend.

dsfAlso, many baby boomers do not understand they can take their lump sum, create lifetime income and NOT GIVE UP THEIR MONEY. Putting all your money in an annuity can feel scary. The solution is simple, DON’T PUT ALL YOUR MONEY INTO ANNUITIES. More and more retirees are finding out that their need for guaranteed income, as well as flexibility and control can easily be met by an allocation that puts some in annuities and some at risk. Economists think more people should sign up for annuities, as research has proven that retirees with some level of guaranteed income for basics at least, are more satisfied and less stressed.

Buying high and selling low is a retirement killer! Why do we do it!

The reasons are numerous but here are two of the psychological reasons. ‘Scarcity’ and ‘social proof’ are steering us to buy high, and sell low. In this case, we are our own worst enemies. Buying low and sell high seems easy understand and follow. Yet most of us are unable to keep this simple rule straight in our heads when it comes to the stock market, including the people managing your money. Our instinct tells us to buy stocks when prices are high and to sell stocks when prices are low. Why?!! There are two key reasons for this –social proof and scarcity.

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It is human nature to look to others to determine the best course of action for ourselves. If we look outside and see people wearing shorts, we assume that the weather is warm and will switch to wearing shorts. If we see cars ahead start to change lanes, we will try to change lanes as well, in anticipation of an upcoming road block or accident.

If we are led to ‘believe’ others are getting rich by risking their money, then it must be the thing to do. Key word, “believe”. The same goes for when everyone else is selling. We think we should sell too. Social proof alone however, does not create such a strong effect that we always contrary to our own interests. There other key force at play is scarcity. In his book INFLUENCE, scarcity is the last of six weapons of influence described by Robert Cialdini. It was probably saved for last because of the strength of its effects.

We all have a natural tendency to want things that are in short supply. We think that cookies taste better when we are only given two, compared to ten. Similarly, we (your advisor too) will rush in and buy stocks at $10 because we are afraid that in a short time they will only be available for $12, $15, or much more. We must buy it now, because this price may not be available for much longer. That is why when the stock market is rising, we (and your advisor) feels a great need to jump in and buy, buy, buy.

As the market rises, stocks at lower prices become more and more scarce, which creates more buying, which makes them more scarce, and on and on it goes until the music stops. Alan Greenspan calls it, “Irrational exuberance.”

I think we have all experienced this, many times; in all areas of our life. We appreciate something most after losing it. Lovers, our freedoms, a chocolate chip cookie, and yes definitely, also money. We like making money, but we hate losing money a lot more. That is why when there is a large drop in the stock market and we have lost a lot of money, we are shy about buying more. Once we have lost, we want to hold on to what we have for fear of losing more.

This makes us most likely to buy when prices are high, because we have lost nothing and have gained much (at least on paper). Similarly, we are likely to sell or at the very least, not buy, when prices are low.

The other aspect of scarcity has to do with competition. And as we all know, competition is the cornerstone of the stock market. When prices are high, we are most compelled to buy because that is the time when there is most competition for a stock. We must get it now before someone else gets it and makes money that should be ours. When prices are low, we are compelled to sell because we do not want to lose the opportunity of getting rid of our crap to someone else. Buying high and selling low will devastate a retirement strategy that depends upon assets tied to market volatility.

Outliving your retirement?

F Blog 1 with borderThe findings of the original Retirement Vulnerability Report revealed that a majority of middle-class Americans are likely to outlive their financial resources in retirement. A significant, guaranteed, lifetime income outside of Social Security, as provided by such retirement vehicles as a lifetime annuity, was a way to help secure one’s retirement future. The updated study reveals that the financial market downturn which began in the middle of 2008 makes this conclusion even truer today. An open mind just may be you’re the answer to a successful retirement.

An open mind and an informed perspective on the value of annuities in retirement just may be the best way to get some badly need security and peace of mind. We are living in remarkable times and uncharted territory. People are retiring earlier and earlier, and living longer. With living longer, we can dream bigger, see more, do more and to invest more time in the lives of those we love. I say, “It’s not about growing older, it’s about growing bolder.” With longevity, comes challenge. We must find a way for our money to live as long as we do. One study (conducted by Allianz Life) surveyed 3257 adults ages 44-75, asking them whether their greatest fear was of dying or of running out of money while they were alive. Sixty-one percent said their greatest fear was of running out of money.

So, what to do? Though there is a lot of confusion, intentional deception (by those who want you to continue to keep all your money at risk in the ‘market’), subterfuge and lack of real knowledge and understanding about how they work, I believe that annuities, when properly integrated into a diversified retirement plan, can be powerful tools in helping a retiree to be confident their money will last as long as they do. Life insurance is purchased in case we die too and to provide for other life uncertainties. Annuities, once understood are purchased in case we live a long life, helping make sure that we will be able to enjoy our retirement years, and to allow us to maintain our independence and dignity.

As a Retirement Income Certified Professional, I know annuities are not the answer for everyone. They are simply a tool. Often times I find they are the best tool to do the job many 55 and uppers have, which is to provide some additional guaranteed income that will last as long as they last.

I do not sell annuities any more than an architect sells hammers, doors or windows. Together with the client, an architect designs the best possible home for someone to live in and then brings it to fruition. The hammer, windows, doors, etc. are merely components and tools of the design. A Retirement Income Certified Professional, together with the client, is designing the best possible retirement, including asset protection and maximizing income for life. An annuity is simply a tool, one tool often utilized to accomplish that task. This brief compendium will help you to see the high view held of annuities as effective tools for the protection and growth of your retirement nest egg. This view is increasingly shared in the media and in the academic community.

The poet Goethe once said that we should never let the things that matter least get in the way of the things that matter most. When it comes to retirement, nothing matters more than having a plan for our money to live as long as we do. Retirement is not a dress rehearsal. It is a one-act play, with one chance to get it right.