So, okay, Hurricane Harvey may be the worst storm to hit America in a while. The damage is really bad, and getting worse. Projections for recovery time are lengthening by the minute as rainfall totals rise. The economic impact will clearly be big. Energy extraction and refining are being hit. The Gulf states have a number of petrochemical and plastics plants, but they aren't manufacturing much. The Gulf ports are major transshipment points for a lot of stuff, but not much transshipment is taking place. The cost of rebuilding may reach $100 billion or more.
Meanwhile, the fat kid in North Korea keeps firing off missiles, in one instance over northern Japan. He may think he's being clever, pushing the world to see how far he can go. But shooting missiles over another country is a way to start wars. The Japanese held their fire. But North Korea's missiles aren't the picture of reliability and sturdiness. If one flies in an unintended trajectory, or falls apart at the wrong time, physical impact on Japan or maybe South Korea is quite possible. Then what? Kim Jong Un has been on a path of escalation in recent months. He's announced that Guam--U.S. territory--is his next target. Since he seems intent on escalating, he will approach a flashpoint.
But do stocks care? Not one bit. Even though U.S. stock futures dropped sharply last night, all indexes closed up today. Mega hurricane--meh. Barrage of North Korean missiles--meh. Discord rife between and among the President, Congress and both political parties--meh. Merrily we roll along. Plus ca change, plus c'est la meme chose.
Why do we have such insouciant stocks? The likely explanation is the Fed. Market participants have gotten so used to Fed bailouts that no one believes stock indexes can fall more than about 3% at the most, and therefore don't panic sell portfolios. In some respects, this market stability may seem desirable.
But market stability based on government subsidies is ultimately chimerical. The Fed produced that stability by screwing over large numbers of people. By keeping interest rates extraordinarily low for almost a decade now, the Fed has decimated pension plans. A lot of middle class people who depended on their pensions are now lower middle class, or even poor. Retirees and others who relied in part on interest income from their savings have learned to like dog food in lieu of steak, or even hamburger. Holders of long term care insurance policies have faced extortionate rate increases, or possibly the prospect of spending old age in homeless shelters until they qualify for nursing homes that take Medicaid (which sometimes aren't exactly top class institutions). Those that still have some faith in the future and want to save for a rainy day need to tighten their belts and put aside more principal, rather than count on the compounding of interest income to make their golden years glow. That means reducing current consumption, which is a drag on the economy and may partially explain why economic growth remains tepid.
As long as the Fed supplies financial opioids for stocks to mainline, the market will be copacetic. But problems lurk. Stock valuations may not truly reflect investment values. Instead, they probably incorporate a large dose of government subsidy. That would mean people are paying too much for stocks. This story won't have a happy ending. Market forces can't stay suppressed indefinitely and government subsidies can't last forever. The failure of Communism in China and the Soviet Union prove that point. Things generally feel good when you're on narcotics. But you don't get good quality sleep on opioids--and investors shouldn't be sleeping too soundly now.
Showing posts with label Annuities. Show all posts
Showing posts with label Annuities. Show all posts
Wednesday, August 30, 2017
Tuesday, April 14, 2015
Is the Federal Reserve Wrecking Retirement?
We're now in the 7th year of Federal Reserve induced ultra low interest rates. The Fed has kept short term rates at zero (actually negative, once you take inflation into account) through monetary policy. Long term rates fell as well, especially after the Fed devoted years to quantitative easing (i.e., purchasing bonds in the open market). Those people old-fashioned enough to actually save money have been bedeviled by the near-absence of interest income. While some have been desperate enough to gamble with risky investments like junk bonds in order to generate more income, many and perhaps most have simply tightened their belts and spent less. After all, if you're not getting any interest income, the last thing you want to do is spend down your principal. That's like eating the seed corn--there will be no more harvests once the seed corn is gone.
Insidiously, the years-long pandemic of low long term interest rates has undermined retirements. Pension funds, insurance companies and other persons and entities trying to provide for America's retirees have historically depended on long term bonds to provide a stable source of predictable income. Pensions funds, insurance companies offering annuities, and other providers of retirement income tend to have relatively predictable obligations (i.e., the payouts they must make to current and future retirees), and look for predictable sources of funding to ensure that they can meet their obligations. U.S. Treasury securities, agency bonds and high quality corporates were the bread and butter of retirement funding. But these same stable long term investments have since the 2008 financial crisis been paying lower and lower interest rates. It's getting harder and harder to finance defined benefits. While pension funds, insurance companies, municipalities and the like have sometimes turned to stocks and alternative investments, the volatility of these alternatives makes them a poor substitute for the plain vanilla fixed-rate, meat-and-potatoes high quality bond.
Of course, pension providers could contribute more funding to pension plans to make up for the shortfall in interest income. But how many corporations, states and municipalities do you see leading the charge to put extra profits or taxpayer dollars into pension plans? Many seem to be looking for spots on the increasing crowded sides of the road to dump current and future pensioners.
Corporations have curtailed and terminated defined benefit pension plans. States and municipalities are in the process of doing the same. Multi-employer pension plans are going belly up like fish in a toxic waste spill. Soon, almost all of America's workers will be left with largely self-funded defined-contribution retirement plans, like the 401(k), or with self-funded retirements using IRAs. Experience teaches that self-funded retirements are usually not as stable or comfortable as retirements funded with defined benefit pensions. And that's just for the 40% of Americans who have any retirement savings at all. As for the 60% who have none (as in zero, zilch, nada), the opulence of life on Social Security beckons.
To be sure, Fed policy isn't the only reason why interest rates are low. Economic and political instability in many other parts of the world are driving capital into safe dollar-denominated investments. Low inflation tends to keep interest rates low. But the Fed, as the single most powerful force in the money markets, has played a crucial role in eradicating high long term rates.
While Wall Street, corporate America, the 1% and many of the unemployed have benefited to varying degrees from the Fed's suppression of positive interest rates, there is, as economics teaches, no free lunch. There are costs to persistently low interest rates, and much of the cost has fallen on those middle and modest income workers who have or hoped for a defined benefit retirement. Okay, so we already know the wealthy enjoy a heads-we-win, tails-those-little-people-lose advantage. But we shouldn't buy into the Fed's story that it's creating stability to prevent a Great Depression. What the Fed has done is transfer losses and instability that could have manifested themselves in another Great Depression, to many of America's current and future retirees, whose golden years may now be more unpredictable and depressed than they had hoped.
Insidiously, the years-long pandemic of low long term interest rates has undermined retirements. Pension funds, insurance companies and other persons and entities trying to provide for America's retirees have historically depended on long term bonds to provide a stable source of predictable income. Pensions funds, insurance companies offering annuities, and other providers of retirement income tend to have relatively predictable obligations (i.e., the payouts they must make to current and future retirees), and look for predictable sources of funding to ensure that they can meet their obligations. U.S. Treasury securities, agency bonds and high quality corporates were the bread and butter of retirement funding. But these same stable long term investments have since the 2008 financial crisis been paying lower and lower interest rates. It's getting harder and harder to finance defined benefits. While pension funds, insurance companies, municipalities and the like have sometimes turned to stocks and alternative investments, the volatility of these alternatives makes them a poor substitute for the plain vanilla fixed-rate, meat-and-potatoes high quality bond.
Of course, pension providers could contribute more funding to pension plans to make up for the shortfall in interest income. But how many corporations, states and municipalities do you see leading the charge to put extra profits or taxpayer dollars into pension plans? Many seem to be looking for spots on the increasing crowded sides of the road to dump current and future pensioners.
Corporations have curtailed and terminated defined benefit pension plans. States and municipalities are in the process of doing the same. Multi-employer pension plans are going belly up like fish in a toxic waste spill. Soon, almost all of America's workers will be left with largely self-funded defined-contribution retirement plans, like the 401(k), or with self-funded retirements using IRAs. Experience teaches that self-funded retirements are usually not as stable or comfortable as retirements funded with defined benefit pensions. And that's just for the 40% of Americans who have any retirement savings at all. As for the 60% who have none (as in zero, zilch, nada), the opulence of life on Social Security beckons.
To be sure, Fed policy isn't the only reason why interest rates are low. Economic and political instability in many other parts of the world are driving capital into safe dollar-denominated investments. Low inflation tends to keep interest rates low. But the Fed, as the single most powerful force in the money markets, has played a crucial role in eradicating high long term rates.
While Wall Street, corporate America, the 1% and many of the unemployed have benefited to varying degrees from the Fed's suppression of positive interest rates, there is, as economics teaches, no free lunch. There are costs to persistently low interest rates, and much of the cost has fallen on those middle and modest income workers who have or hoped for a defined benefit retirement. Okay, so we already know the wealthy enjoy a heads-we-win, tails-those-little-people-lose advantage. But we shouldn't buy into the Fed's story that it's creating stability to prevent a Great Depression. What the Fed has done is transfer losses and instability that could have manifested themselves in another Great Depression, to many of America's current and future retirees, whose golden years may now be more unpredictable and depressed than they had hoped.
Thursday, June 12, 2014
How To Reduce Volatility in Your Retirement Income
The S&P 500 has dropped three days in a row, and after all the market calm of recent months, many investors must be thinking that the apocalypse looms. There are understandable explanations for the recent downdrafts. Islamic radicals of the Sunni variety have rapidly seized several towns and cities in Iraq, along with American weapons and vehicles provided to the Iraqi government (and the administration worries about giving small arms to moderate Syrian rebels?). Iranian paramilitary troops, who are Shiites, supposedly are fighting alongside Iraqi government troops to retake territory seized by the Sunni radicals. Is Iran now a more important ally of the Iraqi government than the U.S.?
Russian tanks have reportedly rolled into Ukraine, where the fighting is escalating. Bashir Assad is winning in Syria, and the moderate rebels that the U.S. supports seem to be almost inconsequential. Most of East Asia is squabbling over this island or that, with contending nations issuing many a proclamation declaiming a neighbor as a ratfink, a double ratfink or even a triple ratfink.
Domestic politics also create uncertainty for the markets. Eric Cantor, House Majority Leader, was just defenestrated in a primary election by a guy from far right field whose name, even if we mentioned it now, you probably wouldn't recognize. (But we're going to, because it's Dave Brat, a marvelously fitting name for a guy who ousted the Majority Leader.) Cantor, who outspent his opponent's six-figure campaign by $5 million, convincingly proved that money isn't everything. Not even in politics. The Koch brothers must be scratching their heads about what checks to write next.
The markets will always be plagued by volatility. And it tends to pop up when you least expect it. That might be inherent in the definition of volatility, but you know what we mean. Yogurt happens, but you don't want your retirement finances smeared with yogurt. While there are no complete protections against the ups and downs of life, here are a few ideas for calming the financial waves.
Build Up Social Security Benefits. Disregard the hyperbole. Social Security will be there when you retire. Maybe not exactly as it is now, but nevertheless in a meaningful form. Any politician who votes to eliminate or sharply reduce Social Security retirement benefits will end up doing an Eric Cantor faster than Eric Cantor as voters reject the idea that they should have to eat dog food in their old age. Work as long as you can to build up your benefits.
Get a Pension. If you're lucky enough to get a pension, stick out it long enough in that job to qualify. Although classic defined benefits pensions are usually found these days only alongside the remains of diplodocus, lasso one if you can. Other pension arrangements, like cash balance plans, are a lot better than no pension.
Save More. Saving more is a salve for portfolio instability and financial insecurity. Those that have the saving jones won't have to get loans.
Use Retirement Accounts. Retirement accounts like 401(k)s, IRAs and so on offer tax advantages that let you leverage your retirement savings, while limiting your ability to prematurely spend your savings. A particular advantage to a 401(k) account comes if your employer provides a matching contribution, which is the freest money most people can get. Use these accounts as much as you can.
Diversity Your Investments. The values of all assets wax and wane. But they usually don't wax and wane in unison. More commonly, some assets get yeasty while others do the fallen souffle thing. And vice versa. So a diversified portfolio is usually kind to your antacid budget. There are moments, like the 2008-09 financial crisis, when it seems like almost all assets belly flop. But these cognitively dissonant interludes are the exception and not the rule.
Consider an Annuity. A fixed annuity (one that pays a specified dollar amount per month) or a fixed annuity adjusted for inflation can be a reasonable way to provide a steady income. Annuities aren't cheap, and you should buy only from an insurance company with a strong credit rating. Don't put more than about one-third to one-half of your portfolio into an annuity because cash needs in old age can be unpredictable and it helps to have a nice pool of cash or cash equivalents. Be very cautious about variable annuities--they often have high expenses, and the point here is to reduce volatility, not subject yourself to it in another form.
Health Insurance and Long Term Care Insurance. Financial volatility can sometimes come from sudden increases in expenses, and not just decreases in portfolio values. Health care and long term care needs are the biggest landmines in the journey through retirement. Most retirees are covered by Medicare, but if you're not, then buy something else. The Affordable Care Act, despite all the teeth-gnashing on the right, is likely to be a good option if you don't have anything else. If you have a significant net worth, consider buying long term care insurance, especially if you have a spouse who may depend on that net worth after you've gone to the great Dance Party in the sky. It's expensive, but so is long term care. If you want more than the quality of care given to Medicaid patients, long term care insurance may be a good choice.
Part-time Work. Okay, you want to hear about retirement, not employment. But part-time employment reduces the extent you need to draw down your savings, so you can keep more powder dry for later. It also lessens your risk of dying from the boredom of day time TV. It may boost your Social Security benefits (depending on your work history). And the dignity of work is better than the indignity of looking for sales on dog food.
Russian tanks have reportedly rolled into Ukraine, where the fighting is escalating. Bashir Assad is winning in Syria, and the moderate rebels that the U.S. supports seem to be almost inconsequential. Most of East Asia is squabbling over this island or that, with contending nations issuing many a proclamation declaiming a neighbor as a ratfink, a double ratfink or even a triple ratfink.
Domestic politics also create uncertainty for the markets. Eric Cantor, House Majority Leader, was just defenestrated in a primary election by a guy from far right field whose name, even if we mentioned it now, you probably wouldn't recognize. (But we're going to, because it's Dave Brat, a marvelously fitting name for a guy who ousted the Majority Leader.) Cantor, who outspent his opponent's six-figure campaign by $5 million, convincingly proved that money isn't everything. Not even in politics. The Koch brothers must be scratching their heads about what checks to write next.
The markets will always be plagued by volatility. And it tends to pop up when you least expect it. That might be inherent in the definition of volatility, but you know what we mean. Yogurt happens, but you don't want your retirement finances smeared with yogurt. While there are no complete protections against the ups and downs of life, here are a few ideas for calming the financial waves.
Build Up Social Security Benefits. Disregard the hyperbole. Social Security will be there when you retire. Maybe not exactly as it is now, but nevertheless in a meaningful form. Any politician who votes to eliminate or sharply reduce Social Security retirement benefits will end up doing an Eric Cantor faster than Eric Cantor as voters reject the idea that they should have to eat dog food in their old age. Work as long as you can to build up your benefits.
Get a Pension. If you're lucky enough to get a pension, stick out it long enough in that job to qualify. Although classic defined benefits pensions are usually found these days only alongside the remains of diplodocus, lasso one if you can. Other pension arrangements, like cash balance plans, are a lot better than no pension.
Save More. Saving more is a salve for portfolio instability and financial insecurity. Those that have the saving jones won't have to get loans.
Use Retirement Accounts. Retirement accounts like 401(k)s, IRAs and so on offer tax advantages that let you leverage your retirement savings, while limiting your ability to prematurely spend your savings. A particular advantage to a 401(k) account comes if your employer provides a matching contribution, which is the freest money most people can get. Use these accounts as much as you can.
Diversity Your Investments. The values of all assets wax and wane. But they usually don't wax and wane in unison. More commonly, some assets get yeasty while others do the fallen souffle thing. And vice versa. So a diversified portfolio is usually kind to your antacid budget. There are moments, like the 2008-09 financial crisis, when it seems like almost all assets belly flop. But these cognitively dissonant interludes are the exception and not the rule.
Consider an Annuity. A fixed annuity (one that pays a specified dollar amount per month) or a fixed annuity adjusted for inflation can be a reasonable way to provide a steady income. Annuities aren't cheap, and you should buy only from an insurance company with a strong credit rating. Don't put more than about one-third to one-half of your portfolio into an annuity because cash needs in old age can be unpredictable and it helps to have a nice pool of cash or cash equivalents. Be very cautious about variable annuities--they often have high expenses, and the point here is to reduce volatility, not subject yourself to it in another form.
Health Insurance and Long Term Care Insurance. Financial volatility can sometimes come from sudden increases in expenses, and not just decreases in portfolio values. Health care and long term care needs are the biggest landmines in the journey through retirement. Most retirees are covered by Medicare, but if you're not, then buy something else. The Affordable Care Act, despite all the teeth-gnashing on the right, is likely to be a good option if you don't have anything else. If you have a significant net worth, consider buying long term care insurance, especially if you have a spouse who may depend on that net worth after you've gone to the great Dance Party in the sky. It's expensive, but so is long term care. If you want more than the quality of care given to Medicaid patients, long term care insurance may be a good choice.
Part-time Work. Okay, you want to hear about retirement, not employment. But part-time employment reduces the extent you need to draw down your savings, so you can keep more powder dry for later. It also lessens your risk of dying from the boredom of day time TV. It may boost your Social Security benefits (depending on your work history). And the dignity of work is better than the indignity of looking for sales on dog food.
Sunday, November 18, 2012
Why Insurance Products Can Make Lousy Investments
If you're considering an insurance product that includes an investment feature, consider the following two examples of why you might want to say no.
Mass Mutual. On Nov. 15, 2012, the SEC sued Massachusetts Mutual Life Insurance Company in an administrative proceeding (an agency process somewhat like a court case, although conducted within the SEC instead of in a court). Mass Mutual settled without admitting or denying the SEC's charges. The essential accusation the agency leveled against Mass Mutual was that it didn't adequately explain to customers how withdrawals from variable annuities under certain circumstances could drain their accounts of value. (See the SEC's press release at http://www.sec.gov/news/press/2012/2012-230.htm.)
Variable annuities involve the customer making periodic payments for a number of years and directing how the money is invested in a tax sheltered annuity. Eventually, the invested amounts can be used to purchase an income stream from the insurance company. The investments may do well or poorly. To ameliorate the potential for poor investment returns, Mass Mutual offered an optional rider that, for an additional premium, gave customers a GMIB, or Guaranteed Minimum Income Benefit. The GMIB guaranteed a minimum value that customers could use eventually to purchase an income stream, regardless of how poorly their investments did.
The GMIB could increase by 5% or 6%, depending on the rider. Mass Mutual capped the level of the GMIB (through a somewhat complex formula). Once the cap was reached, the GMIB wouldn't increase. Mass Mutual also allowed customers to make withdrawals from their annuities before they converted the investment value into an income stream. If they made a withdrawal before the GMIB reached its cap, the withdrawal would reduce the GMIB value (and the value of the invested assets as well), but wouldn't prevent the GMIB from continuing to increase. However, after the GMIB reached its cap, withdrawals would decrease the GMIB and it wouldn't increase the next year. Thus, making withdrawals after the GMIB reached its cap could permanently shrink the GMIB--under some potential circumstances, to zero. According to the SEC, Mass Mutual didn't clearly explain how the GMIB, which might be thought by customers to be a guaranteed minimum value, wasn't guaranteed if the customer made withdrawals after it reached its cap.
Got it? Pretty simple, right? To be sure, after it was nabbed by the SEC, Mass Mutual did the right thing and eliminated the cap on the GMIB. But if you furrowed your brow over the details of this annuity (and we've just summarized them--read the SEC's press release and order cited above for a gorier rendition), you should think twice--and then three times--and then four times--and then five, six, seven and many more times before investing in a variable annuity.
Universal Life. The other example is in today's Wall Street Journal (Nov. 17-18, 2012, P. B9), which reports that low interest rates may require universal life insurance policy holders to pay higher premiums or face the cancellation of their policies. Universal life is a form of permanent life insurance that allows customers to have life insurance coverage for long periods of time (i.e., longer than the perhaps 20 years allowed in term life coverage), often with flexibility in the amounts of the premiums paid. Universal life also has an investment feature, and customers can use money from the investment account to help cover the cost of their life insurance. As customers age, the cost of life insurance coverage naturally increases. But today's low interest rate environment has been detrimental to investment returns, including those of universal life policies. Many universal life customers are facing the need to pay increased premiums, or see a reduction of their life insurance coverage or even the cancellation of their policies. Large numbers of universal life policies were sold years ago, before the Federal Reserve declared war on positive interest rates. So the current low rate environment and its consequences for universal life policies probably come as a surprise to many customers.
Insurance products like variable annuities and permanent life insurance can sometimes put customers into the middle of the complexities of the financial markets. You're subject to many of the same risks as professional investors and traders. But you probably don't have the same level of knowledge, experience, and information as they do. Sophisticated insurance products can be labyrinthine mazes of risk shifting, and it's possible to run into the Minotaur. Traditional insurance, which consists of the pooling of risks, can offer sensible protections. But stick to policies that are easy to understand, because then you'll know what you're getting into. Term life and fixed annuities can be useful for many people. Super dooper, turbo-charged complex insurance products that also invest your savings, pick up your dry cleaning and get the oil changed in your car are to be viewed cautiously, and then skeptically.
Mass Mutual. On Nov. 15, 2012, the SEC sued Massachusetts Mutual Life Insurance Company in an administrative proceeding (an agency process somewhat like a court case, although conducted within the SEC instead of in a court). Mass Mutual settled without admitting or denying the SEC's charges. The essential accusation the agency leveled against Mass Mutual was that it didn't adequately explain to customers how withdrawals from variable annuities under certain circumstances could drain their accounts of value. (See the SEC's press release at http://www.sec.gov/news/press/2012/2012-230.htm.)
Variable annuities involve the customer making periodic payments for a number of years and directing how the money is invested in a tax sheltered annuity. Eventually, the invested amounts can be used to purchase an income stream from the insurance company. The investments may do well or poorly. To ameliorate the potential for poor investment returns, Mass Mutual offered an optional rider that, for an additional premium, gave customers a GMIB, or Guaranteed Minimum Income Benefit. The GMIB guaranteed a minimum value that customers could use eventually to purchase an income stream, regardless of how poorly their investments did.
The GMIB could increase by 5% or 6%, depending on the rider. Mass Mutual capped the level of the GMIB (through a somewhat complex formula). Once the cap was reached, the GMIB wouldn't increase. Mass Mutual also allowed customers to make withdrawals from their annuities before they converted the investment value into an income stream. If they made a withdrawal before the GMIB reached its cap, the withdrawal would reduce the GMIB value (and the value of the invested assets as well), but wouldn't prevent the GMIB from continuing to increase. However, after the GMIB reached its cap, withdrawals would decrease the GMIB and it wouldn't increase the next year. Thus, making withdrawals after the GMIB reached its cap could permanently shrink the GMIB--under some potential circumstances, to zero. According to the SEC, Mass Mutual didn't clearly explain how the GMIB, which might be thought by customers to be a guaranteed minimum value, wasn't guaranteed if the customer made withdrawals after it reached its cap.
Got it? Pretty simple, right? To be sure, after it was nabbed by the SEC, Mass Mutual did the right thing and eliminated the cap on the GMIB. But if you furrowed your brow over the details of this annuity (and we've just summarized them--read the SEC's press release and order cited above for a gorier rendition), you should think twice--and then three times--and then four times--and then five, six, seven and many more times before investing in a variable annuity.
Universal Life. The other example is in today's Wall Street Journal (Nov. 17-18, 2012, P. B9), which reports that low interest rates may require universal life insurance policy holders to pay higher premiums or face the cancellation of their policies. Universal life is a form of permanent life insurance that allows customers to have life insurance coverage for long periods of time (i.e., longer than the perhaps 20 years allowed in term life coverage), often with flexibility in the amounts of the premiums paid. Universal life also has an investment feature, and customers can use money from the investment account to help cover the cost of their life insurance. As customers age, the cost of life insurance coverage naturally increases. But today's low interest rate environment has been detrimental to investment returns, including those of universal life policies. Many universal life customers are facing the need to pay increased premiums, or see a reduction of their life insurance coverage or even the cancellation of their policies. Large numbers of universal life policies were sold years ago, before the Federal Reserve declared war on positive interest rates. So the current low rate environment and its consequences for universal life policies probably come as a surprise to many customers.
Insurance products like variable annuities and permanent life insurance can sometimes put customers into the middle of the complexities of the financial markets. You're subject to many of the same risks as professional investors and traders. But you probably don't have the same level of knowledge, experience, and information as they do. Sophisticated insurance products can be labyrinthine mazes of risk shifting, and it's possible to run into the Minotaur. Traditional insurance, which consists of the pooling of risks, can offer sensible protections. But stick to policies that are easy to understand, because then you'll know what you're getting into. Term life and fixed annuities can be useful for many people. Super dooper, turbo-charged complex insurance products that also invest your savings, pick up your dry cleaning and get the oil changed in your car are to be viewed cautiously, and then skeptically.
Thursday, March 3, 2011
How to Avoid Running Out of Money in Retirement
The fear of running out of money may be the biggest financial dilemma for most retirees. There's no perfect solution to the problem. But plenty of people have long, enjoyable retirements and leave something behind for their heirs. So the problem isn't insurmountable. Here are some ideas.
Build up your Social Security and pension credits. Whatever Congress and the President do to reform Social Security, they won't abolish it. It will be there in one form or another when you retire. Working as long as possible to maximize your benefits ensures a lifelong stream of inflation-adjusted payments. While Social Security won't cover more than the basics, life is easier when you have the basics covered. If you're fortunate enough to have a pension, work as long as you can to boost your pension payments. Working longer, although not as much fun as shuffleboard, is one of the best ways to make sure you're as well prepared as possible for retirement.
Save. The more you save, in retirement accounts or otherwise, the better off you will be in retirement. Non-savers, by definition, have already run out of money, and poor savers will quickly fall into the abyss. It's important to have a pool of cash available for big expenses like assisted living and other medical bills. If all you have are comparatively small streams of payments like Social Security and perhaps a pension, and you need to go into assisted living, you'll have effectively run out of money even though you're still getting a monthly income.
Pay down debts. Ideally, you should have no mortgage and little or no other debt by the time you retire. Debt, and its accompanying interest expenses, are negative savings. Some financial advisers will conjure up scenarios where you supposedly might be better off with a mortgage or some other debt. But debt involves risk, and the recent financial crisis and Great Recession amply demonstrate that risk can easily lead to losses. Financial stability is very important for a comfortable retirement, and debt destabilizes.
Invest conservatively. The older you get, the less time you have to recover from investment losses. Keeping some money in assets with potential for appreciation, like stocks, is a good idea because of long term risks of inflation. But be cautious about investing in stocks and other volatile assets. Perhaps a third of your portfolio might prudently be kept in stocks. As you get older, that proportion should shrink so that you don't get walloped by the stock market when you're 83.
Consider an annuity. It's easier to establish a budget if you have a predictable monthly income. An immediate annuity can provide either a fixed monthly payment or one that rises with inflation. (The latter is costlier, but you get additional peace of mind.) Annuities are issued by insurance companies, and they can go bankrupt. If you want the benefits of an annuity, consider buying two, each for half the amount you want to invest, from different insurance companies. Both should have solid credit ratings. With two different insurers, you diversify your risks.
Be cautious with variable annuities. They tend to have high expenses and varying (as the name indicates) payments. That uncertainty of payments may, for some, defeat the purpose of an annuity.
Note that annuities lock up the capital you invest in them, meaning you can't get access to it. All you can get are the payments. You'll almost surely need some liquid assets during retirement, for medical expenses and large items like cars. Never spend more than half your savings on annuities. Indeed, given the limitations of annuities, spend only the minimum amount needed to give you the peace of mind you're trying to secure.
Think about long term care insurance. Although increasingly expensive, long term care insurance gives you hundreds of thousands of dollars of buying power if you have to go into assisted living or have other major similar needs. Long term care insurance helps to preserve your savings (which may be important if you have a spouse or partner whose financial security you wish to protect). In addition, if you want to avoid a nursing home that accepts Medicaid patients--some feel that such nursing homes provide lower quality services--long term care insurance could be essential to affording a more exclusive facility.
Work part-time. Okay, working isn't exactly what you had in mind for retirement. But it allows you to spend less of your savings while you're able to work. If and when you reach the point where you can't work, you'll be glad you worked as long as you did.
Build up your Social Security and pension credits. Whatever Congress and the President do to reform Social Security, they won't abolish it. It will be there in one form or another when you retire. Working as long as possible to maximize your benefits ensures a lifelong stream of inflation-adjusted payments. While Social Security won't cover more than the basics, life is easier when you have the basics covered. If you're fortunate enough to have a pension, work as long as you can to boost your pension payments. Working longer, although not as much fun as shuffleboard, is one of the best ways to make sure you're as well prepared as possible for retirement.
Save. The more you save, in retirement accounts or otherwise, the better off you will be in retirement. Non-savers, by definition, have already run out of money, and poor savers will quickly fall into the abyss. It's important to have a pool of cash available for big expenses like assisted living and other medical bills. If all you have are comparatively small streams of payments like Social Security and perhaps a pension, and you need to go into assisted living, you'll have effectively run out of money even though you're still getting a monthly income.
Pay down debts. Ideally, you should have no mortgage and little or no other debt by the time you retire. Debt, and its accompanying interest expenses, are negative savings. Some financial advisers will conjure up scenarios where you supposedly might be better off with a mortgage or some other debt. But debt involves risk, and the recent financial crisis and Great Recession amply demonstrate that risk can easily lead to losses. Financial stability is very important for a comfortable retirement, and debt destabilizes.
Invest conservatively. The older you get, the less time you have to recover from investment losses. Keeping some money in assets with potential for appreciation, like stocks, is a good idea because of long term risks of inflation. But be cautious about investing in stocks and other volatile assets. Perhaps a third of your portfolio might prudently be kept in stocks. As you get older, that proportion should shrink so that you don't get walloped by the stock market when you're 83.
Consider an annuity. It's easier to establish a budget if you have a predictable monthly income. An immediate annuity can provide either a fixed monthly payment or one that rises with inflation. (The latter is costlier, but you get additional peace of mind.) Annuities are issued by insurance companies, and they can go bankrupt. If you want the benefits of an annuity, consider buying two, each for half the amount you want to invest, from different insurance companies. Both should have solid credit ratings. With two different insurers, you diversify your risks.
Be cautious with variable annuities. They tend to have high expenses and varying (as the name indicates) payments. That uncertainty of payments may, for some, defeat the purpose of an annuity.
Note that annuities lock up the capital you invest in them, meaning you can't get access to it. All you can get are the payments. You'll almost surely need some liquid assets during retirement, for medical expenses and large items like cars. Never spend more than half your savings on annuities. Indeed, given the limitations of annuities, spend only the minimum amount needed to give you the peace of mind you're trying to secure.
Think about long term care insurance. Although increasingly expensive, long term care insurance gives you hundreds of thousands of dollars of buying power if you have to go into assisted living or have other major similar needs. Long term care insurance helps to preserve your savings (which may be important if you have a spouse or partner whose financial security you wish to protect). In addition, if you want to avoid a nursing home that accepts Medicaid patients--some feel that such nursing homes provide lower quality services--long term care insurance could be essential to affording a more exclusive facility.
Work part-time. Okay, working isn't exactly what you had in mind for retirement. But it allows you to spend less of your savings while you're able to work. If and when you reach the point where you can't work, you'll be glad you worked as long as you did.
Tuesday, June 19, 2007
Annuities
The nice thing about pensions is that you know what you are going to get and when you’ll get it. Anyone who has experienced the stock markets bouncing up and down, and then lived through the real estate roller coaster knows that economic certainty is about as easy to find as Nessie. With traditional pension plans going the way of the dodo, what certainty for retirement is there?
There’s Social Security. Hahahahahahahahaha. Okay, now that we’ve had our little laugh, let’s be serious for a moment. Social Security isn’t going to disappear. It may not be as generous in the future as it is now, but it will be there in some form when you retire. How can we be sure? Because no politician in Washington will let it die for fear of losing his or her job. Congress is one of the few places where you get paid well over 100K a year to talk all day without having to do anything. Very few members want to give up a job like that.
But is there any other certainty? One thing that the insurance industry is promoting is the idea of an annuity. There are about as many different types of annuities as there are types of cars, and we will focus today on the ones that supposedly provide certainty: the lump sum immediate fixed annuity and the lump sum immediate inflation-adjusted annuity.
The lump sum immediate fixed annuity is simple in concept. You pay an insurance company some money and the company agrees to pay you a fixed monthly payment for life. The time period of payments can also be limited, such as for ten or twenty years, but an annuity usually makes the most sense if you get the promise of payments for life. The amount of the monthly payment will vary depending on the amount you invest, interest rates, your age and gender, the fees and charges of the insurance company, and perhaps other factors.
There are also inflation adjusted annuities, where the amount you get will start off lower than it would for a fixed annuity. However, it will be increased in line with inflation, so over the long run, you may feel more secure. It may start out with payments that are 25% to 30% lower than fixed annuities, but depending on inflation could end up much higher.
One of the tradeoffs with these annuities is that you lose access to the principal you invest in them. In other words, if you spend $100K to buy an annuity and die the next day, your heirs are out of luck. They won’t inherit a penny of that 100K. (There are modified annuities that provide for somewhat of an inheritance, but it costs you in terms of reduced monthly payments and the inheritance feature will usually expire after a few years.)
Is it worthwhile to buy an annuity?
First, you need to have some real cash. Insurance companies like customers who can throw 100K, 200K or more at these things. If you’re going into retirement with a house, 50K or 75K in savings and Social Security, don’t bother with an annuity.
Second, if you have the money, don’t spend more than half of your financial assets on an annuity. You may have serious cash needs in retirement—assisted living facilities are not covered by Medicare or Medicaid. And other health care expenses may also not be insured. You can’t retrieve the cash in the annuity, so you’d better keep a good sized bundle on hand. Invest your remaining assets in a diversified portfolio with some stock market exposure, as a hedge against inflation.
Third, if you have Social Security and a pension, you probably don’t need an annuity. Between Social Security and the pension, much of your finances are already annuitized. Keep your financial assets for the major cash needs that may arise. Invest them in a diversified portfolio with some exposure to stocks to provide a hedge against inflation.
Fourth, think about whether an annuity might help you control your spending. If you’re likely to spend down your savings rather quickly, annuitizing part of them might help you make your money last through retirement. You could look to the annuity payment, plus Social Security, to cover your ordinary living expenses. An annuity may not be a great investment (usually, they’re not because the fees and charges are rather high). But if the steady payments from an annuity would give you a psychological boost and keep you from spending down the rest of your savings quickly, then it might be a good idea.
Remember that annuities are subject to the risk that the insurance company may fail, and be unable to pay its obligations. Research the creditworthiness of the insurance company before buying.
Crime News: the British police don’t carry guns, but they ride in pedicabs. http://www.wtop.com/?nid=456&sid=1167116.
There’s Social Security. Hahahahahahahahaha. Okay, now that we’ve had our little laugh, let’s be serious for a moment. Social Security isn’t going to disappear. It may not be as generous in the future as it is now, but it will be there in some form when you retire. How can we be sure? Because no politician in Washington will let it die for fear of losing his or her job. Congress is one of the few places where you get paid well over 100K a year to talk all day without having to do anything. Very few members want to give up a job like that.
But is there any other certainty? One thing that the insurance industry is promoting is the idea of an annuity. There are about as many different types of annuities as there are types of cars, and we will focus today on the ones that supposedly provide certainty: the lump sum immediate fixed annuity and the lump sum immediate inflation-adjusted annuity.
The lump sum immediate fixed annuity is simple in concept. You pay an insurance company some money and the company agrees to pay you a fixed monthly payment for life. The time period of payments can also be limited, such as for ten or twenty years, but an annuity usually makes the most sense if you get the promise of payments for life. The amount of the monthly payment will vary depending on the amount you invest, interest rates, your age and gender, the fees and charges of the insurance company, and perhaps other factors.
There are also inflation adjusted annuities, where the amount you get will start off lower than it would for a fixed annuity. However, it will be increased in line with inflation, so over the long run, you may feel more secure. It may start out with payments that are 25% to 30% lower than fixed annuities, but depending on inflation could end up much higher.
One of the tradeoffs with these annuities is that you lose access to the principal you invest in them. In other words, if you spend $100K to buy an annuity and die the next day, your heirs are out of luck. They won’t inherit a penny of that 100K. (There are modified annuities that provide for somewhat of an inheritance, but it costs you in terms of reduced monthly payments and the inheritance feature will usually expire after a few years.)
Is it worthwhile to buy an annuity?
First, you need to have some real cash. Insurance companies like customers who can throw 100K, 200K or more at these things. If you’re going into retirement with a house, 50K or 75K in savings and Social Security, don’t bother with an annuity.
Second, if you have the money, don’t spend more than half of your financial assets on an annuity. You may have serious cash needs in retirement—assisted living facilities are not covered by Medicare or Medicaid. And other health care expenses may also not be insured. You can’t retrieve the cash in the annuity, so you’d better keep a good sized bundle on hand. Invest your remaining assets in a diversified portfolio with some stock market exposure, as a hedge against inflation.
Third, if you have Social Security and a pension, you probably don’t need an annuity. Between Social Security and the pension, much of your finances are already annuitized. Keep your financial assets for the major cash needs that may arise. Invest them in a diversified portfolio with some exposure to stocks to provide a hedge against inflation.
Fourth, think about whether an annuity might help you control your spending. If you’re likely to spend down your savings rather quickly, annuitizing part of them might help you make your money last through retirement. You could look to the annuity payment, plus Social Security, to cover your ordinary living expenses. An annuity may not be a great investment (usually, they’re not because the fees and charges are rather high). But if the steady payments from an annuity would give you a psychological boost and keep you from spending down the rest of your savings quickly, then it might be a good idea.
Remember that annuities are subject to the risk that the insurance company may fail, and be unable to pay its obligations. Research the creditworthiness of the insurance company before buying.
Crime News: the British police don’t carry guns, but they ride in pedicabs. http://www.wtop.com/?nid=456&sid=1167116.
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