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Derailing Retirement Plans

There are numerous things that can derail people’s retirement savings efforts, which helps explain why the retirement savings picture in the U.S. is so grim today.  With defined-benefit pension plans going away and defined-contribution retirement plans such as 401(k)s on the rise, many Americans are having to make difficult financial choices —

For decades, companies offered pension plans for workers as a way to encourage longevity with a firm. Now, businesses are looking for ways to eliminate or reduce the financial liability associated with the promises of paying retiree benefits.

Companies are looking for the most part to shift the risk of investments and investment decisions and the liability or obligation that accrues over time with the old-style pension plans — the defined-benefit plans — and migrate employees over to a defined-contribution plan. The investment choices are now in the hands of the participant, which products do you choose?

To make it even more difficult and complicated to achieve financial security, is around 99% of what you’ve been told about investing for retirement could be misleading, deceitful, and just plain wrong…Even though the overall stock market is very close to its record highs, many stocks have not fared so well. In fact, some stocks have gotten crushed recently and those may have been the ones you have in your portfolio.

Most retirement investors use IRAs, 401(k) plans, or other strategies to take advantage of tax benefits for retirement saving.  However, Billions of dollars of Americans’ retirement savings gets sucked out of their accounts each and every year, and the astounding thing is that so many retirement savers are utterly clueless it’s even happening. There is almost nothing else in our lives where we pay $1,000 where we thought we didn’t pay anything.”

Each year, 401(k) savers pay a percentage of their account balance toward administrative and investment-management fees, which are usually included in the calculation of fund expense ratios. As an individual’s account balance grows, so do the fees they pay.  While [fees are] a small percentage of your balance, it is a huge chunk of your expected growth.

The typical 401(k) will steal an average of nearly $155,000 from each worker over a lifetime of saving.  The reason for this massive loss of wealth over a lifetime of saving comes down to fees. And those fees are usually expressed in a way that disguises the true cost.

While fee structures vary widely from plan to plan, the following three-layer 401(k) fee structure is most standard.  The first two fee types are associated with the funds within your plan, while the plan level fees consist of the fees and costs of the 401(k) plan provider.

  1. Expense Ratio: The expense ratio associated with each mutual fund is probably the most cited fee you’ll see, but it only tells part of the story.  It measures a fund’s total annual operating expenses.
  2. Other Mutual Fund-Level Fees: While the expense ratio encapsulates many of the costs of investing in a fund, there are also other mutual fund-level costs of purchasing a fund, as well as the trading costs that come with it.
  3. Plan-Level Fees: These are the fees of the 401(k) plan providers and administrators. These are the costs of keeping your company’s 401(k) plan up and running, as well as any investment and service fees.

The problem with investment-related fees on retirement savings is that it’s often hard to see exactly what you’re paying. The majority of Americans have access to mutual funds in their IRAs or 401(k)s, and if you use them, then you’ll pay management fees, advisory fees, and sometimes sales charges and other miscellaneous costs. In smaller company plans, average expense ratios are as high as 1.5% and can eat away at more than $200,000 in savings over the course of 40 years.

In a 401(k) plan, your account balance will determine the amount of retirement income you will receive from the plan. While contributions to your account and the earnings on your investments will increase your retirement income, fees and expenses paid by your plan may substantially reduce the growth in your account which will reduce your retirement income. The following example demonstrates how fees and expenses can impact your account.

Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000. The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent.

Yet you won’t see a specific dollar amount on your account statement that reflects how much those fees amounted to. Instead, the mutual fund provides basic, generic information on expense ratios and typical fees for holding periods of one to 10 years in their required prospectus materials, and the fund company is permitted simply to take money out of the fund’s assets to reimburse its expenses.

I think what people fail to realize is that oftentimes you can save yourself an enormous amount of fees just by picking the right funds in your 401(k). In your 401(k), make sure you’re focusing as much as possible on any low-cost alternatives the plan provides.  In an IRA or other outside account, you have a lot more latitude to choose exactly the investment you want, so you can avoid the highest-fee products in favor of similar options that carry lower investment costs.

Roll over your 401(k) to an IRA – Doing a “rollover” from a 401(k) to an IRA just means moving the money from one tax-advantaged account controlled by your employer to another tax-advantaged account controlled by you.  There are three great reasons to do this.

  • First, the fees on most IRAs are much lower than the fees on 401(k)s because they usually lack the administrative and other overhead expenses.  In fact, some companies even offer No Fee IRAs
  • Second, you will have better investment options in an IRA of your own choosing.  A 401(k) only gives you investment options that your employer or plan administrator chooses.  Often they are overpriced and underperforming due to lack of competition. In an IRA you can invest in virtually any stock, bond, or mutual fund or annuity.
  • Finally, rolling all of your retirement assets into one big account allows you to easily manage your portfolio allocation and make better investment decisions by viewing your retirement assets holistically.

If you’re using these vehicles to help you save for retirement, you shouldn’t necessarily stop using them — but you should take action to make sure no more of your hard-earned money than absolutely necessary gets sucked out of your nest egg.

Annuity plans sold by insurance companies give the investor a regular income for life after making an initial lump-sum investment. This is the only option that gives assured income for a period that extends beyond 10-15 years.  The risk of fluctuating interest rates results in uncertain cash flows. In annuities, the return promised at the time of signing up for investment remains the same for the life of the policy.

Fees and expenses of a fixed annuity are factored into the stated annual percentage rate the investor is quoted. The rate quoted is the rate paid. You will see 100% of your money go to work. Regardless of the type of annuity (immediate, indexed, fixed, etc.), for example….if you put in $100,000, you will see $100,000 go to work.  With deferred annuities, there are surrender charges to get your money out early, with the exception of the 10% allowable annual free withdrawal providing liquidity in the product.

It is important to note that the surrender charge is a decreasing charge so if you surrender a deferred annuity that is past its surrender charge period, then there is no cost whatsoever.  Since fixed annuities provide a guaranteed rate of return, that guarantee already takes into account any expenses the insurance company may incur in managing the investment.

When can Fixed Indexed Annuity guarantees be a good idea?  If you have money in a unstable stock market or bank deposit account earning low rates of interest, a fixed indexed annuity guarantee can protect your investment and offer the potential for better returns.

If you want to make sure you don’t miss out on stock market growth, fixed indexed annuity guarantees offer the potential to lock in gains when the stock market rises and protect them when the market falls. If you are saving for retirement and want certainty of income, a fixed indexed annuity guarantees offer deferred income guarantees which mean you can plan ahead and know how much income you will have when you stop working.

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Monday, November 10th, 2014 Wealth Management, Wealth Preservation Comments Off on Derailing Retirement Plans

Drawdown Means Substraction

So as a retirement-minded saver what should you do? Your main goal in retirement is to have your blood pressure go to zero before your retirement account does.

First, don’t bet the farm on the market. If the market has appeal to you, then limit your exposure to what you feel can be lost without destroying the retirement that you’ve planned. Second, lock up an income you cannot outlive and if you have any money left you can then speculate in the market.

The retirement security landscape in the U.S. has undergone a dramatic shift over the past 25 years. While Social Security remains a bedrock, private-sector pensions are nearly extinct and have been replaced with 401(k)-type accounts.

The shift in the U.S. retirement system away from company pensions and towards individual retirement accounts has placed greater responsibility on workers for ensuring the adequacy of their saving and managing those savings.

401(k)s has become America’s main retirement savings vehicle, but it has a couple of big flaws. Unpredictable markets can put a big dent in the standard of living of a retiree or near-retiree, and even the most diligent saver runs the risk of outliving his or her nest egg.  The average U.S. 65-year-old man is now expected to live to 88.8 years.  Neither of those pitfalls could happen to beneficiaries of old-fashioned defined-benefit pensions, which have almost vanished in the private sector….

Most employer-sponsored retirement plans such as 401(k)s aren’t retirement plans at all, they’re “investment accounts”. Those who sell stocks to the general public make a commission each time a stock is bought or sold; therefore, it is in their best interest that people participate in the market. The “investments” bought and sold take many shapes and sizes from shares of individual stocks, mutual funds, options and more with each offering a dazzling array of choices.

Added to the jargon are myths they spin to keep you committed. Myths like “don’t sell now you’ll miss the coming rally, in the long run you’ll be fine or don’t think losses when the market falls, think buying opportunity.” Yet, the stock market is the main depository for retirement money because myths like “long term you’ll do better in the market” are simply too powerful to resist.  Even though these myths are consistently wrong, many retirees stay the course and keep their money in the market.

When it comes to investing in retirement, people with identical withdrawal strategies can have remarkably different outcomes, especially when they start taking withdrawals from stock funds in a bear market. Drawdown really means subtraction, so when you start receiving your lifetime income payments, that amount is subtracted from your contract totals. But when you take money out in a bear market, you simply amplify your losses. And when the fund does rebound, your withdrawals reduce your gains.

$401(k)s are qualified money, money that is already been put away on a pretax basis. It grows tax deferred. It’s going to be coming out taxable. Typically when you have that type of money in a lump sum, you don’t want to take it out all at once because then it throws you into a higher tax bracket. That lump sum will come out on top of whatever income you have. So, typically, qualified money comes out as an income stream.

There’s been great movement in getting more people access to lifetime income products. Last summer, longevity annuities, which guarantee income later in retirement, received a boost from the Department of Treasury when regulators said the contracts can be included in 401(k) plans and are not subject to the required minimum distributions for other plan assets.

The pros of an annuities are that you won’t outlive the income the guaranteed payments provide, so you don’t have to worry about market performance (which for conservative investors is a great concept), and the longer you live, the better a deal it is (or, the more payouts you will receive).

If you chose the guaranteed route you would actually increase your withdrawals and guarantee them for the rest of your life. Having your own tax-deferred annuity retirement account is a bit like having one of those self-titrating morphine buttons that hospitals use: Press it whenever you need quick relief.

I encourage you to resist the temptation to put all your money in the market if any of the following fits you:

  • you’ll need all your savings to get you and your loved one to the end of retirement’s journey;
  • you have no way to replace losses if you guess wrong;
  • you don’t fully understand the risks you are taking;
  • your past worries with the stock market has kept you from sleeping;
  • the broker/money manager that is telling you what to do today is the same that lost you money yesterday.

Insurance companies have come up with a way to give you the best of both worlds. You can get a guaranteed payment, yet not lose all of your cash value. They do this by creating the “guaranteed withdrawal benefit” which allows you a guaranteed withdrawal for the rest of your life (pension payment); yet, if you would like to stop the withdrawals and take the cash you may, at any time.

Riders for Lifetime Income options. Whilst there are a number of riders available via your FIA, the one which is the most compelling for us is the Lifetime Income rider. The lifetime income rider will guarantee an Income for life irrespective of how long you live. Essentially, you would get certain guarantees on future growth on your Income rider ‘bucket’ which is separate from your accumulated funds bucket.

You would never have the option to cash in your Rider bucket but could only annuitize this into a future income stream as the rider name would suggest. This rider is particularly attractive to those preparing for retirement i.e. where retirement is fairly imminent.

The advantage is that the insurance company would guarantee you a particular rate of return on your rider bucket each year irrespective of what happens in the market. So if the rider guarantee was, say, 6%, then even if the market went down in a particular year, then even though your accumulated funds would remain level, your income rider bucket would increase by 6%.

This is especially effective where one wants to lock in a rate of return so that one has the option to turn to the rider account on retirement rather than to one’s accumulated funds which might not have grown to the same extent. Essentially you are hedging your bets on the market and this is a particularly wise thing to do the closer you are to retirement, and the more you are depending on every nickel for your retirement income and have little to no ‘wiggle room’ for market fluctuations.

Fees. The short answer to this is that there are no fees for a Fixed Indexed Annuity. Where there are costs involved is where you have elected to include a particular rider which carries its own charge which is illustrated up-front. The only other charge as such, is the surrender charge should you elect to take funds out before the expiration of the surrender charge period.

This surrender charge will vary according to the contract but is usually around 10% reducing over the term of the contract to 0%. The penalty free withdrawal is the amount that the insurance company will allow you to withdraw each year without any penalty. There are exceptions but generally this is 10% of the accumulated value per annum after the first year of the contract.

Insurance companies that offer safe money alternatives have stood tall and remained financially strong during the economic storms since 2000.  As we go through this metamorphosis, bear in mind that annuity carriers, unlike Wall Street and banks, have survived and prospered by judicious management and careful attention to their financial affairs. The current rush of others toward fixed annuities is proof that these “safe money alternatives” will flourish in the uncertain economic times ahead.

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Saturday, November 8th, 2014 Wealth Management Comments Off on Drawdown Means Substraction

Decumulation Roadblock Removal

Retirement is a new and potentially long chapter of your life.   As 401(k) plans have evolved from a supplemental retirement or capital accumulation plan to the sole retirement vehicle offered by most plan sponsors, sponsors and participants alike are increasingly focused on the decumulation phase—practically speaking, how to make the money last a lifetime.

That means ensuring that this income has the potential to last for your lifetime and to weather rising health care expenses, inflation, and market ups and downs.  First and foremost, you’ll want to make sure your day-to-day expenses are covered and that your income and assets will last for what could be a 30-year—or longer—retirement period.  There are many roadblocks to accomplishing that goal.

Federal Reserve Roadblock.  Retirees and their nest eggs have been hammered by the Fed’s policy. The Fed has said that low rates help the economic recovery. So it argues, in effect, that investors should enjoy the solid stock market returns and that savers should display a stiff upper lip.

Beyond savings and CD rates, the Federal Reserve’s policy is changing fundamentals of key senior financial products.  There is little new to say about the way non-existent interest rates on savings accounts, certificates of deposit, and U.S. Treasury securities have hurt all savers, particularly risk-averse investors.

Market Volatility Roadblock.  The impact of bad markets on a portfolio while you’re saving and investing during your working years may slow down your plans and delay your future retirement date.  Many investors feel that the stock market remains the most attractive place for investors over the long term – beating out bonds and other low-risk investments. However, to earn those higher returns, investors face more volatility.

After you enter retirement, down markets can be devastating, because your ability to recover is limited.  Many older investors simply don’t have enough time before retirement to risk a big loss. Even investors who are confident they can earn superior returns from stocks may reach a point where they want to lock in some of their gains in case markets turn fickle.

Many retirees learned the hard way that it’s dangerous to rely on outcomes that are merely a “best estimate” of the future. Instead, they need to rely on “scenario planning,” where you see if you can survive worst-case possibilities. It also helps to see what might happen if the future turns out to be better than your best estimate.

It might be smart to get some income from annuities that protect you if economic conditions are unfavorable and then other sources of income in the market that would do well if economic conditions turn out better than expected. Guaranteed products — annuities — provide higher retirement income under unfavorable conditions than products that rely on investing retirement assets.

Why do we suggest including a fixed-income annuity as part of a diversified income strategy? It’s straightforward: Fixed annuities, along with Social Security and/or pensions, provide guaranteed income to help meet essential expenses.  In many respects, Social Security payments are like an annuity, although one that has very attractive cost-of-living increases.

A lot of folks would like to have more retirement income that is that safe.  Often, one spouse wants to make sure that annuity payments continue for his life and, should he die, for the remaining life of his spouse as well. Lots of annuity contracts include that provision.

How can you achieve higher interest earnings without putting your hard-earned principal at risk? With a product that offers a minimum rate of return, ties its interest earnings to a stock market index and guarantees that the principal deposit and any interest earnings credited will always be protected – an equity indexed annuity, also called a fixed indexed annuity.

Fixed Indexed Annuities are tied to major stock market indexes and not to the performance of individual stocks or mutual funds, providing complete safety of principal.  Fixed index annuities allow you to share in stock market gains without risking your principal when the stock market takes a downturn.

Since annuities are based on external indexes like the S&P 500, when the markets go up you have the opportunity to share in gains.  If the stock market falls, your contract value will not decrease. Not only is there “zero market-risk” associated with fixed indexed annuities, but when the market goes up and you have a gain in your account, it is locked-in each year and yours to keep! It cannot be taken away, you cannot lose your gain.

What’s more important is that you now have the protection of lifetime income to ensure that your essential expenses are covered throughout retirement. Even in a 0% return market, although their investment portfolio may run out of money, their annuities continue to pay income for their lifetime

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Monday, August 18th, 2014 Wealth Management Comments Off on Decumulation Roadblock Removal

Abnormal Volatility Protection

As this bull market marches higher, one can’t help but wonder if the abnormal volatility is reminiscent of an excessively low tide that typically precedes a tsunami.  As for equities, last year’s 30% gain has left many investors worried that the other shoe is about to drop. And what with the volatility we’ve seen since January, those fears aren’t going anywhere anytime soon.

Stocks will continue to benefit from low interest rates, and scant inflation.  However the US economy just can’t seem to take off and recent earnings have disappointedWhat’s more worrying is the lackluster pace of business investment despite such high profits.  Companies have spent large sums over the past few years on stock buybacks and higher dividend payments, perhaps a sign they don’t think they’ll generate a sufficient return on increased investment.

The S&P is doing well this year, rising by over 4.1% year to date (YTD) but the other indexes are not so lucky.  The NASDAQ has only risen only 1.58%, the DOW by only 0.85%, and the Russell 2000 has actually dropped 2.5% this year.  The market is currently overbought so that is why you can expect a throwback.

The key reason stocks have done well is the Fed has kept the interest rates low while buying huge volumes of bonds, trying to stimulate the economy.  That forced investors to flee fixed-income investments and shift to equities.  After the financial crisis of 2008, the Federal Reserve set its short-term interest rate target near zero in the hopes that loans would be cheaper for borrowers and that the housing and stock markets would stabilize.

The conventional thought is that low interest rates encourage consumers to purchase more, which will eventually help economic growth.  The Fed intends to end its tapering program by the end of 2014 and could start raising rates in the middle of next year.  Higher interest rates may sting your investments beyond bonds. As interest rates in the Treasury market rise, the relative attractiveness of high dividend-paying stocks, real estate investment trusts, preferred stocks, and other yield substitutes may lose some of their value.

If they’re a bull, they will insist that the market will keep running but admit we are overdue for a pullback and that there is a buying opportunity on a dip. When both bulls and bears are expecting a correction of some kind, it doesn’t bode well for the short-term prospects of stocks, particularly as we enter the thin volume after first-quarter earnings have wrapped up and traders check out for the summer.

It is important to stress that there is no one-size-fits-all investment plan and you have to develop your own strategy.  No one (and I mean no one, despite what you may hear on television) can consistently time the market.  You make your decisions and live with them.

“No Guts, No Glory” can apply to your investments.  You don’t want to be dumb about your money; placing 100 percent of it in volatile stocks a few years before retirement, is a good way to land you in the poor house.  The key reason is that retirement can be a long period of 20 to 30 years.  At the same time, you want to be aggressive enough with your allocations to ensure your returns at least outpace inflation.

Most investors pay unnecessarily high expenses. Even when they are carefully hidden, mutual funds’ expenses inevitably take money away from you.  All funds are NOT created equal when it comes to operational expenses and the costs of portfolio turnover.

That means diversifying your retirement accounts.  We see there being a shift towards some kind of ‘flexible income in retirement’ product, and in essence this is income drawdown.  Social Security retirement benefits aside, the closest many Americans get to achieving a stable and guaranteed stream of income in retirement is through an annuity.

The risk here is that if the market moves against you, the odds increase that a rigid withdrawal plan will increase the odds of running out of money. If the market rallies, the opposite can happen also, and you may leave behind a large unspent surplus.  Most important is the advantages of an annuity can make the difference between running out of money in retirement and being financially secure, and avoid making a mistake that can’t be undone.

A fixed-index annuity (FIA)is a fixed annuity that offers a minimum guaranteed interest rate and potential for higher earnings than traditional fixed annuities based on the performance of one or more stock market indexes.

FIA’s offer several distinct advantages over bonds and equities, including protection from market declines, elimination of bond default risk, participation in positive performance of stock market indexes, tax deferral in non-retirement accounts, sustainable lifetime income with a MGWB or income rider, investment management simplification, and elimination of investment management fees on the portion of a managed portfolio that’s invested in FIA’s.

Given their advantages, fixed-index annuities purchased from highly-rated insurance carriers may provide a suitable alternative for a portion of a portfolio for investors who are able to commit to their long-term duration.

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Sunday, June 1st, 2014 Wealth Management, Wealth Preservation Comments Off on Abnormal Volatility Protection

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