A Guaranteed Income for Life?

Jim Lorenzen, CFP®, AIF®

In a previous post I talked about how everyone now has to be his/her own actuary, if they want to create a guaranteed income for life.

I’ve even provided a 20-minute educational video on how it’s possible to actually create a guaranteed income for life.  I think you’ll find it helpful; grab a cup of coffee and you can register to take a look.

While I’m at it, here’s a link to a report that takes a deeper look at a a ‘hybrid’ scenario many investors might find attractive.  I think you’ll find the report interesting, if not eye-opening.  You can access it here.

How does one GUARANTEE an income for life?  Well, there’s only ONE way to guarantee that outcome:  An annuity.  NO OTHER FINANCIAL TOOL WILL DO THIS.

Oh, yes, they do get bad press (what doesn’t?).  The real problem, though is the confusion around the different types of annuities that exists.

  1. Variable annuities
  2. Equity-indexed annuities
  3. Fixed annuities – can be either immediate or deferred

Options #1 and 2 can be problematic.  They are often loaded with excess costs, moving parts, and restrictions.

Option #3 is generally more straightforward.  It’s more of an I.O.U. with the insurance company.  You pay them; they pay you.

Here are some sample payout examples.  Take the first one:  the payout represents a 6.54% payout; and as you can see, the payouts do increase with age.

There’s a trade-off, however, the money is not just illiquid – it’s gone!  You are essentially buying an income stream for life!   You’re paying cash for a secure retirement.

So, should you do that with all your money?  Probably not.  It should not be an ‘all or nothing’ strategy.  That’s why I think you’ll find this report on a hybrid strategy helpful.

If you would like help, of course, we can always visit by phone.  Just pick a time convenient for you.

Enjoy!

Jim


Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

The Provisional Income Trap

 

… and what it means to your retirement income – particularly your Social Security taxation in retirement.

Jim Lorenzen, CFP®, AIF®

Most people believe that municipal bond interest is tax-free and won’t affect taxation on their retirement income.   Well, it is, I guess; but, there are tax ramifications few people have heard about.   It’s called “provisional income”.

Huh?

There are categories of income which, when added up, determine how much provisional income you’ve received in a given year.  And, during retirement, when you’re likely receiving Social Security income,  the amount of provisional income you receive determines just how much you’ll pay in taxes on your Social Security Income.

As you can see, when adding up your provisional income, it begins with 50% of your Social Security income.  Then they add in all distributions from tax-deferred accounts.  If you’re in retirement, that includes money you’re taking from your 401(k) or IRAs (except distributions from a Roth IRA, which are generally tax-free, and any money you’ve taken from a properly-structured permanent life insurance policy (withdrawals up to your cost-basis and policy loans).  And, as you can see, municipal bond interest is counted.

Once you’ve added up all your provisional income, how much do you owe in taxes?  Well, it depends.  Here are the provisional income thresholds.

If you’re a married couple and your provisional income is below $32,000 for the tax year, you will pay no txes on your Social Security income.  If your income is over $44,000, however, then 85% of your Social Security income will be taxable.  The whole idea was part of a package passed back in the 1980s to save Social Security.  One thing they didn’t do:  index it for inflation.

So, as your 401(k) grows and your assets grow—more importantly, as inflation continues through the years and it will require greater withdrawals for you to live in retirement—the greater the likelihood you’ll be paying taxes on your Social Security.  It doesn’t take much to get past $44,000 in retirement.

Let’s take a quick  look at an example:  Fred and Wilma.  They have $30,000 in combined Social Security income and also take $40,000 annually from their IRAs, giving them a $70,000 income in retirement.

For computing their provisional income, only half of their Social Security income is used.  Added to their IRA distributions, they have $55,000 in provisional income, meaning that 85% of their Social Security income ($25,500) is taxable at their tax rate.  If they’re paying taxes at 30%, their tax bill will be $7,650.

But if they need the entire $70,000 they’ve taken as income, they’ll have to take an additional distribution just to pay the tax bill, and, oh yes, it’s taxable, too.

But, Fred and Wilma have another problem they’re likely completely unaware of.  There’s a ticking time-bomb growing inside their 401(k).  It’s growing.

How can that be bad?  Well, it isn’t, of course, but it might come at a huge price.  If history has taught us anything, it’s that governments exist to get re-elected and they help insure than through spending which never seems to get undone.  Our nation’s huge debt  is growing and the money to pay the bills will have to come from somewhere—and it won’t come from people with no money.   With an ageing demographic bubble moving into the decumulation stage  and wanting more services, particularly health care, the long-term outlook for taxes can’t be too encouraging.    Let’s get back to Fred and Wilma:

If Fred’s 401(k) continues to grow at an 8% average annual rate until he’s 65, he’ll have a balance of over $2 million!  And, at age 71, when he’ll be required to take required minimum distributions (RMDs), his balance will be over $3 million—requiring RMDs of over $115,000 annually.

Fred and Wilma will be paying a lot of taxes.

And, as mentioned earlier, the long-term outlook for taxes isn’t likely very good.  Just take a look at the differences from 2012 to 2017.

How can Fred and Wilma mitigate, and maybe eliminate, their income tax payments in retirement?

Under current tax law, each has a personal exemption of $4,050, so they have $8,100 in combined personal exemptions.  They also have their deductions.  If they’re using the standard deduction, they’ll have $12,700 too, giving them a total of $20,800 in exemptions and deductions.   So, their key is to keep their  taxable income below $20,800.   All income above the standard deduction and personal exemption is subject to tax.

The good news is that  Fred and Wilma are still in their 50s and there’s plenty of time to plan.  Working with their Certified Financial Planner®professional, they can begin “reverse –engineering” the placement of assets in a way they can still grow their nest-egg, but re-arrange their ‘tax buckets’ so Uncle Sam becomes less of a partner—or no partner at all, which would be the ideal making their tax-jockeying a moot issue.  You can get our piece on 4 Steps to a Tax-Free Retirement.  I think you’ll like it.

Enjoy!

Jim


Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Old-Age Financial Security: Silence is NOT Golden, yet Some aren’t talking!

Jim Lorenzen, CFP®, AIF®

Generational planning didn’t seem important  for old age financial security in my grandparent’s day.   They were living at  a time when Social Security was passed and designed to last for a lifetime beginning at age 65.  Of course, life expectancy back then was around age 68!  Who needed to worry about generational issues?  Longevity wasn’t a risk.

My generation—the baby boomerss—became the first  to experience the ‘sandwich’ effect:  Taking care of aging parents and children at the same time.   And, as that was unfolding, people were beginning to realize they were living longer, too!

The cultural quicksand began to materialize, but few have recognized it.  It’s like glaucoma:  You don’t see it coming; but, all of a sudden, it’s there.   It’s silence.  In a recent online survey (cited below), over half of GenX respondents and 60% of baby boomers indicated they’ve never had a conversation about planning for retirement or financial security in their old age, yet their fears were the same.

The reasons tend to tell is why.  They’re repeating the same mistakes their parents made.

Why do we study history?  Because we know human nature doesn’t change—it hasn’t changed for thousands of years.  Studying history allows us to learn the mistakes human nature, unencumbered by knowledge, tends to make.  But, knowledge helps us prevent a repetition!

When parents and children don’t talk about finances, guess what…

Why do they feel they’re not making enough money?  Why do they have too many other expenses and are paying off debt?  The answer is simple.

They’re  repeating mistakes.  But, the GenX group seems to be making more of them.  Are the boomers not talking to their kids?   Are their kids not involved in their parent’s own planning?   Maybe they should be.

As parents are living longer—longevity risk– they run a very real risk of needing long-term care.  If ever there was a threat to old age financial security, this may be it; yet,  relatively few address that issue usually because of cost or for fear of losing all that money paid in premiums if they don’t use it.   However if they do need it, and the kids end up having to pay some or all of the ultimate cost for that and their parents’ support, it also could eat-up their inheritance!

What we don’t know can cause financial hurt.  Perhaps they don’t know  that a professionally-designed life insurance policy might provide tax-free money that could be used to cover long-term care if needed and yet preserves cash if it isn’t—and still maintain the children’s inheritance!   It’s a financial ‘Swiss Army Knife”  type tool that can solve a lot of issues at once.

Unfortunately, few people take the time to have a generational financial planning session either on their own or  – maybe better—facilitated with a  family financial advisor acting as a guide and facilitator.   Some advance planning can make a big difference.  Here’s an example:

Real Life Case History (Names changed)

Fred and Wilma never discussed their finances with Pebbles or Bam Bam.  As Fred and Wilma grew into their 90s, it became evident they could no longer live on their own.  Fred was diagnosed with a terminal disease and Wilma, at  90, was diagnosed with Alzheimer’s.  They could no longer function and it was now Pebbles’ and Bam Bam’s turn to take care of their parents.  Fred lived for eight more months, but Wilma continued living for nine more years.  Despite the fact they did have some retirement savings, it was no where near enough to cover the more than $600,000 in costs that were incurred  by Pebbles and Bam Bam during that 9-year period. 

Had Fred and Wilma taken the right steps sooner, those costs threatening the old age financial security of Pebbles and Bam Bam might have been covered, or—at the very least—Pebbles and Bam Bam would have been reimbursed, protecting their inheritance … and all of the money might have been provided tax-free!   Unfortunately, their attitudes about various financial solutions available to them were colored by what they’ve heard from parents, friends, and even entertainment media, including television gurus selling DVDs.   Not surprising.  Some people even get their medical advice that way.

Old strategies simply don’t address today’s longevity and ageing issues.  Different strategies are required.   How can it be possible to make sure the parents have a lifetime of inflation-adjusted income and still provide an inheritance for the kids?

Rising Inflation ScreenYou might enjoy viewing this educational 20-minute video that shows one strategy that likely makes sense for many people.  While the tools used to implement it might vary, it’s still worth a view.  So, grab some coffee and see for yourself.

If you haven’t had a generational meeting with your family financial advisor, maybe it’s time you did.  Like Mark Cuban’s dad once told him:  This is as young as you’re ever going to be.

If you would like help, of course, we can always visit by phone.

Enjoy!

Jim


Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

How to Diversify Investments – As simple as a pie chart?

Jim Lorenzen, CFP®, AIF®

Most of us want to learn how to diversify investments  so we can reduce investment risk – but it may be one of the most misunderstood of investment principles.  Too many think it’s about simply selecting the right pie chart.

I’ve even seen tv stock gurus tell you that owning three stocks in different industries passes for investment diversification, implying that risk is being reduced.  I don’t think so; it’s just compounding investment concentration.

Believe it or not, you can’t possibly diversify-away market risk.  Think about it; you could own every single stock contained in the S&P 500 Index and all you would have done is duplicate the market’s risk.

I’ve also seen investors buy multiple mutual funds in an attempt to diversify; but, since everything they bought had to be “quality”, all they did was duplicate their holdings (portfolio A) instead of diversifying them (portfolio B) across multiple investment styles (growth/value, large/small, etc.).

Diversification, done properly, can smooth things out, as this simple example shows.

But, what stocks?  Which bonds?  Is buying a few enough?   The answer, of course, is “it depends”; but, it’s worth noting that there are five basic asset classes (stocks, bonds, real estate, commodities, and cash) and within each there are multiple sectors.  It’s also virtually impossible to know which will outperform all others in any given year.  Yet, diversification among them can smooth the ride!

I’ve been telling clients for more than two decades now, “We’re not diversifying money.  We’re diversifying risk; we just do it with money.”

So, how do we diversify risk?  It’s all about something called correlation.

You can think of correlation as pistons in an engine:  They all go up and down, but not necessarily at the same time.  Their going up and down is what propels the machine, but you wouldn’t want your money on any one piston.  If the engine were to stop, you’d have a 50/50 chance of being up or down!  But, if your money was spread over all the cylinders, you’d still have a stable overall value regardless of when the engine shut down.

It doesn’t really work all that clearly in the real world of investing, of course; but the theory is no less valid.  Here’s a chart the relative correlations among a number of classes and styles.

 

 

 

 

 

Correlations don’t remain the same, even from day-to-day; so, they’re not in stone – they just give us a historical look at their relative movements, but the numbers will be different depending on the time-frames chosen.

Diversification is all about correlation reduction in portfolios.  I created a report on all this a while back called Understanding the Diversification Puzzle.   You might find it helpful and you can get it here.

Enjoy!

Jim


Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.