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

The “Black Swan Theory” refers to unexpected events that have dire consequences. Since retirement is associated with a financial world that is not fully understood and the knowledge to make good decisions is not always present, unwelcome surprises do occur. Even without retirement’s Black Swans, small mistakes can lead to unfortunate consequences, but with their unexpected arrival catastrophe can strike.

Here are recent noteworthy “Black Swan” appearances:

• Two stock market meltdowns in the same decade (2000-02 & 2007-09);
• The total collapse of the housing and mortgage markets;
• The lowest level of interest rates in the past 60 years;
• The most profound economic recession since the Great Depression.

These totally unexpected events did happen and countless millions of retirees suffered as a result. Years of growth and contributions to 401(k)s, IRAs and diversified portfolios were lost. Homes and investment real estate values were cut in half in many locations. Near zero interest rates of bank CDs reduced comfortable incomes to poverty levels. Will other Black Swans appear? Runaway inflation? Serious medical setback? Widespread default of bonds? Currency devaluations? Another Great Depression? The chances may be small but outliers do occur. To expect the unexpected is prudent.

It is generally accepted by the financial world that if you plan to retire at age 70, it is safe to spend 4% of your retirement money annually if you’ve invested it 50% in equities (stocks) and 50% in bonds. According to mathematical computations, this strategy results in less than one-in-twenty chances of running out of money if you live to age 95. Of course there is no guarantee that comes with this strategy, yet it is the conventional wisdom among those that specialize in “market” investments. The 5% chance occurs randomly, and when it does, you could be facing financial Armageddon. If you can’t afford the 5% failure risk, what can you do?

If you have retirement plans, investment/savings accounts, pension income, etc., it would be a good exercise to “stress test” them to see the consequences. For example, what happens if inflation suddenly rises to 10% annually? How would your retirement be affected if stock values dropped by 50%, your 401(k) balance cut in half or your real estate became worth half as much? What if taxes doubled? Broaden the stress test to include the loss of a spouse, an expensive prolonged life-threatening illness or chronic unemployment. Become a temporary pessimist: consider all bad things that could happen and how each would affect you.

The best way to prepare for Black Swans is to have your financial advisor conduct an annual review and “stress test” for unexpected economic, health and financial changes. While these are hypothetical and may never materialize, observing the consequences in the unlikely event they do happen will open your eyes to assessing the risk you are taking with your retirement money. Once you see the risk, you can generally manage it with more prudent investment/savings options, insurance coverage or a change of retirement plans. To have a solid retirement plan you simply must expect the unexpected. The greatest fear of most retirees is running out of money before retirement ends; however, most have not significantly changed their investment/savings/spending habits from those of their working years, nor do they know that there is an easy solution called a guaranteed lifetime income option from an insurance product. Many of today’s retirees are currently exposed to unfortunate financial circumstances because they refused to consider the Black Swan Theory. Let the lessons of others serve as your motivation to obtain professional help. Call your financial advisor to schedule an annual check-up and take your stress test today.

Shelby J. Smith, Ph.D.
December 2010

We live in trying times, as you painfully know, should your retirement money be in bank CDs or other fixed-rate places. Interest rates are at historical lows and so are your interest earnings. This is driving many yield-starved savers to take more risks with the money they’ve earmarked for retirement. It is important that you make absolutely sure your retirement money is working as hard as possible but is also rock-solid safe. In today’s low interest rate environment many risk avoiding retirement-minded Americans are investing in bonds for the first time in their life. The watchwords are: “Caution: Bond Could be a Four Letter Word”. This is not to say that bonds should not have a place in your retirement plans, but it is important you understand bond basics so you can make suitable decisions with your hard-earned retirement money.

If you’ve read my other blog entries you’ve run across one of my favorite expressions: “Risk and Reward are Traveling Companions”. This simply means that if you are promised above-market earnings potential, you’ll also be adding more risk. For example, if you put your money in the stock of a publicly traded company, you have the potential to earn a very high rate of return – you could double, triple or more if the company does exceptionally well. On the other hand, if the company does exceptionally poor you could lose most, if not all your money. With big upside – lots of earnings potential – also comes big downside – lots of potential for losses. Please keep the “risk and reward” trade-off clearly in your mind as you continue reading.

Most of the people I know in retirement are concerned about damages to their hard-earned nest egg that they’ve planned to carry them through retirement. They realize that retirement is a long journey, the road is winding and the hazards are many – they also know that you can’t borrow the money to pay for retirement. If your working years are behind you, that generally means paychecks are also in the past. Yes, you’ll have Social Security and maybe a pension, but mostly you’ll be drawing down the money you’ve been able to save over your working years. So, taking care of that money is front-and-center in most retirees’ minds – there are enough risks in life without going out of your way to take more. Running out of money before retirement ends is on the mind of every retiree and some are laying awake at night worrying about it. Once retired, you simply can’t afford to lose your retirement money because you have no way to replace it.

The running-out-of-money fear is prompting some retirees to take more risk and that is my topic here. Before bonds are discussed, I encourage you to find a financial advisor and work with him or her to plan the right retirement solution for you and your loved ones. Remember, one size does not fit all and one of the biggest risks you may face in retirement is managing your money without professional help – this is tantamount to being your own doctor, lawyer, accountant, spiritual advisor or pharmacist. I know most people don’t view it that way, but investing your money in suitable places for your circumstances is best done with professional help.

Low interest rates are driving people to consider places they’ve usually avoided because bank CDs, fixed annuities and other safe places are just not paying enough. In recent months there has been a stampede towards high yield bonds and bond funds – bond funds are sometimes called income mutual funds or balanced mutual funds. Also, to get the interest earnings you can no longer get from your bank or a fixed annuity, you must commit your money for longer periods of time or settle for lower quality – either way you are likely taking more risk. Higher rates may be found in longer term and high yield “junk” bonds, along with more risk than the safe-money places. The question is: can you afford the risk? Many of the bond issuers are blue-chip companies, municipalities and other governments, so what could possibly go wrong? Where is the risk? Let’s discuss the basics of bonds.

First of all, all bonds are rated by independent rating agencies like Moody’s, Standard and Poor’s, Fitch and others. Since the rating agencies missed the mortgage melt down and house collapse, we know they are not infallible – in fact, they are sometimes just plain wrong and if so, it could be you that suffers. If your bonds are down-graded to a lower rating, their value will likely drop because buyers will view them as more risky. This is probably the lesser of the risks, but you should know that not all bond issuers are the same and that assigned rating can change over the economic cycle.

The United States Treasury, or the U.S. Government, has the highest rating and you can be assured that your principal is safe. However, your principal will not be repaid until the bond matures and that could be as long as 30 years in the future. So the longer the maturity you choose, the more risk you assume because there is simply more time for something to go wrong – either in your circumstances or the markets. That’s why longer-term bonds offer higher interest rates: more risk. Remember the traveling companions, risk & reward?

If your bonds are issued by a corporation or smaller government entities such as cities, counties and special improvement districts, more things can go wrong than with U.S. Government bonds. History is replete with local governments being unable to repay their bonds at maturity. In recent times many bond ratings of cities and other local governments have been lowered in response to the Great Recession, falling tax receipts, high unemployment and over-spending. The longer you must wait until your principal is repaid, the higher the risk of something going wrong. As you will learn below, the safest of bonds have risk because price and market value are affected by interest rate changes.

Let’s say you purchased a bond a few years back and it has a fixed rate of 8%. This fixed-rate, called the coupon, determines how much in interest earnings you’ll receive from the bond issuer. Your 8% bond is worth more if rates on similar bonds fall to say 3% but would be worth less if the rates on similar bonds rose to 15%. Do bond rates fluctuate this much? Today’s bond rates are very low with 2% to 4% being normal for high quality bonds whereas in the early 1980’s similar bonds offered rates as high as 20%. So, yes, bond rates do change drastically with the economy.

Bond prices and interest rates have an inverse relationship: if interest rates fall, bond prices rise and vice versa. Why? Because if your bond’s coupon is 8% and if a comparable new bond has a coupon of 4%, investors will pay you more because your “cash flow” or “interest earnings” are higher. In other words, they would have to invest more in a lower coupon bond to get the same earnings as you get from your 8% coupon bond…so they would pay a premium to buy yours. Contra wise, if the 8% rate on your old bond is less than that of a comparable new bond, investors would pay less because of the lower cash flow. Of course, at maturity you’ll probably get your principal back but that day could be years, if not decades, in the future. As you’ve all heard, there is a time value of money because a dollar today is worth more than a dollar in the future. If you had your dollar today, you could put it to work earning interest – you can’t do that with the dollars you’ll receive later when your bond matures. Thus, when interest rates rise your future dollars at maturity become less valuable and investors will pay you less for them. The longer it is until maturity, the more your bond price will change for a given fluctuation in interest rates because the lower cash flow will last longer and the principal repayment in the future is worth less.

So if you are keeping your retirement money in bonds, you are also betting on which way interest rates are going in the future. Given that current interest rates are at historical lows, does it make sense to “bet” that rates are going even lower? Doesn’t it seem prudent that in low-rate times you should keep your investments in short term maturities, but when rates are high you should lock in the high rates for a long time? Two problems with this observation: (1) many times when we think rates are low, or high, and can’t change much, they change substantially — we simply can’t forecast future interest rates, this creates risk; (2) keeping your money in short term bonds when rates are low means you’re also getting the lowest bond rates and this may be unacceptable if you need more interest income.

Why are retirement-minded people putting their retirement money into long-term and extra high yield “junk” bonds? They are simply trying to increase their earnings or income and have not given careful consideration to the risks. I’m sure some people think that if rates rise they can “not sell” their bonds and thereby avoid losses. Is this solid logic? If old bonds are yielding 4% and comparable new bonds yield 8%, holding the old bonds involves an opportunity loss. You’re locked into a rate that is lower than market and therefore are not earning what you could if you were not locked into the lower rate bonds. The loss is simply spread out over many years, but is nonetheless still there and very real. In other words, you can bleed all at once by selling or you can slowly bleed for years by not selling. But there is another complication that needs to be considered: inflation.

Generally interest rates and inflation move up and down together – not in exact lock step but on the same wavelength. If you look at the early 1980’s, our last period of really high inflation, you’ll see that inflation topped out at an annual rate of about 15% in early 1980 and interest rates reached their peak later in the year. So, if you’re holding low rate bonds and there is rampant inflation which pushes interest rates higher, you’re losing twice: you’re getting relatively less interest earnings from your investment and the interest you’re earning, plus the principal you’ll get back at maturity will buy less.

As I’ve shown you, even the safest of all longer-term bonds – U.S. Treasury bonds – have risk because of changing interest rates and inflation. You now know the pitfalls associated with bonds. Still bonds can have a place in your retirement plans – it all depends on your circumstances, tolerance for risk, tax situation and other considerations that are best identified by working with a professional financial advisor. If you found the foregoing confusing, all the more reason why you need professional assistance.

How can you avoid the mistake that many of your fellow retirees are making? You can learn a lot more about bonds – you’ve gotten the basics from this writing – and you can then work with your financial advisor to make sure that where you keep your retirement money is a suitable place for your circumstances. Remember, you don’t practice medicine, law, accountancy or religion without professional help, so please don’t practice financial planning without it either.

Shelby J. Smith, Ph.D.
November 2010

The article below about 401(k) Plans is by Tony Walker, a Registered Investment Advisor and author of a clever little book, Don’t Follow the Herd.  Tony’s “cow” book can be purchased at www.tonywalkerfinancial.com.  I recommend Tony’s book to every retirement-minded American because I simply believe its truths will help you have a better retirement.  Please know that I am not paid for this recommendation nor do I share in any proceeds from the book.  The 401(k) article is a gem and I encourage you to read it, comment if you desire and pass it along to others.                                                                                                     Shelby J. Smith, Ph.D.

The “Ugly” Truth about the 401(k)

My granddad retired in 1978. He and his faithful wife, Hazel, dedicated 43 years of their lives to one employer – the phone company. In return for his years of service to them, the phone company rewarded Granddad with the following:

1. A lifetime pension check – Granddad called it “mailbox money”;
2. Company-provided health insurance for the rest of their lives;
3. Free phone and long-distance service – you laugh, but remember, this was before unlimited cell and texting!

While all three kept Granddad and Hazel WorryFree – it was the “mailbox money” that really kept them out of the Poor House. Because with that guaranteed check each month, all they had to do was “budget” their monthly expenses around the phone company’s predictable monthly check. It was truly a “WorryFree Retirement.”

Apparently, what was good for Granddad wasn’t good enough for my generation – the Baby Boomers. Our question: where in the h-e-double-hockey-sticks did all those “guaranteed” pension incomes go? How come WE don’t get “mailbox money”?

Because of the 401(k) plan – that’s why!

While employers during Granddad’s generation could afford pension plans (more specifically, they were called defined benefit plans) these guaranteed plans also cost the employers a ton of money. That’s because money that would have otherwise gone to profits, research and development, and stockholders had to be “booked” and stuffed away under the corporate mattress to fulfill the promise of future mailbox money to all of their retirees. In addition, back when pension plans were created, employers never dreamed employees would stick around long past normal retirement age (age 65) to collect all of this money.

Forced to “ease” out of these expensive plans, some wise guy (around the year of 1980) came up with the idea of the 401(k) plan.  The thought: we’ll turn all the controls over to the employees by allowing them to team up with Wally World (Wall Street) while the employer would “match” the employees’ contributions. It all sounded really cool.

©2010, TONY WALKER, ALL RIGHTS RESERVED
SOURCES:  Private Pension Plan Bulletin Historical Tables and Graphs.  US Department of Labor,  Employee Benefits Security Administration.  February 2009. 
2009 Investment Company Fact Book 49th Edition.  By the Investment Company Institute.  Copyright 2009.

Basically, the mutual fund industry – thanks to the introduction of the 401(k) plan – went from millions to trillions!

Bottom line: Joe Lunchbox got duped!

Instead of relying on his employer to take care of his retirement, he followed the financial herd and instead made Wall Street rich. Good for them, maybe not so good for him. No wonder folks are so worried today.

So now what are we supposed to do now?

As a Registered Investment Advisor, each day I sit across the table from consumers who are dazed, confused and lost as to what to do with their 401(k) money. Here’s what I advise them:

1. Stop treating your 401(k) as the mother of all retirement plans; contribute to it only “up to” the match. If you don’t get a match, I strongly encourage you to see an outside retirement specialist to decide if you should contribute any new money to the plan. There are plenty of better ideas for your money.
2. Forget the notion that there is some magic to the term “pre-tax.” Rather, think of your 401(k) contribution as “postponing the tax,” because one day, you’ll have to pay-the-piper. Uncle Sam will want his money; it’s called taxes and you still owe them. In fact, the longer you have the plan, the worse it usually gets!
3. Check with your employer to see if you can roll over any monies within the plan. You’ll have to get a copy of the Plan Document to see if there is money that can be rolled out into your own self-directed IRA. In many cases, even if you’re still working with the employer, you can roll out previous 401(k) contributions rolled into this plan, the employer contribution, and in some cases the after-tax portion. Best of all, if you’re 59 ½ or older, some documents let you roll out your “pre-tax” contributions as well. You might even want to spend some of it!
4. If you’ve recently quit, been fired, retired…whatever – get your money out of the 401(k) and into a self-directed IRA so you can get some different options and planning opportunities. One word of caution: if you’re not yet 59 ½, there are some cases where leaving some or all of the money in the 401(k) might make sense since money coming out of the plan is not subject to the 10% tax penalty.

Be Worryfree!

Tony Walker

Tony Walker is a retirement planning expert and author of three books, including WorryFree Retirement.  For the past three years, Tony has been the featured guest each Monday morning on NBC affiliate, Wave3 TV in Louisville Kentucky, answering retirement questions from a live audience that includes over 600,000 households.  www.tonywalkerfinancial.com

Bank CD rates are at historical lows and as a result the incomes of many retirees have also plummeted to new lows. Retirees that have historically kept retirement money in the stock market have been rocked by violent feast-to-famine cycles. With the stock market roughly halfway between its last peak and trough, there is widespread fear about the future direction. Many risk-averse safety conscious retirees have found a compromise in bonds: fixed rates like bank CDs, but less volatility than the stock market. Could it be that danger also lurks here? Let’s look at how bonds really work.

Businesses and governments borrow money by issuing bonds. These bonds are a promise to repay lenders at maturity and a fixed rate of interest in the meantime. Bonds can be backed by collateral or they can be an unsecured obligation of the borrower. The future year when the principal is repaid is referred to as “maturity” and the fixed interest rate paid is called the “coupon”. Of course, there can be other complexities (calls, conversion rights, etc.) but these are beyond our present scope. A bond generally has market liquidity, meaning it can be sold prior to maturity. A major determinate of the value of an existing bond is the difference in the coupon rate and the market rate of comparable bonds. It is this relationship between price and coupon/market rate that needs to be understood.

Let’s say you purchased a ten-year $1,000 bond and the coupon rate is 4%. Parenthetically, purchasing bond mutual funds is one very popular way to generate an income and also get diversification. Fast forward two years when your bond’s maturity is eight years hence and the market rate for a comparable bond is 10%. Assume you need money and you’ve decided to sell your bond. Your bond will be worth about $625 because its coupon rate is 6% below the market rate of comparable bonds. The longer the maturity of a bond, the more prices change as interest rates fluctuate. Bond prices rise and fall with interest rates and this is the risk of owning bonds.

The Federal Reserve, the government agency that manages monetary policy, has forced market interest rates to historical lows in hopes of raising economic activity and returning people to work. They do this by “buying” government bonds with newly created money: demand for bonds increase and their prices rise [rates fall]. In theory, lower rates stimulate borrowing which expands businesses, fosters new construction and prompts people to buy more goods and services. Heightened economic activity is the result. What happens if the economy strengthens and the Federal Reserve sells bonds to push rates higher to control economic activity? The holders of lower rate bonds will (a) realize a loss if they sell or (b) earn below market interest rates until maturity if they hold. Either way a monetary loss is realized. Since the Federal Reserve is also selling, what about their losses? They manage the monetary affairs of the economy and don’t consider profit or loss.

Generally, interest rates and inflation move in lockstep over an economic cycle. There is an emerging consensus opinion that huge federal deficits, the flood of new money created by the Federal Reserve and the deteriorating U.S. currency will fuel future inflation as the economy recovers. Accordingly, locking in fixed rate long-term bonds involves risks that must be considered. My advice is to work with your financial advisor to select suitable savings and investment places to provide the lifestyle you have planned for your retirement. So, instead of blindly following the herd to the new Mecca of bonds please make sure you understand them first.

Shelby J. Smith, Ph.D.
November 2010

We all hate taxes – most of us feel the government spends our tax dollars foolishly.  But government has a secret weapon – a silent tax that eats away purchasing power.  The secret weapon is the cruelest tax of all because it mostly hurts people living on fixed income, like most retirees.

Hello, I’m Dr. Shelby Smith of The Retirement Pros. I want to tell you about this silent tax and how it might affect you.  Thanks for your time.  My sole objective is to help you plan for and enjoy a better retirement – so I want you to relax and open your mind to new ideas.  Let’s get started.

First of all, what is this silent, cruel tax?  You know it by another name – INFLATION.  Inflation is like gravity – constantly pulling down on the purchasing power of your money.  Not too noticeable in the short term, but the long-term effect is astounding.  Let’s see what has inflation to do with retirement.

How long do you expect retirement to be?  According to retirement researchers, most people under-estimate their life expectancy.  And, the greatest fear of most retirees is outliving their money.  If your greatest fear is outliving your retirement money, you’ll want to pay attention because I’m going to show you how to get over the fear and have peace of mind.

Let’s say you and your spouse are both 65.  Actuaries predict that one of you will still be alive at 91½ years of age.  By the way, actuarial science is very amazing – they can’t tell when you’ll die, but they can accurately forecast the number of deaths per year in a given age range.  Actuaries are scientists who manage the risks taken by insurance companies.

Back to our couple: we know that one of them has a 50% chance of being alive at age 91½ – that’s 26½ years after reaching age 65.  Guess who is most likely to be the longest living spouse?  Correct!  Ladies, you’re the stronger gender but that’s a mixed blessing!  You’ll probably be your husband’s caregiver, but he’s not likely to be around when you need help – unless you married a much younger man.  Ever been to an assisted living center or nursing home?  If so, you saw mostly ladies.  Gentlemen, since you love your wife, you’ll want to pay attention because she’s in more danger of outliving the money.

To be on the safe side, our 65 year old couple should plan for a retirement of at least 30 years.  Understand it could be longer – people over 100 are not that rare anymore. 

I want you to go back thirty years – that’ll be to 1980.  Can you recall what prices were?
To refresh your memory, here are the prices of some common items:

Average New Home: $68,714
Average new car: $7,210
Gallon of gas: $1.03
Tailored Silk Blouse: $15.99
½ Gallon of Milk: $0.85
Postage Stamp:  $0.15
1# of White Bread: $0.48
Average Movie Ticket: $2.69
1 Liter Bottle of Coke: $0.94
15oz Package of Oreo Cookies: $0.99
19oz Box of Corn Flakes: $0.99
Average doctor visit: $42
Emergency Room Visit: $103

How do today’s prices compare?  If things were cheap thirty years ago, do you suppose that today’s prices will look cheap thirty years from now? 

Due to recent higher medical costs, an aging population and changes brought about by health care reform, current health care costs are rising at about 12% annually.  Who spends proportionately more for medical care?  Correct…retirees. 

Here’s some scary facts: at 12% annual inflation, prices will double every six years.  If this continues, what cost $1000 in 2010 will be:
$2,000 in 2016
$4,000 in 2022
$8,000 in 2028
$16,000 in 2034 – a 16-fold increase in only 24 years and you’re still in retirement.  The inflation trend continues – eating up your money’s purchasing power.  

What is the probability of future inflation?  You know the answer, but let’s review anyway.  Right now our Federal Government is spending a lot more money than they’re getting in taxes – the difference adds to the Federal Debt and becomes the Federal Deficit.  The Federal Government has been printing money like crazy in recent years and it appears such will continue.  This means more money is chasing the same amount of things to buy which will push prices higher – much higher.  Over simplified, but nonetheless true.

To get inflation under control, the Federal Deficit must be controlled. How likely is this?  There are three ways to fix the Federal Deficit, they are:

1. Government can default or go bankrupt. This has happened to other countries and the results were ugly.  This is not probable in America – at least not near-term – so let’s cross off this solution.
2. Taxes could be substantially raised.  But, the entire House of Representatives and one-third of the U.S. Senate are re-elected every two years.  Voters will not tolerate substantially higher taxes unless the waste is eliminated.  In fiscal year 2010 federal spending exceeded taxes by $1.3 trillion – that’s with twelve zeros.  You don’t want to even think about how much interest the Government will pay on its debt if interest rates go back to normal or higher – and heaven help us if rates match those the late 70’s and early 80’s.  Higher taxes alone are not the solution because the amount needed is astronomical.
3. Government spending could be cut.  Does Congress have the intestinal fortitude?  Social Security, Medicare and Defense account for most of the spending.  Would you vote for someone who cut your Social Security or Medicare benefits?  Not likely. Can you imagine the unemployment and political fall-out that would come with closing military bases if defense spending were cut?  In the foreseeable future Congress will not cut spending – forget this solution.

My belief is that the Federal Deficit will continue to grow, and along with it inflation.  This is actually a solution to the Federal Deficit:  Inflation makes the Federal Debt relatively smaller because it takes less purchasing power to pay it off. If you loaned me a dollar for a year and money you got back would buy less than the dollar you loaned me last year, you’d have a bad deal.  The Debtor – Government – benefits in inflationary times and Creditors – holders of the Government debt – are hurt.  I believe that inflation is just over the horizon – and it will hurt retirees just like a big hike in taxes. 

One American turns age 65 every 7½ seconds and people are living longer.  This growth trend will continue for the next two decades and means that “all things retirement” will be in higher demand.  How can you protect yourself?

This growing number of retirees has captured the attention of the insurance industry.  Insurance companies manage risk that is too large for individuals. For example, you buy insurance on your home at a fraction of the cost of the home because the probability it will be destroyed is small.  Most people are willing to buy this insurance, because should your home be selected by the destruction lottery, the financial costs could be staggering.    Those whose homes are not destroyed subsidize those who homes are destroyed with the insurance company acting as a middle man that manages the risk for a profit.  The growing number of retirees fearful of living too long has captured the attention of insurance companies.  Living too long is called “longevity risk” and you can now purchase an insurance policy to cover this risk. 

Insurance companies first started offering “longevity risk” coverage a few years ago in the form of guaranteed lifetime income.  This coverage was very unique because it was not a “use it or lose it” insurance policy.  You transferred some or all of your retirement money to an insurance company who paid you an interest rate but at your option the account could be converted into a guaranteed lifetime income you could not outlive.  The coverage worked like traditional insurance: those who live too long are subsidized by those who die too soon.  These policies are called fixed annuities.  Note the word “fixed”. This means you are guaranteed a minimum rate of return regardless of what happens in the economy or markets, but you have the opportunity to earn a higher rate of interest.  If you let your money grow a few years before exercising the guaranteed lifetime income option, you do not pay income taxes on the earnings until you actually take the earnings out.  So in effect you have triple compounding: interest on your principal, interest on interest you earn and interest on the money you would have ordinarily paid in taxes.  You earning are taxed at the end of the line rather than along the way – and this could be double good if you expect to be in a lower tax bracket in retirement.  This longevity risk policy eliminates the greatest fear many retirees have:  outliving their money. 

Insurance companies are now adding inflation protection to their longevity risk policies:  guaranteeing you a lifetime income that is inflation-proof.  This means you can now put your money into a fixed annuity and get a guaranteed inflation-adjusted lifetime income you cannot outlive. This is just like your Social Security benefits – a lifetime income that is adjusted annually for inflation.

So how do you take advantage of these new developments?  You simply do the following – but I recommend you work with your financial advisor:

1. Decide how much money you’ll need in today’s dollars to live the retirement lifestyle you’ve planned.
2. Determine how much Social Security you will get, or are getting.
3. Add to SS the other money you’ll get in retirement after you adjust it for inflation.
4. Subtract from the income you’ll need your SS benefits and other money. The result is how much you’ll need to receive from your annuity.

Once you know how much you need from the annuity, you’ll need to decide the following:

1. When will you need to start the income from the annuity?  Now or later?
2. Do you want coverage for you and your spouse, or just you?
3. Do you have enough money to buy the guaranteed income you need?

The “enough money” part can only be determined if you do the homework.  If you have “too little” money this would be good to know because you can scale down your retirement plans now rather than be surprised later. If you have more than enough, you can buy a margin of safety or just leave that money invested where it is today.  But, you need to go through this process with your financial advisor – I think you’ll be surprised with how little money you’ll need to lock-up a guaranteed lifetime income that will give you peace of mind.

The end result, if you follow my advice, is that you and your spouse will have a guaranteed lifetime income from Social Security, or other pension plan, and your fixed annuity income that will be adjusted for future inflation. The inflation protection may not be perfect but it will beat having no protection. 

I strongly recommend that you work with a financial advisor – call the advisor that invited you to watch this video and get started.  Insurance is something we cannot live without, so please don’t close your mind to this innovative idea because it can only help you have a better retirement.  And the best part, it costs you nothing to find out more…so don’t procrastinate, call your financial advisor.

That’s it – now you know about the silent cruel tax called inflation – and what it can do to retirement.  Thanks for your time and have a wonderful day and an even better tomorrow.    

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

Let’s consider a married couple, both aged 65. Actuaries say that at least one of them is likely to be alive at age 91.5. Since ladies are the stronger gender, they’re more likely to be the last survivor. This means that conservatively our hypothetical couple should plan retirement for at least 30 years. Think back to 30 years ago and compare the prices in that world to the present one. Inflation is especially hard on retirees living on fixed incomes. At an annual inflation of 8% [current inflation for medical care], what cost $1,000 today will cost $8,000 in 27 years – years before our couple’s retirement will end. What is the outlook for future inflation, in general, and for retirees specifically?

It is an economic fact that raising taxes in recessionary times will make matters worse; thus, the money presses are working overtime to end the current economic recession. The federal debt is exploding. A Social Security system that cannot continue on the same financial footings as in the past and Medicare programs whose costs are rapidly rising with an aging population, serve to widen the gap between federal spending and taxes collected. Complicating the tax-spending imbalance are the war on terrorism, crumbling infrastructure like highways, high unemployment and needy non-federal governments on the brink of bankruptcy. These all point toward the certainty of much higher general inflation for the future.

Retirees are the fastest growing segment of the population and this means even more inflationary pressure on “all things retirement”. The retirement safety net is Social Security and, thankfully, benefits rise with inflation. Granted there is some concern about its survival, but given the large voting bloc that would be alienated, stopping Social Security is not politically feasible. Yes, there may be more taxes on benefits and future retirees may be shortchanged, but today’s retirees are assured of continued benefits and inflation adjustments. Unfortunately, Social Security is not enough for the lifestyles of most retirees; thus, how can retirement purchasing power be protected against future inflation?

As life expectancy has risen and more than 75 million baby boomers have reached retirement age, the insurance industry, which manages risk of all kinds, has developed new products to protect purchasing power in retirement. Your purchasing power can be safeguarded by giving an insurance company a fixed amount of money today in exchange for the guarantee of a lifetime income that keeps pace with inflation. How much money is needed for your lifetime inflation-adjusted income depends on the age when you’ll start receiving it and the amount of income you choose. Smart retirees will determine the fixed purchasing power (inflation-adjusted income) needed in retirement for their planned lifestyle. Subtracting the amount of Social Security and other income you’ll have from this needed amount yields the guaranteed lifetime income required. It is now a matter of deciding at what age the income should start.

Those that die prematurely will subsidize those that live too long: the same concept as homeowners’ insurance where those whose homes do not burn help pay those whose homes do. Since the insurance company is managing the risk of uncertainty, you and your loved one get the security of a guaranteed inflation-adjusted lifetime income you cannot outlive. Eliminated are market risks, future inflation, changing future interest rates and all things uncertain. You can forget about the greatest fear of most retirees: outliving your money. How do you get started on this guaranteed lifetime income pathway? Talk to your financial advisor about your needs and how best to meet them: there are many options and great flexibility. Unless you investigate this solution, inflation will be a retirement concern.

Shelby J. Smith, Ph.D.
October 2010

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Shelby J. Smith, Ph.D.
September 2010

The long history of markets is volatility, uncertainty, and during recent decades, meltdowns. The major economic events that have rocked the markets since the Civil War include:

1. The Panic of 1873, which closed the New York Stock Exchange for ten days. The country had 364 railroads and 89 went bankrupt; massive business failures occurred, unemployment reached 14% and the 1870s were dubbed the Long Depression.
2. Another deep depression happened from 1893 until 1897 and resulted in a major political realignment that became known as the Progressive Era.
3. There were panics and recessions in the late 1800s up until WWI. The Great Depression started in 1929 and ended in 1941 with WWII. Unemployment reached 24% in 1932 and millions relocated in search of better lives. Risk-avoidance was permanently burned into the minds of an entire generation.
4. The inflation woes of the 1970s resulted as the country grew increasingly dependent on oil importation. Inflation climbed steadily until the early 1980s and was finally broken with 20% interest rates that incapacitated industries dependent upon borrowed money.
5. The late 1980s and early ‘90s witnessed the S&L debacle and widespread government deregulation that planted seeds for turbulent economic times after 2000.
6. The dot-com bubble of the 1990s went bust in 2000-02. Markets skidded to half their previous levels, wiping out the savings of millions and littering the economic landscape with bankrupt businesses.
7. The housing bubble and profligate ways of Wall Street gave us the Great Recession of 2007-09. Again market averages were cut in half and millions were victimized with job losses and foreclosures. What happens in the aftermath is yet to be written but a slow return to normalcy seems certain.

Along the way we witnessed Japan’s lost decade, the collapse of the Soviet Union, global hot spots of armed conflict, major deterioration of the American dollar, corporate scandals reminiscent of organized crime and ballooning budget deficits that threaten future generations. The economic background is abuzz with job losses, inflation, high taxes, trade imbalances, irresponsible government waste, income redistribution and seriously under-funded entitlement programs on which many depend. So, why bring all this up?

History always repeats itself – never exactly, but enough to make certain that periodic interruptions are a way of economic life. What is the next big event? The economic disruption that again rips the heart out of your retirement takes away your lifestyle, undermines the value of your money, fosters market losses you can’t afford or threatens your economic well-being! We don’t know what it will be, when it will come, how big, how long or the exact effect, but we know for certain it is coming. Could it be an energy crisis created by disruptions in the Middle East? Another terrorist strike on one or more major cities? Runaway inflation spawn by out-of-control government spending? Widespread bankruptcy of local or state governments? Will the failure of entitlement programs like Social Security, Medicare and Medicaid be the cause? Will escalating taxes lead to civil discord? What major scandal is now brewing? Chances are the next Big One will be caused by something unexpected as were the past economic downturns and market meltdowns. What can you do to prepare?

It is tempting to reach for the high return, given recent losses you’ve suffered and the barely positive rates now being paid by banks, but the promise of above-market returns also means above-market risks. It is extremely dangerous to travel across today’s treacherous investment landscape without a professional guide that knows the terrain. Some routes through the investment wilderness are simply not suitable for those who want to get to the other side without losing their lifetime savings. If you haven’t already, you’re encouraged to work with a financial professional to keep your retirement money in places that will be spared the next market explosion. We don’t know when – we hope never – but history says a Big One is on the way. Today’s the time to start preparing.

Shelby J. Smith, Ph.D.