Retirement Income Blog

This article is retirement help on how you can recover the $150,000 loss in your 401k in the next 6 months (for tactics to employ now, see my post at ).  This article is about understanding how and why that $150,000 evaporated and why you will not get it back in the next 6 months or likely the next 6 years.

The recent financial crisis is NOT a temporary drop in the market, your 401k and your IRA savings. It is a PERMANENT adjustment in the valuation of assets that became overvalued.  So don’t think of your 401k as down.  It’s now about the right value.  A year ago, your 401k and your house value was artificially inflated due to excessive credit.  Valuable retirement help is to tell you the truth–adjust your retirement plans downward.

Be realistic, how can an economy survive when

1. people can buy houses with 0% down and without the income to make the payments
2. stocks of companies involved in the housing balloon trade as if those houses are worth what the appraiser says

People now see that the emperor has no clothes.  The retirement help we can provide is to advise that you adjust your retirement plans downward and not think that the market will adjust itself for you.

The house that sold for $500,000 has a true value of $250,000. And all of the people involved in the housing market–the Realtors and the mortgage brokers are unemployed.  The lenders who made these ridiculous loans now realize that the loan, carried on their books at $500,000 must now be written down to $250,000, wiping out the lender’s capital.  The person who resided in the home gets foreclosed on and he might also lose his job because the housing calamity ripples through the entire economy (i.e lenders have stopped making loans to individuals or business).  People who had been taking vacations, buying cars, buying second homes and enjoying the good life by borrowing against their home equity can no longer do so as they have no equity.

So the value of real estate and assets in generally, reflected in stock prices, has now returned to a sustainable valuation and not some value created by a mass fantasy.  We all engaged in a fantasy that life could be so good without paying for it.  Reality does not work that way.  Now that you’ve swallowed the truth, let’s get to some retirement help.

Most Americans need to adjust their standard of living downward.  If you planned to retire at age 62, that will now be 66.  That’s four years less of doing as you please and instead, reporting to work.  The 3,000 square foot house you had planned as your retirement residence, better make that an 1800 square foot condo.  Your plans to remain in high cost Southern California, better think about a comfortable community in low cost Texas.  Unfortunately, all of the visions of retirement that you thought could be must now be scaled down to reality.  The best retirement help and advice we can offer is to make your adjusted and realistic retirement plans now. The good news is that you won’t go bankrupt and you won;t miss any meals.  But the fairy-tale visions we all held about a comfy retirement must now be exchanged for the truth.

Its not so bad, it’s just reality.

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After the dot-com bust, the 10 largest securities firms paid a $1.4 billion fine to the SEC for inappropriately recommending stocks to investors.  But the public still had faith and the big firms seemed to be little harmed as to their reputation.  In 2008, we have some of those same big financial asset management firms going under or being merged: Bear Stearns, Lehman, Merrill Lynch (more to follow  in 2009).  This time, the employees, specifically the brokers, have lost faith and are leaving to start their own financial asset management firms.

As employees of these larger companies, the brokers often work on a commission basis.  When they leave, they obtain a Registered Investment Advisor certificate from the SEC to set up shop on their own.  They can no longer charge commissions but rather, operate on a fee basis (e.g. charge a 1% fee to manage your stock portfolio).  It’s estimated that there are 1,000 of these independent financial asset management shops being set up annually.  Can you trust an individual with no “big firm” backing?

How much trust you have in a big firm is up to you.  Understand however that if an individual broker becomes an independent financial asset manager, your portfolio is still maintained at a large firm such as Charles Schwab, TD Ameritrade, E-trade, Fidelity, etc. So you are trusting the intellectual capacity, integrity and advice of your financial advisor but your assets are actual on deposit with a large well known custodian. 

It appears that affluent investors, the typcial clients of independent financial asset managers, have embraced the services of these independent providers. Charles Schwab’s semi-annual “Independent Advisor Outlook Study” for 2008 reports affluent investors turning to independent financial asset managers and away from full-service financial asset management firms. Mutual fund manager, Rydex, found the average registered investment advisor was already doing well before the recent turmoil and had increased their client base by 7 percent in 2007.

Michael Weiss, founder of Frontier Financial Advisors says, “Investors are moving their accounts from the
large brokerage firms and banks to boutique financial asset management firms….For the first time in years, the small boutique asset management firms are better positioned than the larger firms to serve the individual investor.”

For you as the investor, you need to decide if your comfort comes from the individual that you deal with and your relationship with that financial advisor or if you feel batter about your financial asset management being handled by a big name.

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Let’s first state three fundamental principles and then add the details.

1.      Start retirement with sufficient retirement savings

2.      Protect your retirement savings from erosion due to taxes and inflation

3.      Never lose money

Start with your desired retirement income and expenses.  Then, you can use a retirement income calculator to determine how much retirement savings you will need. You need to know how large of a nest egg is required for a comfortable retirement.  Most people don’t like to do this rigorous exercise of charting your expenses and income over time.  If you won’t do it, then hire a retirement planner who will.  I highly recommend the retirement planning software from J&L planners as it allows you to account for detailed changes in your income and expenses year by year.  Only by doing the math do you know how much you need and when you are able to retire. 

Next, you need to take advantage of as much tax shelter as possible.  For most retirees, that means using your unsheltered money first (e.g. your non-IRA, non-401k funds) .  You want to let your tax sheltered money grow as long as possible.  The caveat here is the uncertainty of future tax rates. Future income tax rates may be higher than today. You can have a retirement planner calculate for you the tax rate at which it is better to use your sheltered funds first.  In fact, understand that the plans you make at the beginning of retirement can change because of changes in tax rates or other variables.  That’s why smart retirees will update their retirement plan every 24 months.

Last, you need to be sure your principal never declines.  That would seem impossible based on the advice in the retirement-Income.net web site that recommends you keep 50% of your funds in stocks and everyone knows stocks go up as well as down.  BUT, you will never rely on these stocks for retirement income.  Your money will always be in at least 2 baskets—your liquidity basket from which you make withdrawals for your living expenses and your growth basket which replenishes your liquidity basket at long intervals.  You will never take funds from your growth basket to live on and the long intervals create a very high probability that you will only have gains in your growth basket between transfers to your liquidity basket.  Consider for example that over the last 80 years, when stocks have been left alone for 10 year time intervals, they gained in value 97% of the time.

Of course, in terms of protecting your retirement savings, there may be other asset protection measures such as trust and estate planning that you do for your heirs.

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It’s a little crazy but investors with IRA savings want to know “what do I do now that my IRA account has dropped by 40%?” Would the best time to have asked that question have been before you invested the money?  To ask what to do now is like asking how to catch the train after it left the station.  So rather than succumb to the illogic of how to deal with a contingency when you had no contingency plan, let’s look at the rational way to handle your retirement savings from here on.

1. You can get all of your IRA savings out of the market and into a 2% money market fund.  This will insure that it takes a very long time to recover what you lost because at 2%, it takes 25 years to recover your loss.  Of course, the money market fund also insures that you won’t lose any more.  So you must ask yourself this question: does the market have a higher probability of going to zero or to 15,000?  Does Citicorp at $5 per share have a greater chance of going to zero or to $20?  If you think that there is a greater opportunity to the upside, then the money market alternative would be foolish.

2. You can sit tight and do nothing.  This means you have the same type of risk as when you started–the risk of loss or gain.  If you were willing to accept that risk before with your IRA savings, then why not now?  Additionally, consider that you have taken the risk and experienced the negative aspect of risk–don’t you need to stay in the market to experience the positive aspect of risk?

3. You can do something very irrational like invest all the money in gold because you heard some guy on CNBC says that gold is going to $2000 an ounce.  In other words, you lost money, are unhappy that you took so much risk and now want to take more risk with your retirement savings to gain it back.  Reminds me of the guy who lost everything in a card game and only had one asset left–his house.  In an effort to gain everything back he had lost, he wagered his house.  Does that seem like a crazy idea to you? If so, then you don’t try to gain your money back with an “all or nothing” bet.

4. What’s gone is gone.  You cannot think about “getting even.”  You have what you have and the best way to think of the right action is to ask yourself this, “I have $xxxx of retirement savings.  Based on what I know about myself and my emotional stability, my view of the future and my future needs, what is the best course of action NOW (with no reference to the past)?”

Hopefully, with these distinctions laid out here you can consider them calmly and the appropriate course of action will be obvious with your retirement savings.  And by the way–remember that your retirement savings are no different than the rest of your money (other than they grow tax deferred).  So if your non-IRA savings have been sitting in a money market during the market fall, look at everything you have and maybe you’re only down 10% overall and shouldn’t feel so bad.

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Paying for long term care (LTC) poses a serious dilemma for seniors according to a recent study  by Boston College’s Center for Retirement Research. Who needs LTC, what’s the cost, who’s supposed to pay for it, and who can afford a long term care premium are all issues addressed in the study. Let’s see some of the findings and what seniors can do as long term care issues are an essential part of your retirement plan.

Table 1 shows that three of four 65 year olds (in 2005) are projected to need LTC in their future showing the imminent importance of LTC planning.

Directly paying for long-term care is expensive with average assisted-living facilities costing $30,000 to $40,000, home health costing in the $16 - $20/hour range and private nursing homes costs beginning at around $70,000 per year. Such costs can make a senior citizen retirement miserable.  A long term care premium for insurance is the less expensive way to go.

Table 2, overall funding sources for LTC as of 2005, shows that 18% of dollars spent come from direct out-of-pocket payments by individuals. Medicaid pays most but only for those who have almost no assets, have spent down what assets they had, or had earlier divested themselves of their assets.

Only 7% of dollars were paid through private insurance. long term care premiums for insurance are not inexpensive.  Annual long term care premiums are nearly $2,000 per person at age 65. And the expected LTC insurance dollar benefit for each premium paid is only $0.56 for men and $1.04 for women.

The study concluded that 91% of Americans can’t afford to pay LTC insurance premiums.  It also concluded that many Americans mistakenly think government will pick up much of LTC for everyone. This confusion and competing expenses prevents Americans from purchasing long term care insurance long before 65 when it costs much less. Lastly, long term care insurance will remain a costly dilemma until government provides universal long term insurance or enough Americans purchase LTC insurance to spread the risk and lower long term care premiums.

For now, seniors may try to see if they qualify for LTC insurance to see if it remains an option. They should arrange for transferring their assets long before needing LTC to qualify for Medicaid. Lastly, they can look for LTC with other insurance combos that make paying premiums more palatable.

Check rates for a long term care premium using the long term care calculator.

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Financial planning prior to retirement is focused on asset accumulation, tax minimization and maintaining a budget that allows for maximum savings.   Retirement financial planning however is focused on these different objectives:  maintain an adequate income without salary or wages, maximizing pension and social security, having adequate health and long term care protection and minimizing financial risk.

You can’t know for sure if you have adequate resources until you do some number work.  If you find this nitty gritty of retirement financial planning to stretch your patience, than hire a retirement planner or CPA. 

Here are the steps:

1. Estimate your retirement spending needs: housing (including new furniture and updating), food (including dining out), insurance (including long term care), personal expenses, vacations, entertainment, utilities, transportation, taxes (income and property), etc.  Add to this list anything that applies to your desired lifestyle.  Add up the total and now you know how much you need, which is step one of your retirement financial planning.  Let’s say this figure is $50,000.

2. Next, you want to see how much you have and create a retirement income plan.  Add your sources of retirement income including social security, pensions and annuities.  From any savings such as IRAs and 401k and other investment accounts, assume a withdrawal rate of 5%.  So if you have a nest egg of $500,000, assume that you can take 5% annually and the nest egg should be fairly safe at least for  30 years (see results of the Trinity Study ).  Note that just to maintain your standard of living, you need to always leave some earnings behind in your nest egg to account for inflation.  An item that costs you $10,000 this year will cost you $10,300 next year.  Even if you don’t care about having anything left and want to spend more, you don’t have much wiggle room.  For example, if your nest egg were to earn a constant 6% annually and you withdraw 8% annually of your beginning balance, you exhaust the fund in 23 years.  You could easily outlive your money and that’s why it’s important to stick to the retirement financial planning 5% rule.

3. Compare your total sources of income from step 2 and your expenses from step 1.  If you have excess income, congratulations–you’re a retirement financial planning master!  If you have a deficiency, you have a few options:

• adjust your lifestyle and spend less
• maintain your lifestyle, but move to a less expensive area of the country or out of the country
• work part time in retirement
• retire later — by working a couple more years, a $500,000 nest egg growing at 6% accumulates an additional $61,000.  That additional principal provides an additional $3050 of spending money annually. 

Note that later in life, say at age 75, you may switch your strategy and decide to “annuitize” some of your assets–i.e. spend them down to zero and give yourself more income today.  The safest way to do that is with a life annuity as payments will last as long as you do.  Consult the immediate annuity calculators for annuity payments.

Although this is a stripped down version of comprehensive retirement financial planning, it’s more than 95% of retirees ever plan.

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The largest retirement plan providers n the US are Fidelity, Vanguard and Schwab.  These companies offerings are quite similar in that that all provide competitive investment performance, reasonable fees (Vanguard being the least expensive) and high quality products — which can all have a major impact on the amount of money you’re able to build during your working years.

Features you want in a retirement plan provider:

Broad investment choice. Make sure the company offers a wide range of investment options. For example, look for a firm that has account or fund offerings in different asset classes, such as stocks, bonds, guaranteed, money market and real estate. Diversifying your retirement dollars among at least three asset classes can reduce overall volatility. All mutual fund companies will offer a broad array of fund choices.

Solid investment performance track record.

Different fund families have different strengths.  Vanguard’s strength is keeping costs low.  Fielditiy’s strength is strong equity performance.  So you may want to look for a retirement plan provider that has strength in the aspect most important to you

Low fees.  

Over a 20-year period, a 1% fee differential can have an almost 30% difference in the annual income from a

long-term fund investment. You can read the fund’s prospectus to get full disclosure of fees and get a comparison by checking Morningstar, and independent fund rating service.

Frequent Reporting
There are still some companies that send a statement just annually.  If that’s sufficient for you, great.  But if you would like more frequent reporting of your plan, then ask about that in advance.

Web based or phone based service
If you want to make investment changes frequently, you want to choose a retirement plan provider that has a robust web based front end so that you can fully mange your retirement account on the web.  Having to rely on the phone can mean long waits on hold.  Some retirement plan providers that are not yet up to speed still require changes and administration using the mail.  Those that have fully embraced the web will have web-based tools such as retirement plan calculators, a retirement income calculator, Roth IRA conversion calculators and other useful tools.

Personal Assistance
If you feel you need personal investment advice from your retirement plan provider, you may want to choose a provider that has an office in your town.  That way, you can sit and talk with an advisor, attend seminars periodically held by the retirement plan provider and have a local relationship.

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Typically, when you see the phrase ”retirement plan services,”, these are services developed for companies in helping their employees save for retirement. These services may include several as follows.

Retirement Plan Design
Management of many companies don’t know if it’s better to have a 401k, a profit sharing, a defined contributions plan and how to design the plan.  Management may be faced with such options as whether the retirement plan should have a vesting schedule, which employees should be included (i.e. based on age or hours worked), should there be a loan feature, etc. Retirement consultants experienced in providing retirement plan services will ask for a census of the employee population and based on age, longevity of employment, distribution of salaries, and management’s objectives for having a retirement plan, will design the right plan.

Retirement Plan Administration
Administration includes maintaining records for each employee’s account, preparing tax filings, holding enrollment meeting to explain the retirement plan features to employees, maintaining a staff to answer employee questions, and making changes to the plan design in reaction to changes in the tax code.  The rule of thumb is that this retirement plan service costs $25 per employee per year.

Distribution Processing
As employees retire or leave the company, distributions must be made in accordance with IRS rules.  An experienced provider or retirement plan services have systems established for efficiently helping these employees complete a IRA rollover or explain other retirement options.

ACP/ADP and Cross Testing
The Department Of Labor requires that retirement plans not discriminate in favor of highly paid employees.  Therefore, plans need to pass several tests to show that there is a uniform participation in the plan.  In such cases were the plan becomes biased in favor of the highly compensated, the company may be required to make contributions into the accounts of those with lower pay or the higher paid people may be barred from contributing to the plan (in case of a 401).  This type of compliance monitoring is a critical item on any menu of retirement plan services.

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Trusts play a big part in estate planning. What you don’t know about them can hurt you and your beneficiaries’ financial health and possibly your own.
 
A trust is a legal entity - just like a corporation or a person. It holds assets for a beneficiary.  The beneficiary could be you or another person. A trust document states the purpose of the trust and how it’s to be carried out. A trustee is the person (or entity) that carries it out. The grantor (e.g. you) creates and generally funds the trust.  Trusts in estate planning play a major role as you shall see.

A trust can be revocable or irrevocable. Revocable means that the grantor can decide to revoke the trust and take all the assets back for his use. In fact, such a revocable trust is really an extension of the grantor and taxed as if all the trust assets and their income were his. The most well known type of revocable trust is the living trust.  During your lifetime, this trust is transparent–it does not affect anything.  But upon death, the living trust contains a set of instructions that states how assets are to be divided.  As you see, the use of trusts and estate planning go hand in hand.  Because of the interrelationship and trusts and estate planning and retirement planning, it is a good idea to have single certified retirement planner assist with the overall strategy.

Revocable trusts serve to avoid probate. Probate – the court process of transferring assets in a deceased’s name by will or intestate - is a very public process. Trusts are not subject to probate – being a separate entity from the deceased – and can privately pass assets according to the terms of the trust. One of the objectives of trusts and estate planning is to retain privacy.  The additional benefit of a revocable trust is that it allows the grantor to control the assets and income of the trust as he wishes while he’s alive.

An irrevocable trust –once created by the grantor – is no longer under his control. It’s controlled solely by the trust document and the trustee. In this case, it’s taxed as a separate entity –unlike the revocable trust – and has an existence all its own.  In our tax system, whoever has the ability to control an entity is taxed and responsible for what that entity does. The irrevocable nature of a trust breaks that connection relieving the grantor of any subsequent tax or control issues. However, in reality, the trustee is usually a friend, relative or confidant of the grantor over which the grantor has influence and thus, can still exert indirect control over trusts assets. In this case trusts and estate planning serve to separate control (which the grantor still exerts) from ownership.  Assets are removed form the grantor’s estate with favorable estate tax and asset protection consequences.

The legal separateness of an irrevocable trust allows key benefits. First, that the grantor determines how the assets he puts in it are to be handled and distributed to his assigned trust beneficiaries – according to how he writes up the rules of the trust document. Second, the trust as a separate entity, can survive him indefinitely allowing his wishes to continue beyond his death. Third, the beneficiary, the object of the trust, benefits from the trust. Last, the trust’s legally protected from others (i.e, creditors) who may try to invade it or take the trust assets. Trusts in estate planning play these four major roles as just explained.

The use of trusts in estate planning have a clear objective to achieve. Examples of such trusts are:
o Spendthrift protection
o Charitable trust
o Life insurance trusts
o Asset protection trusts
o Bypass Trusts
o Qualified Personal Residence Trust (QPRT)
o Qualified Terminal Interest Property Trust (QTIP)
o Generation-Skipping Trust
o Irrevocable Life Insurance Trust ILIT

Trust planning, while seemingly complex, becomes easier to understand when you focus on the primary objectives of trusts–reduced taxation and creditor protection.

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You may be able to achieve more of what you want for retirement than you think. The right retirement advisor, often can help you see implications of your actions, decisions, and wishes and how they impact your retirement and estate planning. But your advisor cannot help you unless he knows what wishes are ultimately on your mind.

Retirement planning–in the most general sense–seeks to optimize a retirement income consistent with what makes you happy and financially comfortable. You can start with a simple tool like the retirement income calculator but you need to explain to your retirement advisor in detail, what you desire for your retirement lifestyle–how many trips you want to take, do you need to stay at the Ritz or will a tent be okay, how often you need to done out, go to theatre, etc. And the choices you make impact both your retirement and estate planning because the more you spend in your retirement years, the smaller estate you leave.

Your required retirement income depends on the amount of assets you have, how you intend to use and draw upon them, where you will live, and if you intend to work during some of your retirement years.  How these questions are answered can have significant impact on optimizing what you have. What’s left will dictate a lot about your estate planning since as mentioned, retirement and estate planning are two sides of the same issue.  Of course, how you protect your estate are matters of specific trust and estate planning.

Your legacy may include a donation to charity and bequests to your children and others. How you make charitable donations and bequeath to others can be achieved in a variety of ways through various financial planning approaches. And how much can be devoted to these desires will depend on the amount in your estate.

There’s a general rule offered by most retirement advisors that you can spend 4% to 5% of your nest egg annually and it will remain intact.  Remember that if you spend 5%, your nest egg needs to earn a lot more to compensate for cost of living adjustments and also taxes.  To have $10,000 to spend, your nest egg needs to generate $12,875 if we assume $2,500 goes to taxes and another $375 needs to get reinvested into the nest egg to compensate for the following year when costs will be 3% higher.

For many people, retirement and estate planning are competing goals because what you spend, you cannot bequeath.  In fact, many advisors will show you that you can  “annuitize” your next egg–i.e. spend not only the income but also some of the principal each year so that you have more spendable income.  Of course. if you erode the principal, the heirs get nothing.

A good retirement advisor can help you minimize the tradeoffs of retirement and estate planning. For example, maybe you want to leave your home to charity but want to reside in it for life now. (You get a tax deduction if you make the arrangement now that you otherwise miss if you leave the home at death.) You can in fact have both of these–live in your home for life, leave it to your favorite charity and even get a tax break today. Experienced retirement advisors are aware of how factors supporting your goals are interrelated, often through complicated tax, social security rules, and financial strategies.

To see what you can actually achieve, you need to talk openly to your retirement advisor about your ideas and wishes.

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