Who thinks taxes will rise in the years ahead? Everyone, that’s who! Who has money in the market? Virtually everyone because Wall Street has convinced us that we’ll do better there long-term. The only options currently available in employer-sponsored retirement plans are market investments, and when money is rolled to IRAs or otherwise invested old habits point us toward “the market”. We’re bombarded with ads about “market advantages” and when the crash comes the message changes to “don’t sell now, you’ll be fine longer term, selling now turns paper losses into real losses, ad nauseam”. Meanwhile Washington whistles past the graveyard of worried-to-death retirees as the market changes from Bull to Bear. Lemons mean lemonade!

If you have an IRA that is in the market, you currently have less money because the volatile market has moved south. I’m convinced, and I suspect you are as well, that future taxes are headed higher for everyone. Maybe you have money in low paying bank CDs that are wasting away to inflation. Why not convert some or all of your IRA money to a Roth IRA? You could pay the taxes with zero-interest-earning bank money. If you want, you could even move the new Roth IRA money to a safe harbor like a fixed index-linked annuity. The annuity’s bonus will offset some or all of your market losses and your lower account value means the income taxes will be less even if future taxes don’t rise. Also, if you have a change of mind or circumstances you can “recharacterize”, or do over, and go back to your traditional IRA. Why might you change your mind? Your tax rates could fall; money left in the market could lose more value; your job, health or other circumstances could change. The Roth IRA conversion do-over is truly the free lunch for smart people, served courtesy of a loophole in the Roth IRA provisions. Let’s look at more detail.

The money converted to a Roth IRA must be counted as income in the year of conversion and ordinary income taxes paid. Accordingly, you will want to make sure you don’t graduate to a higher tax bracket. If so, you can convert some of your money with plans to convert more next year. If you later change your mind you can unwind the conversion and go back to your IRA without having a tax liability. If you do a partial conversion, I predict you’ll have ample opportunities in the next couple of years because the outlook for the market is not encouraging. The DJIA is currently at about the same level as April 1999, and that’s before adjustment for inflation. This 12-year period is roughly half an average retirement; thus, so much for the “Wall Street Myth” that you’ll be okay in the long run. The market in the most recent decade has earned very poor returns.

If you go from a market investment to a traditional or index-linked annuity with a bonus, you need to do the conversion to a Roth IRA before you move the money into an annuity. The reason for this sequence is because if you convert to a Roth after the annuity is purchased, your account value could be higher which means you could pay income taxes on the bonus. I say “could” because this matter has not been addressed by the IRS and you don’t want to be the test case; thus, do the conversion before the bonus annuity is purchased. If your brokerage firm is reluctant or slow to complete the conversion to a Roth, you can move the money as an IRA to your bank’s money market account via trustee-to-trustee transfer, convert to a Roth and then transfer again via transfer to the annuity with a bonus. There is no limit on the number of trustee-to-trustee transfers, but a rollover that pays you the money can only be done once per year.

If you want a good summary of Roth Conversions that also shows you how to use fixed and index-linked annuities, read my recently updated “Conversion to Tax-Free Roth IRA” at www.theretirementpros.com.

Shelby J. Smith, Ph.D.
August 23, 2011

In a Wall Street Journal Article on August 15, 2011 titled “Which Way to Retirement?”  Kelly Greene wrote:

“Hitting the “sell” button on your stock portfolio, after the Dow Jones Industrial Average has fallen 11.1% in three weeks’ time, could hurt you more than anything else. Not only would you be locking in losses prematurely to preserve capital you might not need for years, but you also would miss out on any future rally.”

The article goes on to tell horror stories about people who had planned to retire but now can’t because of market losses.  Here are a couple excerpts:

“Lynette Robinson, a 65-year-old executive director of a consortium of colleges, was planning on retiring this November —until her investments took a hit this past week.”

“Kevin Fitzgerald, a 55-year-old marketing executive in Highland, Colo., says he regrets not hedging his 401(k) investments after watching his account lose $250,000 — one-third of its value — last week. Now, he expects to work at least 11 more years.”

Notice article’s advice: don’t sell now because “you’ll be locking in losses”, “you’ll miss the coming rally” and later advice was given to purchase a variable annuity.  A variable annuity is simply a very expensive (pointed out in the article) mutual fund in an insurance company wrapper to make it tax deferred.  Yes, you can get lifetime income from variable annuities but if you decide to bail out early you’ll get the underlying value of the sub-accounts, i.e., mutual funds, and if the market is down they’ll be underwater. 

From this article we’re led to believe if we sell now we’ll be “locking in losses”.  Would it be fair to say that if the market continues to fall we could be locking in smaller losses?  Surely we’re not being told that this is the bottom because no one knows where that might be.  Second, since we’re advised that we could miss the next rally, does this mean there will be a “next rally”?  What is not being told about the next rally is “when” and “starting from what level”.  Last time we had a meltdown it continued until losses were 54% and then it started to rally, stalled and then headed south again.  We’re currently a long way from the last peak and there’s speculation about another market meltdown.  What then?    

The WSJ article is very typical because the “safe money” options are never considered. What is wrong with saying “the stock market is too risky for those near retirement who cannot afford to retire if the market declines”?  What’s wrong is that the authors of such articles and their newspapers are influenced by the loud voices of Wall Street and Wall Street does not offer safe money options.  Since Wall Street only makes commissions when Main Street keeps their money in the market (so they won’t realize losses or miss the next rally), I’m not surprised at their “hang in there everything will be fine in the long run” advice.  Did you know that the S&P is currently at the same levels as 1999 and that’s before inflation is taken into account. Is 12 years long-term?  It is if you’re retired – in fact, it’s about half the typical retirement.  So maybe you will not be “good in the long run”.

My advice to those in retirement’s red zone is to take their money out of the market unless they can afford to lose it.  If they elect to ignore this advice, they may have to forget retiring, work longer or settle for a watered down retirement.  Look at any 401(k) and you’ll see only market options.  Most employer-sponsored retirement plans aren’t retirement plans at all, they’re “investment accounts”.  By not selling you’ll avoid losses, catch the next rally and live happily ever after! Why do retirees continue to believe this nonsense when history proves it’s a myth?

Shelby J. Smith, Ph.D.
August 19, 2011

“It’s best to leave stocks alone to recover from the loss and to draw instead on the fixed-income (bond) portion of your portfolio.”  Katherine Reynolds Lewis, Bankrate, Inc., August 11, 2011

The above statement was made in an article titled “5 Fixed-Income Bear-Market Strategies for Retirement”.  While this appears to be solid advice and mirrors “conventional wisdom” it is based on two questionable assumptions: (1) stocks will recover and (2) bonds are immune to losses. 

If you have your retirement money in a portfolio containing both stocks (including mutual funds) and bonds and have losses in your stocks, the above advice says you should avoid selling stocks for income because you’d have to sell more shares for a given income than if prices had not declined.  Instead you are advised to sell bonds in your portfolio to give your stocks time to recover.

Is there some law that prevents stocks and bonds from losing value simultaneously?  The answer is NO.  If stocks are falling and interest rates are rising, you’ll be losing money in both stocks and bonds.  Has this ever happened?  It most certainly has, as a cursory review of history reveals. So the assumption on which the “conventional wisdom” is based has a serious flaw.

Second, how do you know stocks will recover?  In August 2011 the Dow Jones Industrial Average (“DJIA”), a closely followed index that measures movements in the stock market, is at the same level as August 1999.  That’s 12 years without gains and that’s before we take into account inflation.  If adjustment for inflation were made, the DJIA would be much lower today than it was in 1999.  Twelve years is roughly one-half of a typical retirement and most retirees simply cannot wait this long in hopes that their stocks will recover.

Unfortunately there is no market strategy that guarantees you’ll not run out of money before retirement ends.  Accordingly, it might be prudent to avoid the market with your retirement money UNLESS you have more than needed for retirement and can afford the potential losses. 

Sadly, far too many retirees cannot afford the risks of the market yet that is exactly where they have their life savings that they hope will carry them through retirement.  Retirement is about keeping what you’ve got rather than trying to earn above market returns by gambling in the market. 

Take a stroll back through the years since 1999 and review what has happened to the market.  From mid-January 2000 until early October 2002 the market fell 38% in response to the dot.com bust and did not recover to the 2000 level until early October 2006 – over six and a half years later.  After the market matched the 2000 peak it continued to rise until early October 2007.  It then went into a tailspin loss of 54% in response to the housing bubble before bottoming out in early March 2009.  Since then it has been extremely volatile and has recovered only 62% of the previous loss at the time of this writing.

Where will the market go from here?  No one knows but the economic signs are not encouraging for the stock market in the foreseeable future.  How about bonds?  When interest rates rise, bond values fall. So which way do you think interest rates are going in the next several years?  Loose fiscal policy during and after the Great Recession points toward future inflation and higher interest rates.  Currently interest rates are the lowest in a generation and there is little room for further declines; thus, the odds favor higher future interest rates and falling bond prices.

If your retirement money is in the market – stocks, mutual funds, variable annuities and/or bonds – ask yourself this question: can I afford losses?  If the answer is NO then why are you in the market?  There are safe money options that guarantee you a lifetime income regardless of what the market or interest rates do.  This is where at least some of your retirement money belongs.

Shelby J. Smith, Ph.D.
August 18, 2011

In recent months the financial press has been filled with recommendations to use immediate annuities to lock up a lifetime income. Even the Government Accounting Office (“GAO”) recommends supplementing Social Security with a lifetime income annuity. In today’s low interest rate environment, immediate annuities that lock in historically low rates might not be a smart move because logic says stay in “short maturities” when rates are low. How can a lifetime income be locked-up now, yet not locked into today’s low rates? Here are two alternatives that deserve your consideration.

First is the “laddered approach” to investing. Since you’ll likely use your money piecemeal over the full length of your retirement, some investments can mature near-term to meet next up needs whereas other money can be earmarked for late-in-retirement use. Accordingly, it makes sense to select maturities that come due when the expected expenditure will occur. You can ladder maturities rather than locking in today’s near zero interest rates. Let’s consider an example.

Assume you have $250,000 in retirement savings and want to supplement your Social Security and other income over the next twenty-five years. A five-rung income ladder can be built for you by allocating money to each rung, or bucket. We’ll start with an immediate annuity as the GAO has recommended and use term annuities for the other rungs. We’ve assumed a 3% rate for the immediate annuity, a 5% return on the longer money and a 3% rate of inflation. The first rung of your ladder will use $59,000 to purchase an immediate annuity that pays approximately $12,900 a year for five years. The next rung will use $50,250 to provide at least $14,815 income for years 5 through 10 – slightly higher to compensate for inflation. Rungs 3, 4 and 5 will use $45,283, $40,803 and $36,766 respectively to provide income of $17,037, $19,593 and $22,532 for the three remaining five-year periods. The unused $17,898 will serve as reserve emergency savings that grows to $29,154 at the end of ten years and $47,489 in twenty years and is always available for use.

Bear in mind that a very conservative 5% earnings rate was used over the entire 25 year period. Judging from history, it seems logical to assume that you’ll do much better, which means the annual income shown above will be higher. Importantly, you have not locked in today’s fixed rates for the entire period as happens if only an immediate annuity is used. Using fixed index-linked annuities as the savings choices gives you safety, flexibility, predictability and tax advantages. A plan similar to the foregoing can easily be prepared by your financial advisor and just as easily implemented to give you peace of mind. Since future interest rates are unknown, your future income will be close approximations. To take up the potential slack the reserve emergency fund is created. Your plan not only has inflation protection and potential higher future earnings rates but also prevents you from running out of money.

The second option that beat an immediate annuity is the “lazy way”: lock in a lifetime income using an index-linked fixed annuity whose gains are permanently retained even if the market nosedives or interest rates go to zero. Once your guaranteed income is turned on, there are automatic lifetime income guarantees and peace of mind. You will not earn a bundle if the market soars but you won’t sing the blues if the market tail spins.

Up-front bonuses and rate guarantees allow you to not only earn great rates until the income is started, but to know precisely the minimum amount of your lifetime income. While this isn’t as exciting as trying to outguess the market or as near-sighted as keeping all your money liquid as if it will be needed tomorrow, it is a prudent and safe way to address your greatest fear of outliving your money. Work with your financial advisor to craft the right plan for your circumstances so you can find peace of mind in retirement.

Shelby J. Smith, Ph.D.
August 2011

Roughly 45 million Americans have IRAs and chances are you’re one of them. What is an IRA and how do you get one? There are now several types of IRAs:

1. The Traditional IRA allows you to contribute yearly the smaller of $5,000 or the amount of your taxable compensation. If over age 50, you are permitted to contribute up to $6,000. The contribution amount is linked to inflation and changes annually. The contributions are “before taxes” meaning the money put into your IRA is not counted as taxable income. You’ll pay income taxes when the IRA money is withdrawn in retirement. Until withdrawn the money grows tax-deferred, meaning no taxes are paid on earnings.

2. The Roth IRA is exactly like a traditional IRA with one major exception: your contributions are “after tax” meaning the amount you put into a Roth IRA is counted as taxable income and withdrawals are tax-free. You can split your annual contributions between Traditional and Roth IRA, but combined you cannot exceed the contribution limit.

3. A Roll Over IRA can be either a Traditional or Roth. You can move money from one retirement account like a 401(k) into an IRA or you can move from a Traditional IRA to a Roth, but not from a Roth to a Traditional.

4. An Inherited IRA is an IRA bequeathed to you at the death of the person who owned the IRA. Both spouses and non-spouses can inherit IRAs.

5. SIMPLE IRA is offered by employers to employees, but is beyond the scope of this article.

If you have an IRA you got it in one of three ways: (1) started an IRA and made contributions to it, (2) rolled money from another retirement plan into an IRA or (3) you inherited an IRA. IRA money may be invested in a wide variety of things but most people opt for conservative places.

Here are ten IRA rules you need to know:
1. If you have another retirement plan at work you can still contribute to an IRA but if your income is too high the contributions may be “after tax”.

2. You can only contribute to an IRA if you have “earned income”, investment income does not qualify you.

3. You can contribute to a traditional IRA until the year you reach 70-1/2 but can contribute to a Roth after 70-1/2 if your income is not too high.

4. You can “roll over” or transfer money from another retirement plan into an IRA at any age – this should only be done with the help of a financial professional.

5. All withdrawals from a Traditional IRA are subject to income taxes when withdrawn whereas Roth withdrawals are tax-free. Traditional IRA withdrawals increase “taxable income” and may increase taxes on your Social Security benefits whereas Roth withdrawals are not “taxable income” and do not count in determining the taxes on your Social Security benefits.

6. You can convert a Traditional IRA to a Roth IRA at any time, but you’ll have to pay taxes on the amount you convert.

7. You must start taking Required Minimum Distributions, called RMDs, from your Traditional IRA when you reach 70-1/2 years of age. There are no withdrawal requirements for Roth IRAs during your lifetime.

8. If one spouse dies the surviving spouse may claim the IRA of the deceased spouse as their own. They can convert it to a Roth IRA if they wish.

9. If a non-spouse beneficiary inherits an IRA, they are allowed to “stretch” the withdrawals over their remaining lifetime. A non-spouse beneficiary cannot convert an inherited Traditional IRA to a Roth. Money in an IRA is passed forward based on the named beneficiary and not by a person’s will.

10. If you take withdrawals from your IRAs prior to age 59-1/2, there may be a tax penalty. There are methods to avoid these penalty taxes; thus, if you want to take early withdrawals please consult with your financial advisor. After age 59-1/2 you can withdraw as much as you wish from your IRA without penalty. You may take withdrawals from your IRA while you are working, and if over 59-1/2 there are no tax penalties.

These are the “rules”, let’s now talk about several IRA aspects of interest.

What about transferring money from another retirement plan into an IRA? You can do this at anytime, provided the retirement plan where the money is now permits the transfer. The most common places from which you would transfer are 401(k) and 403(b) plans – the latter being for school teachers and certain non-profit employees. Here is something you need to hear loud and clear: Money at ex-employers should be transferred immediately. There are many reasons for this including:

1. As an ex-employee, employer contributions have stopped;
2. You are paying fees and other expenses that are un-necessary;
3. If you died your spouse or beneficiaries could be paid lump sum which means they’ll have a large and unnecessary tax liability;
4. If no beneficiary is named, your estate could get taxed twice on the same money – income taxes and estate taxes;
5. If the company failed, your retirement money could be in jeopardy.

Transferring to a Traditional or Roth IRA can be done quickly, without cost or hassle but I recommend you get help from your financial advisor. If you have money with an ex-employer, you need to move it NOW – no exceptions.

What is a Stretch IRA and how does it work? First of all, all IRAs should have a named beneficiary – be sure and check to make sure yours does. This detail is sometimes omitted when converting to a Roth IRA – so please confirm you have a named beneficiary. You can name any beneficiary you want: spouse, child, grandchild, church, charity, friend or whomever. If the spouse is your beneficiary, at your death your IRA becomes theirs and would be treated as if they had owned it from day one.

If you die and your IRA has a named beneficiary, they are allowed to take the money from your IRA over their remaining lifetime. The formula is very simple: how much is in the IRA divided by their remaining life expectancy. For example, let’s say you have $100,000 in your IRA and the beneficiary is your 10-year old grandchild that is expected to live another 75 years. They would then have to take 1/75th of $100,000, or 1.33%, in year one. The next year they’d take 1/74th and so on. Since the withdrawal rate is low, chances are the IRA will continue to grow for many years and as it does the annual withdrawals will increase as well. As you can see, the younger the beneficiary the longer and greater will be your legacy. What happens if the person who inherited your IRA dies prematurely? Their beneficiary can continue to take the same payments the deceased beneficiary was getting until all the money has been withdrawn. If the IRA was a Roth, all withdrawals will be tax free – what a gift to leave as your legacy.

Why might you want to convert to a Roth IRA? There are many reasons but here are the principal ones:

1. When money is withdrawn by you, your surviving spouse or a non-spouse beneficiary there are no income taxes, not even on the earnings. So if your $100,000 grows to $500,000 while in a Roth, zero taxes are paid on the growth. How sweet is that?

2. Roth IRAs have no required minimum distributions – you don’t have to start withdrawing money at 70-1/2, or at anytime during your lifetime. No doubt many of you are taking RMDs from your Traditional IRAs and wish you didn’t have to.

3. If you are now paying taxes on your Social Security benefits, converting to a Roth might lower your tax bill.

4. Since you don’t have to take the Roth IRA money during your lifetime, this could be your emergency fund if not needed for retirement. If not used in your lifetime, your heirs will enjoy your tax-free legacy.

5. Which way do you suppose taxes are headed? If you said higher, I’d agree with you. So why not pay the taxes now on your Traditional IRA money before rates go higher? If you don’t know for sure which way taxes are headed, just convert some to a Roth IRA.

6. The only disadvantage to a Roth is that you must pay taxes on the amount converted, but you can convert a portion each year to keep your taxes in the lowest possible bracket. You’ll want to discuss this with your financial or tax advisor.

Roth IRAs are not for everyone, but if you’re concerned about taxes going higher, tired of taking RMDs you don’t need or want to leave a tax-free legacy for your loved ones, you should investigate converting some or all of your Traditional IRA money to a Roth.

What about the required minimum distributions (RMDs) you must take? If you don’t need the money for your retirement you have several good options including:
1. If medically qualified you could use RMDs to purchase a long-term care insurance policy. Long-term convalescent care is something that a majority of retirees will need – especially the gender that lives longer: that’s you ladies! The best strategy for LTC coverage is to purchase what is called linked-benefit coverage: insurance that covers you for LTC if needed, but if not, pays your heirs a death benefit. Ask your financial advisor for details.

2. If you think future taxes will rise, why not use the RMD to pay the taxes on converting to Roth IRA? You could stretch the conversion over several years to make sure you stay in the lowest possible tax bracket. At the end you’d have no RMD requirements and all the money, plus earnings, would be tax-free when used by you or your heirs. An added benefit could be lower taxes on your Social Security benefits.

3. If insurable, you could use the unneeded RMDs to purchase life insurance that will provide your heirs a tax-free legacy. There are many options including multi-generational ones that can stretch to grandchildren and beyond. Of course, you can also name a favorite charity, church, research organization or friend as to receive the tax-free life insurance benefits. By the way, you do not have to be in perfect health to qualify for life insurance.

4. You could use the unneeded RMDs to establish a college fund for your grandchildren, establish a savings account that could later be used for a down-payment on a home or any number of future financial needs. You can even buy a life insurance policy that will pay your grandchildren a stipulated amount of money on every birthday for the rest of their life – now that is a legacy that will keep your name in circulation long after you’re gone.

Of course there are other important things about IRAs, but hopefully I’ve given you a basic foundation about what you can and cannot do. Here are the things to remember:

1. If you have retirement money at an ex-employer, you need to move it to an IRA immediately. Your financial advisor can help you.

2. The Stretch IRA is for the next generation and you must have a named beneficiary for it to work.

3. The Roth IRA is an excellent way to reduce future taxes, leave a tax-free legacy and lower taxes on your Social Security benefits.

4. If you’re taking required minimum distributions not needed for retirement, there are several excellent ways you can use them to benefit you and/or your heirs.

I sincerely hope the foregoing gave you some good ideas. Remember, one of the biggest mistakes most retirees make is trying to solve financial and tax puzzles without the help of a professional. I hope you will find and work with a financial advisor.

Shelby J. Smith, Ph.D.
June 2011

Life insurance and broccoli have a lot in common: not many people like either one. Taxes and life insurance have a lot in common, too. You can’t discuss life insurance without talking about taxes as we’ll see shortly.

Our governments – local, state and federal – are living beyond their means. They’re spending money they don’t have. This cannot continue indefinitely because there is a limit to how much we can borrow and print. Washington knows that spending and revenues must come into balance before forces beyond their control compels a correction. They can (a) cut spending or (b) raise taxes, and I think we all know that meaningful spending cuts will not happen, so that leaves higher taxes. The consensus opinion is that federal taxes of all kinds will rise soon and substantially.

State and local government are also facing revenue/spending imbalances but by law budgets must be in balance. So, services are being cut, property and other taxes are rising, workers are being laid off and revenue from all sources is decreasing. The only feasible solution: state and local taxes will increase substantially and soon.

No doubt you want to pay your fair share of taxes but not one penny more. I bet you’d love to reduce your taxes if it were easy and legal because one dollar less in taxes is one dollar more for retirement. The number one fear of most retirees is running out of money and saving taxes is one way to lessen this fear.

Everyone hates life insurance but probably not more than they hate taxes. Life insurance can reduce taxes! Every financial product has its advantages: bank deposits have FDIC insurance that makes them super safe; many investments benefit from tax breaks like capital gains and lower taxes for dividends; life insurance companies provide tax-deferred and tax-free benefits. For example, tax-deferred annuities let you escape taxes on earnings until you actually withdraw the earnings; life insurance offers tax-free benefits to you and your final beneficiaries. Income tax-free benefits as part of your retirement plan are what I want to talk about.

Let’s say you own investments, real estate and other assets that are more than you’ll need for retirement. What you’ll not need for retirement is ear marked as your legacy to loved ones. Of course, not every retiree is this fortunate and in a moment we’ll talk about other ways life insurance can be used by average retirees.

Federal Estate Taxes are now levied on estate of $5 million or more; however, the estate size subject to taxation is expected to drop to $1 million in 2013 and beyond. The federal estate tax starts at 35% and the top estate tax rate has historically been 55%. States also have “inheritance taxes” on top of the Federal Estate Tax. Since retirement can last 30 years or longer, the value of real estate, farms, ranches and family business are likely to grow substantially during your retirement; thus, you might want to anticipate an estate tax even though it wouldn’t currently apply.

From where will the money come to pay your estate and inheritance taxes? Will heirs have to sell the farm, ranch, real estate or family business? If so, will the market be good or bad? If in 20 years your estate will be $5 million and estate plus inheritance taxes are 50%, $2 million will be needed to settle your estate. Where will your loved ones get that kind of money without selling your assets? Life insurance to the rescue! You purchase a $2 million life policy now and pay annual premiums for a set number of years. Once the policy is “paid up” your premiums stop, you can borrow the cash value, tax-free if needed, and your heirs or estate will get $2 million tax-free to pay the taxes. The business, farm, ranch or real estate stays in the family because you planned by using life insurance.

Are your assets exempt if you have a will? No! Some retirees avoid estate taxes by using various trusts, but generally this is economical only for large estates. Saving estate taxes makes life insurance financially smart – even if you live well beyond your expected lifetime. You should not look at life insurance as an investment even though generally the rates of return are more than competitive. If you die prematurely, the earnings rate from life insurance would be astronomical but if you live longer than expected it will be less. Either way, it greatly exceeds the estate and inheritance taxes you’ll pay without the tax-free benefits of life insurance. You should work with a financial advisor so your exact needs are met – one size does not fit all.

Let’s say you’re worried about spending your later years in a nursing home. By the way, Ladies, this is far more likely for you than your husband, as a trip to a nursing home will show…not a lot of gentleman, just ladies. So husbands take care of your spouse by making sure expensive nursing home costs are covered. Contrary to what you might think, Medicare does not cover long-term convalescent care. There is a welfare program, Medicaid, that does but don’t expect very good care.

There are three ways to cover long term convalescent care: (1) set aside sufficient money and self-insure: the problem is how much is enough especially if life’s lottery deals you a cognitive impairment life Alzheimer; (2) you could purchase a traditional long-term care insurance policy that pays if you actually go to a nursing home or receive long-term convalescent care in your home: the problem is “if you don’t use you lose”; (3) purchase a life insurance policy with a convalescent care rider that provides tax-free benefits if needed. This option avoids “use it or lose it” because the policy will still pay tax-free death benefits.

Life insurance with a long-term convalescent care rider will pay a multiple of the death benefits over a set period if long-term convalescent care is needed. Here’s an example: your life policy might pay $250,000 at your death but if long-term convalescent care is needed it could pay $750,000 tax-free in equal monthly installments over four years. If convalescent care is not needed, your heirs will receive $250,000 tax-free at your death. You’ll still have access to the policy’s cash value in case you need the money. Some policies refund all the money you paid into the policy if you later change your mind and cancel the policy. Many retirees use life insurance for this purpose, especially the ladies.

Are you being forced to take required minimum distributions you don’t need from your retirement account? What’s more, do you wish you didn’t have to withdraw the money and pay taxes on it? If you’re taking the money and putting it in the bank or investments, there may be a better way if you’ve earmarked the money for heirs. It might be smarter to use this money for a life insurance policy that would provide your heirs tax-free money. You’d still have access to the cash value if needed during your lifetime.

We’ve only talked about three ways for retirees to use life insurance; however, there are many more smart ways to use life insurance to avoid paying taxes. Naturally, you must be “insurable” to get life insurance. This doesn’t mean perfect health because most people not chronically ill can get life insurance. If you think future taxes will rise and tax-free life insurance could meet your needs, I encourage you to discuss life insurance with your financial advisor sooner rather than later. There’s an old dictum in life insurance: you can always be early but never one day late. The future is uncertain!

To summarize what we’ve discussed, here are the ways life insurance can benefit retirees. First, if your estate will be taxed at your death, tax-free life insurance money can keep your estate intact and in your family. Second, if you’re fearful of needing expensive long-term convalescent care, only life insurance can provide tax-free living benefits as well as tax-free death benefits. Finally, if you are forced to take money you don’t need from your retirement accounts or have more money than needed for retirement, you can use life insurance to leave a tax-free legacy to your loved ones. The smart way to investigate what is best for your circumstances is to discuss life insurance with your financial advisor. Please make sure you understand the coverage and that you can afford what is recommended without sacrificing your retirement lifestyle.

Shelby Smith, Ph.D.
May 2011

The greatest fear of most retirees is running out of money before they run out of retirement. If you’ve experienced this fear, you’ll be interested in my comments about why this is sometimes a self-fulfilling prophecy.

Hello, I’m Dr. Shelby Smith of The Retirement Pros and my objective is to help you have a better retirement – it costs nothing to listen and I’m confident you’ll learn some things of value.  So, why do retirees fear running out of money?  Can they do things differently to lessen the chances? 

During your working years – and possibly you’re still working – you probably participated in your employer’s retirement plan and/or you had a systematic savings plans that you added to faithfully.  If you participated in an employer-sponsored retirement plan like a 401(k), 403(b), 457 you would have put part of every paycheck into the plan where it would grow tax-deferred.  Hopefully your employer made matching contributions to your account and also, hopefully, your money enjoyed good growth.  Neither of these are certain because employers are not obligated to make matching contributions and we all know that money invested in the market — mutual funds, variable annuities and stock of your employer may not have grown as you would have liked.  Regardless, someone else was managing your money and that’s the point I want to make.  Yes, you may have been making the selection on which option you wanted, but the active money management was done by someone else.  And frankly, most employees participating in their employer’s retirement plan generally make their investment selection based on the recommendation of a co-worker, spouse or friend that supposedly is knowledgeable about such things.  You may now know that they didn’t know any more than you.  Your employer generally does not give advice when it comes to investments.  

So, what happened on the day you retired or maybe shortly following your retirement?  The typical situation is that you were given a large check which went into an IRA or other account and you assumed responsibility for the management of your retirement money.  Let me ask you: did you have the knowledge, experience and know-how to manage your money?  If so, you are not the average retiree.  Your specialty was probably something else – teaching, engineering, sales, construction, retail, legal, medical or another profession that did not involve the management of money.  Managing money without expertise is no different than trying to do what you did for a living without training, experience and know-how.  Money management is complicated, constantly changing, involves numerous options and requires years of study to be good at it.  Eventually, most retirees discover they need help with their money management and seek professional help but far too many are distrustful, think they can do it better and the results are generally not so good. So the first reason many retirees outlive their money is because they attempt to manage their retirement money without professional help.  I hope you’re not one of them.

Maybe you chose to work with a broker that works for a Wall Street firm. Stock brokers generally recommend stocks, bonds, mutual funds, variable annuities, REITs, limited partnerships, options, diversified portfolios or other “investments of the moment”.  The one thing all these have in common is “market risk”.  The market goes up and down with economic and financial cycles and so does the value of the investments in the market.  Before you speculate on which way the market is likely to go, you need to ask yourself: “what happens to me and my loved ones if I lose some or a big part of my retirement money?”  Possibly you were told that “in the long run you’d be just fine”, and maybe that is true, but no one knows what will happen in the future.  The two major market meltdowns since 2000 prove that there is risk.

If you take risk you have the probability of making a higher rate of return but it is not guaranteed. Market risk is generally suitable if you have more money than will be needed for retirement, but if all your money will be needed for retirement you should be extremely careful about the risk you take. The best way to make sure your risk is suitable is to work with a financial planner, carefully consider their recommendations and make sure you understand the consequences of the options chosen.  Ask questions like what happens to the value of my investment if the market falls, rises or stays the same and when can I get my money back if needed for an emergency.  Also, can I get my money if needed without big losses, will this investment guarantee me a lifetime of income, what are the tax consequences and any other questions that concern you.  Do not just take everything at face value – know what you are investing in and make absolutely sure you understand it.  The second big mistake most retirees make that causes them to outlive their money is taking unsuitable risks – if you can’t afford losses, then don’t gamble your money.

Those retirees that were burned in the market or that realized from the outset that “the market” was too risky for them are prone to make an equally serious mistake: putting all their money in super-safe bank deposits.  Granted you’ve eliminated the risk of loss but have taken on another type of risk: earning less than a market return.  We all know that a dollar lost is a dollar not available for retirement.  And, if the dollar is not earned due to below-market earnings it, too, is lost and not available for retirement.  Those that chose the 100% bank option now find themselves locked into the lowest interest rates in a generation.  Low bank rates may have forced you to dip into your principal.  You don’t have a lot of good options now: if you go back into the market in hopes of getting better returns, you assume risk and possible losses; if you select longer term CD maturities you possibly lock in very low rates for years to come; if you stay where you are you’ll worry that inflation will erode your purchasing power.  On the other hand, if you were experienced in money management, you would investigate “laddering” your money in different maturities so it would come due when needed.  Laddering assures you’ll earn the “average” amount over the cycle rather than guessing when to “go long or stay short”.  The third mistake many retirees make that causes them to run out of money is keeping all their money super-safe in short-term bank deposits as if all the money will be needed tomorrow.

Most retirees, and also brokers working for Wall Street firms, measure retirement money by “how tall” it is rather than “how long” it will last.  Since the greatest fear is running out of money, doesn’t it make sense to think in terms of “how long” rather than “how tall”?  Wall Street always touts “how tall” because they can’t guarantee “how long”.  Yes, they have models that predict how long your money might last but there are no guarantees because the market is not predictable.  The insurance industry, on the other hand, has developed policies that do guarantee you a lifetime of income – they’re called fixed annuities and they are backed by the full faith and credit of some of the world’s oldest, strongest and most trusted insurance companies.  The same companies that insure your home, car, boat, health, life, business and virtually every other asset you have.  But when it comes to “retirement money” the typical retirees don’t even consider the insurance company and the guaranteed lifetime income.  The fourth reason why retirees run out of money is because they do not consider all the options, even the safe ones like fixed annuities.

Another area that needs your attention is taxes: retirees have a tendency to pay too much because they don’t plan.  For example, let’s say you have $250,000 in a bank CD that is ear-marked to be used during late retirement and let’s also assume the CD is earning 5%.  Annually you’re earning $12,500 in taxable income that you don’t need until late in retirement. If you’re in the 25% tax bracket you’re paying $3,125 in taxes. What if you invested this money in a tax-deferred place?  Tax-deferred means you’d pay no taxes on the earnings until you actually withdrew it.  The $3,125 annually would continue to earn interest rather than going to the IRS and over the years would add up to a lot of money.  Also, the extra $12,500 in income you’re earning from your bank CDs will boost the taxes you pay on your Social Security benefits.  If income taxes rise, as I’m confident they will, tax-deferral could give you a big advantage.  Your financial advisor can show you several suitable tax-deferred options so you can get triple compounding on your retirement money: interest on principal, interest on interest and interest on money now being paid to the IRA. The fifth reason retirees run out of money is because they pay the IRS money that they could have used for retirement.

So, what’s the solution?  It’s simple: you need to become a financial expert or find one to work with. I know you might not trust anyone or think you can do it better; however, please know there are many hard working, honest financial advisors that make their living helping retirees prepare for a better retirement.  If you elect to continue to be your own money manager, then learn as much as you can and make sure you righteously safeguard your retirement money because I suspect these next few years are going to present some serious challenges as the economy, markets, banks and retirees adjust to the irresponsible policies of our nationally elected representatives in Washington.

Thanks for your time and please have a wonderful day and an even better tomorrow.

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

What follows is a “hands on” approach to taking good care of your retirement money. Keep in mind that everyone has different needs, aspirations and plans – meaning your retirement plan will be unique. One size does not fit all.

There is a logical and commonsense approach to how you can have a worry-free retirement without financial headaches, and it is presented in a book by David Vick. Dave is a financial planner and his book for the retirement minded is: Bat-Socks, Vegas and Conservative Investing. Dave calls his approach the ABC Planning Process.

To start you should imagine that all the money you’ve saved for retirement is in cash – not the case of course, but assume it is. You’re 100% liquid and can invest wherever you want. How would you re-invest the money and why? What assets would you hold – stocks, bonds, mutual funds, bank CDs, annuities, real estate, options, commodities or something else? Most people don’t know what they would do if they could start over, but by using Dave Vick’s ABC Planning Process it is easy to decide which assets to own and how much of each.

Imagine that all the retirement money you have will be put into three buckets – a green bucket, a yellow bucket and a red one. This green, yellow and red color scheme resembles a stop light at a busy intersection: an intersection with lots of cars, crazy drivers and a high risk of having a wreck. An intersection, much like the crossroad of working years and your retirement years: conflicting signs, uncertainty and the potential for bad financial decisions that could wreck your retirement plans.

Let’s start with the green bucket. The money you put in the green bucket is your “protected growth money”. From the green money you should expect potentially moderate growth along with safety of your principal – no possibility for loss. Just as a green light means safety, so does the green bucket. In addition to safety for your green money, you’ll also want some liquidity, tax deferral would be nice and peace of mind is a must.

There are three rules for green money:
1. Your principal must be protected.
2. If you had earnings last year, they should be added to your principal and cannot be lost in the future, i.e., retaining your gains is a must.
3. Green money can be turned into a lifetime of income you can’t outlive.

The best example of green money would be fixed annuities because all the green money rules are met. Green money could also include cash value life insurance, certain government savings bonds like Treasury Inflation Protected bonds and possibly other safe money options. To use a golf analogy, green money is what you’ll need during the front nine of retirement. Since the green money is your safe money, how much you want in the green bucket will depend on how much retirement money you have, what would be the consequences of losing some of it and your tolerance for risk? If you can’t sleep if your money is at risk, then relatively more of your retirement money should be green.

The yellow money is what you’ll need for everyday expenses and to pay for unexpected emergencies. Yellow money will earn a low rate of return because it must be safe and have high liquidity. Yellow money should have no risk of loss. Liquid means it can be turned into cash on short notice and without suffering a loss. Examples of yellow money are bank CDs and deposits, savings accounts, money market accounts, very short-term government bonds and other safe assets that are matured or due to mature very soon.

The red money is what is at risk and in danger of loss. If the risk is high then generally the potential return is also high. The red money is earmarked for the back nine of retirement or is money you’re unlikely to need for retirement. Red money could be the legacy you want to pass to your loved ones or a favorite charity. How much you put in the red bucket will be determined by several things including your attitude about risk, past experiences with risk, how much money you’ve saved for retirement, the consequences of suffering a loss and your peace of mind or ability to sleep knowing losses are possible. Examples of red money places are stocks, bonds, mutual funds, variable annuities, REITs, options, ETFs, commodities and other investments that can go up and down in value. Naturally the percentages of green, yellow and red money chosen will vary widely by retirees, even among retirees with the same amount of retirement savings.

There you have the three hues of money – green, yellow and red. Since you’ve assumed all your money is liquid and you could put it anywhere you wanted, what percent would you put in each bucket? Without thinking too hard, write down the three colors and put a percentage beside each that you feel is appropriate for your circumstances. It could be 60% green, 20% yellow and 20% red or any other percent with which you feel comfortable. There is no right or wrong answer – just jot down what you’re thinking.

Not an easy assignment, is it? Not for sure you got it right, are you? Not to worry because most retirement-minded people have trouble making allocations to the green, yellow and red money buckets. Maybe there is a better way.

Let’s first work on the yellow money. If you considered all your income sources – pension, minimum required withdrawals from IRAs, Social Security benefits, income from rental property and other money coming in you can count on, you’d have your total income. If you then subtracted all your expenses like food, medicine, housing, household purchases, clothing, entertainment, taxes, insurance, travel and others, you’d have your total outgo. If your outgo exceeds your income, you’ll need to reserve a few years of the shortfall and put that money in the yellow bucket. If your income is sufficient to cover expenses, you’ll only need to reserve for emergencies and other big ticket purchases you’ve planned for the next few years: new car, boat, dental work, helping kids with college, home repairs, etc. You’d also put this money in the yellow bucket. The yellow bucket amount is the easiest to determine, but if you keep more than needed in the yellow bucket you’ll be giving up earnings. Overdoing the yellow money is a common mistake of many retirees because they keep most, or all, of their retirement money in bank deposits as if it were going to be needed tomorrow. Remember, no risk means low returns, and low earnings could mean less for your retirement years.

Now let’s jump to the red money. A good rule of thumb that Dave Vick uses, and which is a standard in retirement planning, is called the Rule of 100. This Rule of 100 says to subtract the age of the oldest spouse from 100 and express the answer in percent. This percent is the most that should be kept in the red bucket. For example if the oldest spouse is 72, then no more than 28% should be in the red bucket: 100 – 72 = 28, or 28%. The world will not end if you miss by a few percentage points because the Rule of 100 is a guideline, but you’ll want to stay close to the percent shown by the Rule of 100 unless you have unusual circumstances.

Since the yellow money and the red money have been determined what’s left must go into the green bucket, right? Pretty simple approach to allocating your retirement money into the right categories and you’re encouraged to go through the exercise. The ABC Planning process helps you determine how to allocate your retirement money among the various options. Of course your retirement money is probably not 100% liquid, so you now will be faced with actually implementing your ABC Plan into green, yellow and red money. Let’s review the colored buckets into which retirement money should go.

First is the percentage that will be needed for daily living, expected large purchases and emergencies for the next three to five years. This will be your yellow money. Yellow money is best kept in bank CDs, savings & checking accounts, money market accounts or other safe places. Yellow money can be turned into cash quickly without loss.

Second is the red money. The proper amount can be determined by using the Rule of 100. The guideline is 100 minus the age of the oldest spouse expressed as a percent. Your red money will potentially have a higher growth rate but will also have higher risk of loss. Red money places are stocks, bonds, mutual funds, variable annuities, options, commodities, REITs and other market investments. This money may be convertible to cash quickly but you could also suffer a significant loss. Red money is for the back nine of your retirement.

The rest of the money goes into the green bucket. This is protected growth money that has the potential for moderate growth but is safe from risk. It is kept in fixed annuities, index annuities and possibly super safe short term bonds. The three rules of green money are: (1) protection principal, (2) earned gains are retained, and (3) at your option can be converted or used for a guaranteed lifetime income.

You now have the percentages you’d want if you could do it over again. Compare this to where you are now. Simply review all your current investments, savings and cash holdings and put them in the green, yellow or red buckets. Compute the percentage in each bucket and compare to your “ideal” position. Dave Vick’s book does this by showing you before and after color pie charts. Would you believe that most retirees would like their pie chart to have a large green slice and a small red slice? And would you also believe that most retirees actually have a pie chart that has a large red slice and a small green slice? If the two are different you will want to start re-arranging until you get to your ideal.

A word of caution: it is recommended you work with your financial advisor to do the re-arranging. To get the best results you’ll need professional help unless you’re a financial expert or are willing to become a financial expert. By going through the exercises suggested above, you should now have a good idea of what you want and where you are currently. Unless you are willing to make the needed changes, you will continue to face a very dangerous intersection where retirement mistakes are easy to make. The typical retiree needs a professional chauffer to take them through the intersection where working years turn into retirement years. Unfortunately far too many attempt the crossing without help and suffer a market crash, wrong turn or other mishap that causes them to realize their greatest fear: running out of money before retirement ends.

David Vick’s ABC Planning book (Bat-Socks, Vegas and Conservative Investing) can be purchased at: www.lulu.com (do a search for David Vick). It’s a fun read and chocked full of great stuff that will help you have a better retirement.

Shelby J. Smith, Ph.D.
March 2011

What’s your biggest worry about retirement? The most common among retirees is outliving their money. This is called longevity risk and my topic today is how to avoid this risk in retirement.

If you’ve had money in the market these past several years, chances are you know that your money is at risk. I know you’ve been told that in the “long run” you’ll do just fine but have you ever asked what “long run” means? The stock market averages are currently at about the same level they were a decade ago because the market has suffered two major market meltdowns in recent years: the first coming in 2000-02 when the tech bubble burst and the second from 2007-09 when the Great Recession hit. If something is unpredictable, it is risky – risky means you can lose your money. If you lose your retirement money you have no way to replace it; thus, if you can’t afford losses you need to be cautious about market investments. Can Wall Street or your broker predict or control market risk? They cannot, but they encourage you to put your money there nonetheless.

There are several messages from Wall Street about managing risks. The most common is “diversification”. Spread your money over many investments – stocks, bonds, mutual funds, variable annuities, Real Estate Investment Trusts, commodities, master limited partnerships, etc. On the surface this sounds prudent and a great way to manage risk…that is until you realize that a falling tide lowers all boats. Have you noticed that all Wall Street recommendations are “market connected”? If the entire market drops from 14,164 to 6,547, all market investments lose value regardless of diversification. This drop is exactly what happened between October 9, 2007 and March 9, 2009. The bottom in 2009 put the market at about the same level as in mid April 1997. End point to end point over this 12-year period, the market was the same – it was much worse if you take inflation into account. Let’s see, 12 years is about half of your retirement years – can you delay using your money until the last half of your retirement? If not, please realize that if you have to use your money when the market is down it will not last nearly as long. By the way, the market is still considerably below its last peak in 2007?

Will the market melt down again? We don’t know. If it does melt down, when will it come back? We don’t know. Does this sound like risk to you? Of course it does. Accordingly, how much of your retirement money should you have exposed to market risks? There is no clear-cut answer because that depends on your circumstances. For those who have more than enough for retirement, taking market risks may not threaten their retirement but for those with barely enough, or maybe not quite enough, market risk could be a frightening thing. In retirement, avoiding risk is more important than during your working years because you have no way to replace losses; therefore, doesn’t it make sense that your investment “style” should change in retirement? Are you still managing your money like you did during your working years? If so, you might need to change!

How do you determine how much risk is enough? If the next market down-cycle cut your retirement money in half, could you live with that? Could that happen? It has in the last decade, not once, but twice. If your financial advisor or broker says not to worry you’ll be fine in the long run – press them for the worse case outcome and ask: “how long is long run”. Remember, it is not their retirement that is at risk, it is yours. The market has risks, as well as rewards, but in retirement you should be more concerned about the risks. My advice: work with a financial professional, listen closely and ask lots of questions and make 100% sure you understand the risk and suitability before committing your money to the market. While diversification can help manage risk and is generally better than no diversification, you cannot safely lock up a retirement income by diversifying with 100% market investments because the market is volatile, and that makes the outcome uncertain.

There is currently a lot of focus on investing for dividends. Many American companies, old and new, pay dividends. What’s more, currently dividends are taxed at a low rate of only 15%. One message you’ll hear from Wall Street is buy blue chip stocks that pay good dividends and don’t worry about the price of the stock – if it goes up that will be great, but if it goes down you’ll still have your dividend. That’s a tempting choice in today’s world of near-zero interest rates on bank CDs and gilt-edged bonds, but as we learned from the near meltdown of the economy during the 2007-09 Great Recession, blue chip companies guard their cash by cutting dividends. Sometimes the outcome is worse as we learned from General Motors, Citibank, Merrill Lynch, Lehman Brothers, AIG, Blockbuster Video, K-Mart and other huge American companies that had to resort to government bailouts, forced mergers or bankruptcy. Will history repeat itself? We don’t know and that is the risk we face. Remember, since dividends can be, and often are, cut in hard economic times, you cannot lock up a retirement income with dividend investment alone.

What about bonds? They pay fixed rates of interest. Two problems with bonds: first, if you need your money before maturity and rates have risen since you purchased them, you’ll have to sell at a loss. This “interest rate risk” is also true for fixed-rate U.S. Government bonds as well as all other corporate and government bonds. Second, with bonds, other than U.S. Government ones, there is credit risk – sometimes bond issuers cannot honor their obligations and they default. You may rationalize there is no risk by buying only AAA rated bonds, but remember that bond rating can change. Again, do your homework, consult with a professional and proceed with caution because while bonds are touted as a good strategy for your retirement money, there is risk – and risk means you cannot lock up a guaranteed lifetime income with bonds.

We haven’t talked about bank CDs! I think you know the risk – in uncertain economic times rates go to almost zero and so does the income you earn on your money. Yes, you can buy longer term CDs but most folks don’t because they’re fearful rates will rise and they’ll be stuck in lower rate CDs. While bank CDs are rock solid safe and your principal is never at risk, falling rates can push your retirement income down and inflation can eat away at your purchasing power. Many retirees learn the danger of bank CDs when rates crashed in 2007. Banks are a great place to keep your rainy day money you’ll need for emergencies and other purchases you’ll make in the near future. However, before you put all your retirement money in banks, remember that being too conservative is also risky and can have a big cost. I like to say bank CDs and chocolate are great, but both are easy to overdo. Bank CDs alone are not the answer to locking up a lifetime income for retirement.

There are other things we’ve not discussed – real estate for example: usually high maintenance, risky and hard to sell if you need cash quickly. Generally not a suitable place for all your retirement money and certainly will not give you a lifetime retirement income in a poor rental market.

A lot of folks are moving their retirement money to gold and other precious metals. Why? I’m not sure because history is clear about the risk: gold is a speculative investment. You can’t eat it, it will not give you shelter, you must protect it from theft, it’s costly to store and you buy retail and sell wholesale. If you feel that gold is a must for you, talk to your financial advisor about recommending to you a gold mining stock – that’s gold still in the ground so you don’t have to worry about storage costs, theft and it is easily sold if needed. Gold is not a place to put your money if you need an income in retirement.

The last option is one you’ve not heard a lot about but one that holds exceptional benefits for many retirees. As you know, retirees are the fastest growing segment of the U.S. population and their numbers will accelerate rapidly as the 76 million baby boomers enter retirement over the next two decades. Every 7.5 seconds someone in America turns age 65 – that’s 10,000 a day and 4 million a year – and this trend will continue until 2030.

The longevity risk faced by retirees that I mentioned at the beginning is no different than other risks. Normally we buy insurance for risks we face or assets we want to protect – cars, homes, boats, health, life, businesses or you name the risk. We pay an insurance company to manage this risk for us – and you’ve got to admit they’ve done a pretty good job over the centuries. Insurance companies manage risk by spreading it over many policyholders. For example, you buy homeowners insurance at a fraction of the cost of your home because the probability your home will be damaged is small. But the risk of loss is too big for you to shoulder alone; thus, you willingly buy homeowners insurance. Those that do not suffer damages help pay for those that do – the insurance company is simply managing the process, collecting the money and for this, earning a profit. All types of insurance works by spreading the risk.

Along comes a growing population of retirees and they “want and need insurance for their longevity risk”. The insurance industry has obliged them by creating a policy that guarantees a “lifetime income regardless of how long they live”. Yes there is a cost: the same as any insurance, but the policy protects against longevity risk. The policy is called a fixed annuity with a guaranteed lifetime income benefit – I know the name is long and confusing but insurance companies have a way of making simple things complicated. Here’s what the policy does:

1. You can start your income account with the payment of premiums, either lump-sum or in installments. Thereafter, your income account is guaranteed to grow at a given rate (generally between 5% and 8% annually) every year until you start your income. You’ve got to admit that beats what you’re doing now unless you’ve gotten very lucky in the market.
2. When you retire the income you receive is based on your income account at the insurance company – the annual percentage typically starts at 5% at age 60 and goes up with age. You can generally start the income immediately if you don’t want to wait for the growth.
3. You can stop your income and withdraw your money lump sum – this flexibility is good in case you change your mind, have an emergency or need the money for something else.

Let me give you a high level overview by way of example: Let’s say you take $250,000 from your 401(k) and put into such a policy because this will give you the right amount of retirement income when combined with your Social Security benefits. Of course, you can do more or less depending on your circumstances. Let’s further say you purchased the annuity at age 60 and leave it with the insurance company growing at 7% annually until age 70. At age 70 your income account will be about $492,000 – you’ll not have paid taxes on the earnings because annuity earnings are tax-deferred meaning you only pay when you take the money out. At age 70 your income factor is 6% – meaning you’ll get 6% of $492,000, or $29,500 a year, from your annuity for as long as you live. You cannot outlive your money because it is guaranteed to continue until your death. What’s more if you die prematurely, your heirs will get the balance in your account. If your account balance goes to zero there is nothing left for your heirs, but your income will continue for as long as you do. There are no “gotchas” and no exceptions – you have the guarantee of the insurance company. Now before you complain about trusting an insurance company with your retirement money, remember you already trust them to protect your other assets: homes, cars, boats, life, business, health and more.

Like all insurance policies there is legal language because it is a contract; thus, I recommend you purchase a longevity risk policy by working with a professional financial advisor to make sure everything is right for you. The long and short of this option for a guaranteed lifetime income is safety, predictability and peace of mind.

Those that die before the mortality tables say they should subsidize those that live beyond their life expectancy. You’ll be surprised at the modest amount of money it takes to get the guaranteed lifetime income you’ll need and how easy it is to qualify – unlike other insurance there are no medical examinations nor will you be turned down for poor health. If this option is of interest, ask your financial advisor to explain the process and details – make sure you learn as much as you can, read the materials supplied by the insurance company and get answers to all your questions.

I personally like this simple solution for longevity risk. No worry about the market, rates going up or down, safety of your money, or “what’s my income going to be next month or next year”. Most retirees don’t think in terms of how long their retirement money is because they’re too busy worrying about how big, or high, their retirement money is. Folks, it’s how long your retirement money is that’s important. Lay your retirement money on its side as a guaranteed lifetime income rather than worry about how big it is. If the annuity option I’ve explained will get the income you need with less than all your retirement money, then have a ball speculating in the market with the excess…or use it to treat yourself to something you’ve always wanted but were afraid was too expensive. You’ll have your lifetime income guaranteed – peace of mind is what retirement is all about.

There you have it – we reviewed all the major options for lifetime income and you now know the one I recommend. If you haven’t already, take a look at the annuity option. This is not to say the market, banks, bonds, stocks and the other options are bad for everyone – I’m simply saying you get no guarantees with them. If you entrust some of your retirement money to the same people that safeguard your other worldly possessions like homes, cars, businesses, boats, valuables and more – insurance companies – you can rid yourself of the longevity risk that comes with retirement.

Thanks for your time. I hope you’ll follow my advice and work with your financial advisor to select options that are suitable for you – and if don’t have a financial professional on your retirement team you should find one. Have a great day, a wonderful retirement and much happiness.

Shelby J. Smith, Ph.D.
February 2011

One topic is front and center for most retirement-minded Americans: Social Security. Will it be there in the future? Will benefits be reduced? What changes will Congress make? When should benefits be started?

I want to bring to your attention several aspects of Social Security that you’ve possibly not considered before. Things that could help you get higher lifetime benefits – I want you to get your decisions about Social Security “right”. The “right” decisions on Social Security will help you and your spouse, if you’re married, have a better retirement. First, let’s paint a background for Social Security and retirement.

All the money you paid into the Social Security fund while you were working has been spent by Washington – mostly on foolish things like bridges to no where and wasteful ear-marked pork barrel projects like the mating habits of boll weevils, indigenous to the high plains of west Texas. The money is gone and in its place the Government has given you IOUs – they’re called Treasury Bonds and Notes. Not to worry, there’s light at the end of the tunnel…and it’s not a train.

Will the government redeem their Bonds and Notes so they can continue to pay you Social Security? I think they will because they have options!

First, take more money from workers now paying into Social Security and pay it to you. Does that sound like a Ponzi scheme where there is no pool of money but old investors are paid with money coming from new investors? Well, it is a Ponzi scheme, but unlike other Ponzi schemes it is legal. There’s a slight problem with the Social Security Ponzi: 75 million Baby Boomers born between 1946 and 1964 are now turning 65 at a rate of one every 7.5 seconds, 10,000 a day or 4,000,000 a year and this will continue for the next 18 years. All the boomers want their Social Security benefits. The ratio of workers to retirees is getting smaller and this means taxing workers more will fall short of closing the funding gap. This leads to the second option the government has to redeem the IOUs to pay your SS benefits: taxes are going to rise…not just on workers but on everybody. I know the politicians have told you that won’t happen – but what always happens when politicians tell you something is not going to happen? Correct, it happens.

Politicians are becoming very good at raising taxes without admitting they’re raising taxes – here’s some ways it will happen.

Print more money! What’s happened in the past couple of years? Government expenditures have exceeded government revenues – to the tune of about $1.4 trillion in FY 2010. The shortfall has been financed by borrowing – but that can’t go on forever, so it is inevitable that more money will be printed UNLESS the government cuts expenditures. Fat chance that’s going to happen! So what does printing money have to do with taxes? Cranking up the printing presses creates inflation – which means everything costs more and if you’re living on a fixed income, like retirees do, your money will not buy as much. So inflation is a “silent tax” but the end result is the same: you have less and the government has more. If Washington just raised taxes you’d vote them out of office – so inflation is the stealth method they use to trick you. So what else can they do?

They could raise taxes, and no doubt such will happen but in a shadowy way – like under-funding states and cities so they have to raise your taxes and in turn take the blame. Expenditures could be cut, but massive cuts are needed to address the problem. Frankly, Washington doesn’t have the fortitude to make the drastic cuts in expenditures to bring the printing presses to a halt. No doubt some or all of the foregoing will be tried at one or more times in the future, but I suspect the problem will not be totally solved. There are only two remaining solutions.

First, the government could refuse to honor its Social Security and Medicare commitments. You’d vote politicians out of office in a flash and they know it. So default is not going to happen – over 50 million voters now get Social Security benefits and another 75 million boomers are turning Social Security age and will also vote to keep their benefits. Default or doing away with Social Security benefits will not happen.

The only remaining option, in addition to raising taxes, cutting expenditures and printing more money is to start whittling away the benefits for current and future Social Security recipients. The retirement age could be raised for future retirees! The annual cost of living adjustments could be lowered or eliminated! Spousal benefits, which are discussed below, could be scaled back! The “wealthy” could be denied benefits! A loophole was closed which permitted previous benefits to be repaid without interest so the recipient could qualify for higher benefits going forward. The reason cited was expense reduction. You’ll pay more taxes on your Social Security benefits – this is a certainty as we’ll see in a moment! So what can you do to protect yourself? Plenty – let’s see what’s available.

Did you know that Social Security benefits grow by 8% annually, plus a yearly cost of living adjustment, if you’re postponing benefits beyond age 62? Age 62 is the first year you can start taking benefits and you never want to delay beyond age 70 because that is when the 8% growth stops. Also, did you know that a surviving spouse gets what the deceased spouse was getting if it is greater? In other words, postponing Social Security as long as possible up to age 70 is probably the best investment you can make! Where else can you get: 8% annual growth guaranteed, not all of the income is taxed (as we’ll see shortly), a government promise that payments will be made, an annual raise for inflation and out of this world spousal benefits?

What could go wrong if you postpone? You might die – when dead you’ll not worry about not getting your Social Security and your surviving spouse will be thankful for the higher benefits resulting from your postponement. The fact is, for a couple aged 62 or more there is almost a certainty that your lifetime benefits will be greater if you postpone as long as you can. If Las Vegas were giving the same odds you’d be there with your retirement money on the table. Postponing Social Security is the smart move if:

1. You can afford retirement without Social Security.
2. You have qualified money – IRA, 401k, 403b, etc.—you can use first.
3. You are the primary breadwinner and have a younger spouse.
4. The non-breadwinning spouse is in good health.
5. You want to save taxes – I’ll explain in a moment

Even though postponing Social Security until age 70 is smart, over 70% of the current SS recipients started before normal retirement age. Why? Mostly because they did not know about the 8% growth and the annual adjustment for inflation, they didn’t know about the super spousal benefits, they were afraid that the government would default on making SS payments, they didn’t know you could save taxes by postponing SS and using qualified money first, or they got bad advice from their broker who said “take it early and invest it in the market so you’ll have more later” – of course, those that followed that advice have generally had less later, not more.

How do taxes work on Social Security? It’s complicated, so bear with me. You first have to measure your Provisional Income – sometimes called Combined Income. This is a special measure of income that includes 50% of your SS benefits and most other income you receive including income from tax-free municipal bonds. Regardless of your Provisional Income, never more than 85% of your Social Security benefits are subject to federal income taxes. That’s why I said earlier that SS is tax-advantaged! Currently, a maximum of 85% of your SS benefits are taxable if your Provisional income exceeds $32,000 and you are single, or if married and filing jointly the level is $44,000. The tax is only on the amount that exceeds these threshold levels. How do you feel about paying taxes on Social Security? Would you like to reduce the taxes? There is a way, I’ll explain in a moment.

Previously I mentioned that if Congress does nothing, eventually everyone will pay taxes on their Social Security. The reason is because these threshold levels – the $32,000 for single and $44,000 for couples – is not indexed to inflation. So, in future years as inflation raises SS benefits above the threshold limits – remember Social Security benefits are adjusted annually for inflation – everyone’s benefits will exceed the thresholds and be taxed. That’s the sneaky way Congress used to make sure everyone eventually pays taxes on Social Security. So the question is: how can paying taxes on Social Security be eliminated or lowered? There are at least three ways you can do this:

1. You can postpone taking Social Security and first use your fully-taxable money – IRA, 403b, 457, 401k or other employer pension plan money.
2. You can put your interest earning money in tax-deferred annuities whose earnings are not counted until you actually withdraw it. Currently tax deferred income is not counted in computing the Provisional income.
3. You can convert IRA money to Roth IRA, pay the taxes now and use the money converted and earnings thereon tax-free later in retirement. Currently, Roth IRA income is not counted in Provisional Income.

By postponing SS benefits, you’ll get more later which means more of your retirement money will be tax-advantaged. You’ll keep more of your money and pay the government less. In other words, by using fully taxable money first while SS is growing at 8% annually, relatively more of your retirement money will be in SS benefits which have lower taxes. So you don’t think this is a small number, research shows that for a married couple when the primary breadwinner postpones SS, their lifetime benefits will be about $200,000 more. That is a meaningful amount of money and it’s yours if you postpone SS and use your fully taxable money first. The brokerage industry argues that the foregoing is incorrect because you could start early, invest the SS benefits and you’d have more later! Sounds logical but does it ring true? Let me dispel the logic by asking you a question: where can you earn 8% annually, get an adjustment for inflation, use on a tax-advantaged basis and get a government promise the money will be paid? I know of no place you can get these sterling benefits other than “postponing SS”.

If you’re married and both are at normal retirement age you can have your cake and eat it too. Here’s how…let’s say John and Mary, a married couple, are each age 66 and both are eligible for SS benefits. Mary is the stronger gender and is expected to outlive John by at least 5 or 6 years – if you don’t think ladies are the stronger gender, visit a nursing home and you’ll see the proof. Here’s John and Mary’s plan: Mary will start her SS benefits immediately, but John will postpone his benefits and become Mary’s dependent. As her dependent, John will get 50% of what Mary gets – and when he reaches age 70 he’ll file for benefits based on his work record. John’s benefits will be about 40% more than Mary’s because he postponed. Since John is expected to pass on several years before Mary, she can look forward to a higher income as John’s surviving spouse. Yes, she’ll miss John, but at least she’ll have the peace of mind of a better income.

How can you lower taxes? Simple! Let’s say you have $250,000 in a bank CD and it is earning you $10,000 a year – dream on, but maybe in a few years it will. This $10,000 is not only fully taxable but also included in your Provision Income calculation – remember this measure of income is what determines the taxes on your SS benefits. Let’s say you’ll not need this $250,000 until several years later – if at all. So you move it from the bank to a fixed annuity issued by an insurance company. You earn the same $10,000 annually, only now it is tax-deferred –meaning you do not have to claim it as income on your tax return. Also, it is not counted in the Provisional Income calculation. Presto, you just lowered your taxes – more for you and less for the government.

Would you like to make future earnings on your qualified money tax-free and also not have to count it as income, or include in Provisional Income, when used? If you think income taxes are headed higher – and I do – or you think you’ll be in a higher income tax bracket when you use your money, then converting totally or partially to a Roth IRA could be a wise move. You pay the income taxes during the year you convert and thereafter all earnings are tax free. What’s more, you can pass it forward to your loved ones as your legacy and they get to use it tax free during their lifetime. Current tax rates are fixed until tax year 2013, unless Congress changes, and then the smart money is betting they will rise markedly to address the huge federal deficits that is adding $1.3 trillion annually to the $14 trillion national debt. You can systematically convert to a Roth IRA over several years to manage your marginal tax bracket, and many astute retirees are doing exactly that because they predict that taxes are headed higher. I would advise you to work with a professional if converting IRA money to a Roth because there are certain limitations that need to be taken into consideration.

There are lots of little tricks like the foregoing in my book, The Guide to Social Security: Higher Lifetime Benefits and Lower Lifetime Taxes. For the full story about SS I recommend you read the book, but if you’re not the reading type, I suggest you get with your financial advisor and work out the best Social Security strategy for you and your loved one. Chances are you can save taxes, get higher lifetime benefits from Social Security, leave a larger income for your surviving spouse to use and enjoy a better retirement.

It is easy to get Social Security wrong because it is complicated, you generally get no advice or bad advice – even from the good folks at the SS office—and everyone wants to start early because they think benefits are going to stop. Yes, Social Security and Medicare will remain legal Ponzi schemes operated by the federal government, but there is no feasible way to stop the charade. Right now over 70% of retirees got it wrong and it will cost them dearly in retirement – don’t join them, get SS right.

My SS book is available free on the website www.theretirementpros.com if you have an interest. Comments and suggestions are welcome. Read it, talk to your financial advisor and get SS right – you’ll have more money and a better retirement as a result.

Shelby J. Smith, Ph.D.
January 2011