Longevity Insurance


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“Sustainable Withdrawals” Retirement Income

Retirement income is a major concern for the middle class and the challenge of providing lifetime income has never been greater.  Many Americans are struggling to make ends meet in their golden years. Retirees are not only competing against the higher incomes of their younger counterparts, but they are also battling higher costs for housing, gas, food and other necessities.

Although retirement is often seen as a time to take your foot off the pedal there are often life changes that occur that could lead to financial upheaval. It is therefore essential that retirees have a degree of flexibility around their finances so they can adapt to a change in their needs, as people are living longer, it is inevitable that retirees will see their circumstances change at least once. Research points to the need for “flexibility” to cope with changing circumstances.

For most of our adult lives, we sustain our standard of living by working and generating income from the fruits of our labor. As we receive a paycheck from our employer–or draw payments from a business we own–we report the income we generate to Uncle Sam, who takes a portion in the form of taxes, and the rest is used for some combination of consumption for our current needs, and saving to fund our spending in the future.

At the point of transition into retirement (or at least, “financial independence” from work), the basic goal is relatively straightforward: to replace the income we had during our working years, with income from the assets we have saved for retirement. Simply put, we aim to replace one income stream with another, thereby allowing us to maintain our lifestyle.

The problem, however, is that the word “income” does not mean the same thing in retirement that it does while we work.  One of the most confusing problems in the world of investing is that sometimes payments are a combination of principal and income.  While some may wish to leave  a generous inheritance to their heirs, for many retirees, the reality is that they can’t afford to not use their principal at some point in their retirement.

Achieving sustainable withdrawals from your “retirement pot” becomes extremely important.  While it’s obviously dangerous to spend too much principal too soon, it’s an unnecessary constraint on lifestyle to avoid spending it ever. The end result: At some point, retirement spending needs to include principal, too. Especially in low-yield environments where relying solely on “income” alone can severely (and potentially unnecessarily) constrain retirement spending.

This is all about retirement and yet people are having their pockets picked and they don’t realize it.  There has been a fundamental shift in employer-sponsored retirement plans: In 1979, of employees with a company-based retirement plan, 84 percent had a defined benefit like a traditional pension and 38 percent had a defined contribution plan like a 401(k). By 2010 that flipped: 93 percent of workers with a retirement benefit had a 401(k) or the like, and 31 percent a pension.

With pensions and other employer-provided retirement plans disappearing from the retirement landscape, it is placing more responsibility than ever on the average American to provide a steady income stream for themselves during their golden years.

In the context of retirement accounts, the matter is even more confusing. As an accumulated asset, the account balance of an IRA, 401(k) or 403(b) is “principal” in any normal accounting of investment results, yet it is treated as “income” for tax purposes–because the principal is actually a deferral of income back when it was wages during the working years!

These confusing overlaps in what constitutes retirement “income” can lead to serious problems. Retirees may purchase “income” guarantees that are actually just a return of principal, or spend principal thinking that it’s income, or rely too heavily on income and unnecessarily constrain their spending by not tapping principal when it is appropriate to do so.

A company offering a 401(k) does have a fiduciary duty to run it in the best interest of beneficiaries. But the Wall Street guys — typically hired for advice on how to set up the plans, run them and decide the menu of investments options — don’t have the same obligation. They are also retail brokers who sell financial advice on myriad mutual funds, IRAs and other investments, including many that could be potential 401(k) offerings.

And servicers have an incentive to steer employees to higher-cost investments — especially those offered by the servicers themselves —Small differences in fees can add up. Take an employee with 35 years until retirement and $25,000 in a 401(k). If yearly returns average 7 percent and expenses 0.5 percent, and assuming no additional contributions, the balance will be $227,000 by retirement. But raise fees to 1.5 percent and the balance will be $163,000, a reduction of 28 percent.

It may be hard to swallow, but the truth is that some people are delusional about their nest eggs – not because they’re worried they’ll break, mind you, but because they’re overly confident in their impenetrability. Why? Because they’ve been listening to a financial planner who has helped them prepare for what they want in retirement, not what they need.

Wouldn’t it be nice if we all had a trinket that made us instantly feel more secure, especially when it comes to our own eggs – our nest eggs?  Lifetime income is very important for retirement security. Look, people are living longer, and that’s a good thing. But longer lifespans make lifetime income more expensive and difficult for self-investors to achieve.

In retirement planning, an individual’s ability to customize a portfolio that best suits their needs is important. However, when shifting from lifetime annuities, we should not lose sight of the benefits of longevity insurance.  The life insurance industry is the one industry designed from the ground up to manage longevity risk. The life insurance industry is reliably solvent because state insurance regulations are strict, with stringent reserve requirements and conservative investment standards.

Annuities that pay a fixed income for life provide a unique longevity hedge that is not available from non-insurance products. Much like flood or fire insurance, lifetime annuities share risk over a large pool of people, allowing individuals to hedge the risk of outliving one’s savings. Without a large starting amount, it is difficult to self-insure with capital markets alone.

Fixed Indexed Annuities (FIA) are unique in that they offer the possibility of competitive interest crediting, if the markets are doing well. “Having an FIA is a smart way to balance your financial portfolio. It allows you to lock in your principal so it never declines in value due to market downturns, while also enjoying potential upside through market-linked growth. That allows you to enjoy moderate rewards without taking on too much financial risk.

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Wednesday, November 5th, 2014 Wealth Management Comments Off on “Sustainable Withdrawals” Retirement Income

Retirement Nest Eggs Pensionized

How do you feel when stocks fall more than 200 points one day, and only to gain that and more the next? If market volatility puts you on edge, welcome to the club.  Since Labor day, the Dow Jones has logged 20 triple–digit trading days, 10 gains – 10 losses.  It’s enough to make an investor feel like ping pong balls.

No one wants to lie awake stressing out about their investments. But when the entire retirement portfolio of someone age 60-plus is wiped out by a cataclysmic event, it can be tough to get through the night.  The psychological and financial impact of such loss is deep and devastating, especially when so little time remains for these seniors to replenish their savings.

Retirees who have had their retirement nest eggs shatter require help—badly. Often their original retirement plan was designed through their 401(k) facility.  If you withdraw assets systematically from a 401(k), you’ll either need to spend less to avoid running out of money if you live longer than average, or spend more and take the risk of running out of gas by hitting the spending accelerator too hard early in retirement.

The worst way to rebuild retirement savings is to invest too aggressively in an effort to recoup assets instantly. A last-ditch effort with a slim chance of success is indeed a bad idea.  Above all, you have to avoid really big losses in the market. The only way to do that is to be somewhat conservative and make sure you have some sort of hedge in place.

The problem is that “non-retirees worry about their ability to earn more in their lifetime, and they are skeptical the stock market is the place for them to grow their savings.” Retirees are concerned about investment risk and income fluctuations, having protection against rising costs and the need to make ongoing investment decisions.  How do you secure an income after you stop working?

The sigh of relief comes from understanding there is a path—though maybe not the path they had in mind because here they are 60 years old and beginning again. Maybe it’s time for pre/post retirees to consider adopting a guaranteed lifetime income plan and ‘pensionize’ the proceeds of their 401(k)s.

Not only is life expectancy increasing rapidly but the number of people in retirement is expected to balloon with many spending as long in retirement as they will have done in employment. You have no idea how long you’re going to live.

They have the choice of putting their savings in the market that goes up and down, in bonds paying 2 per cent, which would generate a small, risk-free return which could theoretically cover costs as they rise with inflation without exposing their portfolio to investment risk. Alternatively, you could use some or all of the proceeds from your 401(k) to buy a life annuity that would give him/her stable, guaranteed income for life.

If you want to make sure you don’t run out of money, the options are to be very conservative with spending or to annuitize. The U.S. government recently issued guidelines for the ownership of annuities in 401(k) plans, patching what had been a big hole in many workplace retirement offerings:

Annuities also provide the advantage of a real retirement paycheck that has important psychological advantages over spending down investment assets. Annuitization pools the risk (among retirees) of living a long time. This means (theoretically) that if you don’t want to run out of money, the highest retirement paycheck comes when your investment assets are within an annuity wrapper because your spending is based on the average longevity of annuitants.

Retirement income is any method of obtaining a stream of income from a retirement account.  If you buy an income product, such as an annuity, you are paying a third party to assume longevity, market, interest and inflation risks on your behalf. (In other words, they are contracted to pay you for as long as you live, regardless of what the market does.)

Annuities are actually insurance products, not investments.  An annuity is a type of investment, typically issued by a life insurance company that tries to mitigate your risk exposure to the financial markets. For instance, if you don’t want to expose your retirement funds to market risks, an annuity may offer you the ability to participate in the upside of the market, while protecting your money from the downside of the market.

There is great intangible value in knowing that you are going to be okay in your old age, regardless of how old you get. If you have an annuity that is adjusted for inflation (some adjust for changes in the retail price index), you have a very good picture of your spending power in retirement without worrying about the oscillations of the markets or dying with a lot of money that you may have no use for (obviously, because you will be dead).

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Tuesday, October 28th, 2014 Wealth Management Comments Off on Retirement Nest Eggs Pensionized

Buy Yourself A Retirement Paycheck

Americans are less prepared for retirement since the decline of defined benefit plans in favor of defined contribution plans.  The main concern across the nation is the financial worry of having the ability to retire comfortably.   We are living longer, but the life expectancy of our money may have trouble keeping pace.

We have some big assumptions that go into any retirement projection. For instance, inflation rates for decades. Over 20 years, even a 3.5 percent inflation rate will cause prices to double. So expect that today’s $2 loaf of bread will cost $4 in 20 years.

The combination of longer retirements and more exaggerated cycles in financial markets heightens what is called longevity risk, the possibility of running out of money before running out of time. If income is not ample, a retiree may be forced to either continue working, or face a more modest retirement lifestyle.

An affirmative answer comes down to two things: investing intelligently and allocating assets correctly. If you don’t, you may witness a train wreck in slow motion, degrading your future quality of life.  As Harry S. Truman explained, ‘It’s a recession when your neighbor loses his job; it’s a depression when you lose your own.

Social Security retirement benefits normally may be taken as early as age 62, but your income will be substantially higher if you can afford to wait.  There’s tremendous value to deferring until 70.  Social Security is the best-priced annuity you’re going to buy.

Many suggest that you need to withdraw your retirement funds slowly – The other way you get paid in retirement is to invest your money for growth and income in a way that makes sense based on your risk tolerance – then come up with a plan for how to withdraw your money.

Many people focus on the 4 percent rule which essentially says that as long as you withdraw no more than 4 percent from your retirement accounts each year, the money should last you 30 years. Unfortunately, as we’ve learned recently, if the markets tumble big during your first few years of retirement this rule is going to fail you.

Indeed, you need to be very conservative about how much you’re withdrawing in the early years of retirement, especially if the market isn’t performing well. The fact that so many people tell us they’re planning on working in retirement means they don’t trust that they will actually get the investment returns they need but working longer may be a good thing – the income can subsidize a lower level of withdrawals.

One investment vehicle, an income annuity — which in exchange for an initial lump sum typically pays a fixed monthly amount, no matter how long the holder lives — is good to counter longevity risk.  There is a way to make sure your money lasts after you leave the work force.

Convert savings into an immediate or longevity annuityTake a lump sum of money and use it to buy yourself a paycheck. Depending on the circumstances, this paycheck can last the rest of your life and your spouse’s life.

A sliver of silver lining is the fact that Annuities are a powerful tool for managing cash flow. Guaranteed lifetime income products make it easier to manage a budget and provide more long-term security than other financial product.

The sooner an investor puts up the lump sum, the cheaper a certain fixed payment later will be.  A deferred income annuity is similar to an immediate income annuity, however guaranteed income payments typically start anywhere between 5 to 20 years after purchase.

A 55-year-old man buying an annuity would need to put down only $50,000 to collect $625 each month starting at 70, while a 70-year-old man would need $100,000 to buy immediate monthly payments of the same amount.

It may be possible for the 55-year-old to come out ahead by keeping his $50,000 for 15 years, investing it and buying an annuity at 70. But the point of an annuity is to produce guaranteed income, so for someone who wants that, why not guarantee the amount sooner?

You have to remember that even at 65 you still have a couple of decades to live on average and a decent shot at significantly more than that. That means you can’t put all of your money in safe havens. You still need at least some growth from stocks.  But how much should you keep in? Take 100 and subtract your age. That’s about the percentage of your portfolio you should keep in stocks.

Being able to rely on annuity income allows working and retired people to take more risks with their other assets, say, by owning more stocks to try to capture growth and not just income. That used to be discouraged for retirees in case the market plunged just when they needed their money.

With an “immediate annuity” you take a sum of money at retirement and buy a paycheck. The amount you’ll get for your money depends on your age/life expectancy and interest rates. The older you are when you buy an annuity, the shorter your life expectancy will be – so the greater a monthly paycheck the same sum of money will buy you.

When interest rates are higher, the size of the paycheck for the same sum of money will rise also. For that reason, it makes sense to not annuitize all at once, but to annuitize chunks of money over time as your fixed expenses rise.

A longevity annuity works the same way: you buy it at say age 50 but don’t start drawing your paycheck until retirement. Because the money has that 15 years (or however many) to grow, your paycheck is much larger.

We’re living longer, better and healthier, and we’re going to continue to be more active. It’s not about how long you live, but how well you live long

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Friday, October 24th, 2014 Wealth Management, Wealth Preservation Comments Off on Buy Yourself A Retirement Paycheck

Women’s Gold Plated Retirement System

Some people, including women, continue to believe that only men retire. This misconception ignores the career women who have the same retirement adjustment problems that men have.   While working it was all about building a large pile of money. Now when retired they’re worried about the check in the mailbox.  Pensions paid by defined benefit programs pay an income for as long as one lives however, on death no money is passed to dependents (the program may offer a spouse’s pension).

Final salary schemes have been phased out by many employers because they became so expensive. In the old days, before the growth of 401(k) plans, many employers paid you a pension that lasted a lifetime. The employer paid you your benefit no matter what happened to the stock market.

Today, while some people are fortunate to still have those types of pensions, many people must make their own key decisions, decide how to manage their own funds and how to cope with the three big what ifs of retirement. What if I live too long, what if my investments lose money and what if inflation hurts my investments?

Because the stock market has become a part of our daily conversation – the deal is everyone is supposed to be building retirement assets. Okay, so you build your assets, but how do you make sure that you don’t outlive them?  With traditional pensions disappearing, many boomers especially women boomers will be relying on not-fully funded 401(k) plans that could take a massive hit in a recent volatile stock market.

Retirees and near-retirees are increasingly aware of the need for lifetime income sources; people are living longer than ever before, and the threat of running out of money is not one to take lightly.  How long your savings will last will depend on how well you planned. In addition what you use during retirement should depend both on savings and continued income.

The goal for retirement is to start saving/investing early in life, be consistent, take advantage of any employer matching plan, max out contributions when possible, eliminate debt, avoid risks with your nest egg and plan for multiple streams of income once retired (social security, pensions, dividends, part time work, etc.).  Today’s near retirees have been smart with their money and are now looking for equally smart ways to turn their accumulated funds into lifetime income security and a worry-free retirement.

Men and women approach retirement differently: from how they save, to spending plans and what they expect out of their golden years, there are major difference between the genders.  It’s been well reported that more women than men encounter financial hardship during retirement.

What’s more frightening to me is the retirement income gap that women retirees face. Many women still earn lower wages than men in many occupations. Women across all occupations earned 81% of what men earned, according to the U.S. Bureau of Labor Statistics. In retirement, lower income translates to smaller Social Security benefits or defined benefit pension payments, along with smaller balances in 401(k) accounts, IRAs, and other retirement-savings vehicles.

Women face some challenges that are purely logistical, like the simple fact that they live longer than men.  Women face greater longevity risk in retirement, which means they need to stretch their resources across more years.  Women outlive men usually by six years and the combination of longer lives and limited finances can put older women at risk.

Women are more likely than men to move in and out of the labor force to raise children and care for older relatives, which typically reduces any pensions they may qualify for and makes it harder to build up a nest egg.  Caregiving, whether for aging parents or children, often cuts into earnings and destabilizes retirement plans.

Women need to plan for more years in retirement and they need to be saving more for their retirement. A comfortable retirement should be their number one goal and they should have on blinders when it comes to reaching that goal.

Few of us realize that we have to make that money last for perhaps 20 or 30 years after we stop working. There are two ways to make your fund last for the rest of your life:

  • Make withdrawals that you estimate will last for the rest of your life – and keep whatever money you haven’t spent in an investment.
    Or
  • Take some of your money and buy an income annuity – which will provide you with guaranteed income payments for the rest of your life.

Women want the certainty of knowing they won’t outlive their means. An annuity is the best way to be certain you will get payments for the rest of your life, no matter how long you live. Some people worry they will die early. An alternative is to get an annuity that is guaranteed to pay benefits for at least 10 years, even if you die before then. You may be able to make more money in the stock market, but you may not. If you can live with the uncertainty, you can just time the withdrawals from your investments.

If you have retirement expenses not covered by monthly pension and Social Security benefits. An annuity can guarantee a regular monthly payment for the rest of your life. If you have a large income to pay all your expenses, you may not need an annuity.

How Much Annuity do I Need?
1. Estimate your annual expenses in retirement. Remember that some of your expenses will go down. You won’t have to pay Social Security taxes, you won’t need to pay work-related expenses and you probably won’t need to save. However, be prepared for some expenses to go up – especially your health care expenses.

2. Subtract your annual Social Security benefit from your estimated annual expenses.

3. Subtract your pension benefits.

4. If you decide to buy an annuity, it should cover your expenses NOT covered by Social Security and pension benefits.

Many retirees would rather use drawdown instead of using the money to buy an annuity that provides an income for life.  It is swapping a capital sum for a guarantee of income.  Many retirees do not see that they are buying an income stream.  If you buy a car, you don’t get to keep the money you use to buy the car.

Annuities carry two important advantages: they provide a guarantee of income for the rest of an retiree’s life, however long that may be; they also allow investors to benefit from the “mortality cross-subsidy”, by sharing out some of the value of the pensions of those who die young, they increase the payments to those who live longer. This is an extremely efficient “Gold Plated” retirement system for all retirees but especially for women.

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Saturday, October 4th, 2014 Wealth Management Comments Off on Women’s Gold Plated Retirement System

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