We live in very interesting economic times. It appears we barely avoided the second great depression, but the jury is still out. We now have the lowest interest rates in a generation and market uncertainty is keeping investors awake at night. What to do?

I’d like to tell you about a Forgotten Safe Money Option that will add predictability and stability to your financial life even if the uncertain economy continues indefinitely.

Before we talk about the Forgotten Safe Money Option, let’s review the biggest concerns that most retirees have. The retirement research I do and the data I collect tell me Americans age 60+ have the following major fears about retirement:

1. Outliving their money
2. Being financially ruined by illness or bad health
3. Losing their money in investments

Chances are you have the same fears about retirement. If so, it makes a great deal of sense to investigate ways to calm these fears. This investigation starts with a question: “where should you keep your retirement money?”

If you’ve over-funded for retirement, if that’s possible, you can be careless. But if there is some chance you’ll come up short, you should be cautious. How your money is managed will determine your retirement lifestyle. Let’s look at your options!

Bank CDs are very popular. They are rock-solid safe because FDIC insurance is provided by the government. The bad news is the rate of interest. You’ll need a magnifying glass to see the tiny amount you’re being paid – very close to zero! If you’re a bank CD advocate, chances are you’ve suffered a massive loss of income. Will bank rates come back? Probably, but when? I don’t have the answer, nor does anyone else. Even if CD rates rise, is it smart to keep all your retirement money highly liquid even though it will not be needed for years? Why pay income taxes on the interest earnings you’ll not need for years? I think of bank CDs like chocolate: very good but very easy to overdo. Smart retirees keep the money they’ll need soon and their emergency money in bank CDs. The money you’ll need later in retirement is best kept someplace else, but where?

For the vast majority of retirees that “where” is the “markets” – stocks, bonds, mutual funds, variable annuities, real estate investment trusts or other places that wax and wane in value with economic rumors and financial ups and downs. These options have one thing in common: risk. Risk is not a bad thing if you can afford it and it can be managed – if you have too much money for retirement, you can afford to take risks. However, average retirees are afraid of risk because risk means possible losses. They don’t have excess money for retirement and risk is not suitable. Losses make their worse fear a reality: running out of money before retirement ends. So why do average retirees have their money in the “markets”?

The loud voices of Wall Street, constant and pervasive advertisements, have convinced average retirees that the market is the only and right place. Only way to overcome inflation! Returns have averaged 10% long term! Remember, Wall Street and their brokers only offer “market” investments, so naturally their advertising is positive. Why do Wall Street and brokers not talk about losing 50% of your money in the 2000-02 period or the 2007-09 years? Why is risk never in the forefront? Their responses to loss are: “you can’t sell now, you’ll miss the coming rally” or “selling now will turn a paper loss into a real loss”. Obviously they didn’t predict the market downturn, so what makes you think they can forecast the upturn?

If you believe the “in the long term you’ll be just fine” look back over the last two decades. Oops, we have a problem because your money has not grown. Now compare two decades to your remaining lifespan. Sobering, isn’t it? Do you have enough time for the long term?

If you think 10% long-term growth is the norm, I invite you to again look back over the last several decades. Will the roller-coaster markets settle down? Will interest rates come back up? Victor Borge, the great vaudeville comedian and humorist said it best: “Nobody knows nobody that knows”.

What about real estate, gold bullion, collectibles, art and other treasures? All these options suffer from the same things as the market: risk. Plus they are difficult to sell quickly if you have an emergency. So, what about this Forgotten Safe Money Option?

Actually, it’s not “forgotten” because roughly $100 billion of retirement money goes to this option every year. It can work just like a CD: rock-solid safe, with a fixed rate declared in advance and good for one, two or several years. Don’t get excited because the rates are pretty low right now. You can choose to have your interest rate pegged, or indexed, to a market index like the S&P 500 stock index or a bond index. The index choice means your earning rate rises if the market index rises. If the market index falls you do not get any of the loss. How good is that? If the market goes down year after year after year, you’ll earn a minimum rate comparable to current bank CD rates.

Also, there are zero current income taxes on your earnings until they are actually withdrawn – which could be years later. So you earn interest on principal, interest on interest and interest on money that heretofore you’ve paid to the government. This triple compounding means your money will grow faster without loss of safety, which is very attractive to many retirees

The best part is the Forgotten Safe Money Option addresses your greatest fear: running out of money in retirement! At any time, you can, if you choose, convert some or all of your money in the Forgotten Safe Money Option to a guaranteed lifetime income you cannot outline. You can even have your lifetime income increase yearly with inflation. You can also take all or some of your money in a lump-sum, if you want or need. You’ll have total control: income for life, partial withdrawal for emergency or full withdrawal if you change your mind or think you can do better someplace else. Of course, if you take all your money lump-sum from the Forgotten Safe Money Option prior to maturity, there will be a penalty. What happens if you die too soon and there is still money left in your account? Relax, your beneficiaries will get the money that was not paid out to you in income.

Okay, who offers the Forgotten Safe Money Option? It’s not a bank, or the markets, nor is it the government – it is an insurance company. Did I hear a gasp? Did you think you’re afraid to entrust your money to an insurance company? The same insurance company that covers your house, car, boat, life, health and every other valuable asset you have. Why not entrust to them your retirement money?

Why do insurance companies offer the Forgotten Safe Money Option? Living too long is called longevity risk – and insurance companies insure people against risks too big for individuals. Risk like your home being destroyed, your car being wrecked, your boat sinking or your health failing. Insurance companies manage risk by insuring large numbers and the large numbers allow them to manage the risk profitably. Since living too long is your greatest risk, why not take some of your retirement money and get a guaranteed lifetime income from an insurance company? An income you can’t outlive – after all, running out of money is the #1 risk of retirees. This is the ideal safe solution to your greatest fear.

Does this Forgotten Safe Money Option have a name? Yes, it is called a fixed annuity or an index-linked annuity. How can you find out more? Talk to your financial advisor. If you don’t have a financial advisor, get on-line and learn all you can about fixed and index-linked annuities and then find a financial advisor. Is an annuity suitable for you? It certainly is for many retirees but I don’t know your circumstances – that why I’m advising you to find a financial advisor and work with them.

There you have it – the Forgotten Safe Money Option is no longer a mystery. If you’d like to read an entertaining little book about annuities, pick up a copy of Don’t Follow the Herd by Tony Walker. Tony is a financial planner and a friend of mine – you can get the book on-line or at any book store. Don’t Follow the Herd by Tony Walker.

I’ve given you a possible solution, where you go from here is up to you. Proceed wisely.

Shelby J. Smith, Ph.D.
The Retirement Pros

Interest rates are currently at historical lows and expected to stay there for the foreseeable future. If you had $500,000 in a 5-year bank CD paying 6% your annual interest was $30,000. Currently the national average rate for 5-year CDs is 1.84% to yield $9,200 a year – 70% lower than before. Lower interest rates have left many retirees with perplexing choices: live on less money, invade the principal or find something paying 6% to replace the matured CD. What are many retirees doing to make up their loss of income?

Many retirees are switching to bonds because many bonds have fixed rates better than CDs. Wall Street is loudly shouting that bonds are great for income seekers and retirees are listening. There is a problem: if interest rates rise, the value of fixed rate bonds will fall. Let’s see how this works. Let’s say you purchase a new AAA rated, 10-year bond with a face amount of $1,000 and a 3% fixed rate. This bond will pay you interest of $30 (3%) annually. When the bond matures in 10 years, you’ll receive $1,000. What could go wrong?

Let’s say that due to massive overspending by the federal government, 10-year AAA bond rates rise to 10%. You could now buy the same bond as before and get $100 annually in interest. What will happen to the market value of your $30-a-year-interest bond? Correct, it will fall because the interest it pays is lower than the identical new bond. You’ll still be entitled to the $1,000 at maturity in ten years. Generally higher interest rates and inflation are traveling companions; thus, the $1,000 you’ll receive in ten years will buy less than it will today. How much the market value of your bond falls will depend on: (a) how much rates rise, (b) how close maturity is, and (c) changes in the rating. The higher rates rise, the longer the maturity and lower the rating goes, the higher the market loss of your bond will be. Can any or all of these things happen?

First interest rates are at all-time lows; thus, it seems prudent to expect higher rates in the future if the economy recovers. If you need to sell before maturity, say because of an emergency, chances are you’ll have a loss. Second, prices may also rise due to the exploding federal deficit and the need for corporations to recover losses of the past several years. If so, your money will not buy as much as now. If the economic recession continues, corporations and governments will experience harder financial times and their bonds will suffer lower ratings. Unfortunately, some retirees are buying lower rated bonds to get the higher interest rates. The immutable law of investing says: potential risk and interest rate always move in lock step. Retirees beware!

So, what alternative do you have other than very low rate, short-term bank CDs? There is a little known “forgotten option” called fixed annuities. They offer: a fixed rate, plus an opportunity to earn more if the market to which they’re linked does better; tax deferred earnings until withdrawn; creditor-proof in many states; bypasses probate; have no-loss guarantee if held to maturity; convertible into a guaranteed lifetime income at your option; generous liquidity and penalty-free money if needed for an emergency. Fixed annuities are offered by insurance companies – the same ones that insure your home, car, health, life, business and other valuables. While annuities are not for everyone, you owe it to yourself and loved ones to find out if they’re right for you. The best way to find out about fixed annuities is to ask your financial advisor for guidance. If you don’t have a financial advisor, find one immediately because managing your retirement money properly is complicated and should involve a financial professional. I encourage you to check out the “forgotten safe money option”.

Shelby J. Smith, Ph.D.
September 2010