Retirement Income Blog

The Annual Report on the United States Government reports that Americans paid $25 Billion in estate planning tax. Every dime of those taxes could have been avoided.  How do you think the kids felt when they wrote out a check for $300,000 for estate planning tax and then learned from the estate planning attorney that mom and dad could have saved them every penny?

If you don’t like wasting money on taxes and don’t want your kids squandering money either, then this article will explain what you need to do.

You must realistically answer these questions: 

1. Will your estate be worth more than $2 million (2008 estate planning tax exempt amount, subject to change) when you die?   By the way, you cannot assume that the estate exemption will grow as some people believe.  Congress can change this number at any time and there are powerful people in Congress who want to reduce the exemption.  All you do know is that right now, you can shelter  $2 million of assets, while it lasts.
 
2. Do you have any assets that could be double-taxed at your death (double taxed by income tax and estate planning tax, which could consume 70% of the value) such as IRAs and annuities?
 
3. Do you think that if you need to take action, that your attorney would call you up on the phone and tell you? (He probably won’t as many attorneys wait until you call them).
 
4. Do you think you have plenty of time to take care of any estate planning tax problem–like the people who paid $25 billion last year?
 
5. Do you incorrectly think that to eliminate or reduce estate planning tax means giving up control of assets or making gifts or giving to charity?  (With good estate planning, you can keep total control of assets and still remove them from your taxable estate).
 
6. Do you have the false notion that a living trust will eliminate your estate planning tax? (You will pay estate tax on assets over $2 million living trust or not).
 
7. Do you think that you need to die in order to get your $2 million estate exemption? (You don’t, $1 million is available right now and many wealthy people use their estate exemptions when they can make the most of them– during their lifetimes).

If you answered “yes” to any of the above, you probably have an estate tax problem.

There are several ways to reduce or eliminate estate planning tax, including:

• gifting of assets to heirs now rather than leaving at death
• the use of estate planning strategies and tools (e.g. GRATS, QPRTS) to divide assets into their lifetime value and their discounted remainder value and this reduce the estate planning tax
• discounting the value of assets with minority or fractional discounts (and thus reduce the exposure to estate tax)
• proper estate division between spouses

Other posts in this blog will address these estate planning strategies individually.

Note:  this article uses the term “estate planning tax” to help the 6000 people who search Google each month for this term when they really mean “estate tax.”

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Index annuities are fixed annuities that have the interest you receive tied to a stock market index. An index annuity is ideal for investors who want to participate in market-related returns yet are uncomfortable
with market risk. But with about 40 known interest crediting methods, you may find that even if
two index annuities are linked to the same index, their returns might not be the same.  That’s because these index annuities have several moving parts as described below.

The Participation Rate in an index annuity is the amount of the increase (not including dividends)
in the underlying index that will be credited to your index annuity. For example,
suppose the index (the S&P 500) increased 9% and the participation rate is 70%. The index annuity will be
credited with 6.3% interest (9% x 70% = 6.3%).

Annuity companies can set different participation rates for newly issued index annuities as often as each
day. Therefore, the initial participation rate will depend on when the company issues your index annuity. Annuity companies usually guarantee the participation rate for a specific period (from one
year to the entire annuity term). Then when that period is over, a new participation rate is set for
the next period. Some annuity companies promise that the participation rate will never be
set lower than a specified minimum or higher than a specified maximum.

However, you should insist on a fixed participation rate for the entire annuity term.
Some annuity companies may provide 100% participation today, but if they change that
to 50% next year, you won;t be happy. Therefore, look for an index annuity with a fixed participation rate for the entire term.

Try to get an index annuity with an Annual Reset. This feature compares the index value at the end
of the contract year with the index value at the start of the contract year. And it is
especially important for retirees as the gains are better protected from subsequent declines in the index. Without the annual
reset feature, you cannot protect one year’s gain from the next year’s loss. There’s
nothing worse than when you make 30% one year then lose it the next. If you want to take that risk, you
may just as well be in a variable annuity or in a mutual fund.
However, in every case of an index annuity that offered an annual reset, we have seen it
combined with an averaging feature, which is not beneficial.

Averaging of the S&P 500 at the beginning of a term is supposed to protect you from
buying at a high point in the index cycle, which would reduce the amount of interest you might earn over the term.
Averaging at the end of the term protects against severe declines in the index and losing
index-linked interest as a result.
And while most annuity companies claim that this is a good feature, it’s not beneficiaial for the index asnnuity owner. It dilutes the return. However, it’s nearly impossible to find a product that
doesn’t use averaging.

Based on an analysis of periods over the past 30 years, an index annuity with a 55%
participation and no averaging will do about as well as a 100% participation, with
averaging. However, from the annuity owner’s view, the 100% sounds better.

The best index annuity performance will come from the riskiest arrangement: A point-to-point design
with no averaging. The point-to-point method calculates the interest return every
contract year and then, ultimately, combines these returns to arrive at the total return for
the contract term. This permits index annuity owners to take advantage of a market recovery after a
year of losses. The change in the index is a “price change only” measure and does not
reflect dividends.

The high-water point, or high-water mark, is a variation of the point-to-point term
method. Rather than using the ending point, the calculation is based on the highest
obtained value during the term of the contract based on annual contract anniversary index
values. For example, if the index doubled its original value on the first anniversary date
and then proceeded to decline for the remaining contract period, the high-water point
method would calculate an index return of 100%. The high-water mark is locked in no
matter how much the market may go down. This is a beneficial index annuity feature for the investor.

Any type of Annual Cap has a significant effect on returns. Most people don’t realize
that two or three years out of 10 produce the big gains in the stock market. If you remove
those big gain years by capping them, the performance dives. Averaging of the S&P 500
reduces those big gains. And since index annuities already protect the original principal,
there can be no argument that averaging provides any value in down markets. Try and avoid index annuities with any type of cap.

Index annuities are not designed to outperform the index long term. So you will
not earn anything near what the stock market delivers. Index annuities will deliver about 40%-65%
of stock market returns. So if the stock market has delivered a 12% return over time,
figure an index annuity (with the averaging feature) will deliver 6%.

Start with the retirement planning calculatorto see how index annuities may fit into your retirement income strategy and then use the fixed annuity calculator to determine what part a fixed annuity can play in your retirement portfolio.

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Most retirees have two main senior health insurance options–Medicare and managed care. Medicaid is a program that pays for medical assistance only for those seniors with low incomes or disabilities.

As long as you have contributed enough through FICA taxes, you will be eligible for the best senior health care option–retired or not–for Medicare when you turn 65. Apply for Medicare coverage three months before your 65th birthday.

Senior health care provided by Medicare is divided into four components:

Part A–Hospital Insurance

Part B–Medical Insurance (Optional)

Part C–Additional Insurance Coverage

Part D–Offers voluntary prescription drug coverage offered via private vendors

Let’s look at each of these components of Medicare senior health coverage.

Part A is called hospital insurance. It covers most costs of your stay in the hospital, as well as some follow-up costs after being in the hospital. It also pays some outpatient medical services, including medically necessary equipment and supplies, senior health care at home, and physical therapy. Under most circumstances, you do not have to pay a premium for Part A.

Part B is medical insurance. It’s optional. If you elect it, the monthly premium is deducted from your Social Security check. It provides for certain out-of-hospital treatments and is intended to help pay doctor’s bills for treatment in or out of the hospital. It also covers many other senior health care medical expenses you incur when you are not in the hospital, such as the costs of necessary medical equipment and tests.

Medicare Part B has spawned additional senior health insurance coverages:

Its Original Medicare Plan and Medigap insurance.

Medicare Part C coverage: Medicare Managed Care Plan (like an HMO) and Medicare Private Fee-for-Service Plan.

With the Original Medicare Plan, you pay your Part B monthly premium and then pay for additional services as you use them. With this plan, you might also choose to buy Medicare Supplement Insurance, or “Medigap” insurance. The term ‘Medigap’ implies that these insurance policies will cover the gaps in Medicare payments. Medigap does not fill all the gaps in senior health insurance but it helps.

Part C: Medicare Managed Care and Private Fee-for-Service plans are offered by private insurance companies. Managed care plans generally fall into two main varieties: health maintenance organizations (HMOs) and preferred provider organizations (PPOs). HMOs are generally less expensive than PPOs, but usually more restrictive in their services and choice of doctors.

With these latter two plans in Part C, you must continue to pay your Part B premiums, and you may also have to pay an additional premium to the insurance company, as well as any related deductible or co-insurance payments; however the services you receive may be more comprehensive than those offered through the Original Medicare Plan.

When considering senior health care option, compare the costs and local availability of Medigap with the Medicare Managed Care and private fee-for-service programs. Be prepared for heath problems in retirement. They are part of aging. Do not wait until they happen to cover the costs as it will be too late.

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Long term care premiums are not cheap but these recommendations may help you get a policy with an affordable long term care premium.

While it would be ideal to have complete coverage (inflation protection, lifetime coverage, at least $160/day benefit), it is better to have at least a basic policy than to have none at all. In other words, a minimum policy is better than being uncovered for the high cost of long-term care. In order to help you minimize your long term care premium, below are five ways to help you reduce costs and yet provide basic coverage. No one knows when a health catastrophe can strike. An onset of a heart attack, stroke, cancer, Parkinson’s and Alzheimer’s are debilitating illnesses, which give no advance warning. Protect yourself and your family financially.

Here are five ways to get covered at a lower long term care premium
:
1. Reduce the coverage period. For example, reduce the term of the policy from five years to four years. Statistics indicate that a four-year policy has historically covered 88% of the long-term care cases. Of course, there is no guarantee that this pattern will continue on in the future.1

2. Reduce the daily benefit. The actual cost of nursing care averages $208/day.2 If you cover just $130 or $160 per day with insurance, some people can make up the difference with other income sources, such as Social Security or interest income.3  Since use of benefits from a long term care policy may not be needed, it makes financial sense to keep your long term care premium lower and supplement your actual costs with other resources should you have a long term care need.  The retirement income calculatorcan help determine if this option is suitable for you.

3. If you are age 75 or over, consider omitting the inflation protection. Although you will hopefully never need long-term care, if you do, you could need it within 10 years-by age 85. Therefore, you do not need to protect for inflation over as long a period of time as, for example, a 65-year old would need to prepare.  Omitting inflation protection accounts for a BIG drop in a long term care premium.

4. Consider partial home care coverage. Many companies offer, as an example, $100/day benefit for nursing home payments and $50/day for home care payments (home care costs can be less expensive if you have family or friends who can help with care). By reducing the benefits for home care, you can lower your long term care premium.

5. Many people have a spouse or friends or relatives who can assist them in the home. Depending on the hours of needed care, the costs of a home health aid ($19 per hour on average) can be less than the costs of round-the-clock nursing home care.4 With this in mind, the most important coverage area for many is the care provided outside the home.

To approximate your long term care premium with modifications for the above options, use the long term care calculator.
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1 Met Life Market survey of nursing homes, 2007. 
2 Average daily rate for a private room is $77,745 annually or $6,478 monthly. Average daily rate survey of all 50 states and the District of Columbia. MetLife Market Survey of Nursing Home and Home Care Costs, 2007. 
3 If you have sufficient interest income or Social Security income, it may be better for you to insure for a majority of the cost of long-term care and self-insure for the remainder. This has the effect of lowering the current cost of the insurance premiums without subjecting you to being unable to cover the costs of long-term care, if and when they arise. 
4 Average hourly rate, MetLife Market Survey of Adult-Day Services and Home Care Costs, September 2007.
Other Options and Ideas

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McKinsey in their recent report on The Coming Shakeout in the Defined Benefit Market estimates that 50-75% of all private Defined Benefit assets will be in a frozen or terminated status by 2012.  In plain English this means that retirement plans offered by companies will cease or terminate in the next few years.  If you are working, the pension plan is likely to cease and your balance will be rolled over into a 401k  — meaning that any future contributions to your retirement plan will come from you, not the company.   If you are already retired, it’s likely you will get a lump sum payout as the employer will terminate the plan. In other words—you’re on your own. Start with the retirement income calculator to determine your needs.

The trend in retirement solutions is that you must fend for yourself.  Companies, being for-profit entities are facing the music and closing down their plans because they simply cannot afford them.  The US Government can delay facing the music and keep people in denial that the Social Security system will never sustain itself.   While people currently age 65 or older will likely not see any changes to their Social Security benefits, they will likely see a dilution in their employer retirement benefits, possibly with a reduction in monthly pension payments or the reduction or elimination of heath care benefits.  Those under age 65 should not rely on anyone but themselves for retirement solutions.

Fortunately, there is a lot you can control that determines your comfort in retirement.  These retirement solutions include:

Where you live—if you live in a high costs area (e.g. Ney York, California), move to a lower cost area.  You may not like this option, but it could be the keystone to your retirement solution program. Lower housing costs mean more that you add to your retirement nest egg.

Lifestyle choices–opt for savings and not luxuries—vacations, luxury cars, dining out, even driving 75 on the freeway instead of 55 all take money out of your pocket today that could go to retirement savings. 
Keep working—you may still retire from your current job at retirement age but consider doing what you enjoy and also making money.  You can get a HUGE impact on your retirement solutions by working more years (you get the double benefit of not consuming any of your retirement nest egg and having it continue to grow for each year you continue to work).

Investing better – it’s easy to let money sit rather than be properly invested.  As you see from the table below, investors expose half of their 401k assets to equities and this should be higher, particularly for those more than 10 years form retirement.

Allocation of 401k Assets -- More Equities Needed for Sound Retirement Solution

Also, determine how much of your assets you are willing to “annutize.”  Some retirees are fixated on leaving and inheritance or a house to their heirs.  If they annuitize that asset into an income stream, they can live more comfortably.  Annuitization can be accomplished with or without commercial annuities.

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