America is facing troubling economic times: collapsing credit markets, advancing inflation, exploding energy costs, crumbling dollar, massive trade and budget deficits, wildly unstable stock market, diminutive interest rates and more. All indicators point toward a full-blown recession and trouble for those in or near retirement. It is time to circle the wagons and button down the economic hatches for the turbulent economic weather ahead.

If you have a 401(k) or other employer-sponsored retirement plan, chances are you own mutual funds or other investments that rise and fall with the market. Can you afford to lose some or all of your hard earned money if the market crashes? Is there a better place to shelter my money and still earn a good rate of return?

<<Updated>> If you missed Dr. Smith’s Video Webinar on “Recession Proof Your Retirement Money” you can go back to the Retirement Planning website and view recorded video >>

If you’ve read my book Guide to Social Security…and A Better Retirement you know that postponing Social Security until age 70 makes a great deal of sense for most healthy, married Americans that can do without the income. I mentioned this in my retirement blog in other posts. Of course, there are numerous exceptions and before postponing your benefits you should seek professional guidance. Obviously most haven’t because about two-thirds of current Social Security recipients started taking benefits before their normal retirement age? For the vast majority, this was a mistake and will cost them dearly in retirement as the result will be lower lifetime benefits. Is there a way to reverse this mistake and start again?

Yes! The Social Security Administration allows you to pay back the money you’ve received in Social Security benefits - without interest and without adjustment for inflation - and reapply for higher benefits. All you need to do is complete form 521, “Request for Withdrawal of Application”. You’ll be asked the reason for your action but don’t worry because any answer is acceptable. Let say you started at age 62 and have been drawing $1,000 a month for eights months but now want to reapply. Along with form 521 you’d write a check for $8,000 and then you can reapply when ready. If you filed a tax return during the period, you’ll probably want to file an amended return because chances are you overpaid your taxes and are due to refund. If you wait until age 70 to reapply, your benefits will grow about 8% annually, plus the cost-of-living-adjustments, which means your benefits will more than double from those at age 62. As you’ll learn from reading my Guide to Social Security there are several other good reasons to postpone Social Security if you can possibly afford to do so. In fact, the typical family may be able to add as much as $200,000 to their lifetime retirement income if the primary breadwinner postpones Social Security until age 70.

Let’s look at Fred and Sue, both aged 65. Both worked outside the home and are entitled to $1,500 each in Social Security benefits for the reminder of their lifetime. A quick glance at a Mortality Table shows that Sue is expected to outlive Fred by several years. The Social Security regulations says that one spouse is entitled to what they qualify for based on their own lifetime earnings record or 50% of what the higher earning spouse will receive, whichever is greater. Since Sue is expected to outlive Fred, wouldn’t it be nice if Fred postponed benefits until age 70 so that Sue would get a big raise in Social Security benefits if Fred dies first? Is there a way for Fred to get benefits based on Sue’s lifetime earnings record and then apply at age 70 for higher benefits based on his lifetime earnings record?

Due to a little-known glitch in the Social Security regulations, there is a way. Fred would apply for spousal benefits and receive 50%, or $750, based on Sue’s earnings. He would draw this amount, increased annually for cost of living adjustments, and at age 70 reapply based on his earnings. Presto, he will get substantially higher benefits for postponing and these, too, will be adjusted annually for inflation. At Fred’s death, Sue will be entitled to the greater of the two and her benefits will ratchet up to what Fred was receiving.

The foregoing shows two easy ways to maximize your Social Security benefits by taking advantage of little known glitches in the rules. More and more married couples are realizing that postponing Social Security is the wise move because there is an increasing probability that at least one of them will live well beyond age 90. Since Social Security is a lifetime annuity promised by the U.S. Government with benefits annually adjusted upward for inflation and tax-favored when taken, making them a relative larger part of your retirement income is smart. This is done by postponing until age 70 if possible and taking advantage of the two “loopholes” we’ve discussed. Of course, by using these loopholes you’re adding to the financial woes of the Social Security System. If you find these glitches attractive, act soon before Congress wakes up and closes the gate.

Shelby J. Smith, Ph.D.
April 2008

If you’re getting the same economic news I am, you’re probably nervous. You’re not worried about losing your job because that is something you used to do before you retired. But bad economic news also means retirement worries. To sidetrack a recession our government has printed a lot more money to bail out the bad boys, pay for imported oil and more, and spur demand for everything from apples to zucchini. More money is now chasing the same, or fewer, things to buy. The inflation rocket is set for launch. Rising prices means fixed retirement income will buy less and you’ll have to make adjustments. The double bogey is higher prices with lower interest earnings on your savings [looked at CD rates lately?]. Once the elections are over and your Congressperson is safe for another term, the triple bogey will be higher taxes across the board, including your Social Security benefits, to arrest a ballooning federal deficit. Not to add insult to injury, but if you happen to have your money exposed to risk - say in mutual funds, stocks, real estate, or anything else that waxes and wanes - you could be in for times-two double bogey if not a quadruple bypass. What can you do to recession proof your lifestyle?

Let’s start by dividing your retirement money into three categories:

(1) money you’ll need during the next five years;

(2) money you’ll need during years six through about years 15;

(3) money you’ll not need for at least 15 years.

Each category is special and “the time of planned use” will determine where to put the money. These categories can vary slightly between individuals and I recommend you get professional help from a financial advisor to help you determine what is right for you and your family.

The first category should be kept in “super safe and super liquid” places. The appropriate investments, or savings places, are: cash, money market accounts, bank CDs, money market mutual funds, savings accounts and high quality bonds that mature in less than five years. I know the rate of return will be depressing but if you take risk or invest in longer terms, you could lose part or all of your money. The price of the liquidity is the lower interest rate you’ll suffer. I know you want a higher rate of return along with low risk, but risk and reward travel together. By working with a financial advisor you can get the proper mix of this low-rate, super-safe investments. Your retirement income is now covered for five years.

Category two is the places you need some liquidity - just in case there is an emergency - and tax deferral would be nice also and you’ll want great safety. But, since market cycles can’t be counted on to be less than 10-12 years, we don’t want this category to be invested in investments whose value is determined by markets. At this point in history there are not many options in this category other than fixed and index-linked annuities. While you may not know anything about annuities now, you need to “get educated” by self-learning or working with a financial advisor who understands annuities. By the way, you’ll want to avoid advisors who don’t understand annuities because they’ll recommend against them. To tell the difference, you’ll need to help yourself get the basic knowledge about annuities by reading my “Is Your Annuity Good or Bad?”.

The last category is, unfortunately, where you currently have most of your retirement money: market investments like mutual funds, stocks, long-term bonds, REITs and other investments that Wall Street proclaims, in a very loud voice, that you should own. All these have one thing in common: risk. To offset this risk, you should be prepared to leave your money in these investments for a minimum of ten years and probably fifteen to be cautious. For example, as this is written the last peak in the market indexes (DJIA, S&Ps, etc.) adjusted for inflation was in 2000. We are coming up on ten years and the markets have not yet recovered from the dot.com bust of 2000-2002. How long will the sub-prime and mortgage bust keep the markets depressed? No one knows - they may say they do, but no one can see the future. While you still have some risk with this category, you odds are pretty good for your longer-term retirement money you’ll need fifteen year or more from now.

What was covered above is called an investment ladder for the retirement-minded. It is not sexy or risky, but it does position your money to last you for full retirement. Since each family’s circumstances are different, I strongly recommend that you engage the services of a financial advisor to help you craft a personalized retirement plan. Good luck.

Shelby J. Smith, Ph.D.
April 17, 2008

In this retirement blog we talk about retirement options that can help you get ready for Life’s Longest and Most Expensive Journey. You’ve reviewed your trip plans and recounted the money you’ll have to pay for your most expensive journey ever: retirement. You think you have enough money, but there could be trouble along the way. You’d feel better if you had a guaranteed lifetime income for you and your spouse. After all, your dad got a guaranteed pension for life from Mega Industries when he retired in 1972. Is there a way for you?

Most Americans have a guaranteed lifetime income: Social Security. The bad news is that this paltry pension will probably fall short of what you’ll need for the retirement lifestyle of your dreams. The good news is that it will be paid until you die. Plus, it has spousal benefits that could provide income to your loved one after you’re gone. If you’re already taking Social Security - and 50 million Americans are - you’ll get lifetime cost-of-living raises unless Congress eliminates them, which is not likely. Sadly, most current Social Security recipients started benefits before normal retirement age and will get lower benefits during their lifetime. Starting Social Security at the right time is a major retirement decision: to get it right, read my ‘Guide to Social Security… and A Better Retirement‘.

If you haven’t started your Social Security benefits yet, use SSA Gov. Calculators to estimate how much you’ll get. Let’s say you and your spouse will be entitled to $25,000 annually when you start. What’s more, you’ve estimated that $55,000 a year in today’s dollars will be needed for the lifestyle you’ve planned. Is there a way to “buy” this $30,000 shortfall so you’ll be assured - guaranteed - your yearly income in today’s dollars will always be $55,000 regardless of how long you live?

When facing a risk - in this case outliving your money - you turn to insurance. Insurance companies protect your home, car, life, health and more, so why not your retirement? They manage risk by spreading it across a large number of individuals. This allows them to accurately predict the probability of loss. For example, the odds of your house being totally destroyed by fire are 1 in 500 or being involved in a car crash are 1 in 82. The homeowners and drivers that have no claims subsidize those that do - the same principle works with guaranteeing you a lifetime income. If you live too long someone else will die too soon. Insurance companies know the odds and price their coverage accordingly. Buying insurance for longevity risk, or outliving your retirement money, is both cheap and easy.

Back to the $30,000 more in annual lifetime income you need to augment your Social Security benefits and maintain the $55,000 lifestyle you’ve planned! If you are age 65 and willing to deposit about $500,000 into an annuity, you can receive the $30,000 annually for as long as you or your spouse lives. The best part is that if you and your spouse die too soon, the balance in your account goes to your loved ones. Mortality tables show that for a couple aged 65, the median expected age that one of them will still be alive is 91. Of course, if one or both live beyond this ripe old age they will continue to get the $30,000 every year. The older you are when you lock-in the lifetime income, the less money it takes. The insurance company offers options about when to stop, start or store your income AND you will maintain control of your money in case you change your mind.

You’ll have more peace of mind knowing that regardless of what happens to the economy, your other investments, or how long you and your spouse live, you’ll have an adequate income for a good retirement lifestyle. Don’t move on this opportunity without shopping the market for the best annuity. The smartest way to do this is work with a financial advisor that specializes in annuities. If you want a guaranteed lifetime income, there is a way.

Shelby J. Smith, Ph.D.
April 2008

We discussed many topics in this Retirement Blog such as safe retirement investing, when to take social security, how to save on taxes…etc. One of the favorite places for retirement nest eggs is bank CDs. While this choice is rock solid safe and easy to access in case of an emergency, it may not be appropriate for all of your retirement money. Bank CDs are like chocolate – a good thing that can be overdone. In this month’s Internet video seminar we’ll discuss:

Far too many retirees just blindly put all their retirement money in short-term bank CDs without thinking about all the extra taxes they’ll be paying and the higher interest rates they can get elsewhere. Also, if bank rates are less than the rate of inflation – and that’s the case today – the longer your money stays in the bank the less it will buy. There are other safe alternatives that may be suitable for your retirement money, and you owe it to yourself and your loved ones to get as much return as possible without taking risks. The more income you have in retirement, the better you can live.

This Internet video seminar is free, educational and accessible on-line. You don’t have to leave home, can tune out anytime and remain anonymous while you learn more about your retirement alternatives. My objective in this free presentation is to help you and your loved ones make better retirement decisions. I sincerely hope you’ll register now and plan on joining in.

- Shelby Smith, Ph.D.

<<Update>> If you missed April’s Retirement Video Seminar online you may watch the re-broadcast on “When Bank CDs Make Sense” by going to the video library section of this website.

Many of you are in the red zone right before retirement, or you’ve already retired. No doubt your number one fear is running out of money in retirement. You’re part of a very large and growing demographic force: 35 million over age 65, 50 million drawing Social Security and 78 million baby boomers now turning 62. This means the future demand for everything used by the “retirement set” will increase, and “retirement prices” will rise dramatically. Many of you may have accumulated a retirement nest egg in a pension account, will draw a company pension and/or have other savings and investments earmarked for retirement. Where should you keep your retirement money?

If you’re keeping up with economic and financial developments, here’s what you’re seeing: sub-prime credit meltdown that has destroyed housing and is now spilling over into automobile debt and credit cards; highly volatile stock and bond markets; a weak dollar fueling higher prices for oil and other goods; more unemployment and rising inflation; retail sales, consumer confidence and new jobs creation in sharp decline; drastic interest rate cuts by the Federal Reserve to avoid a recession; a money giveaway stimulus package from Washington to prop up the lagging economy; widespread talk of recession and stagflation. These all add up to troubled economic times which should prompt you to review where you have your retirement money.

Learn about “safe” retirement planning today.  If you missed the video webcast on “Economic Outlook for Retirement Investing” you may watch the re-broadcast seminar by going to the Retirement Video Library Or by using this link >>

You can now buy insurance to protect you and your spouse against outliving your money. This coverage is for the retirement-minded whose biggest fear is living longer than their money. You simply deposit with an insurance company part or all of your retirement money, and they guarantee you, and your spouse, a lifetime annual income. Let’s see how this works.

Let’s assume you’re age 62 and retirement is heavy on your mind. You’ve been saving money during your working years, and let’s say you now have $500,000 to pay for your retirement years. You’ve determined that you’ll need at least $50,000 in guaranteed annual income when you retire at age 66. How could you arrange this lifetime guaranteed income now that will be ready for you in four years?

Let’s make this easy by assuming your only other source of income will be Social Security. By using the calculators at www.ssa.gov you’ve estimated your Social Security benefits will be $25,803 per year. You are interested in getting a guarantee from an insurance company to pay you the remaining $24,197, so you’ll have the $50,000 annually you have decided is adequate. The insurance company offers you a fixed index-linked annuity which guarantees that your money will grow by at least 7% annually until you turn it into an income (yes, there are annuities from top-quality insurance companies that will do this). The annuity you have chosen will also pay a 10% bonus when you open the account. Yes, such bonuses are available if you shop. At age 66, the annuity you have selected will guarantee you a lifetime annual income equal to 5.5% of the present amount in your account. Also, some annuities offer protection against inflation.

Since you’ll need $24,197 in four years, which will be 5.5% of your annuity’s account value, we know that $439,945 will be needed four years hence ($24,197 divided by 5.5%). This is where the math gets complicated, so call your financial advisor. If you invested $305,120 of your $500,000 retirement money with the insurance company today, and they credited you with a 10% bonus and guarantee that your account would grow by at least 7% annually over the next four years, you’d have the needed $439,945 when you retire at age 66. You and your spouse are now guaranteed to never run out of money during your lifetime, plus you have about $200,000 left, and growing, to cover emergencies.

But, what happens if you die too soon? The bad news is that your worries about money are over, but the good news is that your spouse continues getting the income if you chose the joint life option. If you chose the single life coverage, the remainder of your account value goes to your beneficiary. The account value is based on the market index to which your annuity is linked so that you avoid all market loses but participate in the gains. Additionally, you’re guaranteed a minimum rate of return by the insurance company even if the market loses every year. You’ve got upside opportunity without downside risk!

You’re set for life because the insurance company must pay you until you die, and Social Security is an entitlement for your lifetime. What’s more, you can start, stop and store the annuity income if your circumstances change (win the lottery or get an inheritance) AND there are no current taxes on the earnings until you actually start your income. You’ve covered your longevity risk without giving up control of your money. Your income is guaranteed for life, but you still have all your other options.

Are these policies fair to the policyholders? Insurance companies are successful because they spread the risk over a large population and price for the “average” outcome. This “average” outcome allows them to make a profit and simultaneously deliver a valuable service by protecting their policyholders against losses they can’t afford. In our longevity case, some live too long and benefit greatly while others die prematurely and benefit less. But, if you and your spouse have longevity insurance, you’ll have peace of mind knowing you can’t outlive your retirement money. Call your financial advisor and talk to him/her about insuring against this risk.

Shelby J. Smith, Ph.D.
March 2008

There is currently a lot of talk in the press about how reverse mortgages can be used to supplement your retirement income. Some sources advocate the use of reverse mortgages while others preach against them. First of all, reverse mortgages, like virtually every investment or financial decision, are good for some and bad for others. How they apply to you depends on your circumstances and what you’re trying to accomplish. Let’s set the record straight on reverse mortgages and retirement planning.

A reverse mortgage, as the name implies, is the opposite of a regular mortgage. Instead of making monthly payments on your home mortgage, the equity you’ve build up in your home over the years pays you. To qualify for a reverse mortgage you must meet two conditions: first, every person on the deed must be age 62 or better, and second, you must have enough net equity in your home to make a reverse mortgage loan feasible. The same lenders that offer traditional, or forward, mortgages also offer reverse mortgages.

A reverse mortgage is not related to your ability to repay the loan, having a job, your income or net worth. The only requirement other than being age 62 or better is that the equity in your home must be sufficient to justify the reverse mortgage loan. When you apply for a reverse mortgage you’ll go through the normal steps of obtaining a mortgage: an appraisal, title search, confirmation of insurance coverage, inspection, etc. The reverse mortgage closing costs can be taken from the loan proceeds so you can avoid out-of-pocket costs.

The interest on a reverse mortgage loan is accrued and added to your loan balance. Accordingly, the loan balance will grow throughout the life of the reverse mortgage; however, you have no personal liability to repay the reverse mortgage since the home is the only collateral for the reverse mortgage loan. If the home is not sufficient to repay the reverse mortgage loan, the shortfall is not your concern. When you pass on or move on, the loan can be repaid from the sale of the home with any shortfall being the responsibility of the lender and any excess going to you or your estate. The reverse mortgage can also be repaid by getting another loan, paying the balance from your savings or investments or the children/beneficiaries could repay the loan and obtain clear title to the home.

You cannot be evicted nor can the you be foreclosed as long as you are alive, living in the home, maintaining your insurance coverage and keeping the home in reasonably good repair. If you are married, the reverse mortgage loan is not repayable until the death, or moving, of the last spouse. You can take the reverse mortgage loan proceeds, less closing costs, as a lump-sum, installment payments or have a line of credit established with the lender that you can access at any time. There are no restrictions on how you can use the money from a reverse mortgage: vacations, new car, investments, vacation home, giving money to children, or whatever. Before reverse mortgages you had access to the equity in your home only by selling (and generally moving) or by refinancing (meaning payments would start all over again). This third option — reverse mortgage — is something you need to know about and consider should you ever need the equity from your home to help improve your retirement lifestyle. The reverse mortgage allows you to stay in your home and turn your home equity into spendable cash for other uses. The question is: why would you do a reverse mortgage? First and foremost, you might need the money for retirement or to cover an emergency. Secondly, a reverse mortgage could be incorporated into your estate planning by using the equity in your home to purchase a paid-up life insurance policy to pay tax-free death benefits to your children, charity or beneficiary. Third, you just might want to splurge and take an around-the-world vacation, buy that sports car you’ve always wanted or buy a second home on the lake rather than leaving the equity in your home to be fought over by the kids.

A better question is: why would you not want take a reverse mortgage loan? Many retirees use a reverse mortgage loan to finance investments. In fact, the reverse mortgage specialist helping you might even recommend making an investment with the loan proceeds. Generally, this is not a good idea because rarely will the return from the investments cover the interest and closing costs associated with the reverse mortgage. Far too often, a retiree will unlock the equity in their home using a reverse mortgage loan and then turn right around and buy a long-term investment that keeps their money locked up and out of their reach. This is generally a bad idea.

The one exception that oftentimes makes a great deal of sense is using the reverse mortgage money to purchase a guaranteed lifetime income to supplement your Social Security or other retirement income. A guaranteed lifetme income is generally obtained by purchasing an annuity from a life insurance company. Annuities now allow you to obtain a guaranteed lifetime income but still retain control of your money in case you change your mind about the lifetime income, need a lump sum to cover an emergency or get an opportunity to purchase a higher lifetime income should the economic/financial picture change. By using the reverse mortgage loan, which you do not have to repay during your lifetime, to purchase a guaranteed lifetime income you cannot outlive, you could remove the anxiety and fear of running out of money before your death. All the while you are assured of a place to live, no mortgage payments and the peace of mind of knowing that you’ll have a new income source for the remainder of your life.

The reverse mortgage loan is a great tool that can be used to improve your retirement and you definitely should learn more. But, before taking out a reverse mortgage loan make sure you have a sound reason and have a definite non-risky use for the money or need extra income to supplement your retirement income. If you simply want to “be prepared” just in case you need money for an emergency, leave the reverse mortgage money in a line of credit at the lender.

Generally, the costs associated with a reverse mortgage are no greater than you’d incur if you sold your home to free up the equity, but shop the market for the lowest closing costs. Also, there are several programs – some government sponsored while others are private – and you’ll want to review all your options. Again, don’t do a reverse mortgage just because you want to take the money and invest it hoping to “beat the market” or speculate you’ll make a higher return than the reverse mortgage loan is costing. Also, make sure you get professional help by talking to your banker or financial advisor before proceeding.

Have questions about your retirement investments? View questions and answers in our Expert Archive that we’ve given to others inquiring about their retirement investments: http://www.theretirementpros.com/ask_expert.php

Join Dr. Shelby Smith’s video seminar online (usually 10 min long or less) on safe retirement planning: http://www.theretirementpros.com/Tele-Seminar-MRM.php

Lately there have been a lot of references to “stagflation” when describing the current economic outlook.  Webster’s defines stagflation as:  an inflationary period accompanied by rising unemployment and lack of growth in consumer demand and business activity.  In other words, there are a lot of people who are out of work but prices are increasing like there is too much money chasing too few goods.  What does this mean for your retirement planning?

Most retirees, or soon to be retirees, live on fixed incomes. That is, retirees don’t get a pay raise just because prices go up.  Yes, you might get a small cost-of-living-adjustment on your Social Security but most other “mail box” money does not increase with inflation.  What’s more, the money you’ve set aside for retirement grows only as fast as the earnings will allow, and generally these are below the rate of inflation. In the early stages of stagflation, judging from the limited times it has occurred, interest rates are generally very low even though prices are rising rapidly.  This means your earnings on bank CDs and fixed-rate bonds are below inflation and your purchasing power (what your money will buy) is losing ground.  But, you’re reluctant to move your money to the stock market or put it in real estate because they are generally depressed, or highly volatile, as well.  So, how do you protect your retirement nest egg?

Unfortunately, you’ve received a difficult assignment because there are not a lot of safe harbors.  You should immediately assess the risks you are taking with your investments — if you can’t afford the worst case outcome, you need to take action.  Inflation and the erosion of your purchasing power is bad enough but add to that losses from investments and you might have a really dull retirement.   What investments might be at risk?  Any money that you’ll need in the next ten to twelve years that is currently invested in stocks, bonds, mutual funds, variable annuities and anything else that goes up and down in value with economic and financial cycles. 

The next thing you look at is income taxes.  Are you paying income taxes on your Social Security benefits?  If so, how might you reduce them without lowering your lifestyle?  Let’s see, you have a bank CD that earns interest which is included in your taxable income and boost income taxes overall as well as makes a larger share of your Social Security benefits taxable.  Why not move this into a fixed, tax-deferred annuity that either pay you a fixed rate of interest or interest that is determined by a stock market index?  You will pay no current taxes on earnings, there is no tax bite on your Social Security benefits and you have the guarantee of an insurance company that you’ll not lose money unless you cash in your annuity early.  As an added sweetener, with an index-linked annuity you’ll get the opportunity for an above-market return while avoiding the possibility of market losses.

The last way to protect yourself is to divide your retirement money into segments.  The first segment will be the money you’ll be using in the next five years.  This money will need to go into safe investments and be readily available.  This means you’ll be forced to stick with bank CDs, money market accounts and possibly money market mutual funds.  Stagflation is going to have an impact on this money and there is little you can do except hope for a near-term economic turnaround.

The second segment is where you put your annuities to get the tax deferral and the opportunity for higher earnings without sacrificing safety.  This is the money you’ll need in five to fifteen years from now.

The last segment is the money you’ll need in twelve years and beyond.  I’m assuming you have enough for this segment, if not you’ll simply place none of your retirement money here.  Since it is reasonable to expect economic and market cycles to work themselves out over a decade or longer, you can afford to take a bit more risk; therefore, conservative mutual funds, diversified stock portfolios and other securities may be appropriate assuming you can afford the risk and sleep well.

You’ve just constructed a retirement ladder with your money.  Each “rung” means that the money you’ll need during that time period will be maturing and ready for use “just at the right time”.  You’ve minimized your taxes, lowered your risk, shelter more of your money from stagflation and diversified your investments.  If all this sounds a bit too complicated for you, why not call your financial advisor and get professional help?  If you elect to do nothing different in the face of changing economic times, then you’ll probably not sleep as well, have less to carry you through retirement and pay more taxes.  What are you waiting for?

As we’ve discussed elsewhere in my retirement blog, longevity risk is the greatest fear of most retirees. You can now buy insurance to protect you from longevity risk: the risk of outliving you money. Just like you insure your home, car, health, etc. from the expenses of loss, insurance companies now offer annuities to protect you in retirement. What’s more, it is the best kind of insurance because even if you lose (die early) your spouse and beneficiaries can remain protected.

Like all insurance, you need to shop for the policy that best suits your needs and circumstances. Unlike health and life insurance, longevity insurance is not based on your health because you’re insuring against living too long rather than dying too soon. The coverage you get to protect your retirement years looks more like an investment than insurance. You simply deposit with an insurance company part or all of your retirement money and they in turn guarantee you an annual income for life, or joint life if you want to protect your spouse. The amount of the guaranteed annual income is based on the amount of money you deposit with them and whether or not you want single or joint coverage. Let see how this works.

Left assume you’re age 55 and have started to think about retirement when you reach 65. You’ve been saving money during your working years and let’s assume you have $300,000 accumulated for retirement (this could be in a 401(k), 403(b) or in an account that does not qualify as a pension such as stocks, bonds, bank CD, annuities, real estate, etc.). Let’s say you want to make sure you’ll have at least $50,000 per year when you retire in ten years and this amount will be guaranteed for your lifetime. How could you arrange this lifetime guaranteed income now that will be ready for you in ten years? First, we need to see how much you’ll be getting from other sources. Let’s make this easy by assuming your only other source of income will be Social Security. By going to the calculators on the Social Security Administration’s web site (www.ssa.gov) and making some assumptions, you can estimate your Social Security benefits. Let say you do that and find that your Social Security benefits will be $25,803 in ten years when you plan to retire. The task at hand is to determine how much you’ll need to give the insurance company today to buy an annuity that will guarantee you the remaining $24,197 when you retire in ten years. You’ll want to shop the market for the best buy and this is usually accomplished by engaging the services of your financial advisor. Let’s say you find a fixed index-linked annuity with a guarantee that your money will grow by at least 7% annually if you later turn it into an income (yes, there are annuities from top-quality insurance companies that will do this). Also assume the insurance company rewards you with a bonus of 10% on the amount that you deposit with them – that is, if you give them $100,000, they’ll credit you with $110,000 if you later take a lifetime income. Yes, such bonuses are available if you shop.

At age 65 when you “lock in” the lifetime income the annuity you chose will guarantee you a lifetime annual income equal to 5.5% of the amount in your account. How much of your $300,000 will it take to get the guaranteed lifetime income of $24,197 you need to supplement Social Security so you will always have at least $50,000 for the remainder of your life? Since you’ll need $24,197 in ten years, and we know that will be 5.5% of your annuity’s account value, we can determine the account value by dividing 24,197 by 5.5%. This amount is $439,945. But, you’ll not need this for another ten years, so we have to determine how much you’ll need to give the insurance company now. This is where the math gets complicated and why you’ll need help. If you invested $203,314 with the insurance company today and they credited you with a 10% bonus and guaranteed that your account would grow by at least 7% annually over the next ten years, you’d have the needed $439,945 when you retire ten years hence. You have successfully insured your longevity risk by buying an insurance policy. But, what happens if you don’t get to age 65 or you die sooner than the insurance company estimated you would? There’s good news and bad news! The bad news is that your worries about money will be over. The good news is that your spouse can continue the income for the remainder of his/her life if you chose the joint life option. If you are not married or did not choose the spousal option, your beneficiary will get the remainder of your account value. The remaining account value will be based on how much income you have taken, if any, plus the earnings credited to your annuity. The earnings are credited based on the market index to which it is linked BUT you never participate in market losses; however, you will participate in market gains as measured by the market index. Additionally, you’ll be guaranteed some minimum rate of return by the insurance company even if the market loses every year you’ve got your money in the annuity. In other words you can’t lose but you could do really well.  You’ve got good upside potential but zero downside risk if you keep your money in the annuity for the agreed upon term, usually ten years or less.

So, you’ve covered your longevity risk: you simply cannot outlive your guaranteed income because your insurance company must pay you until you die and Social Security is obligated to pay for the remainder of your life. Also, you will not lose your annuity money if you die too soon because your spouse, or beneficiaries, will get the remainder at your death. Social Security also has spousal benefits.  The best of both world! What’s more, you can start, stop and store the income if your circumstances change (you might win the lottery or get an inheritance) AND you’ll not pay income taxes on the earnings inside your annuity until you actually start withdrawing it ten years from now.

What happens if you need an income in five years? You can start it after one year as long as you’re age 59½ or better, but the amount will be lower than if you wait the full ten years. Do you have to start at the end of year ten? No, because you’re in control. You could decide to take all you money in a lump sum and reinvest it elsewhere (make sure your annuity is not a payout two-tier that requires you to take installment payments over five or ten years if you don’t want a lifetime income – see the article on two-tiers in this retirement blog and the link below).  You’ve covered your longevity risk without giving up control of your money.

Why have insurance companies started offering these types of annuities? It’s all because of the baby boomers. As you know there were 78 million folks born between 1946 and 1964. The demographic bulge started turning 62 in 2008 and one boomer will turn 62 every 7.5 seconds for the next 18 years. And guess what is utmost on their mind? Correct, outliving their money because they do not have a lifetime pension like their parents and grandparents did. They are turning to the insurance industry to guarantee that they’ll have a lifetime income if they live too long and have demanded that they not give away their money if they die too soon. The insurance industry has responded.

Are these policies fair? Like all insurance policies, they offer protection against loss and in this case those who die too soon don’t get nearly as good a deal as those who live too long. But, since your number one fear is outliving your money and you’ll not be disappointed at leaving money on the table once you’ve transcended to a place where money is not important, you’ve covered your risk at a fair price. Insurance companies are doing what they do best: pooling risk across a large number of people and guaranteeing that they’ll pay if the worse happens. In this case, the worst is living too long for the money you’ve set aside for retirement. If you’re worried about longevity risk, call your financial advisor today and talk to him/her about this new type of insurance. When selecting an annuity with a guaranteed lifetime income benefit, always consider the following:

1. Compare carefully how much money is needed by doing exercises similar to the above. Get help from your financial advisor!
2. Compare the cost of the rider: they range from 0% to 0.4% annually.
3. How often do income factors change? Annually, every 5 years, every 10 years, etc.
4. Spousal continuation provisions and also is there inflation protection?
5. What income “step-up” features are offered? At step-up does the income factor, related to age, also increase?
6. How long can you lock-in the guaranteed growth of the income account?
7. What is the rating of the insurance company?

I mentioned the evils of two-tier annuities above, here’s more info on this topic:

http://www.agentssalesjournal.com/index.php?option=com_content&task=view&id=797&Itemid=26&ed=64