I was going through my e-mails the other day when I received another e-mail from an insurance company (I say that because I receive a lot of e-mails from various insurance companies) advertising some change in their current offerings.  I breezed over it when something jumped out at me.  The thing that really caught my eye on this e-mail was that it was advertising a rate increase.  The current economic environment isn’t leading to very many rate increases.  It seems like nowadays all I’m seeing is rate decreases, so it was refreshing to see an increase.

This got my attention so I read on. The e-mail was promoting an immediate annuity.  The big hook that the e-mail had was that a 65 year old male could get 7.2% income from this particular immediate annuity.  In a world of the 4% rule this caught my attention.    What this company is saying is that $100,000 could be turned into approximately $7,200 per year for as long as you live.

I’m not someone that says everyone needs an annuity but it does give you some advantages:

• Guaranteed stream of income – The company that sent me the e-mail has a Comdex of 98 which means that they are financially rated in the top 2% of all insurance companies.  That’s a pretty strong guarantee.
• No down years - One of the biggest killers of retirement withdrawals is years like 2008.  When you withdraw money during a down year, your accounts will never be able to recover.  You are not depending on the market.
• Diversification – Everyone talks about it.  People talk about diversifying your streams of income.  Here is a great way to do that.
• Leave something behind – This is probably the second biggest argument against annuitization.  I looked into it closer and a 65 year-old male in average health can guarantee an insurance policy for the $100,000 he just annuitized for about $2,000 per year.  This means that he would still be receiving 5% income guaranteed for the rest of his life.
• Control – The number one reason against annuitization is that you are giving up control of your money.  This is true.  So don’t annuitize all your money.  You only want to annuitize a portion of your money.  Usually this will be a portion that will cover fixed expenses that you know are going to be there.  Bills such as property taxes, insurance, utilities; these are bills that are always going to be there regards less.  If you’re not sure where your money goes I recommend using personal finance software to help track your spending.

What about inflation?

I have not mentioned inflation.  I know what you are thinking the 4% rule is indexed for inflation.  Well the advertisement they sent me never even mentions inflation.  I would be willing to bet money that some stupid people that call themselves financial advisers are going to go out and try to sell 7.2% income and never even thought about inflation.  It’s the first thing I thought about so I went into my software and started to dig around quickly.  When indexed for a 2% inflation the payout was about 6%.  But this is where your other assets come into  play.  Here is where your investments would be used to hedge against inflation.  Diversification is key.  There’s no perfect fix.  Your investments would be part of your income rather than all of it.

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1. RMA: Income Planning Program

I am a contributor at FiLife.com.  For anyone who has never been there, I highly suggest you check out the site.  There is a lot of great information there.  It also has the best Question & Answer section I’ve seen in regards to financial information.  Here’s where my experiment comes in, I asked the following question:

What is the single, most devastating thing that can completely destroy your retirement and all the planning you’ve put into it?

This question received 14 comments by 9 different people.  I first want to thank everyone for their contributions.  I will do so by doing my best to link to their sites in the following list.  Without further ado…

The Top 10 Most Devastating Things that Destroy Your Retirement

10.  Liability Exposure from Mark Kantrowitz – I feel like this is something that is easy to protect yet most people don’t understand it so they do nothing, until it’s too late.

9.  Divorce from Kevin Brosious – I’ve been through this so it wasn’t going to be too high on my list.  Definitely recoverable.

8.  Company Stock from Kees DeWit – To me you are investing in something you know more about or might be more comfortable with.  This isn’t a horrible thing but you do need to be diversified in other investments as well.

7.  Lack of Diversification from Mark Kantrovitz – Going hand-in-hand with #8.  Overexposure to one area can cause a lot of pain.

6.  Unemployment from Morris Armstrong – Being out of work for an extended period of time can cause you to eat into or eliminate everything you have worked for and everything you were hoping for in regards to retirement.

5.  Inability to Live Within Your Means from Elanor Blayney – It does matter how much money you make or what your investments look like.  If you keep building debt then you are either destroying your retirement or you just might never have one.

4.  Chronic Medical Issue from Fern Alix LaRocca – With the rising cost of health treatments and how increasingly difficult it is to have adequate (not even good) insurance coverage, this not only affects you during the illness but long after as well.

3.  Total Disability from Fischer Financial – Unfortunately, you don’t recover from this.  Once you stop working you can’t even contribute to your retirement plan so no need to worry some earlier numbers.

2.  Death from Morris Armstrong – No one can ever truly prepare for this.  Nothing is worse for your retirement then never even getting there.  Hopefully those that depend on you are protected.

1.  Lack of [Proper] Preparation from Elanor Blayney – As I look back at this list, there are a lot of things that can be negated to some extend.  The only way to do that is to plan and prepare.

So there’s my list, what do you think?  I struggled with a few of these and there are definitely arguments to move a few things around.  I’ve love to hear your responses…that’s what the comments are for.  In the end I had to add in the word ‘proper’ to really finish the list off.  Unfortunately, so many people hire a so-called financial planner but they don’t get proper planner.  I see planners all the time gloss over a lot of the things I just listed.  Maybe this will work as a guideline to help you make sure you are working with a good planner.  Did he/she cover everyone of these areas?

Related posts:

1. 401k, God or Devil?
2. Your 403b Could Be Detrimental To Your Pension
3. Retirement Denial?

When you look around at people’s lives there seems to be 2 things that show up in most people’s financial worlds.  If they aren’t there directly it’s 2 things that the people are working towards.  Any guesses?  They are both marketed to widely by the largest financial companies in the US.  Give up?  The 2 things are your 401k and your house.

Chances are you read everywhere how you should be contributing as much as possible to your 401k.  Most of these messages are initiated by two groups, the financial companies and the government.  Then you add in that your whole life you are told that you need to own your own house.  It is instilled in us at such a young age that most people never even question it.  They work to get a mortgage, in order to get their own house.  I have to ask, is this a good thing?

As I was reading The Best Way to Avoid the Worst Financial Problems from @wisebread it reminded me of the 6 principles of the Evolution of Wealth.  Honestly, I have put aside the principles that I originally wrote up.  Why?  Well I really don’t have a reason, basically because life happens and I’ve tried to let this blog go where it goes.  It was the following paragraph in that post that jumped out at me:

I can give it to you in once sentence: Keep the cost structure of your household flexible. That is, arrange your life so that you can react to a fall in your income by reducing your expenses.

This screamed principle #1: the power of LUC.  Did I forget the k?  No.  LUC stands for liquidity, use and control.  These are the main features of flexibility.  Now let’s look at the 2 most popular financial tools that play a major role in everyone’s financial world.

How does a 401k provide flexibility?  Does it provide liquidity, use and control?

1. Liquidity – Fail!  When flexibility is most important, it is difficult to access the money that you put into a 401k.  There are penalties and fees associated with the access as well as probably having to jump through a few hoops.
2. Use – There’s only 1.  It’s saving for retirement.  The money is in your account doing 1 thing, or should I say hopefully doing 1 thing.  People loose track of the main purpose or maybe the only purpose of a 401k.  Saving for retirement.
3. Control – Do you even have any?  The government dictates when and how you can access the money.  The employer or plan administrator dictates the rules surrounding access and investments.  Might you just be a pawn?

How about your house?  Any flexibility there?

1. Liquidity - Is it easy to get money out of your house?  I guess you might be able to convince me if and only if you have a large equity line of credit established.  Oh, what did you say?  Banks are taking those away?  Guess this is a FAIL too.
2. Use - You could make an argument for some use here.  It provides shelter.  It provides some tax benefits.  It might provide some rate or return (emphasis on maybe).
3. Control - This should be a good one…who controls your house?  Let’s see, you need to ask permission and prove that you should be able to pay just to get a mortgage.  Then if something bad happens, just when you need there help the most, the bank says ‘NO’.  Doesn’t sound like much control to me.

Might the 2 most widely used financial tools also be the worst based on Principle #1 and wisebread.com‘s “Avoiding the Worst Financial Problems”?

Related posts:

1. Max Out Your 401k Math
2. 401k, God or Devil?
3. 6 Reasons Not to Max Your 401k

What will it cost you to delay your retirement savings for 3 years?  Maybe you want to wait a few years while you pay down debt, save for a house, have a family, save for your kids college, etc.  Whatever the reason might be we can always come up with some excuse to put off your retirement savings.  In fact, it is probably easier to delay your retirement savings because you see no immediate benefit of it.  All the things I mentioned have an upside that you will see the difference of before your retirement.  We all like to see the sugars of our labor.

There’s a psychology involved as well.  Just like every, healthy well-adjusted human being, we believe we are going to live a long, healthy life.  By thinking this it gives you a real sense of having plenty of time to save for retirement.  We can do that tomorrow.  I’ll start tomorrow.  There’s plenty of time for that.  Have you heard yourself say any of these things?  It’s normal to feel this way.

Maybe you feel the opposite.  There might not be a tomorrow.  Life is short.  Why would you save for retirement with that mentality?  It might never come.  This is completely reasonable as well.  It’s normal to feel as though you want to live your live.  Carpe Diem.

So how are you ever suppose to save for retirement?  I don’t know I’m not a psychologist.  People are living longer today than ever.  “The oldest old are projected to be the fastest growing part of the elderly population into the next century.” (Population Profile of The US)  This means we’re spending more time in retirement than ever.  It’s becoming more and more common to spend 30 years in retirement or you work longer.  I know my goal is to have the choice of whether I want to work longer not have to do it because of money.  I don’t want money to rule my life.

Here’s a graph of what it would look like to save for retirement, you max out your Roth IRA.  You save $5,000 the first year and index that for inflation (I used 3%) for every year for 40 years.  You get a 6% rate of return on your money over that time.  Then you end up with about $1.24 million.  That’s not too shabby.  You are now a millionaire.

We started with 3 years right?  So if you miss the first 3 years then you actually are losing the 3 years off the end.  Think about it.  That’s 3 less years your money can compound.  That’s 3 less years you have with your good ole friend compound interest.  You’re destroying your compound interest.  So where would the 3 less years leave you?  It will leave you with just under $1 million.  That’s 20% less money.  Those 3 less years cost you 20% of your retirement.  Those first 3 years aren’t about putting aside $5,000 a year it’s about saving $250,000.  Is that worth it?

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1988 is here and Mary is ready to enjoy her retirement.  She’s had a rough past year and can’t wait to be able to relax.  Unfortunately her husband Bill has recently passed away.  Bill had taken good care of her while she worked hard to maintain a household and raise their three kids.  He worked very hard as well and consistently saved money.  In fact his retirement account is now worth $500,000.  Mary has always been the one responsible for paying the household bills but has never handled that much money at one time.  She needed help.

She turned to the local financial planner.  The financial planner tells her that if she withdraws 4% of her portfolio for income it will last her for as long as she lives.  She does her calculations with the bills that she usually pays and figures out that she needs to withdraw $21,000 in the first year to live the way she is accustomed to.  The financial planner says that should work and ties her withdrawals to an inflation rate of 3.5% so that her income will keep up with rising prices.  The financial planner then invests her money in an index fund that invests in the S&P 500 with no expense ratio and charges her nothing to set this all up. (Don’t laugh it’s my story)

So how will Mary fair?  What if I told you the possibilities are endless?  Now we have the luxury of knowing what’s going to happen to Mary over the next 21 years.  Jump ahead and it’s the end of 2008.  The S&P 500 has enjoyed compounded annual growth rate of 8.8%.  That’s pretty good.  You’d probably guess that Mary is sitting pretty.  You are right she has plenty of money and her biggest problem is how to get the money to her kids the best way possible.  She actually ends up just shy or $1.8 million.

Could things have been different?  What if we take the same exact returns except reverse the order?  So this means that the returns of 2008 happen first and her final year would be the return from 1988.  Should this make a big difference?  I mean it’s the same performance right?  Well what if I told you that if we did this she would have just over $14,000 left.  Yes you read that right.

Now let’s look at why the big difference.  The key here is the sequence of returns.  This is the reality that people the have retired in this millennium might very well face down the road.  By having bad performance early on, the account never quite recovers.  When you add withdrawals to this it gets even worse.  People are telling you today to keep putting money away.  You hear about dollar cost averaging and how this will help you account bounce back more quickly.  What they don’t tell you is if you are withdrawing during these bad times it’s like a double hit on your account.

This is the reality of what retirees are facing today.  This is the opportunity for future retirees to learn.  Learn that you don’t want your future based on the sequence of market performance.  What can you take away from this?  What do you think is the most valuable information?

There are really three sets of people that have some very real and slightly different problems.  You have future retires that should be learning how not to have their retirement success determined by the market.  Then there are people about to or who have just retired who have to figure out real quickly how to not have their success determined by the market.  Finally, there are the people who have been retired that are trying to figure out how not to have their survival determined by the market.  Are you noticing a pattern?

Follow this blog, follow me on twitter or e-mail me about your situation.

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Have you heard of the new IRS website for small businesses? In an attempt to make it easier for small businesses to find the right retirement plan, the IRS has rolled out the IRS Retirement Plan Navigator.  It is tagged as “An easy retirement plan guide for small employers”.  It’s main content is directed to choosing, maintaining and correcting a plan.  As well as providing a plan comparison table.

Do you think a website like this really works? It does accomplish providing a comparison based on very broad information.   Does that really help an employer?  Or does it just confuse them?  I guess I just feel bad for the small businesses out there, trying to do all of this themselves.  It must take a lot of time and effort.  Isn’t it just easier to have a trusted professional do it for you?

What other options does an employer have? They can do the research themselves or they can find someone to do it for them.  At the very lease they will need an investment company/person to work with no matter what their plan.  Isn’t it easier to just start their and find a trusted investment person to help you figure out which plan is best?  Do they feel it is easier to deal with the person that answers the 800 number after they’ve done all the research themselves?  The time it must take to figure out what type of plan they want and who they want it with.  How many man hours do they put into this research?

What can you do to help? Most employees feel helpless about their retirement plan options.  Have you talked to your employer about it?  Better question, do you know who to talk to?  Take 5 minutes out of your day and let the HR department or CFO or owner of your company know what you think of their retirement plan.  If you love it, tell them.  If you hate it, tell them.  Just make sure to tell them why you feel the way you do so that they know what kind of job they are doing and how to make it better.  This information will be a lot of help to a good employer, trust me.  Send me an e-mail and let me know how you feel about your employer plan.  I’m interested and maybe I can help if you need it.

Related posts:

1. Who Controls Your Retirement Money?
2. Max Out Your 401k Math
3. 2 Worst Financial Tools

Have you ever heard of cognitive dissonance?  This is how Wikipedia defines it:

Cognitive dissonance is an uncomfortable feeling caused by holding two contradictory ideas simultaneously. The “ideas” or “cognitions” in question may include attitudes and beliefs, the awareness of one’s behavior, and facts. The theory of cognitive dissonance proposes that people have a motivational drive to reduce dissonance by changing their attitudes, beliefs, and behaviors, or by justifying or rationalizing their attitudes, beliefs, and behaviors.

So what exactly does this mean?  This means that at points in your life you are going to feel uncomfortable about things that you do and/or believe.  The reason you feel uncomfortable is because you behaviors and your beliefs aren’t lined up.  They aren’t balanced.  You’ll be sitting on a seesaw and won’t be flat.  So what are you going to do?

Have you ever been stuck at the top of a seesaw?  It happened to me when I was a little kid.  I didn’t know what to do and I definitely didn’t like it.  This is cognitive dissonance.  You believe that gravity will pull you down.  However, you realize that you’re stuck up in the air.  You’re uncomfortable because your feet are off the ground.  I know I don’t like that.  You begin feeling nervous and it’s getting worse.  So, you try to squirm or struggle a bit to see if you can get the thing moving.  It shakes a little and nothing happens.

Now you have two choices.  You either convince yourself that you are up there for a reason.  By doing this you are actually modifying or changing your belief that gravity should be pulling you down.  This would then make you feel more comfortable about being stuck up in the air on one end of a seesaw.  Does this actually make your situation better?  Maybe it makes you feel better about it but it doesn’t fix anything.  You’re still stuck.

Your other option is to do something drastic to get down.  Squirming didn’t work so we know it’s going to have to be drastic.  Maybe you jump.  There is a risk in jumping.  You might get hurt.  It’s a long way down.  The difference is if you jump, if you make a drastic change, things get fixed.  You’re not just figuring out how to deal with the problem, you are fixing it.  You don’t have to deal with being stuck on a seesaw anymore, you’re off that seesaw.

How does this relate to personal finances you may ask?  Well I’m writing this at night.  The time you go in to kiss your little girl or little boy goodnight, I want you to look them in the eye and tell them the truth about your life insurance.  Then tell them the truth about your disability insurance.  Climb into bed with your spouse and tell them the truth.  Tell them the truth about your retirement.  Do you know the truth?  Tell them what you know and how you feel.

It will probably go something like this:

“(your child’s name here) I just want you to know that I have no life insurance (or not enough) because I’ve convinced myself that I will live a long and happy life.  I’m convinced that I will have plenty of time to make the tough decisions about dealing with something bad happening.  The truth is though (remember I told you to tell the truth) that when something does happen, it will be too late.  And because I’ve become comfortable with this, you will NOT be financially prepared for when something bad happens to me.”

Could you say that?  Could you repeat those words?  How about to your spouse about the two of you’s retirement?  Then do something about it.  Jump off of that seesaw.  If you ask the right person they will even help you down so you don’t have to jump.  I’m right here.

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1. Technological Change

You can read anywhere and everywhere about how so and so lost x amount of money in their 401k or retirement accounts.  How much did you lose?  Is it done 10s of thousands?  100s of thousands of dollars?  I wonder, if someone came to you and said I can give you a safety net on your investment but it will cost you a percentage of your return, what percentage would you pay for that, if any?  Would you give up 1% per year to guarantee a safety net of 6%?  What if that safety net only cost you 0.5% per year?

No one can predict the future of the market.  They will always try and someone will guess right but no one knows for sure.  I find that as people get closer and closer to retirement they become more and more cautious of their investment losses.  Makes sense right?  Would they sleep better knowing that they had a safety net?

You might say why not just invest in safe investments.  My response to that is opportunity cost.  How much do you give up over the long term by moving to safe investments.  In todays environment you’re lucky to get a 2% rate of return from your 1-year CD.  According to the AllFinancialMatters the 20-year return for the S&P 500 from 1989-2008 is 8.41%  That gives an opportunity cost between the two of about 6%.  This gap is as big now as it has ever been due to interest rates being at historic lows.

What if you can have your cake and eat it to?  Let’s say your 55 or so years old.  You are very likely to live another 20 years if not 30 or more.  You plan on retiring in about 10 years and you’re a bit nervous about being invested in the market yet you need some returns on your money to retire comfortably.  You might even have a financial planner that showed you a nice compound interest curve.  Maybe you even realized that as your asset allocation gets more conservative you just might be Destroying Your Compound Interest.  What if someone offered a safety net?  Now it’s not free.  You get a guarantee that your account won’t earn less than 6%.  Meanwhile the account still stays fully (or as much as you choose) in the market.  The cost is that your fee comes out of your return.  So that if you earn 9% you would only see an 8 or 8.5% rate of return depending on your fee for this safety net.

There’s a lot more details to this obviously but I’m just wondering what fee would you be willing to pay.  Would you pay 1%?  Would you pay less?  I also understand that your answer might be different today than it would have been in 1999 or even in 2007.  That’s why I’m asking you today.  If you want clarification or you have questions, e-mail me.

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If your goal is to put as much money as possible into your 401k then you best bet is to fully fund your Roth 401k. The IRS set the contribution limit for your 401k in 2009 to $16,500 and a $5,500 catch-up contribution if you are over age 50. The funny thing is that the IRS doesn’t differentiate between Traditional and Roth contributions. They are not equal.

With a Traditional 401k contributions are pre-tax which means that you don’t pay taxes today. So if you were to max out your Traditional 401k then you could contribute $16,500 or $22,000 if you are over age 50. Simple enough right?

Now is the fun part. If you were to contribute to a Roth 401k the limits are the same. Remember though, that this is post-tax contributions which means you pay taxes today before the money goes in.  So if you were to contribute the maximum of $16,500 you would really be putting aside even more income depending on your tax bracket. Let’s say you are in a 25% federal tax bracket. That would mean you would essentially be putting aside $22,000 of your income for retirement. If you were over age 55 that number would be about $29,333. My point is that it’s not apples to apples so make sure you are realizing how much you are contributing.

To take this one step further. You max out your 401k. Either way $16,500 goes into the account correct? It grows at about 7% for 30 years. Using the Rule of 72 we know that it will double every 10 years. So it doubles once to $33,000, twice to $66,000 and a third time to $132,000. Are you with me so far? Good. Here’s the key. If you have $132,000 in a Traditional 401k you still owe taxes on it, at 25% worst case scenario you really only have $99,000. Where as if you have $132,000 in a Roth 401k you really have $132,000.

If you goal is to put away as much money as possible for retirement then you should be taking advantage of the Roth 401k. If it’s not an option for you go to your HR or the owner of your company and ask them to make it an option. In most cases it can be added at no cost. If there are any questions please direct them to me.

One more side not, whether you contribute to the Traditional or Roth portion of your 401k, any employer match will be pre-tax so it will show up in the Traditional portion.

Related posts:

1. 6 Reasons Not to Max Your 401k
2. Tax Savings, The Finale
3. 401k, God or Devil?

I was talking with a teacher about this the other day so I thought I would share.  The teacher told me that him and his wife are no longer eligible to contribution to a Roth IRA so he figured he should start a 403b.  So then I mentioned a Roth 403b to him.  He then asked me what that was.  So I proceeded to tell him it works like a Roth IRA except that there are no income limits, higher deposit amounts and the school had an approved vendor list from which you had to choose.

This is a normal conversation I have with teachers.  I usually hear one of two things.  I was told to do a 403b and so I started funding one or that they contribute to a Roth IRA.  The Roth IRA can work great if you are eligible and you don’t want to exceed the contribution limits ($5,000 under age 50 in 2009).  So then let’s look at alternatives that especially come into play when a Roth IRA isn’t available.

Before we get there let’s look at what most people seem to do.  They hear from other teachers that they should contribute to a 403b and they do.  What they don’t realize is this decision might be hurting their pension.  Let’s look at it.  I’m going to use Massachusetts numbers because that’s what I am most familiar with.  The concept should work with most pensions.  So in Massachusetts teachers are contributing 11% of their salary into the pension program.  These contributions are made pre-tax so the teacher doesn’t pay taxes on the money that goes into the pension.  What this means is that when a teacher receives their pension the money is taxed as ordinary income.  A Traditional 403b works the same way, pre-tax contributions, fully taxable withdrawals.

Before January 1^st, 2006 the only other payroll deduct plan available to teachers besides their pension was a Traditional 403b.  So when people wanted to save for retirement that was the only option they knew about so they thought it was best.  Now times have changed.  There are more options available.  The biggest of these is a Roth 403b.  The biggest benefit of this is that the withdrawals are tax-free.

The great thing about the Massachusetts teacher’s pension is that they are probably going to receive 80% of their income in retirement.  You take that number and take away their extra tax deductions they might have today; they probably end up in the same tax bracket in retirement.  If on top of this you add a Traditional 403b then you are adding more taxable withdrawals.  This could cause you to be in a higher tax bracket if you are not careful.  This could hurt your pension income.  So learn about your Roth 403b options.  Ask your employer for their approved vendor list and which ones offer a Roth 403b.   Learn your options and more importantly ask questions.

Related posts:

1. Who Controls Your Retirement Money?
2. Max Out Your 401k Math