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Guaranteeing Retirement Income

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Getting pre-retirees to view their retirement savings as a monthly paycheck is an uphill battle.  As millions of Baby Boomers head toward retirement, they will have to figure out the cash flow challenge of retirement living.  As their goals shift from building wealth to generating stable income, “Retirement income distribution planning” as a key goal for pre-retirees.

Retirement is one stage in life where you don’t want to have to guess the availability of income to meet your needs. You would like your retirement corpus to not only generate an income to meet your needs but also to meet those retirement dreams that you have nurtured for years. However, all income is subject to risks.

There are significant risks to consider when it comes to assuring financial security in retirement: There is the risk of outliving one’s assets—also known as longevity risk.  This ranks right up there with Market risk, as we know, markets don’t move in straight lines, when you take distributions, the funds are gone.  Average returns don’t take that into consideration.

Your first priority when structuring your retirement portfolio must be to secure a level of income that is adequate to meet basic living expenses.  A Defined Benefit (DB) plan promises a certain level of income during retirement, usually based on an individual’s salary and years of service when he or she retires.

This highlights that the shift away from defined benefit pensions to defined contribution plans has transferred the responsibility for managing longevity risk, along with investment and inflation risk, to the individual.  Your post-retirement income also needs to be predictable to an extent to match your expenses. So, to build in predictability of income you will need to look at fixed income products.

An annuity can be a source of steady and substantial income. Here’s a sense of how much you might get from an immediate annuity: For $100,000, a 65-year-old man could start receiving about $563 per month for the rest of his life. That’s about $6,750 per year. It may not seem like much, but imagine that you have $300,000 with which to buy an annuity. That could generate almost $1,700 per month, or more than $20,000 per year.

Add that to Social Security, which recently paid average monthly benefits of $1,337, or about $16,000 per year, and it can be quite a powerful support in retirement. (Of course, depending on your earnings history, your monthly Social Security benefit may be significantly higher or lower.)

There’s a lot more to immediate annuities. For example, you can customize them according to your needs or preferences. By paying more (or receiving less), you can have the payments increase along with inflation over time. You can also have the payments continue not only to the end of your life, but to the end of your spouse’s, too.

A safe option is to look into locking in a guaranteed lifetime income you can’t outlive.  You see, there is insurance for longevity risk: insurance companies which are among the world’s largest, strongest and oldest financial institutions are willing to guarantee you a lifetime income you can’t outlive if you’ll deposit with them some of your retirement money.

They will take the risk associated with the markets, stocks losing value, real estate crashing and other unforeseeable developments that can erase your retirement money.  You, on the other hand, got protection from your most feared risk in retirement: outliving your money.

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Tuesday, October 27th, 2015 Wealth Management Comments Off on Guaranteeing Retirement Income

“De-Risk” Your Retirement Income

This is the first generation that does not have a defined-benefit plan to fall back on.  We’ve gone from defined-benefit plans where the employer made all the decisions and took all the risks to where employees make all the decisions and take all the risks.  We had this big transition from defined-benefit to defined-contribution plans and we are discovering that these 401(k) plans aren’t working very well.

The industry buzz word for the actions that companies are doing is called, “de-risking” as they rid themselves of future risk and liabilities. But the risk doesn’t just disappear; it’s transferred from shareholders and executives to employees and retirees, who often are poorly equipped to handle it.  Companies have been able to shift longevity risk to retirees, as well as investment risk, interest-rate risk and inflation risk.

Investment risk is very real as a market downturn is “inevitable.”  If retirees haven’t rebalanced over the past six years during the bull market, then it’s very possible that they could be relying too heavily on equities.  Recovering from financial losses can be extremely difficult in the retirement years. In many instances, this problem forces people to withdraw retirement savings to cover their living costs

One standard rule of thumb for asset allocation is to subtract your age from 120 to determine what percentage of your portfolio to put in stocks.  If you are 60, that would mean 55% in stocks.  One thing we learned from the last recession is that having too much stock, based on your target retirement age, in your retirement account can expose your savings to unnecessary risk.  That’s a recipe that could spell disaster for some Boomers.

Today’s defined contribution pension pots tend to be seen in the terms of the fund size – often running to many thousands of dollars – giving a distorted sense of wealth when not put into the context that it must provide income for as many years or decades as it is needed.

As traditional pensions disappear, retirees are stepping up their purchase of annuities, which promise pension-like, lifetime income.  A blend of life annuities and withdrawals from an investment portfolio is recommended as the best policy for individual retirees.

One explanation for greater interest in annuities is the increase in life expectancy.  Longevity risk relates to not knowing how long a given individual will live.  With life expectancies now moving into the 80s and, in quite a few cases, the 90s, retirement assets still need to be invested for the long-term – even if you’re retired.  As ninety becomes the new seventy, the risk of running out of retirement savings becomes all too real.  Longevity risk is one of the key risks that can be managed effectively by an income annuity.

Investment and sequence risks are also alleviated through the more conservative investing approach for the underlying annuitized assets. Sequence risk relates to the amplified impact that investment volatility has on a retirement-income plan sustaining withdrawals from a volatile investment portfolio. This amplified investment risk also forces a conservative individual to spend less at the outset of retirement in case their early retirement years are hit by a sequence of poor investment returns.

People with defined contribution pensions (401K’s) can choose whether and how much of the fund to convert into a guaranteed income.  In order to “self-annuitize,” a retiree has to spend more conservatively to account for the small possibility of living to age 95 or beyond while also being hit with a poor sequence of market returns in early retirement.

The regular payment received in return for a lump sum offers a shield from market volatility, fixing the return rate regardless of what equities and other investments do.  The insurance-company annuity acts just like an old-fashioned company pension, providing a steady, lifetime income stream.

The income annuity supports a higher spending rate and a license to spend more from the outset of retirement.  Income annuities support longevity through risk pooling and mortality credits rather than through seeking outsized investment returns. Do you want to shoulder all of the risk, or do you want to transfer some of the risk?   Annuities are contractually guaranteed transfer-of-risk products.

Much like a defined-benefit pension plan, income annuities provide value to their owners by pooling risks across a large base of participants.  An income annuity also avoids sequence risk because the underlying assets are invested by the annuity provider mostly into individual bonds, which create income that matches the company’s expenses in covering annuity payments.

Retirees could probably “maximize their utility” by holding a mix of investments and annuities.  A combination of annuities and investments could give many retirees the most income and the most peace-of-mind in retirement. Surveys of retired readers show that having a pension — guaranteed income — correlates with satisfaction in retirement.

Income annuities are a form of insurance. They provide insurance against outliving one’s assets. In the same vein, someone who purchased automobile insurance might wish they had gone without if they never had an accident. But this misses the point of insurance. We use insurance to protect against low-probability but costly events. In this case, an income annuity provides insurance against outliving assets and not having sufficient remaining income sources.

Annuities are effectively an insurance policy against living beyond expectations. You just have to hope you live long enough to not regret it.  This is an incentive to commit at least part of your retirement portfolio to an annuity, as it provides some guaranteed income regardless of longevity and the risk of outliving your retirement savings. This may also alleviate anxiety over the rest of the portfolio, which can be given a higher-risk investment profile.

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Friday, August 7th, 2015 Wealth Management Comments Off on “De-Risk” Your Retirement Income

Guarantee of Retirement Income

The financial realities of our world are changing. More and more people need to rely on their own investments for income during retirement. The assets from which you expect to create a vital stream of income during your retirement face risk from economic turmoil, interest rate uncertainty and market volatility. Markets don’t always go up, and if the first year of our retirement coincides with a market crash, the future doesn’t look so bright.

Stocks plunged nearly 2 percent or more on Monday for their worst day of the year, then on Tuesday The Dow Jones industrial average traded about 90 points higher.  Talk about “Volatility” if you are retired this is like being on a roller coaster ride.  What will ignite the fuse that sets off the next big market crash?

Fortunately, positioning your portfolio to weather the next big downturn doesn’t require that you be able to foresee when the setback will occur or what will instigate it.  One lesson of the 2008 financial crisis has been the importance of having some investment diversification in your retirement portfolio.

If you’re retired, you likely still want to have at least some of your nest egg in stocks to assure that your savings can generate income that will stand up to inflation throughout retirement.  However, the lesson learned is, the more places one invests their retirement assets, the less chance that the overall retirement portfolio will take a big hit when any single asset class slumps.

Many future retirees and present retirees have not taken in consideration the impact that “Uncle Sam” will have on the income from your 401(k), 403(b) or IRA accounts.  Uncle Sam owns up to 30-, 40-, or even nearly 50-percent of your account value.  If you have not started taking distributions yet you probably don’t realize the impact this will have on your actual retirement income.

Whether you like it or not, if you have a traditional IRA or 401(k), when you turn age 70 ½ you will have to start taking money out and pay taxes on that amount annually. Think of it as the IRS gently tapping you on the shoulder.  Required Minimum Distributions, (RMD) is the amount of money Uncle Sam requires you to withdraw each year from your IRA and 401k accounts once you reach age 70-1/2. The IRS makes you take this money out of your IRA and 401k accounts so it can tax that money.

In July, 2014, the Treasury Department relaxed the RMD rules a bit, reflecting the government’s desire to encourage you to prepare financially for your retirement.  The new rules allow you to buy a longevity annuity with your 401(k) or IRA money and not worry about having to include the value of that IRA annuity in your RMD calculations from age 70-1/2 up to age 85.  By investing in the QLAC you essentially postpone paying income tax on some of your IRA money.

Annuities should be in place for lifetime income, lifestyle, and a worry free retirement that doesn’t involve the stock market.  Annuities contractually solve for only four things: Principal protection, Income for life, Legacy, and Long-term care. The acronym you can use to remember this is P.I.L.L.

Most retirees prefer to continue to receive a secure income for the rest of their lives.  Start taking some of the risk off the table and transferring that risk to an insurance company to provide the needed income right now or at a specific time down the road. It really comes down to lifetime income now or lifetime income later.

When you add up your pension (if you are so fortunate), Social Security payments, and other investment income, there might be a gap in the amount of guaranteed income required that needs to be filled. Annuities are the only strategy that can provide a lifetime income stream that you and your wife can never outlive.

A QLAC is a new breed of longevity annuity (also known as deferred income annuity). You set up a QLAC by transferring money from any of your existing IRA or 401k accounts to an insurance company annuity. Your QLAC is designed to pay you a steady monthly income later in life.  Income options can be single or joint life, either life income or life income with cash refund.

This is an annuity in which you pay a lump sum premium to an insurance company and then at a future date which you specify today, you begin receiving a guaranteed monthly payout amount that continues for as long as you (or your spouse) are alive.

The beauty of the longevity annuity is that the insurance company tells you today exactly how much income you will begin receiving in the future. There is no stock market or interest rate risk. The future income amount that’s quoted is guaranteed!

With a longevity annuity you get income security that starts in your old age and at an attractive price. Financial planners estimate that if you own a longevity annuity you can increase the amount you withdraw from your savings in the early years of retirement by as much as 30% because of the reassurance in knowing your income in later retirement is guaranteed by the annuity.

QLACs can also be used in more complicated annuity and financial planning strategies that are based on a concept called laddering in which you space out the maturity dates or dates on which income becomes available. The goal of these strategies is to diversify your portfolio and minimize interest rate risk.

With staggered maturity dates that may stretch across years or decades, you can also plan for times when you anticipate needing more money such as for increased care or even to fund a purchase such as a retirement home.

Another advantage is knowing you have the income security from your QLAC which doesn’t have exposure to stock market or interest rate risks might make you feel more comfortable with being more aggressive with your other investments.

Annuities can be useful in financing retirement.  Your retirement income plan is probably the most important investment decision you’ll make in your life.  Thanks to advances in healthcare, retirees are living longer than ever – sometimes stretching their retirement out 20 years or more.

Living longer, healthier lives is certainly an exciting proposition, but ensuring that your retirement savings will last 20 to 30 years, and possibly longer, is the challenge. Annuities are one of the only guarantees that you can get in life.

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Wednesday, July 1st, 2015 Wealth Management Comments Off on Guarantee of Retirement Income

Retirees Must Manage Risk

After a lifetime focused on maximizing wealth or beating a benchmark, your goal becomes creating sustainable income over an indefinite length of time—the rest of your life. Lifetime risk can be framed simply as the possible shortfall in the amount you will need to spend, which can happen when market returns are bad or your life is unusually long.

Not very long ago in America, most people who had a long-term job could look forward to a pension based on their level of income while working and that was pretty much guaranteed by their employer. In other words, along with Social Security, they had a somewhat predictable retirement income that would last them the rest of their lives. Any risks associated with the investments that underlay their pensions were assumed by their employer.

Today that scenario has changed radically: Employees must rely on 401(k)s based mostly on the employee’s contributions and, if they can, any extra money that they put into personal IRAs. While the employer-run 401(k)s may offer a limited set of mutual funds chosen by the employer and the 401(k) custodian, presumably with the employee’s interests at heart, the individual employee must still choose which of those funds to place their retirement money into.

Retirees must manage risks like market performance along with their own longevity and the uncertainty about their spending requirements. There are some key differences to investing before retirement and investing after retirement. Before retirement, an investor has the opportunity to use automatic contributions to their retirement account to gain the benefits of dollar cost averaging.

The importance of avoiding risk is substantially increased in retirement because dollar cost averaging can start to work in reverse. If an investor is drawing down the value of their account during retirement, then they are effectively using dollar cost averaging in results and will sell the most shares at the worst times.

When people think of risk, they are usually thinking of volatility, or the daily fluctuations in the stock and bond markets. Many people understand they need to take some risk in their portfolios — it’s an inherent part of investing. They focus on getting the highest return possible on their funds, but may end up taking on too much risk as a result.

The U.S. retirement system has long been based around three main sources of income: Social Security, employer retirement benefits and personal savings, however, their results indicate that today’s worker are expecting to draw their retirement incomes from a significantly more diverse set of sources.  Exposure to more volatile higher-risk assets, such as equities, means that members run the very real risk of a sudden drop in the value of their investments before and at retirement.

And the personal IRAs must be managed by the employee. In both cases the employee assumes all of the risk that will influence how much money he or she will have at retirement and during retirement.  It makes sense to protect retirement savings by selling when the market is going down, but where’s the best place to put that money if a retiree investor does decide to sell?

Retirement plans are like containers. They hold your investments within them. When you sell, you sell one (or more) of the investments inside the container and you can buy a different investment inside.  With the aging population, and declining defined benefit plans, it stands to reason that demand for income replacement tools such as Fixed Indexed Annuiies (FIA)s will continue expanding.

These annuities offer a minimum guaranteed return like traditional fixed annuities or bonds, combined with an interest rate that’s linked to a market index such as the S&P 500.  One key reason retirees purchase FIAs—also called indexed annuities or equity-indexed annuities—is to protect their retirement income from market loss.  One of the core elements of the FIA value proposition is the opportunity to participate in market performance without putting principal at risk.

FIAs are not necessarily an equity replacement, but they are certainly a way for consumers to hedge themselves in equity markets. FIAs can offer a higher return than a traditional fixed annuity. Any gains earned are locked in and will never decline.  The primary pro is that they allow investors to partially participate in the upside of equities, and then lock in that upside.

As reliable sources of income, they resemble bonds more than stocks. They can serve the purpose that bonds traditionally have in an asset allocation model, though FIAs do not participate in any stock, bond or other investment directly.

A fixed-indexed annuity, or FIA for short, is an annuity that earns interest that is linked to a stock or other equity index. One of the most commonly used indices is the Standard & Poor’s 500 Composite Stock Price Index (the S&P 500).

With concerns over inflation and making sure that investments will meet our future needs, many people have turned to the fixed market for higher returns. It makes sense when you consider how well the S&P 500 index has performed historically.

The first and possibly most attractive provision of a fixed-indexed annuity is the no-loss provision. This means that once a premium payment has been made or interest has been credited to the account, the account value will never decrease below that amount. This provides safety against the volatility of the S&P 500.

FIAs offer consumers what could be described as the best of both worlds: a market-driven investment with potentially attractive returns, plus a guaranteed minimum return. In short: You get less upside but much less downside.

While it’s a lot like investing directly in the stock market, you don’t get the full boost of a rising market. With fixed-indexed annuities, the money put down by you, as a purchaser, isn’t invested directly in the stock market. Instead, you are offered a percentage of how much the index gains over a period of time, and a guaranteed minimum return if the stock market declines.

Your fixed-indexed annuity, like other fixed annuities, also promises to pay a minimum interest rate. The rate that will be applied will not be less than this minimum guaranteed rate even if the index-linked interest rate is lower. The value of your annuity also will not drop below a guaranteed minimum.

A fixed-indexed annuity typically offers other benefits that are not generally included in traditional policies: a 100 percent money-back guarantee, no front-end sales charges, and no annual management fees or administrative fees.

Before you invest in a fixed-indexed annuity you will want to read the fine print. There are surrender charges for early withdrawal, although most companies now allow yearly withdrawals at set amounts. Notably, the surrender charges often decrease the longer you let the company keep your money.


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Wednesday, June 3rd, 2015 Wealth Management Comments Off on Retirees Must Manage Risk

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