Hidden Secrets of Insurance Company Promises

6a017c332c5ecb970b01a73dd6e411970d-320wiJim Lorenzen, CFP®, AIF®

Life insurance illustrations have had, for more years than I can count, a well-deserved reputation for less than transparent and amazingly inaccurate projections of what the policyholder could expect in future years. Typical whole life policies had a lot going on “under the hood” and virtually invisible to the buyer.

One major problem for the typical insurance consumer is the inability to tell one company from another. While many truly professional and credentialed independent agents do make an effort to represent only “investment-grade” companies, there are far too many others who will represent the highest commission, which can often lead to selling substandard products for companies that appear to be substantial. An agent who is also an investment advisor can be a benefit for the buyer.

Here’s an example: Before Executive Life of New York went under, they had over 50% of their portfolio invested in less than investment grade ‘junk’ bonds, despite the fact that in June 1987, the New York legislature had mandated that insurance companies licensed to business in that state were to limit their general portfolios to no more than a 20% allocation to such bonds.

Remember, there are no guarantees; there are only guarantors. [Source: The New Insurance Investment Advisor, Ben G. Baldwin, McGraw-Hill 2002, p. 37.]. A good advisor would look at that allocation and realize it was one he would never recommend for a client; so, why would anyone use it to back their legacy planning?

Here’s what most people don’t know: Most of the well-known rating agencies we’re familiar with are actually paid by the insurance companies they rate! Little wonder many insurance companies that failed actually had good ratings when they went under.
Have you noticed that virtually all insurance companies tout ratings from the same rating agencies in their promotional materials? Few, if any, however, tout their rating from Weiss, maybe because Weiss doesn’t get paid by the companies they rate – their revenues come solely from subscriber revenue (kind of like Consumer Reports).
For example, according to the September 2002 Insurance Forum, of 1221 life and health companies rated by Weiss, only 3.9% of companies made it into the ‘A’ category. Compare that with the 54.9% rated ‘A’ by Standard and Poor’s. At Moody’s, 90% of their list made it to ‘A’ that year. A.M. Best gave ‘A’ to 56.3% of the companies they rated.
By the way, Companies with ratings in the A or B brackets from Weiss are considered secure, while some of the other rating agencies will give B and even A bracket ratings to companies considered vulnerable.
Recently, indexed universal life (IUL) policies have become quite popular – both among agents and their clients. The reasons are many, but two big attractions are (1) transparency – virtually no hidden moving parts. These products are easy to understand; and (2) low cost – insurance costs are basically like term policies. Admin costs are also low and, as noted, everything, including costs, is transparent, including performance going forward.
Does that mean the illustrations can be believed? No, but for different reasons. To understand the reasons why illustrations can be misleading and how to know you’re comparing apples with apples, it’s important to know how these policies work.
First a caveat: This is not an exhaustive text on IUL products and there’s a lot more to know than is being discussed here. This is simply a quick overview highlighting the stand-out characteristics.
Quick IUL Overview
IULs are often, but not always, designed as financial tools for maximum cash accumulation in a tax-advantaged vehicle. In these cases, the death benefit is often a secondary consideration; however, it’s the life insurance that buys the tax benefits – and, for many, these benefits far outweigh the cost of insurance, which is typically priced like term insurance.
These buyers want to buy the minimum amount of insurance for the maximum amount of premium they can put in (there’s a limit). This is because after the minimum insurance is purchased and expenses are covered, the rest goes into a cash accumulation account.
The cash accumulation account accumulates tax-deferred, but can be accessed as tax-free loans. How fast does the cash accumulate? Interest is credited to the account based on the performance of an outside index. While there are often many choices, most people tend to choose the S&P 500 index.

To keep this simple, I’ll just quickly cover the simplest approach: Let’s suppose our policyholder purchased an IUL policy using the S&P 500 index as the crediting option. The policy might offer 100% participation in the index’s upside moves up to a ‘cap’ during a crediting period, typically one year.

For example, if the index rises 8% by the policy’s 1-year anniversary date, the policyholder participates 100% in that move and receives the full 8%. If the index rose by 25%, the policyholder would receive whatever the ‘cap’ is.
So, on a 1-year, 100% participation with a 12% cap, a 25% rise in the index means the policyholder would receive 12%, i.e., 100% of the increase up to the cap. That amount would be credited on the policy’s anniversary date.
The next crediting would take place on the policyholder’s second anniversary.

Note: It doesn’t matter what happens between anniversaries – only the value ON the anniversary date counts, nothing else.
The good news is that if the stock market index has a drop, the policy loses nothing. The amount credited is 0. No gain, but no loss, either. Another nice thing is that, in our example above, after the 12% gain is achieved, it’s locked-in. That’s the new floor and that money can’t be lost.
How can the insurance company, investing in a conservative bond portfolio do this? It’s simple. Again, I’ll oversimplify with rounded numbers just to make the concept easier. Premium money received might be invested 95% in bonds, and 5% in stock options. If the market goes down, the options expire; if the market goes up, they execute the options and, of course, the cap on the policy limits their exposure.
Important: The policyholder is not invested in the market or the options. The index is only a ‘ruler’ to measure how much the insurance company will credit. It’s the insurance company’s investment account that is doing the investing, not the policyholder.
Returns and Illustrations
Can the policyholder receive stock market-like returns? Not likely. The caps limit the upside, and while there is no downside, down years representing no gain will sometimes occur. So, positioning IULs as a stock substitute is probably not the best strategy. I would look for returns that are more bond-line, maybe a little better, which means, it’s the bond portion of your portfolio that you’re really dealing with.
And, here’s where illustrations can be a bit misleading.
If one company is offering a 12% cap and another company is offering an 11% cap, but both are showing you an illustration using a 7% crediting rate, saying that the S&P average over all their back-tested periods indicates that 7% is conservative, are you really seeing an apples-to-apples comparison?
Maybe. Maybe not. It depends.
First, the company: How have they treated policyholders in the past when they’ve reduced or increased their caps? Did existing policyholders receive the same treatment as new policyholders?
Secondly, a decrease in a cap rate isn’t all bad. Responsible insurers are custodians for client assets and need to act responsibly, rather than chase risky investments to meet caps they can’t pay. However, a decrease in the cap also can affect your outcome.
As you can see from this chart below – I apologize if it’s a bit difficult to read – a 7% illustration for a 12% cap IUL has a 79.5% chance of meeting its projections, based on a 20-year historical probability study of the S&P 500 at various cap and crediting rates. If the cap is 11%, the probability is reduced to 60.7%.


IUL Crediting Rates_001
This has less to do with the insurance company than it does with expectations. It’s important to know, when you’re buying, what you can reasonably expect; and, often, it may not be what you’ve been promised with a rosy illustration. High quality companies providing investment-grade products will tend to be conservative in their projections – and a good advisor will educate clients on realistic outcomes.
Note: An illustration for a policy with an 11% cap but using only a 6% crediting rate may not look as rosy as the 7% illustration, but the odds of the company delivering on its promise rises to 95%. This means, it’s virtually certain your policy will perform this well or better. The 7% illustration will look so much better at the point of sale, but it also has almost a 40% probability of doing worse than promised.
The Real Benefits
If someone begins utilizing these benefits early, say in their 40s or 50s, the benefits can be substantial. As a matter of fact, it’s a strategy being used by 85% of Fortune 500 CEOs and many members of Congress in order to create a tax-free retirement. Other proponents of this strategy include retirement and IRA expert Ed Slott, who is also a CPA, and David M. Walker, former US Comptroller General [Source: The Power of Zero, David McKnight].
I’ve created a report on this concept. You might find it interesting. You’ll receive it free by going here. If you’d rather take the time (about an hour) and view the webinar with all the slides, you can do that here.

Is Your Indexed Annuity a Stock, a Bond, or Something Else?

Jim Lorenzen, CFP®, AIF®

6a017c332c5ecb970b0192ac851ba2970d-320wiGood question, ya’ think?[1]  Maybe we should begin with what a fixed annuity is; then move to an indexed annuity.

Fixed Annuity (FA

When you loan your money to a bank, they give you a CD that pays a fixed rate until the CD matures and then return your money, paying off the loan.

When you loan your money to a government or corporate entity, they give you a bond that pays a fixed rate until maturity and then they return your money, paying off the loan.

Both of the above scenarios are basically bond scenarios:  A bank bond, a government bond, a corporate bond.  All three are I.O.U.s.

When you loan your money to an insurance company, you get an I.O.U. from them, too.  They pay a fixed rate – sometimes even a bonus on top the first year – with one extra  benefit:  As long as the interest accumulates inside the annuity, it’s tax-deferred.  The benefit of tax-deferral, of course, comes with a price:  You might have tax issues if you ‘cash-in’ before age 59-1/2.  That’s an I.R.S. requirement, not the insurance company’s – but, I digress.  At its core, a fixed annuity is essentially a loan to an insurance company in exchange for a tax-deferred fixed rate of interest, paid by the company – it’s an insurance company I.O.U.   Annuitizing, a separate discussion, is an option, not generally required.

An Indexed Annuity (IA)

This is a fixed annuity, too.  It pays a fixed rate of interest for a term chosen by the annuity holder.

What’s the fixed rate?  It depends on what it’s “pegged” to.  Most people seem to like the S&P 500 Index.  They don’t’ own the index – which is impossible, anyway – they simply receive a rate of interest determined by the performance of the index.

What is the term?  It depends on the crediting option chosen.  Annual point-to-point (comparing only two index values – beginning date and anniversary date – has a one year term.  Others could be monthly, etc.  Companies are also beginning to use a volatility control index, as well.

The point:  It’s still a fixed annuity with the insurance company resetting the interest rate according to the performance of an outside index.

What do you own?

Is this a stock?  No.  There’s no equity ownership in any company, either directly or indirectly.

Is this a bond?  Well, yes BUT.  It is a bond in the sense it’s an insurance company I.O.U.  The fact that the interest rate will move up or down based on the performance of some outside index is immaterial.

The BUT is this – and it’s a good one:  These can be used to supplement the bond portion of a portfolio but will often outperform bonds.  The reason is simple:  The rate credited, tied to an outside index, can rise with that index (often up to a ‘cap’).  When they do, those gains are ‘locked-in’ on the anniversary date.   They never go back down!  You never lose money.  Those gains are also tax-deferred, which is better than paying taxes on CD money you’re not touching or bond interest you’re not using.

Are FIAs right for everyone?

No.  Nothing is.  They certainly shouldn’t be purchased al-a-carte; they’re complex products and should be installed into a portfolio as part of an integrated financial plan.  While FIAs carry no annual fees, unless you attach riders, they do carry surrender charges if funds are accessed in greater amounts than the contract provides.  Even though many contracts allow 10% free liquidity provisions, it’s still worth noting.  This may not be an issue for those who do not need to touch the money; but, it’s another reason they should be part of an integrated financial plan that has planned for liquidity contingencies.

Someone who’s looking for guaranteed income as the main focus –  not focused on liquidity or needing to walk away with a giant lump-sum at a future date – FIAs can be an excellent portfolio supplement.  The combination of (1) no downside risk, (2) tax-deferral, and (3) returns that will probably outpace bonds (due to equity upside participation with no downside risk), make FIAs pretty attractive.  For those under age 55, there are other insured options that might be considered before settling on an FIA.  Many experts believe that taxes will rise and it might make more sense to reposition assets early to arrange a tax-free retirement.   IRA guru Ed Slott, a CPA, and David M. Walker, former U.S. Comptroller General, are big proponents of this.  If you’d like a free report on this, you can get it here.

Why the surrender charge and how does the insurance company make equity-related payouts?

These two issues are related.

Insurance companies may be the best risk managers on the planet, which may explain why so many of them went through the Great Depression never missing a claim payment while Wall Street was watching people jump out of windows.

Their process for meeting index-related obligations is pretty simple, really (though not simplistic).  The vast majority of premiums are generally invested in long-term bonds.

But, with rates so low, how do they earn enough money to make higher payouts when an index goes up?   Just for the sake of illustration, I’ll use simple numbers.  An insurance company might invest, for example, 95% of its FIA premiums in long-term bonds, in order to get a decent bond market return.  The other 5% would go to buy call options on the index – a ‘call’ is the right to purchase at a specified price if the market rises.  If the index goes up the company executes the option to purchase.  If not, the company lets the option expire.  Naturally, some options are paid-for and never executed.

As for the surrender charges, there’s not only the cost of unexecuted options – a relatively small piece of the puzzle – but, there’s also the long-term bonds that must be sold in order to meet a redemption request.  The company not only may face a loss on those bonds – maybe not, it depends on interest rates and price movements – but must also forgo the interest they would have received on those bonds as part of their total portfolio in order to meet all outstanding obligations to policyholders.  The surrender charges also serve to help reimburse the company for the marketing costs they had originally paid out of their general account.

Potential problems in sales situations

Because FIAs can be sold by insurance agents who have no securities license – it’s not a securities sale – they can easily be either misrepresented or, more often, even misunderstood by the agent making the sale.  One area has to do with a working knowledge of the underlying indices from which a client must select.  The biggest issue, however, may be the solvency of the issuer.  As I said, FIAs are really insurance company I.O.U.s.  The risk of performance may be on the insurance company, but the risk of an insolvent carrier may be another issue.  It’s worth noting that most of the ratings from agencies cited in their ads are actually paid for by the carriers being rated.   Ideally, the person recommending the annuity issuer would be someone who can get “under the hood” of the insurance company financials and not rely on paid-for company ratings.  This would call for, at a minimum, someone who’s securities licensed or preferably a Registered Investment Advisor with additional recognized credentials.

The Outlook

There was a time when companies in America provided pensions to their retired workers.  These defined-benefit plans have all but disappeared, which is why income-replacement has become a huge issue as boomers face retirement.

Some are even wondering if it’s time to dump the 401(k) altogether.  Take a look at this:

The argument in favor of income replacement tools is simple:  You insure your house, your car, your health, and some even their dental visits; why wouldn’t you insure your future income.   Many people who pride themselves in paying cash for everything else still find it difficult to pay cash for an income they can’t outlive; but, as I said earlier, it must be done carefully and as part of an overall plan because income isn’t the only factor in everyone’s lives.


[1] This excellent question was posed by Ben Mattlin in the June issue of Financial Advisor Magazine.

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Do You Know the 5 Biggest Risks To Your Retirement?

Jim Lorenzen, CFP®, AIF®

Do you know what your biggest retirement risks are?

5 Biggest Risks to Your Retirement_ifgi_001Many might think, after watching all the coverage about Greece, computer glitches on Wall Street, and stories about hackers, that it might be the financial markets; but, the fact is there have been all kinds of melt-downs over the years and some people’s plans were unaffected!

Those people, of course, tended to be the ones that had plans that anticipated the 5 Biggest Risks!

You can download this report here.



To Roth or Not to Roth – Should You Do a Conversion?



Jim Lorenzen, CFP®, AIF®

Steven Elwell,  a CFP® practitioner in Amherst, NY recently wrote a nice piece for NerdWallet on this subject.

In his piece, he mentions five situations that might suggest a conversion would be a good move:

  1. You are in a low tax bracket
  2. You don’t need the money and plan to leave it to your kids
  3. When your investments are down (did you do it in 2008?)
  4. When you believe tax rates will go up
  5. You want to reduce the value of your estate for income tax purposes.

If you’d like to read Steve’s article, you can access it here.

The points worth noting in particular – my own opinion – are #1 and #4.

Tax brackets are historically low.   There was once a time when the highest marginal bracket was 90% before the early 60’s, when President  Kennedy began to initiate cuts.  As you can see from the chart below, the general trend has been down for some time, although it’s also worth noting a lot of deductions have disappeared along the way.

While top marginal tax rates have declined, it’s also true that the Government is still spending your money – usually favoring whatever groups will help them get re-elected  – I know, I’m a cynic.  Nevertheless, as I take great pains to avoid any mention of Greece, the government keeps spending.  While those in office take pains to point out the annual deficits have been in decline, the fact is those deficits still add to the existing debt.
There is a difference between the reported national debt and the REAL debt.  The reported national debt is now over $18 trillion; but the real debt is very different.

The government engages in different accounting than the rest of us.   If you purchase a car with nothing down, for example, you would have to list the entire outstanding balance as debt on your balance sheet.  Not so with the government; only the current year’s payments are counted as debt.  Result:  While the government reports $18 trillion, Townhall.com estimated the debt at $87 trillion – and that was in 2012!

Not long ago I did a webinar entitled How To Plan for an Income Tax-Free Retirement.  A number of those who attended, and a few who couldn’t make it, have asked me if I had a written report they could download.   I’ve created an updated version outliining this strategy, which is really most worthwhile for those who are successful and most likely between ages 35-55.  Those between 55 and 60 may still benefit.   You can learn more here.


Enjoy the 4th!

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

One of my hobbies, if you can call it that, is American history – particularly the period between 1765 and 1800.


It was during that 35-year period that the colonies declared their independence, and  began a rebellion that morphed into a full-fledged revolution (which had NO chance of success) that defeated the largest and best-equipped fighting force on earth.
During the summer of 1787, the best minds the colonies could produce met in Philadelphia to hammer-out a framework of government.  While Adams and Madison had performed extensive research on the history of republics, they had to make adjustments because few lasted very long and all had failed.
The resulting constitution provided the framework of government that became a reality in 1789 when George Washington took office as the first President of the United States.  The new government was funded by a financial genius Secretary of the Treasury, Alexander Hamilton.  The funding came from a bank he founded:  The Bank of New York (now BNY Mellon, which owns Pershing).
The Constitution they created that summer, that we still have today, is – are you ready? – the oldest functioning constitution in the world today.   No country anywhere on our planet is operating under a constitution older than ours…. Not Greece, not France, not Italy, no one.
It says something about the minds that met in Philadelphia that summer.   Each of them brought something unique and brilliant to the table.  Few people realize that the banking system, credit and stock markets, our system of trade, including the customs service, were all designed by Alexander Hamilton.  He’s one founding father that could walk into our financial system today and recognize all of it, maybe except the machines, because he created it all.
James Madison, the father of the Constitution, would probably be amazed to see that the constitution still lives, albeit with expected amendments since that process was provided for in the original document.   All other constitutions in existence around the world at that time are no longer around.
Enjoy the holiday!  This one is one of the great birthdays we celebrate.

Econ. 101-Supply and Demand – and Longevity Credits

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

More and more boomers are beginning to approach retirement. 


No news there; but something’s been happening – and continues to happen – that can negatively impact people who waited hoping to get a better deal regarding their retirement income.  It’s little wonder that so many retirement plans are in jeopardy.

You see, immediate income annuity sales totaled $9.7 billion last year – a 17% spike.  My guess is, as the boomer retirement bubble really begins to hit, that number will be much higher.

6a017c332c5ecb970b0192ac851ba2970d-320wiIt’s Economics 101: Supply and Demand.  As more and more boomers purchase annuities to cover their basic expenses in retirement, this demand coupled with increasing life expectancies, will likely have a dramatic effect on payout rates for future purchasers.

According to an excellent article by Tom Henga, writing in the June issue of Retirement Advisor, a Society of Actuaries (SOA) committee released the final report of RP-2014 mortality tables in October and those tables reveal a consistent trend, which if it continues for the next 14 years, means in 2028 life expectancy might rise to 88.6 years for males aged 65, and 91.2 years for females the same age.

So what?

According to Mr. Henga, these updated mortality tables will require insurance companies to lower their payout rates in order to properly reflect longer life spans.   His logic is easy to understand and the math isn’t hard to do.

The trend increasing life expectancies – along with the consumer demand for guaranteed income solutions – could very well result in annuity payout rates going from 14 percent to 10 percent, from 9 percent to 7 percent, and from 7 percent to 5 percent.    It’s about longevity credits.  As demand increases, something has to give.

People who’ve been avoiding annuities now because of today’s low interest rates may find themselves wishing later that they had understood the situation.  As Mr. Henga points out, income annuities are not an interest-rate play; they’re a longevity credit play.

Most people have no idea how annuities work or why the insurance companies can provide such high cash flows in a low interest rate environment.  The key is longevity credits, i.e., mortality credits.  It’s what separates annuities from investments.

When new mortality tables reflect increased aging, chances are better than good that insurance company payout rates will be reduced because of the adjustment in mortality credits.  And, chances are, due to the factors cited above, we may be seeing the highest longevity credits we may ever see the rest of our lives…. And many of these adjustments may very well occur in the next 12 months!

its-about-timeLongevity credits aren’t unlimited.  It’s the life insurance on the books that provides the built-in hedge to lifetime annuity sales.  As people live longer and the demand for credits increases, the pool of available credits decreases.  Econ. 101:  This will affect pricing of annuity products in the future.

Boomers, of course, are becoming more preoccupied with covering 100% of their non-discretionary, basic retirement needs, and using other investments to address inflation and discretionary spending.  Those who secure their annuities earlier in their planning can lock-in these longevity credits early.

Tom Henga likens it to fishing in a fully-stocked pond, as opposed to a pond with a limited supply of fish.

Income annuities come in all shapes and sizes, of course, and the long list of insurance carriers selling them each offer a variety of designs, each with their own bells and whistles.  They can be complex products; but, they can also have simple, easy to understand designs.  It’s important, however, to avoid the tendency of grabbing the best-looking shiny thing that may have other problems embedded.

Annuities, as mentioned earlier, are gaining in importance however; and they may be worth a look now, more than ever, because of the Econ. 101 issues cited above.

Retirement planning can be a little tricky.  In fact, I believe – and many experts agree with me – that most retirement plans will probably fail.  I’ve even created a special report that explains why.  I think you may find it interesting.  You can access it here.

Hope it helps!



Will YOUR Money Last?

Jim Lorenzen, CFP®, AIF®

6a017c332c5ecb970b01a3fd0c994a970b-320wiWhen I first entered the advisory business in the early 1990s, financial entertainment television was a new phenomenon.  All the tv gurus were being interviewed regularly and talking heads discussed which funds were likely to do best in the coming months.

The ‘baby-boomers’ were in the accumulation mode and the mantra was “buy term and invest the difference”.  Few did it, though.  They acquired their insurance through work and they invested as long as the market when up.  When the inevitable market pull-backs occurred, they often got out and sat on the sidelines as professionals went in to grab the bargains.

The boomers are older now.  Accumulation is no longer the priority; now, it’s safety – and many are avoiding the market altogether.  Understandable, but problematic, when you consider that the stock market is THE all-time heavyweight champion of inflation hedges.

Inflation, of course, measures what things cost; and the market is comprised of all those companies that sell all those things to us.  Those dots are easy to connect, even for me.

Storm Clouds are Gathering

Many people may be blindsided, according to retirement expert Ed Slott, who also happens to be a CPA, and David M. Walker, former U.S. Comptroller General.   As they point out along with author David McKnight in “The Power of Zero”, the bottom line is this:  The Government is in debt and needs money.  Most Americans will once again be caught on the wrong end when the dog wags his tail.\

Demographics and realities tell the story:

  • The boomers were accumulating and Uncle Sam convinced them to put money into their 401(k)s, IRAs, and other tax-deferred accounts. They avoided taxes on the ‘seed’ so Uncle Sam could reap the harvest.  If tax rates never change, no problem; but, with a license to spend, higher taxes seem bound to follow.
  • The Government has been running up debt. Just 7 years ago, the 219-years of accumulated national debt totalled $9 trillion.  Now, it’s over $18 trillion – doubling in 7 years – and there’s more:  The government counts only the current year’s outlay as debt, not the total outstanding obligations.  Don’t you wish you could do that?
  • The boomers will begin drawing on their now-taxable retirement accounts just when Uncle Sam will need more revenue to fund federal obligations. It has to come from somewhere.  Successful people are the ones in the cross-hairs.
  • Uncle Sam is a partner in every boomer’s retirement plan – a partner with the SOLE vote on how much of the plan he gets to take to fund his promises. The boomer-partner has no vote.   A boomer with a $500,000 IRA might have $125,000 in embedded taxes today and could have $250,000 or more in embedded taxes tomorrow – no one knows, but Uncle Sam has the only vote.

So, for many boomers, the issue of longevity risk is very real; and particularly so for their spouses as boomers wrestle with making sure they’re provided for if something should happen to them.

It’s something I’ve witnessed in my own family.  My dad died at 94, but my mom lived to age 99… a full eight years after my dad passed away… and she needed full-time care the entire time he was no longer around.

Industry Responses

Picture from my first industry conference.

Picture from my first industry conference.

When I attended industry conferences in the early days, all the sessions seemed to be about “adding alpha” (manager value-added) and the efficient frontier (risk mitigation).

Today, increasingly, conferences, webinars, and trade publications are addressing the issue of longevity risk and sustainable withdrawal rates.  The academics are running models with back-testing to aid planners and others who serve clients facing these real-world issues.

Traditionally, most advisors counseled clients to use the 4% rule:  Maintain an optimized portfolio mix and withdraw 4% of your initial balance annually, taking cost of living increases each year the market experiences a gain.

The April 2015 issue of the Journal of Financial Planning[1] featured an in-depth study by Wade Pfau, Ph.D, CFA, addressing this issue testing three different strategies:

  1. The SPIA strategy: Buy a joint/100% survivor’s life-only single premium immediate annuity.
  2. Buy a ladder of bonds maturing over the next 30 years.
  3. Buy a ladder of bonds maturing over the next 20 years and purchase a deferred income annuity (DIA) that will continue the same income level and trend in years 21 and beyond.

Dr. Pfau detailed how each strategy had its own advantages and disadvantages, as one would expect since we’ve never seen anything that’s perfect.  For example,

#1 sacrifices some liquidity but also eliminates both market and longevity risk.

#2 can provide inflation protection by laddering TIPS (Treasury inflation-protected securities), however there is no longevity risk protection beyond 30 years.

#3 is actually fairly attractive and seems to provide the highest sustainable withdrawal rate, despite giving up liquidity on about 25% of assets; but, the trade-off is still inflation risk since no company currently offers a DIA that provides inflation protection for the initial payout made in the future.  The planner would have to do some ‘reverse engineering’ to come up with an estimate of what funding would be required to provide an inflation-adjusted initial payment.  The downside is that it might require funding at a level requiring less liquidity than desired or an inaccurate result.

The models I’ve seen in this and other studies would suggest that sustainable withdrawal rates must inherently be conservative to allow for the spending rate to work.  While the three strategies above may support spending rates between 3.65-4.03% in the back-tested models cited, sustainable spending rates for those not willing to give up liquidity, i.e., in traditional investment portfolio, are more likely to be in the 2.35%-3.51% range, the latter being considered aggressive.

While there are a number of sophisticated strategies available to individual investors, they often require abandoning long-held, well-ingrained beliefs in order to achieve the long-term goals that matter.


If you’d like to view my 30-minute webinar, Why Most Retirement Planning Will Probably Fail, you can do so here; our you can go here for more information.

[1] The Costs of Retirement with Different Income Tools, Wade Pfau, Ph.D., CFA, professor of retirement income at The American College.  Published by the Financial Planning Association.

Need to Manage an Inheritance? Here’s Your Checklist!

Jim Lorenzen, CFP®, AIF®

For some, managing a large inheritance can be as daunting as winning the lottery; the windfall may sound good initially, but the money can disappear quickly if not managed properly.

What needs to be considered?  What needs to be done?  What comes first?  What’s been overlooked or forgotten?   Who should I be talking to and what should I ask?

Lots of questions…

Here are some answers.  As part of our IFG LifeGuides series, we’ve created a LifeGuide for Managing an Inheritance.  I hope you find it helpful.


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Five Times When An Annuity Makes Sense


Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

My recent blog posts,  as well as on this platform, discussed the advantages of arranging assets early – ten years or more before retirement – to lay the groundwork for an income-tax free retirement.  Many experts believe it’s time to dump the stock-market-based approach in favor of an insured retirement solution – see Time To Rethink the 401(k).

Planning for an income tax-free retirement is very doable for many people, though not everyone, to be sure.  I’ve even posted a recorded webinar on this subject (Note:  It’s about an hour long; so get some coffee and get comfortable).

Then there’s the Obama administration’s Green Book, which I discussed last week, detailing budget and tax proposals for the coming year.  It leaves little doubt, if there was ever any, that the government will be looking at all types of retirement vehicles (401(k)s, IRAs, Roth IRAs, etc.) – vehicles the government created, regulates, and is therefore in a position to write the rules.  You can see that post here.

Of course, there are other insured solutions, designed to address the issue of longevity risk – we do seem to be living longer; and, some are worried that their money won’t last as long as they will.

Last week, Rich Lane of  Magellan Financial outlined five reasons annuities can make sense, especially for financially conservative investors who want to build and protect their assets.   He was talking about fixed annuities (which is good – I must admit I am  not a great fan of variable annuities; but, that’s another story.

6a017c332c5ecb970b01a3fd41160b970b-320wiThose who remember losing money back in the economic downturn are often  interested in a vehicle that has a guaranteed minimum rate of return – something few alternatives offer; and that’s one of the reasons why the fixed annuities industry is seeing strong sales growth.

Fixed deferred annuities can provide a predictable future with flexible payout options that offer a guaranteed income stream, and those earnings aren’t taxed until the funds are withdrawn.  In effect, they are treated as a source of income, just like a pension.  So you can think of it as your own “pension” that you fund yourself.

A deferred indexed annuity – a fixed annuity with an interest crediting rate that’s linked to an outside market index of some type – can be “turned on” before or after retirement to create a liquid stream of income.    When you think about it, how many investments do you know of — other than a fixed annuity — that can provide a predictable and guaranteed stream of income?

Banks?  Maybe.  But, during the Great Depression, banks across the country closed.  Insurance companies thrived (risk management is their business).   Bonds?  Maybe.  But, governments seem to habitually spend beyond their means and you face interest rate risk when it’s time to reinvest at maturity.  Bond ladders can reduce this risk; but, few people in their second decade of retirement want to spend their time tracking the bond markets.

Here are Rich Lane’s five reasons an annuity might make sense for you:

  1. Safety: Fixed annuities can ensure that if anything should happen to you, your surviving spouse has a source of continued income in place.  This can help in case of a catastrophic illness or if there should ever be a need to enter a nursing home.
  2. Liquidity: Today’s challenging economy has heightened interest in liquidity.   Many hesitate to make long-term financial commitments without flexibility and access to funds – even if it means creating an income stream should they need it.
  3. Tax deferral: The tax benefits of fixed annuities are important to many.  Because earnings will not be taxed until withdrawals are made or regular distributions start, annuity owners can benefit from triple compounding: earning interest on principal, interest on interest, and interest on tax savings.
  4. Control: Another appealing aspect of fixed annuities is the ability to choose a predictable income stream.  Lifetime income options provide clients with the control of selecting payments that are guaranteed to continue for life.
  5. Wealth transfer: Financially-conscious investors tend to be keenly focused on what happens to their money after they pass away.  Annuities can bypass a lot of red-tape and provide greater control over outcomes.

It’s worth remembering that no investment, vehicle, or strategy will be right for everyone; and no investment or vehicle should be regarded as “the answer” to all your needs.  Creating a retirement strategy is more like assembling a puzzle.  There are always trade-offs.  The key is not to get blinded by single issues; it’s really about finding the mix of solutions that create a master strategy for accomplishing your prioritized goals.
Do you know how much risk is embedded in your current investment and retirement portfolio?  If you’d like to find out your risk number, you can begin here.


Are YOU a Target in the Green Book?

Last week we heard from many experts who believe it may be time to dump the 401(k).

Two weeks ago we discovered that many experts, like retirement guru and CPA, Ed Slott and former US Comptroller General David M. Walker, believe income taxes are going up – I even conducted my first-ever webinar on how you might be able to plan for an income tax-free retirement.

(You can access a recorded version here.  Be aware: There’s a lot of information, so it lasts about an hour).

This week, I want to tell you about the Green Book.   The Green Book is what the administration releases every year, detailing budget and tax proposals for the coming year.   The Obama Administration released their latest version in February, detailing their proposals for the fiscal year beginning this October.

Surprise:  Many of the Green Book retirement planning proposals are aimed at limiting taxpayer use of tax-advantaged qualified retirement plans and IRAs.

Maybe you’d like to view that recorded webinar, after all.

This proposal should cause some concern because many who have contributed to retirement plans throughout their working lifetime and hit the proposed “retirement savings cap” will lose the ability to make future contributions and lose matching contributions provided by an employer.

By the way, under the Green Book proposals, after-tax contributions to an IRA could not be converted to a Roth IRA.

As many experts recommended in the second video featured in last week’s post, the current system might be better replaced with an insured solution, taking market-risk off the table and potentially removing much of the legislative risk, as well.

What the Green Book proposals would do.

According to David Cordell, PhD, CFP®, CFA, CLU®, and Thomas Langdon, J.D., LL.M., CFA, writing for the Journal of Financial Planning, these are some of the key proposals:

  • Raise the capital gains rate from 20% to 28%
  • Treating gifts of appreciated property (this would include your investments) as realized gain, requiring the payment of capital gains tax
  • Reducing the estate and generation-skipping transfer tax exemptions from their current level of $5.43 million to $3.5 million with (ready?) no inflation indexing
  • Reducing the lifetime gift tax annual exclusion from $5.43 million to $1 million. Eliminating the IRC Sec. 1014 “step-to” basis provision and replacing it with a $100,000 per person exclusion at death – the “steps” can be down, as well as up.

How this might impact your planning:

The “insured solution” may be where much planning is headed.  The Green Book proposals might make life insurance policies designed for cash accumulation even more attractive than they already are, for both individuals and businesses.

The most significant changes in the Green Book include:

  • Eliminating “stretch” IRAs by requiring non-spouses to distribute inherited IRA funds within five years.
  • Depriving individuals with more than a specified amount in their retirement accounts from making contributions to retirement accounts – they’re currently projecting this figure to be about $3.4 million, which could be expected to produce an annual income of $119,000 before taxes with a comfortable margin of safety using a 3.5% withdrawal rate while allowing for inflation adjustments. The figure, however, could vary – the government will let you know.
  • Repealing the special exclusion for net unrealized appreciation for lump-sum distributions of employer securities from employer plans.
  • Requiring plans to expand eligibility requirements to include part-time employees who worked at least 500 hours per year in three consecutive years, and
  • Limiting Roth conversions to pre-tax dollars

[Source:  Journal of Financial Planning, May 2015]

If you missed my webinar, you might want to take a look now.  Grab a cup of coffee, a pad and pen – you’ll be taking notes – and see what you might be able to do to secure your future and remove, as much as possible, government intervention from the picture you have of your 30+ year retirement.