How To Avoid the Family Business Wealth Evaporation Trap

Jim Lorenzen, CFP®, AIF®

Family business owners face wealth evaporation daily.  It’s like glaucoma.  You can’t tell it’s happening on a daily basis, but the cumulative results can be costly.

Many years ago – before the internet – I was in the business of publishing weekly newspapers and shopping guides.   It was a business that included advertising sales, ad layouts and graphic design, production and composition, printing and distribution, and (of course) all the financial disciplines of managing cash flow and credit lines.

I mention this simply to point out that I know the challenges the owners of closely-held businesses face… and also to point out that there are some common mistakes many such owners have in common.

It was during this period I remember reading an interview with Jack Nicklaus, who was then at the top of his game and was THE golfer that “moved the needle”, as they even said back then.  It was in that interview he pointed out one of the biggest mistakes he made had to do with his approach to cash management, pointing out just how costly his mistakes were – until he corrected them.

I learned from that article and it made a huge difference in my life.    That article, however, didn’t provide much detail; it was, after all, a golf magazine and didn’t have a financial focus.

Santa Barbara-based business expert George Issac, however, has written an excellent piece, entitled, Avoiding the Family Business Wealth Evaporation Trap.   If you own a family business, you just might find this information highly valuable.

I recommend it highly; and you can get your own copy when you subscribe to my ezine –  If you decide later you don’t want the ezine, you can unsubscribe immediately with a single click.  By the way, IFG never shares your email address with anyone.

I recommend this piece by George Issac.  I think you’ll be happy you read it.
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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.

Managing Retirement Income Decisions During Retirement

Jim Lorenzen, CFP®, AIF®

Managing retirement income has never been easy.  Those who retired in the early 1970s saw interest rates rise dramatically, then fall the same way – all within about a 15-year period.   When interest rates were going up, it made them feel good; but, few paid attention to inflation or tax implications.   During one period, interest rates were in the double-digits, but so was inflation, which meant their “increased” income wasn’t really increasing at all.    Money is worth only what it buys at the checkout counter.

So, the retiree who felt great about a 15% interest rate during 15% inflation (yes, it really happened and could happen again, blindsiding people who didn’t live through it before), weren’t really getting a raise at all – and that was before taxes!

The real problem, of course, came when interest rates began to fall.  During the period that interest rates (and inflation) dropped to 12% from 15%, retirees were seeing their incomes drop by 20% (a 3% drop in rates from 15%) while still seeing prices rise by 12%.

How do you manage income in retirement?  It ain’t easy.

Naturally, you could consider a basic withdrawal sequence using a straightforward strategy to take money in the following order:

  1. Required minimum distributions (RMDs) from IRAs, 401(k), or other qualified retirement accounts.
  2. Taxable accounts, such as brokerage and bank accounts.
  3. Tax-deferred traditional IRAs, 401(k), and other similar accounts
  4. Tax-free money – from Roth IRAs for example

This sequence can provide an order of withdrawals; but, other than the RMDs, it doesn’t tell you how much!

But wait! (as they say on tv).

How much?  And, how can you be sure you won’t run out of money?

RMD can provide a clue!

The RMD calculations can provide sound guidance for your entire portfolio!  Using the IRS formulas, Craig Iraelson, executive-in-residence in the financial planning program at Utah Valley University, did some back-testing with hypothetical portfolios invested in different investment allocations with RMD withdrawals starting in 1970 (the beginning of a relatively flat ten-year stock market).   Using beginning values, and even with a portfolio invested in 100% cash, there was still $850,000 left after 25 years!   And, a portfolio that was 25% stocks had $2 million left.

RMDs appear to address longevity risk pretty well; but, there’s another question.   Is the income level provided by the RMDs enough to preserve the pre-retirement lifestyle – or anything close?

There’s the rub.  In the back-tested portfolios, the initial RMD was 3.65% of assets… and that falls within the widely-accepted 4% rule…  but, that’s only $36,500 of pre-tax income.  Even if the retiree family has an additional $30,000 from Social Security, that’s still just $66,500 before taxes; and, for many successful individuals, that isn’t enough.

So, there’s the trade-off:  Sacrifice income for longevity, or accept longevity risk in order to take increased income.

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Maybe there’s another way.    How can a couple have more freedom to take greater income early while still addressing the risk of running out of “late-life income”?

My “Late Life Income” report shows how many couples have addressed this issue.   You can access it here!

By the way, when you get my report, you’ll also receive a subscription to my ezine.    If you decide you don’t want the ezine when you receive it, you’ll be able to unsubscribe immediately with a single click and, of course, your email is never shared with anyone.

Enjoy the report!  Hope you find it helpful.

 

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.

Business Valuation Matters

Jim Lorenzen, CFP®, AIF®

Business valuation matters!   And, not just when you plan to sell.   Few business owners realize that valuation ‘what-if’s’ can help determine the advisability of major purchases and investments, not to mention the implementation of pre-funded buy-sell arrangements.   Yet, of the more than 200 million businesses in operation globally, fewer than 2 percent value themselves annually.   Over the next 10 years, approximately 10 million businesses will change ownership, according to BizEquity, but 75 percent of small business owners don’t know what their business is worth.

Business owners often hold mistaken assumptions about their business’s value, he says; technology companies often overvalue themselves while retailers, manufacturers and professional firms don’t value themselves highly enough.

The lack of knowledge puts small and midsize business owners at particular risk because they are unaware of how to create the right capital structure for their business, what amount of insurance to buy or how to plan for a business transition into retirement.   According to BizEquity, 50 percent of small businesses are uninsured and more than three-quarters of business owners plan to fund 100 percent of their retirement through the sale of their business.

How do you establish business value?  You might find our report helpful.  You can learn more 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.

What To Do With Business Sale Proceeds

Jim Lorenzen, CFP®, AIF®

 

When you receive business sale proceeds, you’ll likely pay a capital gains tax; but, that may not be the end of the story.

Suppose you have $1 million or more after the sale – money you’d like to put somewhere for future use – but you also want growth with safety and tax-deferral, too!

You could use our 401(k); however, there are funding limits in any given year and those limits don’t carry over.  Besides, the safety issue could be problematic.

Bank certificates of deposit can provide safety, but not growth or tax-deferral.

If you’re selling your business next year, you’ve waited too long to plan.  However, if your sale is scheduled for ten, fifteen, or twenty years from now, this IS the time to get your ducks lined-up – and this report might help.
Click Here!
By the way, when you get the report, you’ll also be subscribed to our free ezine.  If you decide you don’t want it, simply unsubscribe at any time – your name will be removed immediately.  IFG will never share your email address with anyone for any reason.

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.

Business Owners Face Potential Tax Law Changes

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Jim Lorenzen, CFP®, AIF®

1954

1986

2017

What do those years have in common?    If you guessed those were the years of major tax reform, you’d be right—at least about the first two.  2017 is still a question mark.

While tax law changes can occur quite often, major reforms appear to come around about every thirty years.    Business owners, unlike the rest of America, will have to deal with the impact of any changes on both the personal and business front.

Most Americans don’t own businesses and can be excused for not understanding many of the issues business owners face.    First, most businesses tend to be small – proprietor-owned – and are therefore taxed at individual rates; and that includes partnerships.  They don’t get taxed at the lower corporate rate; yet, these owners represent most of the job creation.  Those who are successful, pay at high rates – and even more if they’re in a high tax state!   It’s not uncommon for a successful small business owner in a high-tax state, like California or New York, to be faced with having to make $300,000 in pretax profit, only to see half of it go to federal, state, and local government, leaving about $150,000.  Sound like a lot?  Not if you’re in one of those high cost-of-living states, which usually happen to be the same ones, in which case $150,000 is often just middle-income.   Makes it pretty hard to create jobs for other people – often the reason many of these businesses often relocate to low-tax states (with a lower cost of living) to grow their businesses, where they find it easier to create jobs.

How about corporations?  Most Americans don’t realize that those who incorporate their businesses are taxed twice.   Their business pays a tax on profits BEFORE the business pays a salary to the business owner, who then must pay a second income tax!  And, of course, we’re back to the high income-tax state issue.

The government drains money from the people who create the jobs; so, no wonder – as people want to see more jobs in the economy – tax reform is such a big issue.

Proposed Changes for Business

Under the proposed tax bill, which still faces much debate, the corporate tax rate would be reduced to 20% – a substantial cut.  S-Corps would see their rate drop to  25%.  Well, maybe not – what day is it?  This all changes with the wind until it’s law.

One of the proposed changes, favored by many business owners,  would allow for the expensing of capital expenditures—no doubt in an  effort to spur growth.   However, there could be a fly in the ointment for many business owners in a provision no one’s talking about.

You’ve heard about the  ‘border tax’.  Under this provision, there would be no cost-of-goods deduction on imported goods—a potential problem for many retailers, as well as manufacturers who outsource some or all of their supply chain.

Many businesses that have spent years researching and developing their supply chains may face some formidable challenges.  There would be a deduction for the cost of goods exported.

Finally, there would be no deduction for business loan interest under the proposed plan.  This may not be a big issue now, given today’s low interest rates; but, it could become a major issue if we should ever experience the double-digit interest rates similar to those of the late 1970s.

Business owners are individuals, too.

As if dealing with all a business owner faces isn’t enough, there’s also the personal side.   There are  some potential changes looming on the horizon there worth knowing about.

Individual tax rates would come down and reduced to three brackets.

The elimination of all itemized deductions except for mortgages and charitable contributions is also popular with many, but not everyone.  The proposed change for charitable deductions limits those deductions to $100,000 for a single payer and $200,000 for a married couple.  It may become difficult for a  charity to convince a multi-millionaire to donate that $1 million work of art !

And, while there’s talk of repealing the estate tax, it doesn’t appear to be a complete repeal.  The government still wants that unrealized appreciation taxed!  The talk is about going to a system similar to what they have in Canada.

The idea would be to tax unrealized appreciation over $5 million at a capital gains rate.  Taxes on gifts would correspond to eliminate people using gifting to avoid the estate tax.

Finally, the newest proposal would also do away with deductions for medical expenses—or at least have a very high threshold.

All these are proposed—not passed.  But, it’s good to be aware

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of what could be on the horizon.

What Should Business Owners Do?

You might discuss these points with your tax advisor—I am not a CPA.  I am a CFP®, AIF®,,,,  EIEIO.

 

Planning Point

If you don’t have an executive bonus plan, you may want to consider starting one and paying the bonus before March 15, 1018.  Same if you do have one.  Your business gets the 2017 deduction while the employee may be paying tax on the bonus received at lower tax rates.   If you’re `grossing up’ the bonus to cover the employee’s  tax payment, that would be under the 2018 rates, as well—remember, talk to your tax advisor.   If you want to learn more about these plans, you can access my special report here.

Planning Point

Don’t neglect what is probably the most versatile financial tool available today:  cash value life insurance—it has tax benefits that no other financial vehicle can provide and is an ideal retirement supplement—especially for high-earning executives and owners who are limited in what they can put away in qualified tax-deferred vehicles.  Quite often, these executives are stunned to find out those limits simply will not allow the account to provide enough capital at retirement for them to preserve their desired lifestyle.

As David McKnight points out in his book, Tax Free Retirement, life insurance is used as a key retirement strategy by more than 85% of Fortune 500 CEOs and many members of Congress.  The book was also endorsed by retirement guru and CPA Ed Slott, as well as David M. Walker, former Comptroller General of the United States.

Sometimes, I will see arguments against this approach in the media – arguments that are little short of idiotic – but, the simple truth is that insurance, including indexed universal life (IUL) in particular, is becoming widely accepted among leading experts in the profession as a true asset class (in addition to cash, stocks, bonds, real estate, and commodities), probably as a result of an aging population with changing priorities and increasing economic uncertainty (where the government’s future need for tax revenue is concerned).

  • Your tax advisor can provide the best insight regarding tax strategy;
  • your estate planning attorney can help you make sure your documents are updated and in order; and
  • your financial advisor should be able to help you arrange assets to fit your needs.

Never use a podiatrist for dental advice.

I hope you found this helpful.

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.

What Business Owners Need Most!

Jim Lorenzen, CFP®, AIF®

 

Business owners spend long hours for many years trying to build their dream.  For many, their business represents 70%, 80%, even 90% of their net worth!   It’s not unusual to have everything tied-up in their business ownership.

In essence, they have everything riding on one stock – something they’d never do with any other stock, even if the company was run by the greatest CEO on earth.

Their business is the source of their income, including salary and bonuses, as well as the source of all their benefits, including retirement funding and health insurance.

Business owners spend 110% of their energy on trying to grow their business; yet, if you ask them how they’ve planned their exit, you’ll often get a blank stare.  Some say they plan to work ’til they drop; others say they’ll sell it, sure that it will be an attractive purchase.

How many will exit their business?  Answer: 100% – either head first or feet first.   Either way, how will the business be monetized?

Many don’t know what their business is worth.

I personally know one person who built a small but very successful restaurant chain that enjoyed excellent sales – until he unexpectedly (and rather quickly, unfortunately) contracted terminal cancer and died.   The restaurants soon all went into receivership and were either liquidated or taken-over for pennies on the dollar – the family left with only his life insurance proceeds.

Many have no idea how they will exit.

It didn’t have to happen that way.  He had key people in-place; but, he didn’t know how to plan business continuity.   He also could have created a funding mechanism for his family to monetize all he’d worked for (in addition to his life insurance), but he hadn’t done that, either.

He, like many successful business owners running established businesses, didn’t even know what his business value, let alone have a mechanism in place to convert his asset into liquid dollars…. something he could have enjoyed even if he’d lived.

He probably didn’t want to spend the money on a formal appraisal; but, he didn’t have to do that, either – informal valuations for retirement and exit planning could have met his needs.  [You can learn more about business valuation in our free report, which you can access here.  If you would like a copy, we’ll also make sure you receive other relevant information from time to time.]

How about the business with multiple ownership?  If/when something happens to one of them, do the others want to have the surviving spouse as a partner – maybe an equal partner – even though they may make little or no contribution to business success?

What if there’s a divorce?  What if one simply decides to ‘hang it up’?  What if one files for bankruptcy?  Without the right mechanisms in place, the other owner(s) could be facing litigation or liquidation.

Many don’t know the solutions that are available.

He might have felt he didn’t want to siphon off dollars from cash flow that could be otherwise used to grow his businesses; but, there are mechanisms that can mitigate that concern, as well.

Successful owners of established businesses can be busy – often too busy to pay attention to the very issues they see as their ultimate objective in the first place.

I can empathize.  Years ago I built a publishing business.  Publishing weeklies combines the functions advertising, sales, production, manufacturing, distribution, credit and collections.   Front to back, it entails virtually every business function you can think of, including deadlines and resource management.

I had a general manager named Nick who came up ‘through the ranks’ and became very capable at running the entire organization, allowing me to pursue other initiatives.  I ended-up selling my businesses on the open market; but, had I known, I could have actually sold the whole thing to Nick – probably for more money even though he didn’t have much money.  Simply by putting the right mechanisms in place early, I could have had a ready-made buyer in place… and one who not only knew the business, but knew the customers – and one that wouldn’t have made the bankers nervous.

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.

Beware of Mortgage Loan Scams

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Jim Lorenzen, CFP®, AIF®

First I want to point out that this post is really courtesy of Senior Deputy Becky Purnell of the Moorpark Police who provided this information in the City of Moorpark Guide; but, I thought it was so worthwhile I wanted to relay the information here.

According to Deputy Purnell, you should be aware that scammers are targeting email accounts of realtors and escrow and title companies in order to steal your money!

So, if you are buying a home or refinancing, you should be alert to what could be happening and how to protect yourself.

  • The scammer hacks into the email account of a real estate agent or escrow officer and monitors correspondence between that person and the home buyer.   The scammer then creates an email that is nearly identical to the agent or officer’s email, including their writing style, logos, and signatures.
  • About the time the home buyer would expect to receive instructions on how to wire the money, the scammer sends instructions to wire the money to a specified account which goes to the scammer.  The agent or escrow officer is unaware this is happening

This scam targets people who are in the refinancing process and any other transactions that include the wiring of money.  Here are some ways Deputy Purnell recommends for protecting yourself:

  • Before you wire money, speak with the realtor/escrow officer by phone or in person to get wiring instructions and confirm the account number is legitimate.
  • Do not email financial information.  It isn’t secure.  Many financial firms do what I do:  they provide secure vault access to their clients so that documents never go through an email system.
  • Look for web addresses that begin with https (the s stands for secure).   Don’t click on email links that come in emails – it’s always safer to look up the website’s real URL and type in the address yourself.
  • Be cautious about opening email attachments.  Those files could contain malware.
  • Be sure your browser and software are up to date.

Especially if you’re getting emails from someone you don’t know, never click on the link.   Even when I get a link from my own bank, I never click on it.  I always enter the correct URL manually to gain access.

You can set-up a spreadsheet with columns for website names, URL, ID, Username, Passwords, and security questions and answers; but, make sure you spreadsheet is password protected and not accessible to others (you may want to store the data on an external drive, or example).

Hope this helps!   If you’d like to learn more about IFG, we can always visit by phone.   You can click on that link (if you feel confident), or you can simply go to the IFG website and contact me through the site.  www.indfin.com.

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.

There’s More than One Path to Retirement Security

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Jim Lorenzen, CFP®, AIF®

People often think investment strategies for retirement security involve a either/or choices, i.e, risky stocks or savings as a zero-sum choice, or active vs. passive investing as an either/or choice; Believe it or not, there’s more than one path to retirement security.  Sometimes (often) they can be blended.

Active vs. Passive

Vanguard on active vs. passive investingFor example, low-cost passive investments are attractive simply because it’s widely believed that active managers can’t beat their relevant indexes’ average return on a consistent basis.

That’s probably true, however the argument often ignores the downside protection active management can offer – something index investing doesn’t provide, and something important to investors for retirement security.

Does that mean there’s only one path to financial security… that active is better?  No – it’s just different.  Sometimes, the extra fee an active manager charges can be worth far more than the alternative downside exposure.   Vanguard has created a client education piece about active and index investing that you might find helpful.  You can download it here.

Active Institutional Management

Investors with smaller accounts often achieve diversification by investing in mutual funds.  While these investors can benefit from the diversification they offer, those with larger accounts can be penalized.  The reason is simple:  Mutual fund costs don’t scale.

For example, if you have $50,000 invested in a mutual fund that carries a 1.25% expense ratio (just to pick a number), you’re paying $625 a year in annual expenses.  Not too bad.  But, suppose your investment is $500,000 and you have a basket of mutual funds and all charge about the same 1.25%.  Your annual expenses would now total $6,250 per year.

Fund expenses don’t go down as the asset level increases.  1.25%, in our example, would stay 1.25%, regardless of how much your account increases in value.  And, those aren’t the only expenses!  You can learn about the other hidden expenses in another report, Understanding Mutual Funds, which you can also download instantly, right here.

Institutional money managers – at least all those I use – have fully disclosed fees; but, furthermore, their fee percentage actually declines as the investor’s asset level grows.  They can also provide tax-managed benefits not available in mutual funds.

Institutional managers seem to do far better than the individual investor.  As you can see from this independent Dalbar study, individual investors didn’t even come close- and the time period for the study included the famous ‘meltdown’ of 2008.

Institutional investors tend to outperform individual investors.

Screening for investment managersThe selection process for institutional managers, of course, is important, if not critical.

If you’d like to see the process I have been using here at IFG, you can get it here.

Of course, it’s not an either/or proposition:  Blending active institutional management with passive indexes can be quite effective.

It begins with a philosophy.

The key to successDo you know your investment philosophy? By the way, “I don’t want to lose money” is not a philosophy; it’s a wish.  A philosophy goes deeper – it’s the roadmap that helps you as you go through the investment/manager selection process.  IFG’s can be accessed immediately here.

Managing the Downside.

There’s a tv commercial sponsored by a mutual fund/insurance complex that asks the question, “Do you know your number?

While it’s a good question, it doesn’t go far enough.  The real question may not be how much you have, but how long it will last!   After all, that’s the key to almost everyone’s definition of retirement security.

Longevity risk – “Will I run out of money?”

This is the key issue for most Americans; even those with $1,000,000+ who want to maintain their standard of living, let alone the vast majority of Americans who have less.  You might enjoy getting our Money or Income report when you sign-up for the IFG ezine (you can always unsubscribe later).   You can get the report here.

 

 

What’s right for you is likely no one strategy, but a blend of this – and other strategies not even covered here – that best fits your particular needs and desires.

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.

MONEY OR INCOME: Which is most important to you?- Part 3

Rising Inflation ScreenJim Lorenzen, CFP®, AIF®

An income for life – a lifetime retirement income strategy is what most people want – but are they willing to do what’s required?

For most, if not many, the idea of ‘bucketing’ money into categories – current needs, emergency needs, and future needs – is intuitive.  An that’s the ‘secret’ behind having a retirement income for life!  It’s not a secret, really; just a common sense strategy for creating a stress-free lifetime retirement income.

We don’t want to take money from one to fund another unless we’re absolutely FORCED to, which we seldom are – yet, that’s what a lifetime retirement income strategy demands.

This likely explains why people generally hate the idea of annuitization, even though retirees routinely say their biggest fear is running out of assets  –  aha!  Assets!  Not income?

I’ve known people who’re retired with generous pensions (with cost-of-living adjustments) from the federal government and lived amazing retirements, living on Florida waterfront property with boats outside their back doors, even though they had only a couple hundred thousand dollars in savings… and loving it.  You couldn’t get them to trade those pensions for anything!   It was predictable – it would never stop – and they had COLAs built-in!

But, the rest of society seemingly isn’t willing to make the liquidity trade.  Research seems to back this up, finding that the size of liquid holdings is directly related to their sense of well-being and satisfaction.  Apparently if they can’t achieve their need for future income until they meet their need for current assets, they feel cash-strapped – or they’ll choose retirement solutions that are inferior but psychologically more satisfying..

Mental bucketing comes in two forms:

  • Time segmentation:  Cash, bonds, and stocks are segmented according to time frames.  Cash funding near term, laddering bonds for intermediate term and interest-rate risk, and stocks for long-term inflation-hedges.
  • Spending segmentation:  Using financial tools to put predictability into outlays – Using Social Security and immediate annuities to create an ‘income floor’ for meeting essential expenses, and using portfolio withdrawals throughout the entire retirement period to provide for discretionary expenses.

For many, however, the delineation between essential and discretionary expenses can be fuzzy.   When people prioritize their goals, some will classify travel and cable tv as a need, while others will find few needs beyond food, shelter, transportation, medical expenses, etc.   And, many neglect to think about the biggest outlay they’ll make during their entire retirement – the annual tax payment to the I.R.S.

The most straightforward solution to longevity risk

For most, the biggest risk is outliving their money.  In short, it means running out of income.  The straightforward solution is simple:  Trading a portion of liquidity to pay cash for a lifetime income – and transferring longevity risk to an insurance company in exchange for an immediate annuity.  For many, this is a tough sell because they aren’t willing to give up liquidity of current assets to secure a lifetime income, despite the fact all those retired federal retirees in Florida have been doing it for years – and loving it.  And, also despite the fact that an immediate annuity solution is far superior to that of using a variable annuity with a guaranteed lifetime withdrawal benefit.[1]

Not only that, retirees want the potential for an increasing standard of living, as well!  Others may have additional legacy goals!   Inflation-adjusted immediate annuities are available, but haven’t been too popular due to their lower initial payout

The Hybrid Time-Segmentation™ (HTS) solves many of the issues and may appeal to investors who need a greater degree of certainty for their income strategy.

 

The HTS strategy puts an ‘income floor’ under the segments – a floor that’s both predictable and expected to last a lifetime, while still preserving short-term liquidity needs and providing for long-term inflation concerns.  For example, one popular approach is to use a portion of assets to purchase a ten-year deferred income annuity that provides a lifetime retirement income beginning in year #11.  In this way, an additional guaranteed income source is added providing an increased floor as the rest of the portfolio grows for future years.[2]  The entire strategy, of course, should coordinate liquidity, security, inflation-protection, and income needs.

If you’d like to learn more – and it’s worth doing – we have a twenty-minute educational video that explains this lifetime retirement income strategy.  I think you’ll  like it!   Grab some coffee, sit back, and learn more here.

 

Enjoy!

Jim

[1] I must admit my own bias against variable annuities.  To me, using the stock portion of a portfolio to purchase a variable annuity is only turning a potential capital gain into taxable income – something that’s made little sense to me, expenses aside.

[2] Using an ‘investment grade’ insurance company is more important, in my view, than simply grabbing for the best-sounding promise of a slick marketing campaign.

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


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.

MONEY OR INCOME: Which is most important to you?- Part 2

Jim Lorenzen, CFP®, AIF®

Last week I asked which was most important to you:

Never running out of money

Never running out of income

Whether you’re building a house or your ‘financial house’, it begins with a plan – that’s common sense.  Yet, I’ve seen more than a few people make major financial decisions BEFORE ever walking through my door for the first time:  Ready, fire, aim.

I’ve seen them retire, make Social Security claiming decisions and even pension decisions… then seek out financial advice – moves that often put them behind the 8-ball before they start.

So, what are the hazards retirees face?

  • Being underfunded.   It’s not uncommon today for people to live thirty years in retirement – one good reason why so many are opting to continue working after their ‘formal’ retirement.  It takes a lot of capital to fund thirty years of income after taxes and inflation – for two lives.  The problem with this hazard is that it’s extremely difficult, if not impossible, for an advisor to change at the point of retirement.
  • Bad timing.  This is something we call ‘sequence of returns’ risk.   To illustrate using simple numbers and ignoring taxes, imagine this scenario:  You retire with $1 million and plan to withdraw 4% annually.  That $40,000 combined with Social Security should meet your needs.

If the market goes up 20% and you withdraw 4%, you should have $1,160,000 after the first year.   Allowing for a 3% inflation rate, you can withdraw $40,000 + inflation = $41,200 in your second year, which computes to 3.55% of the second year’s beginning balance.  Not bad.  If the market does that every year forever, you’re fine!

What if the market goes down 20% in the first year as you withdrew your $40,000 (4% of the original balance)?  The market loss was $200,000 and you withdrew $40,000.  At the end of year #1, you’re down $240,000 and your new balance is $760,000 at the beginning of year #2.    And, of course, prices are higher – inflation has driven your living costs up by 3%!  You’ll need to take $41,200 in the second year, just as in the first scenario above, but now it’s coming from a starting balance of $760,000, which means your withdrawals now represent  5.42% of assets.  Another down year could be disasterous.

Diversification can help[1].   Diversification is all about using asset classes that have low correlation in their movements.  Think of pistons in a car:  If they all went up and down and down at the same time, where would they all be if the engine were to shut down?  Oddly enough, you may not want a portfolio that contains investments that all go up – the opposite could happen, too!

  • Withdrawing too much too soon.

Some people may simply not know how much they can, or should, withdraw.  With longevity risk becoming greater with our medical advances, knowing how much we can withdraw presents a problem for many.

How do you know how much you CAN withdraw and never run out of money?  The government has the answer!   They even publish it!  It’s the IRS required minimum distribution rules!  Just plug your numbers into the calculator[2] and that shows how much can be withdrawn!  The RMD rules apply to all qualified plans, but not to Roth IRAs while the owner is alive, and can be used for other accounts as a guide to avoiding longevity risk.

The good news:  RMD math virtually guarantees against running out of money within 45 years if the amount withdrawn is that calculated and no more.   There’s a practical weakness in this method as a guide for annual income, as well:   Remember our sample $1 million portfolio?

Practical:  Withdraw 4% of the original account balance each year, adjusted for inflation, regardless of market returns, i.e., $40,000 base adjusted only for COLAs each year.  Weakness:  Could lead to early depletion of assets if there are continuous market declines.

Not practical:  The RMD calculation is based on a percentage of the account value.  If the market declines, the percentage could result in a declining income for one or more years.

The bad news:  The RMD amount might be less than what’s needed to meet living expenses and, as noted, could even decline!  So, asset allocation, using the RMD rules, does not affect portfolio survival; but it does affect how much the retiree might receive each year – an unpredictable income.

How do we create a sustainable LIFETIME income?

That’s our subject for next time.

[1] You might want to access our report, Understanding the Diversification Puzzle.

[2] http://apps.finra.org/calcs/1/retirement

Enjoy!

Jim

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


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.