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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

We lament that lifetime pension from employers are now a thing of the past. Maybe that’s why the greatest retirement fear of most boomers and seniors is outliving their money. If there were only a way that we could take some of our 401(k) or other retirement money and convert it into a lifetime we couldn’t outlive! Well, there is!As you probably know insurance companies will insure practically any risk you face…and longevity risk (the risk of living too long for the money you have saved for retirement) is no different.

In recent years the aging of the U.S. population and the vast, and growing, number of retirees (and near-retirees) has prompted insurance companies to develop new products that guarantee a lifetime income you can’t outlive. Virtually every insurance company that offers annuities can cover this risk. You place with them a sum certain of money and they guarantee you a lifetime annual income. The amount will depend on the amount of money you deposited with them, your age and gender.

Occasionally, they’ll take your health into consideration but not always. What’s more, you do not lose control of your money with this new lifetime annuity option. With most annuities you can start, stop or store your income payments — you can even change your mind and withdraw the remaining money in a lump-sum. Since inflation is a continuing part of our lives, several annuities has begun to include cost of living protection which allows your annual income to rise with inflation. So they next time you’re lamenting that you don’t have a lifetime pension like your parents or grandparents, call your financial advisor and ask about annuities with guaranteed lifetime withdrawal benefits or guaranteed lifetime income benefits. Or better still, learn a bit yourself first by doing an Internet search for “annuities with guaranteed lifetime withdrawal benefits”. Here are some links that may be helpful.

http://www.sunlife-usa.com/sun/sl_24.cfm

https://www.forethought.com/ffs/forethought.portal?_nfpb=true&_pageLabel=forethought_annuities_products_guar_dest

https://www.forethought.com/ffs/forethought.portal?_nfpb=true&_pageLabel=forethought_annuities_products_dest_income

http://www.ing-usa.com/us/aboutING/pressreleases/1030468.html

Most successful retirees will have three sources of money for retirement:

1.  Qualified: IRA, 401(k), 403(b), Thrift Savings Plan, etc. that they contributed to during their working years for use during retirement.  Income taxes have not yet been paid.

2.  Social Security: Virtually every private-sector worker is eligible for Social Security during their retirement years.   Also, a non-working spouse of a qualifying worker is generally eligible to receive at least one-half of what the working spouse qualifies for at normal retirement age.

3.  Savings and investments: These are your other savings you’ve set aside for retirement or to pass on to the next generation.  This pool of money is sometimes called non-qualified money because income taxes have mostly been paid or lower tax rates apply — for example capital gain taxes or taxes on stock dividends.

Two of these sources have age restrictions.  Social Security can be taken as early as age 62 (earlier if disabled or there are other special circumstances) and should be started no later than age 70 because this is age when benefits peak based on the mortality tables.  You are generally penalized for using your qualified money before age 59-1/2; however, there are numerous exceptions.  You must start withdrawing a minimum amount from your qualified retirement money when you reach age 70-1/2.  Of course, you can convert your qualified retirement money to a Roth IRA which allows you more latitude in its use.  You can use your non-qualified savings and investments at any age or you can bequeath these moneys to others at your death.

What about taxes?  Your Social Security benefits will always receive favorable tax treatment.  Of course, the more income you have the greater will be the income taxes on your Social Security benefits.  But, under current law Social Security benefits are always tax favored.  Your qualified retirement money will be taxed at your normal income tax rate when you begin to withdraw it — and remember you must start taking required distributions at age 70-1/2.  You can convert your qualified money to a Roth IRA and pay the taxes all at once and then enjoy tax-free income indefinitely into the future.  Converting to a Roth IRA makes sense for some but not other; therefore, you’ll want to get professional advice before converting to a Roth IRA.  Your non-qualified savings and investments generally have the least amount of taxes due when used because you’ve already paid income taxes or they receive special treatment such as capital gains or dividend income.

What happen at your death?  For Social Security, your spouse will be eligible to get the greater of what he or she qualified for on their own or as your dependent OR whatever the deceased spouse was receiving.  This spousal benefits is very important because it will be received as long as the surviving spouse lives — which could be a very long period of time.  If the deceased spouse elected to postpone Social Security until age 70, that means the surviving spouse will get a much larger amount than if the decreased spouse started early at age 62. For qualified money such as IRA, 401(k), 403(b), etc. it can generally be passed tax free to the surviving spouse, or others, and they will pay taxes at their normal rate. Generally payout must occur over their remaining lifetime.  There are methods whereby you can stretch payout if left to non-spousal heirs and I encourage you to speak with your financial advisor about this if you do not plan to use all your qualified money during your lifetime.  Your non-qualified savings and investments are part of your estate and can pass to whomever you elect at your death.  I’ll not comment on the tax consequences of these money but will encourage you to get professional advice from a financial planner, attorney and CPA if you have a sizable estate that will pass to others at your death.  This is very important if you wish to prevent the Government from being your beneficiary.

Now that I’ve set the stage, which of your money should be used first in retirement?  Of course it depends on your individual circumstances but the average retiree that can afford to postpone Social Security until age 70 will generally benefit. Why?  Because, the money is always tax-favored so you want a relatively larger portion of your retirement money to come from Social Security.  Since Social Security benefits grow about 8% for each year postponed PLUS a cost of living adjustment (making total growth about 11% annually), you can’t beat this rate of return with any other safe money investment.  Add to this exceptional growth the spousal benefits and the lower tax rates and you have a powerful reason to postpone Social Security for as long as possible.  I know, you’re worried about dying before you reach the break-even age of about 80 — remember the spousal benefit and look at the mortality tables.  You’ll find that there is almost a certainty that one or both of the average married retirees will live into their 90’s which is well beyond break-even age.  So, contrary to conventional wisdom, postpone your Social Security if you can afford to — especially if the wife is a few years younger than the husband and the husband was the principal breadwinner.  What, you’re worried that Social Security will be eliminated by Congress?  Think about the 50 million now getting Social Security benefits and 78 million more (the baby boomers) now turning Social Security age!  That a powerful voting block that Congress knows will vote them out of office if they tamper with Social Security too much.  Social Security is not going anywhere — it will be available for the remainder of your life.

Okay, so you postpone Social Security: what about your qualified money like IRA, 401(k), etc.?  You know that 100% of your withdrawals will be subjected to ordinary income taxes…and they’ll also help determine the income taxes you’ll pay on Social Security benefits.  No tax breaks here.  Which way to you think income taxes are headed?  Me too — higher and higher because of a sea of red ink from national debt, rising deficits and excessive federal expenditures which will continue unabated.  So, by taking this money first you (a) will pay lower taxes now rather than higher taxes later and (b) you’ll be taking less of this money later when Social Security benefits starts, meaning you’ll pay fewer taxes on these benefits.  Of course, if you think taxes are going to go down (are you crazy?), you might conclude this sequence of use is backwards.  But, you’d be wrong if you run the numbers as I did in my publication The Guide to Social Security…and A Better Retirement. (link below). 

What about the your non-qualified savings and investments?  You should use these to bridge the income gap as needed and for emergencies.  Again, if you have more money than you’ll need in retirement, get professional help so that taxes can be minimized when this money passes to your heirs at your death. 

In the past year there has emerged a lot of chatter about delaying Social Security…and the conventional wisdom of taking it first (which almost three-fourth of Americans do) is dead wrong.  You don’t agree?  Well, remember that at one time the conventional wisdom said the earth was flat, but we know different now.  At one time the conventional wisdom was take Social Security at age 62  but we now know that is wrong for most folks.  If you started early and it was a mistake, I wonder what other financial mistakes you’ve make with your retirement money?  If you’re wondering too, I recommend you get professional help so you can have a better retirement. 

Here are some links that support the foregoing analyses:

http://www.theretirementpros.com/eReport_Social_Security.php

http://www.boston.com/business/personalfinance/articles/2005/11/27/it_pays_to_delay_taking_social_security_benefits/

http://www.usatoday.com/money/perfi/columnist/block/2008-01-14-social-security-early-benefits_N.htm

http://www.webcpa.com/article.cfm?articleid=21897

http://money.aol.com/kiplingers/investing/canvas3/_a/fresh-ideas-for-retiring-rich-3/20051005142009990001

You hear a lot of horror stories about fixed and index-linked annuities — mostly coming from sources that are biased, have a vested interest in trashing annuities or are just plain uninformed.  Ironically, most of the stories (sometimes referred to as case studies) feature payout two-tier annuities and discuss these dogs as if all fixed annuities are two-tier. 

A two-tier annuity is one that requires you to take your money out in installment payments over a period of time in order to get the full account value.  Unfortunately, you are not guaranteed by the insurance company (very few insurance companies even offer payout two-tier annuities) a market rate of return during the installment payout period; therefore, you’re trusting the insurance company to pay you a market rate and you can bet your  next Social Security check that an insurance company that would issue a payout two-tier annuity can’t be trusted to pay you a fair interest rate during the installment payout phase.  On the other hand, if you withdraw your money lump sum you’re in for a shocker because you’ll lose any previous bonus paid and get only the minimum guaranteed earnings rather than the more attractive returns shown on your last annual statement.  In other words, lump sum withdrawal means the rate you’ll earn will never keep you even with inflation — you’ll lose purchasing power with every passing day.

The sad truth is that most of the horror stories involved elderly people that should never have owned an annuity — any annuity — in the first place.  Unfortunately, they were sold a two-tier annuity which is, in my opinion, the worst of the worst and then found out they were locked into a long-term contract with no escape  clause.  Their complaints fell on deaf ears at the two-tier insurance company and the financial advisor who sold them the two-tier.  Their complaints were picked up by the press, regulators and brokerage community which then painted all fixed annuities with the two-tier paint brush.  The facts are: annuities, like all saving and investment vehicles, are not good for everyone nor are they universally bad for everyone.  So, before you nix all annuities, take the time to learn the real truth about annuities in general and two-tiers in particular.  I think you’ll be surprised to learn that the “no loss” provision of most fixed annuities along with avoiding income taxes on earnings until you actually withdraw them, are two major pluses that you can’t find in other safe places where you keep your retirement money.

The first link below is to a recent article I wrote which appeared in a trade journal for financial advisers.  Read it critically and with an open mind.  I think you’ll see that fixed annuities, with the exception of the payout two-tier outcast, have merit for many retirement-minded folks that are interested in low risk, good returns and paying fewer taxes. 

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

If you’d like to read more about the lawsuits filed against two-tier annuity issuers and see what other say about tw0-tier annuities, go to any of the following links:

http://www.anapolschwartz.com/practices/NASD/allianz-annuity.asp

http://www.nctimes.com/articles/2005/07/10/business/news/20_58_387_8_05.txt

http://www.ag.state.mn.us/Consumer/PressRelease/AllianzSnnuities.asp 

 http://mcppremium.blogspot.com/2006/04/who-owns-your-insurance-marketing.html

In the February 4, 2008 edition of the Houston Chronicle newspaper (and I suspect lots of other major newspapers throughout the country) appeared an article titled “What to do When You Want to Run from Risk”.  The article is all about the volatility in the stock market and where to park your money if you’re concerned about losing your retirement nest egg in a market meltdown.  As you can imagine, there were quotes from “experts” who advised that you should not panic because you’ll be just fine in the “long run” (meaning ten or more years from now).  I suspect these so called “financial advisers” were really “stock brokers” who are more concerned about their commissions than they are about whether or not you’ll be around for the “long term”. 

As you know if you’re retirement minded, “long term” is something you can’t take for granted because ten years could be over 50% of your retirement years.  You should also know that the “long term” Wall Street touts always comes with the assumption that you have the discipline to not take profits when prices rise and not to bail out when the market stinks.  Research shows that the “average small investor” does not realize the market averages over the “long run” because they don’t have this discipline.  Wall Street also fails to tell you that their professional money manager rarely even match, let alone beat, the market averages like the DJIA and S&P (that’s why index traded mutual funds are so popular right now).  Yet, you’ll still pay them fees for managing your mutual funds, variable annuities and diversified portfolios.

So, exactly where are you advised to put your money to hide from risk?  The article talks about U.S. Treasury bonds that are currently paying about 3%.  They do point out that these shoe-top-high rates are nothing to get excited about.  What they forget to tell you is Treasury bonds, especially in small denominations that “average” investors would buy are not readily salable because this is an institutional market that deals in round lots ($1,000,000 or more).  The spread in the bid and ask is likely to be rather large when you call your broker for a sell quote.  What’s more, if interest rate rise from the time you purchased them (and who thinks rates will stay at current levels very long?), you’ll have to sell at a discount.  That’s right, even Treasury bonds can be unsafe if you have to sell before maturity because they have interest rate risk.  Also, if rate go back up and you’re holding fixed rate Treasury bonds you’ll suffer an opportunity cost because you’ll be getting a below market rate of interest.  So, maybe Treasury bonds are not all that hot as a safe harbor for your retirement money unless you definitely plan to hold them until maturity.

What about U.S. Government Savings Bonds?  Everyone agrees that Series I and EE bonds are hard to buy, limited in the amount you can purchase plus pay a very low rate of interest.  Accordingly, not a good place for your retirement money.

Bank accounts that are FDIC are rock-solid safe, easy and familiar to about everyone who is retirement-minded.  The only problem is that current interest rates are very low.  This means your bank money will decline in purchasing power and the longer you keep it there the less it will buy because taxes and inflation exceed the interest rate you’re paid.   In other words, you might bleed slower with a bank CD but the end result will be the same. 

These, dear readers, are the only safe-money options presented by most “financial advisers ” because they can’t see the elephant standing the tallest.  No, I’m not talking about real estate, gold or international investments…I’m talking about putting your money with an insurance company.  I can hear what you’re thinking: I don’t trust insurance companies and will never let one invest my retirement money!  Whoa there…who insures you home, car, health, life, business, children, household goods, jewelry and every other assets you covet?  That’s right, an insurance company.  In fact, insurance companies are among the oldest, financially strongest and largest global businesses around…and they have survived wars, depressions, government collapses and natural disasters of biblical proportions.  And, they also manage the money of hard working people who are retirement-minded and want the opportunity to earn a good rate of interest without exposing their money to the ups and downs of the market. 

In recent years, and in response to an aging population, insurance companies have developed new products to guarantee you a lifetime income you can’t outlive.  In addition you are entitled to a rate of interest linked to a stock/bond market index:  if the market rises you have the opportunity to earn an above-market interest rate but if the market falls you get a guaranteed rate of interest that is greater than zero.  In other words, you get upside potential with no downside risk.  The worse you can do is get zero interest if the market falls — slightly or drastically — in any given year.  If the market heads south and continues going in that direction for the entire term of your insurance-company managed money, the worse you can do is some very low, but positive rate of interest guaranteed by the insurance company. 

These safe money places are called fixed annuities or index-linked fixed annuities and literally hundreds of billions of dollars are placed in them annually.  Of course you never read about them in the personal financial advice column of the newspapers, bankers are silent about them and stock brokers will tell you they are bad, bad, bad.  The simple truth is they are not good for everyone but if you’re tired of risking your money to the whims of the market and are scared stiff that you just might outlive your money in retirement, you need to at least investigate the feasibility of annuities for some of your retirement money. 

Yes, you can read horror stories about senior citizens who purchased two-tier index-linked annuities that have not treated them well.  But most fixed annuities are not two-tier and no self-respecting financial advisor would ever offer them to his or her clients…but some do because they’re more interested in their income than your welfare.  How can you find out what to avoid and what might be good for you on the annuity front?  I’ve recently written a book called “Is Your Annuity Good or Bad” and I recommend it to any person considering an annuity and to any fianancial advisor offering them.  If you’d like to read this new publication for free, just click on the link below.  Check the You Tube skit for a slightly funnier discussion of the topic.

http://www.theretirementpros.com/RP_annuities_primer.php

http://ezinearticles.com/?Is-Your-Annuity-Good-or-Bad?&id=915406

http://youtube.com/watch?v=4nYyUm1NHm4

Longevity risk: the risk of outliving your money…that is, the risk of running out of money before you do breath.  This is the number one fear of most retirees…and for good reason.  Retirement can last thirty years or longer, is the time of life when very expensive medical emergencies may strike or a sudden meltdown of the market could rob you of your financial resources.  When you add in the uncertainties of the shrinking purchasing power of your fixed savings caused by inflation, rising property taxes, lower interest rates and your inability to work, it is easy to understand by Longevity Risk is top-of-mind for most retirees.  Not much we can do about inflation and taxes except use our votes wisely to selecting honest, caring political representatives.  Health can be controlled somewhat by eating right, exercising and not abusing our bodies by excessive smoking and drinking.  Not much we can do about being excluded from the labor market nor can we control the economic cycles and interest rates.  In fact about the only thing we can control for certain is how much risk we take with our retirement money.

If you have your retirement money in a risky place like the stock market and there is a meltdown, you’ll probably suffer a significant loss with no way and no time to make it up.  In fact, if you lose your retirement money because you gambled in the market and lost, there will be no second chance…you’ll be dependent on the government, your children or a welfare organization.  Not a pleasant thought and probably the main reason most retirees say living longer than their money is their number one fear.  Unfortunately, far too many retirees have not taken steps to reduce their investment risks by heading for the safe places. Why is that?

First, you’re bombarded with advertisement, advice and promises that encourage you to keep your money in the market.  You’re told that “longer term” you’ll do a lot better with stocks, bonds, mutual funds, diversified portfolios and other risky investments than if you keep your money in safe places like bank CDs, government bonds and fixed annuities.  You’re presented with slick graphs and charts showing that here’s how much better you’ll do with your money at risk.  The entire brokerage industry is dependent upon you to put your money at risk in the market and they’re working very hard to make sure you do.  You can’t read a newspaper personal advice column, watch the news or read any of the thousands of magazines or newsletter devoted to investing without being told you’ll be much better off by placing your retirement money with Wall Street for safe keeping.  You’re never reminded of the market meltdown of 2000-2003 or the early 1970’s nor are you reminded that currently Wall Street is awash in losses from their profligate activities.  The incessant calls from your broker are about how now is the time to buy at bargain prices.  What about the losses you already have?  You’re scared into believing that unless you put your money at risk you’ll not make a reasonable return.  In fact, you’re told that if you keep your money super safe you’ll realize your greatest fear of outliving your money.  The truth is, you’re a lot more likely to outlive your money by taking risks you can’t afford than you are keeping it super safe and earning an interest rate that goes with safety.  Remember that risk and reward are always traveling companions:  if you have a chance to make a big return, it is certain that you are taking risks of loss.  On the other hand, if you take zero risk of loss, your earnings will be positive and certain but not above market.  So which do you prefer: the possibility of great growth but also the possibility of great losses OR absolute safety and a low but certain return?  As Will Rogers once said, “I’m more interested in the return of my money than the return on my money”.  I think Mr. Rogers had it right when it comes to the average retiree.

The current state of the economy is less than reassuring: unemployment is rising, dollar is very weak and falling, oil is teetering near $100 barrel, housing market is totally depressed, sub-prime credit problems are spilling over into autos and credit cards, inflation is heading higher and there is widespread talk of recession.  The Federal Reserve — the nation’s guardian of monetary policy — is obviously scared stiff judging from the drastic moves they’ve made in recent weeks to rapidly force short-term interest rates into the basement.  Most economists — including me — are skeptical that a nosedive of the economy can be avoided: recession is heading our way is what I see.  Yet, you probably have most of your retirement assets in mutual funds [check your 401(k)], portfolios containing stocks and bonds and other risky investments.  Have you forgotten what happened when the dot.com bubble burst?  Have you thought about what you’d do if the market drops drastically?  Do you realize you’ll not have a second chance if you lose too much of your retirement money?  What can you do?

One option is to look into locking in a guaranteed lifetime income you can’t outlive.  You see, there is insurance for longevity risk: insurance companies which are among the world’s largest, strongest and oldest financial institutions are willing to guarantee you a lifetime income you can’t outlive if you’ll deposit with them some of your retirement money.  They will take the risk associated with the markets, stocks losing value, real estate crashing and other unforeseeable developments that can erase your retirement money.  You’ll still be left with taxes, inflation, health issues and non-investment risks but you’ll not be able to outlive your money.  How can insurance companies make such guarantees?  The same way they are able to insure your home, car, health, life, business and other valuables: the law of large numbers and spreading the risks.  If you live too long and they lose money on guaranteeing you a lifetime income there is someone else in your cohort group that didn’t live as long as they were expected.  So, over time the numbers average out and the insurance company is able to manage the risk and make a profit.  You, on the other hand, got protection from your most feared risk in retirement: outliving your money. 

How do you find out more?  Ask your financial advisor to talk to you about a guaranteed lifetime income secured by an insurance company.  By the way, if your advisor starts talking about “variable annuities” tell him or her that you want something without risk: mention a fixed annuity without downside risk and one that allows you to start, stop or store your guaranteed lifetime income.  You don’t have to give up control  of your money to get a guaranteed lifetime income because in the past couple of years insurance companies have begun offering new products that specifically take care of longevity risk faced by retirees.  These new plans allow you to change your mind if your circumstances change.  Insist on flexibility and insist on no market risks.  If you choose not to investigate this option but instead keep your retirement money exposed to the market, make sure you have a good answer for the following question: “What will you do if the worse case becomes a reality?”

Here are some links if you’re interested in finding out more about longevity risk and how to insure against it:

 http://findarticles.com/p/articles/mi_m0EIN/is_2007_July_23/ai_n19378797 

http://www.financial-planning.com/pubs/fp/20060201023.html

https://www.forethought.com/ffs/forethought.portal?_nfpb=true&_pageLabel=forethought_annuities_home

The economic storm clouds are gathering and it’s looking like the U.S. is in for some tough financial weather.  If the U.S. catches an economic flu will the rest of the world get pneumonia?  The warning signs include a credit crunch, a real estate depression, rising inflation (including gas prices), higher unemployment, a weak dollar with rising deficits, widening trade balance, lower interest rates engineered by the Fed, a highly volatile stock market and widespread forecast of economic recession.  The Bush administration and Congress, with the endorsement of the Fed, are crafting a stimulus package to bail out the economy.  Consumer confidence is low and sinking with investors rushing toward safety with their retirement dollars.  In the first few trading days of 2008, investors have moved billions from the stock market into safer options.   If you’re leaving you money in the market, make sure your retirement plans won’t be derailed by the worst case outcome.  If so, you need to head to higher investment ground.  If you’re taking your dollars out of the market to safer places, what are your options?

First there’s bank CDs, Treasury bills and money market accounts.  The good news is that these are super safe, ready available and easy to cash in when the time comes.  The bad news is the interest rates they pay don’t even keep up with inflation.  These options are super safe if your only concern is “safety of principal” but they are extremely unsafe if you’re afraid of “outliving your retirement money”.  Since these options have historically not kept up with inflation, they may be a good short term parking place for your retirement money but are not a long term solution.  Plus, income taxes take a big bite out of your paltry earnings.

Corporate or government bonds can provide you good safety but not during times of low interest rates.  As rates rise — and you may be assured that the interest rate cycle has not been cured — the market value of fixed rate bonds will decline.  Yes, you’ll get your principal back at maturity but in the meantime you’ll have a hard time keeping up with inflation.  Plus, if you have to sell before maturity the loss could be a shocking surprise.  Not a good long-term solution and much too risky for the short term.

What about real estate?  Since most retirees are not real estate gurus, the safest route is to put your money in real estate investment trusts where it is professionally managed.  Given the recent track record of “professional real estate investors who fueled the sub-price meltdown” are you sure you want to entrust your money to them?  Maybe a good long term solution but why buy when prices are dropping like a rock?  International investments available in mutual funds and stocks are getting strong endorsements at this time… so maybe this is the ideal place! The last time I looked  mutual funds (which are nothing more than a collection of stocks and bonds inside a single investment) and corporate stocks waxed and waned with economic gyrations.  If the U.S. sneezes and the rest of the world catches a cold, you’ll be caught outside without a coat.  Generally way too much risk for retirees and that why your exposure to international markets, even in the best of times, is a small fraction of your total portfolio.

How about annuities?  These are savings options guaranteed by insurance companies that offer more than safety if you stick to the fixed variety.  Variable annuities are nothing more than mutual funds wrapped in a tax deferred package by an insurance company — they still have risk plus the ownership costs are much higher than just plain mutual funds.  Stay away from variable annuities.  Fixed annuities on the other hand come in several varieties: traditional fixed that mirror a bank CD and offer a set interest rate plus no current income taxes on earnings; index-linked which offers the opportunity for a higher rate because the interest rate they pay depends on the movement or growth of a stock/bond market index like the S&P 500 … but if the market nosedives you don’t because the worse you can do is the minimum return guaranteed by the insurance company; lastly there is the income annuity which guarantees you a period certain or lifetime income in exchange for depositing with the insurance company all or some of your retirement money.  The income annuity can give you what employers once guaranteed their retiring employees: a lifetime income you can’t outlive — even if you live to be 125.  If you haven ‘t yet discovered the fixed annuity option, get in touch with your financial advisor and demand to know more about them — just steer clear of the variable annuity because they pose market risk just like a stock, bond or mutual fund.  Oh yes, don’t be leery of fixed annuities because they are guaranteed by insurance companies because you’ll be dealing with some of the world’s oldest, largest and financially strongest businesses that have weathered wars, economic depressions and failure of governments.  These are the same companies that insure your home, car, life, health, business and virtually every valuable you own or risk you face.

When the economy goes into a tailspin and investments sink like a rock thrown into a lake, wall street and its army of brokers go into battle mode because their commissions hang in the balance.  Their war cries include “now is the time to buy at bargain prices”, “don’t sell just buy more to average down” and “over the long run you’ll do just fine by leaving your money in the market”.  Remember: no sale - no commission and that is bad for Wall Street and it brokers.  Granted, longer-term the stock market has outperformed the safer alternatives but the ten years you need to ride out the market cycles is a substantial portion of your retirement years. Years when you’ll be worried about your financial well-being, whether your money will run out before you do and whether an emergency will force you to sell at a loss before the long term has run it course.  Retirement is a time to keep what you’ve got rather than speculate in hopes of making more.  If you lose your retirement money, there will be no second chance.  Consult with your financial advisor and check out all the safe options — it could be the most important retirement decision you’ll make. 

If you’d like to hear and see what others are forecasting for 2008, click this link:  http://www.youtube.com/watch?v=op4BNyU6QQ4    

If you’d like to know where to invest your retirement money, there are virtually thousands of asset allocation calculators that will tell you. Go to the web site on any mutual fund company or brokerage firm for the free use of their asset allocation program. You simply answer a few questions about risk preference, give your age and presto they’ll tell you where to invest your retirement money. There’s only one problem: the results you get are rigged to give answers that create sales for the host company and their brokers. Invariably the recommendations will be stocks and bonds — no bank CDs, annuities or other non-brokerage options. I call this “broker-channel bias” because the advertising might of the large investment firms put other alternatives at a disadvantage. Far too many retirees are listening to the loudest voice when it comes to investment choices. My advice is to re-balance your mindset about retirement choices before you re-balance your retirement portfolio. Let me illustrate my point.

Here are the abbreviated questions asked to assess risk for a 65 year old. My answers are underlined.

1. If I inherited $10,000, I’d want to invest it in the stock market: strongly disagree
2. I will accept the possibility of loss, if gains are likely: strongly disagree
3. If potential return is twice normal, I’d accept up to 50% loss: strongly disagree
4. I avoid investments that are risky or unpredictable: strongly agree
5. If my investment dropped 20% in 2 weeks, I’d sell and go elsewhere: strongly agree
6. I prefer growth and performance over low risk: strongly disagree
7. I would choose job security even if the salary were lower: strongly agree
8. I’ll have sufficient money for a comfortable retirement: strongly disagree
9. I’m content waiting five years to recover market losses: strongly disagree
10. A stock market decline of 20% is a buying opportunity: strongly disagree

Not surprisingly I got the lowest risk tolerance score available.

Here’s how the investment allocation calculator said I should invest my retirement money.

1. Corporate bonds 52%.
2. U.S. large cap stocks 22%.
3. U.S. small cap stocks 11%.
4. Short term U.S. Treasury 10%.
5. International stocks 5%

Let’s say that I follow this advice and shortly thereafter the global economy goes into a tail spin, stock markets plummet and interest rates rocket upward. Can’t happen you say, check the conditions of the late 70’s and early 80’s. How have my investments fared? U.S. Treasury obligations are short-term (meaning less than 5 years), but higher rates will cause their value to decrease: the longer to maturity, the bigger the loss (actual loss if I sell and opportunity loss if I continue to hold). Not too bad, but I’ve got losses. Higher rates would cause corporate bond values to drop, and the recession could also undermine the creditworthiness of the issuers. Double trouble brewing here! The stocks would all decline in value with the recession: the losses range from bad to catastrophic. Not to worry, it’s only my retirement money. I could go back to work were it not for the recession… and my age. Can I handle the loss of 30% - 40% of my retirement money? I’ve just learned that there is a world of difference in diversifying a portfolio to “work toward retirement rather than making it through retirement”.

The fact is that retirement stakeholders are making terrible mistakes with their investment choices, because institutional advisors are putting their “returns” before your “retirement safety”. Rather than hedging investment risk using an asset allocation model, you might want to consider hedging against longevity risk (living too long) or the loss of a regular income. Some of the finest minds in the financial world say that the diversified portfolio approach used since the 1950’s is in real need of updating. I agree completely and encourage you to be aware of broker-channel bias the next time your broker calls. One last thing: consider all the options before investing.