401(k) Plans – by John Jastremski

Qualified cash or deferred arrangements (CODAs) permitted under Section 401(k) of the Internal Revenue Code, commonly referred to as “401(k) plans,” have become one of the most popular types of employer-sponsored retirement plans.

How does a 401(k) plan work?

With a 401(k) plan, you elect either to receive cash payments (wages) from your employer immediately, or defer receipt of a portion of that income to the plan. The amount you defer (called an “elective deferral” or “pretax contribution”) isn’t currently included in your income; it’s made with pretax dollars. Consequently, your federal taxable income (and federal income tax) that year is reduced. And the deferred portion (along with any investment earnings) isn’t taxed to you until you receive payments from the plan.

Melissa earns $30,000 annually. She contributes $4,500 of her pay to her employer’s 401(k) plan on a pretax basis. As a result, Melissa’s taxable income is $25,500. She isn’t taxed on the deferred money ($4,500), or any investment earnings, until she receives a distribution from the plan.

You may also be able to make Roth contributions to your 401(k) plan. Roth 401(k) contributions are made on an after-tax basis, just like Roth IRA contributions. Unlike pretax contributions to a 401(k) plan, there’s no up-front tax benefit, but qualified distributions from a Roth 401(k) account are entirely free from federal income tax.

When can I contribute?

You can contribute to your employer’s 401(k) plan as soon as you’re eligible to participate under the terms of the plan. In general, a 401(k) plan can make you wait up to a year before you’re eligible to contribute. But many plans don’t have a waiting period at all, allowing you to contribute beginning with your first paycheck.
Some 401(k) plans provide for automatic enrollment once you’ve satisfied the plan’s eligibility requirements. For example, the plan might provide that you’ll be automatically enrolled at a 3% pretax contribution rate (or some other percentage) unless you elect a different deferral percentage, or choose not to participate in the plan. This is sometimes called a “negative enrollment” because you haven’t affirmatively elected to participate–instead you must affirmatively act to change or stop contributions. If you’ve been automatically enrolled in your 401(k) plan, make sure to check that your assigned contribution rate and investments are appropriate for your circumstances.

How much can I contribute?

There’s an overall cap on your combined pretax and Roth 401(k) contributions. You can contribute up to $18,000 of your pay ($24,000 if you’re age 50 or older) to a 401(k) plan in 2017. If your plan allows Roth 401(k) contributions, you can split your contribution between pretax and Roth contributions any way you wish. For example, you can make $10,000 of Roth contributions and $8,000 of pretax 401(k) contributions. It’s up to you.
But keep in mind that if you also contribute to another employer’s 401(k), 403(b), SIMPLE, or SAR-SEP plan, your total contributions to all of these plans–both pretax and Roth–can’t exceed $18,000 ($24,000 if you’re age 50 or older). It’s up to you to make sure you don’t exceed these limits if you contribute to plans of more than one employer.

Can I also contribute to an IRA?

Yes. Your participation in a 401(k) plan has no impact on your ability to contribute to an IRA (Roth or traditional). You can contribute up to $5,500 to an IRA in 2017, $6,500 if you’re age 50 or older (or, if less, 100% of your taxable compensation). But, depending on your salary level, your ability to make deductible contributions to a traditional IRA may be limited if you participate in a 401(k) plan.

What are the tax consequences?

When you make pretax 401(k) contributions, you don’t pay current income taxes on those dollars (which means more take-home pay compared to an after-tax Roth contribution of the same amount). But your contributions and investment earnings are fully taxable when you receive a distribution from the plan.
In contrast, Roth 401(k) contributions are subject to income taxes up front, but qualified distributions of your contributions and earnings are entirely free from federal income tax. In general, a distribution from your Roth 401(k) account is qualified only if it satisfies both of the following requirements:

  • It’s made after the end of a five-year waiting period
  • The payment is made after you turn 59½, become disabled, or die

The five-year waiting period for qualified distributions starts with the year you make your first Roth contribution to the 401(k) plan. For example, if you make your first Roth contribution to your employer’s 401(k) plan in December 2017, your five-year waiting period begins January 1, 2017, and ends on December 31, 2021. Each nonqualified distribution is deemed to consist of a pro-rata portion of your tax-free contributions and taxable earnings.

What about employer contributions?

Many employers will match all or part of your contributions. Your employer can match your Roth contributions, your pretax contributions, or both. But your employer’s contributions are always made on a pretax basis, even if they match your Roth contributions. That is, your employer’s contributions, and investment earnings on those contributions, are always taxable to you when you receive a distribution from the plan.

Should I make pretax or Roth contributions?

Assuming your 401(k) plan allows you to make Roth 401(k) contributions, which option should you choose? It depends on your personal situation. If you think you’ll be in a similar or higher tax bracket when you retire, Roth 401(k) contributions may be more appealing, since you’ll effectively lock in today’s lower tax rates. However, if you think you’ll be in a lower tax bracket when you retire, pretax 401(k) contributions may be more appropriate. Your investment horizon and projected investment results are also important factors. A financial professional can help you determine which course is appropriate for you.
Whichever you decide–Roth or pretax–make sure you contribute as much as necessary to get the maximum matching contribution from your employer. This is essentially free money that can help you reach your retirement goals that much sooner.

What happens when I terminate employment?

Generally, you forfeit all contributions that haven’t vested. “Vesting” means that you own the contributions. Your contributions, pretax and Roth, are always 100% vested. But your 401(k) plan may generally require up to six years of service before you fully vest in employer matching contributions (although some plans have a much faster vesting schedule).
When you terminate employment, you can generally take a distribution (all or part of which may be taxable to you), leave your money in your 401(k) plan (if your vested balance exceeds $5,000) until the plan’s normal retirement age (typically age 65), or you can roll your dollars over tax free to an IRA or to another employer’s retirement plan that accepts rollovers.*

What else do I need to know?

  • Saving for retirement is easier when your contributions automatically come out of each paycheck
  • You may be eligible to borrow up to one-half of your vested 401(k) account (to a maximum of $50,000) if you need the money
  • You may be able to make a hardship withdrawal if you have an immediate and heavy financial need. But this should be a last resort–hardship distributions are taxable events (except for Roth qualified distributions), and you may be suspended from plan participation for six months or more
  • If you receive a distribution from your 401(k) plan before you turn 59½, (55 in certain cases), the taxable portion may be subject to a 10% early distribution penalty unless an exception applies
  • Depending on your income, you may be eligible for an income tax credit of up to $1,000 for amounts contributed to the 401(k) plan
  • Your assets are generally fully protected from creditors in the event of your, or your employer’s, bankruptcy

 

 

The information in these materials may change at any time and without notice. Securities offered through FSC Securities Corporation, member FINRA / SIPC . Investment advisory services offered through The Retirement Group, LLC, a registered investment advisor which is not affiliated with FSC Securities Corp. Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. 

 

 

Posted in Retirement Planning | Comments Off

Variable Annuities – by John Jastremski

Some basics

A variable annuity is a contract between you (the purchaser) and an insurance company (the issuer). In return for your premium payments, the issuer agrees to make periodic payments to you (if you elect this option), beginning either immediately or at some future date.

Annuity premium payments may be made with after-tax dollars and are not tax deductible. Annuities also may be purchased within tax-advantaged plans, such as 401(k) plans, Section 403(b) retirement plans (TSAs), or IRAs. Premiums for annuities in tax-advantaged plans are generally paid with pretax dollars, and may be subject to annual contribution limits.

You can pay your premiums in one lump sum, or you can make a series of payments over time. Annuities funded with after-tax premiums are not subject to annual contribution limits.

If your annuity is funded with after-tax dollars, you’ll pay taxes (at your regular income tax rate) only on the earnings portion of withdrawals, since your contributions to principal were made with after-tax dollars. As with a qualified retirement plan, if you withdraw from an annuity before age 59½, a 10% tax penalty may be imposed on the taxable portion of the withdrawal, unless an exception applies.

Annuities are designed to be very long-term investment vehicles. In most cases, if you take a withdrawal, including a lump-sum distribution of your annuity funds within the first few years after purchasing your annuity, you may be subject to surrender charges imposed by the issuer. As long as you’re sure you won’t need the money until at least age 59½, an annuity is worth considering.

Your investment choices are varied

As the purchaser, you can designate how your premium dollars will be allocated among the investment choices (often called subaccounts) offered within the variable annuity. A variable annuity’s subaccount choices will be described in detail in the fund prospectus provided by the issuer.

Typical subaccount investment offerings

  • Government securities
  • Corporate and high-yield bonds
  • A balanced subaccount (made up of both stocks and bonds)
  • A growth and income account
  • A guaranteed subaccount (in which the issuer guarantees* a minimum rate of interest)

With the exception of a guaranteed subaccount, variable annuities don’t offer any guarantees on the performance of their subaccounts. You assume all the risk related to those investments. In return for assuming a greater amount of risk, you may experience a greater potential for growth in your earnings. However, it’s also possible that the subaccounts will perform poorly, and you may lose money, including principal.
*Guarantees are subject to the claims-paying ability and financial strength of the issuer.

A note about variable annuities

Variable annuities are sold by prospectus. Variable annuities contain fees and charges including, but not limited to mortality and expense risk charges, sales and surrender (early withdrawal) charges, administrative fees and charges for optional benefits and riders. You should consider the investment objectives, risk, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the variable annuity and the underlying investment choices, can be obtained from the insurance company issuing the variable annuity or from your financial professional. You should read the prospectus carefully before you invest.

How a Variable Annuity Works
  1. In the accumulation phase, you (the annuity owner) send your premium payment(s) (all at once or over time) to the annuity issuer.
  2. You may choose how to allocate your premium payment(s) among the various investments offered by the issuer. These investment choices, often called subaccounts, typically invest directly in mutual funds. Generally, you can also transfer funds among investments without paying tax on investment income and gains.
  3. The issuer may collect fees to manage your annuity account. These may include an annual administration fee, underlying fund fees and expenses which include an investment advisory fee, and a mortality and expense risk charge. If you withdraw money in the early years of your annuity, you may also have to pay the issuer a surrender fee.
  4. The earnings in your subaccounts grow tax deferred; you won’t be taxed on any earnings until you begin withdrawing funds or begin taking annuitization payments.
  5. With the exception of a fixed account option where a guaranteed* minimum rate of interest applies, the issuer of a variable annuity generally doesn’t guarantee any return on the investments you choose. While you might experience substantial growth in your investments, your choices could also perform poorly, and you could lose money.
  6. Your annuity contract may contain provisions for a guaranteed* death benefit or other payout upon the death of the annuitant. (The annuitant provides the measuring life used to determine the amount of the payments if the annuity is annuitized. As the annuity owner, you’re most often also the annuitant, although you don’t have to be.)
  7. Just as you may choose how to allocate your premiums among the subaccount options available, you may also select the subaccounts from which you’ll take the funds if you decide to withdraw money from your annuity.
  8. If you make a withdrawal from your annuity before you reach age 59½,you may have to pay a 10% premature distribution tax on the taxable portion of the withdrawal, unless an exception applies.
  9. After age 59½, you may make withdrawals from your annuity proceeds without incurring any premature distribution tax. Since annuities funded with after-tax dollars have no minimum distribution requirements, you don’t have to make any withdrawals. You can let the account continue to grow tax deferred for an indefinite period, subject to limits specified in the annuity contract.
  10. To obtain a guaranteed* income stream for life or for a certain number of years, you can annuitize, which means exchanging the annuity’s cash value for a series of periodic income payments. The amount of these payments will depend on a number of factors including the cash value of your account at the time of annuitization, the age(s) and gender(s) of the annuitant(s), and the payout option chosen. Usually, you can’t change the payments once you’ve begun receiving them.
  11. The tax you pay on withdrawals (at your ordinary income tax rate) depends, in part, on whether the annuity is funded with pre-tax or after-tax dollars.

* All guarantees are subject to the claims-paying ability and financial strength of the issuing company.

The information in these materials may change at any time and without notice. Securities offered through FSC Securities Corporation, member FINRA / SIPC . Investment advisory services offered through The Retirement Group, LLC, a registered investment advisor which is not affiliated with FSC Securities Corp. Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual’s personal circumstances. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Posted in Retirement Planning | Comments Off

Protecting Your Loved Ones with Life Insurance – by John Jastremski

How much life insurance do you need?

Your life insurance needs will depend on a number of factors, including the size of your family, the nature of your financial obligations, your career stage, and your goals. For example, when you’re young, you may not have a great need for life insurance. However, as you take on more responsibilities and your family grows, your need for life insurance increases.

Here are some questions that can help you start thinking about the amount of life insurance you need:

  • What immediate financial expenses (e.g., debt repayment, funeral expenses) would your family face upon your death?
  • How much of your salary is devoted to current expenses and future needs?
  • How long would your dependents need support if you were to die tomorrow?
  • How much money would you want to leave for special situations upon your death, such as funding your children’s education, gifts to charities, or an inheritance for your children?
  • What other assets or insurance policies do you have?

Types of life insurance policies

The two basic types of life insurance are term life and permanent (cash value) life. Term policies provide life insurance protection for a specific period of time. If you die during the coverage period, your beneficiary receives the policy’s death benefit. If you live to the end of the term, the policy simply terminates, unless it automatically renews for a new period. Term policies are typically available for periods of 1 to 30 years and may, in some cases, be renewed until you reach age 95. With guaranteed level term insurance, a popular type, both the premium and the amount of coverage remain level for a specific period of time.
Permanent insurance policies offer protection for your entire life, regardless of your health, provided you pay the premium to keep the policy in force. As you pay your premiums, a portion of each payment is placed in the cash-value account. During the early years of the policy, the cash-value contribution is a large portion of each premium payment. As you get older, and the true cost of your insurance increases, the portion of your premium payment devoted to the cash value decreases. The cash value continues to grow–tax deferred–as long as the policy is in force. You can borrow against the cash value, but unpaid policy loans will reduce the death benefit that your beneficiary will receive. If you surrender the policy before you die (i.e., cancel your coverage), you’ll be entitled to receive the cash value, minus any loans and surrender charges.
Many different types of cash-value life insurance are available, including:

  • Whole life: You generally make level (equal) premium payments for life. The death benefit and cash value are predetermined and guaranteed (subject to the claims-paying ability and financial strength of the issuing insurance company). Your only action after purchase of the policy is to pay the fixed premium.
  • Universal life: You may pay premiums at any time, in any amount (subject to certain limits), as long as the policy expenses and the cost of insurance coverage are met. The amount of insurance coverage can be changed, and the cash value will grow at a declared interest rate, which may vary over time.
  • Indexed universal life: This is a form of universal life insurance with excess interest credited to cash values. But unlike universal life insurance, the amount of interest credited is tied to the performance of an equity index, such as the S&P 500.
  • Variable life: As with whole life, you pay a level premium for life. However, the death benefit and cash value fluctuate depending on the performance of investments in what are known as subaccounts. A subaccount is a pool of investor funds professionally managed to pursue a stated investment objective. You select the subaccounts in which the cash value should be invested.
  • Variable universal life: A combination of universal and variable life. You may pay premiums at any time, in any amount (subject to limits), as long as policy expenses and the cost of insurance coverage are met. The amount of insurance coverage can be changed, and the cash value and death benefit goes up or down based on the performance of investments in the subaccounts.

With so many types of life insurance available, you’re sure to find a policy that meets your needs and your budget.

Choosing and changing your beneficiaries

When you purchase life insurance, you must name a primary beneficiary to receive the proceeds of your insurance policy. Your beneficiary may be a person, corporation, or other legal entity. You may name multiple beneficiaries and specify what percentage of the net death benefit each is to receive. If you name your minor child as a beneficiary, you should also designate an adult as the child’s guardian in your will.

What type of insurance is right for you?

Before deciding whether to buy term or permanent life insurance, consider the policy cost and potential savings that may be available. Also keep in mind that your insurance needs will likely change as your family, job, health, and financial picture change, so you’ll want to build some flexibility into the decision-making process. In any case, here are some common reasons for buying life insurance and which type of insurance may best fit the need.
Mortgage or long-term debt: For most people, the home is one of the most valuable assets and also the source of the largest debt. An untimely death may remove a primary source of income used to pay the mortgage. Term insurance can replace the lost income by providing life insurance for the length of the mortgage. If you die before the mortgage is paid off, the term life insurance pays your beneficiary an amount sufficient to pay the outstanding mortgage balance owed.
Family protection: Your income not only pays for day-to-day expenses, but also provides a source for future costs such as college education expenses and retirement income. Term life insurance of 20 years or longer can take care of immediate cash needs as well as provide income for your survivor’s future needs. Another alternative is cash value life insurance, such as universal life or variable life insurance. The cash value accumulation of these policies can be used to fund future income needs for college or retirement, even if you don’t die.
Small business needs: Small business owners need life insurance to protect their business interest. As a business owner, you need to consider what happens to your business should you die unexpectedly. Life insurance can provide cash needed to buy a deceased partner’s or shareholder’s interest from his or her estate. Life insurance can also be used to compensate for the unexpected death of a key employee.

Review your coverage

Once you purchase a life insurance policy, make sure to periodically review your coverage; over time your needs will change. An insurance agent or financial professional can help you with your review.

 

 

The information in these materials may change at any time and without notice. Securities offered through FSC Securities Corporation, member FINRA / SIPC . Investment advisory services offered through The Retirement Group, LLC, a registered investment advisor which is not affiliated with FSC Securities Corp. Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. 

 

 

Posted in Retirement Planning | Comments Off

Long-Term Care Annuities – by John Jastremski

When planning for the potential cost of long-term care, you’ve probably considered long-term care insurance. But premiums can be expensive and if you do buy the coverage, you probably hope you never have to use it. The prospect of paying costly premiums for long-term care insurance that you might never use might discourage you. Enter the long-term care annuity.

What is it?

This hybrid product, offered by insurance companies, is a nonqualified annuity that provides long-term care benefits (it can’t be used with IRAs or employer-sponsored qualified retirement plans). These policies allow you to use the annuity proceeds for long-term care, and if you don’t use the long-term care benefit, you still have typical annuity options. For instance, you can convert the annuity to a stream of income payments (annuitization), redeem the annuity at its maturity (e.g., cash in the annuity), or, at your death, you can pass the remaining balance of your annuity to your named beneficiaries.
While policy provisions may differ from company to company, generally you put money into the annuity, usually in a lump sum or through a series of premium payments. You may also exchange another annuity or cash value life insurance for a long-term care annuity via a Section 1035 exchange. The annuity typically pays a fixed rate of interest each year. In addition, the annuity provides a long-term care benefit amount, usually equal to two or three times your annuity cash value, subject to a maximum benefit period, which is the maximum length of time that you may receive long-term care benefit payments from the annuity. Long-term care annuity benefits are usually paid monthly. There is usually a charge for the long-term care component (generally ranging from 0.4% to 1.25% of the annuity’s cash value) that is deducted from your annuity each year.

How does this product work?

Typically, long-term care annuities have the same qualification requirements as most stand-alone long-term care insurance policies. You first have to be considered “insurable” by the annuity company, which means you have to answer questions relating to whether you have suffered any major illness such as cancer or heart disease, or whether you have a significant cognitive impairment like Alzheimer’s disease. But you usually don’t have to undergo a physical, and the underwriting is generally less stringent than with stand-alone long-term care insurance, meaning it’s a little easier to qualify for the long-term care annuity.
Like most stand-alone long-term care policies, in order to be eligible for long-term care benefits from the annuity, you must either suffer from cognitive or mental incapacity or be unable to perform at least two of six activities of daily living that include feeding, bathing, dressing, transferring, continence, and toileting. Thereafter, benefits are typically available after a waiting period of between 30 days and 2 years (depending on the particular product).

Say you pay $75,000 to purchase a long-term care annuity. You select a long-term care benefit equal to 200% of your annuity’s cash value, with a 5-year benefit period. Initially, your long-term care benefit equals $150,000 ($75,000 x 2). Let’s assume the annuity earns 4.5% per year and the cost of the long-term care provision is 0.5% per year. At the end of 20 years (presuming you take no withdrawals) the annuity is worth about $163,622 and the long-term care benefit amount is $327,244. This will provide maximum long-term care benefit payments of $5,454 per month for as long as 5 years. And even if cumulative long-term care payments exceed the annuity’s contract value ($163,622), the long-term care payments will continue until you either exhaust the long-term care benefit amount ($327,244) or you no longer need long-term care. (This is a hypothetical example. It does not represent a specific product. Product terms and conditions may differ. Check with the annuity issuer for specific product details.)

What about taxes?

Generally, withdrawals from an annuity are considered to come from earnings first and are subject to income tax. With respect to long-term care annuities in particular, prior to 2010, payments of long-term care benefits from annuities were also deemed to have been taken from annuity earnings first, then principal. Thus, each long-term care benefit payment was taxed as ordinary income to the annuity owner until all earnings within the annuity had been exhausted.

Beginning January 1, 2010, potentially favorable tax treatment applies to certain withdrawals from annuities purchased after 1996, if the withdrawals are used to pay for qualified long-term care insurance coverage. This means you won’t have to pay income tax on the benefits you receive from your long-term care annuity used to pay for long-term care expenses.

More on exchanges

Prior to 2010, you couldn’t exchange your annuity for a long-term care insurance policy without incurring income tax on the earnings portion of the annuity. Now you can exchange your deferred annuity for either a stand-alone long-term care insurance policy or a long-term care annuity on a tax-free basis. However, with any exchange, be sure your current annuity has reached maturity before exchanging it; otherwise surrender charges may reduce your current annuity’s value. Also, if you exchange your current annuity for a long-term care annuity, you will likely incur a new surrender charge period that accompanies the new long-term care annuity. Surrender charges may apply to withdrawals you take from your annuity. However, surrender charges generally do not apply to long-term care benefit payments. Before entering into an exchange, you should talk to your financial professional or tax professional to be sure the exchange will be tax free.

Pluses/minuses

As with most insurance products, there are pluses and minuses to consider in determining whether a long-term care annuity is right for you. On the plus side:

  • Long-term care annuities allow for tax-free withdrawals if used to pay for qualified long-term care coverage
  • With typical long-term care insurance, if you don’t use the coverage, you generally don’t get a return of your premiums; but with a long-term care annuity, at your death you can pass any remaining annuity balance to your beneficiaries
  • If you’re not in the best of health and you want some long-term care protection, you might not be able to qualify for stand-alone long-term care insurance. But, it’s generally easier to qualify for a long-term care annuity (e.g., you probably won’t need a physical)
  • Once you put money in the annuity, you don’t have to make any more premium payments as you would with stand-alone long-term care insurance policies

On the other hand:

  • Most long-term care annuities are funded with a single premium payment of at least $50,000, so you may need to have at least that much available in a lump sum
  • Long-term care annuities, like most deferred annuities, come with surrender charges, so taking money out of the annuity that’s not used for long-term care expenses may be subject to surrender charges, income tax, and a penalty of 10% if taken before age 59½
  • Currently, long-term care annuities do not qualify as partnership plans, which otherwise afford some asset protection when trying to qualify for Medicaid
  • If you don’t deposit enough money into the long-term care annuity, you may not have enough protection to cover your long-term care expenses
  • There’s a cost to purchase the long-term care benefit which can range from 0.4% to 1.25% of the annuity’s account value
  • Since the cost of the long-term care portion of the annuity is deducted from your investment in the annuity (and not the earnings), you can’t take the cost of long-term care as a medical expense deduction

Is it right for you?

Whether a long-term care annuity is right for you depends on a number of factors. But the long-term care annuity is certainly a viable option available for long-term care planning that might merit a second look.

The information in these materials may change at any time and without notice. Securities offered through FSC Securities Corporation, member FINRA / SIPC . Investment advisory services offered through The Retirement Group, LLC, a registered investment advisor which is not affiliated with FSC Securities Corp. Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. 

 

Posted in Retirement Planning | Comments Off

Get More Income from an Impaired Risk Immediate Annuity – by John Jastremski

Having enough income during retirement is a challenge and concern for most retirees. Immediate annuities offer a retirement planning option by providing a guaranteed income. (Payment guarantees are based on the claims-paying ability of the annuity issuer). In exchange for the payment of a single, lump-sum premium to an insurance company, you receive a stream of payments for either a fixed period of time (such as ten years) or for the rest of your life. The amount of each payment depends on the premium paid, your age, gender, and whether the annuity is for an individual or a couple.

If you have a medical condition or a disability that may shorten your life expectancy, you may qualify to receive immediate annuity payments that are larger than standard payments. Known as a medically underwritten immediate annuity, an impaired risk immediate annuity, or a substandard immediate annuity, this annuity lets you benefit by either reducing your premium for a specific stream of payments or by receiving larger payments for the same premium.

Get more income for your premium

Ordinarily, before an insurance company establishes the amount of the annuity payments it will make to you, it first must estimate how long it will have to make those payments. To project the length of time payments are expected to be made, companies refer to actuarial tables that project the life expectancy of a person of your particular age and gender. But if you demonstrate to the company, primarily through your medical records, that due to a health impairment your life expectancy is shorter than the actuarial projection, then the company projects that it will make payments over a shorter period of time. Since it anticipates making fewer payments, the company can make higher payments for the same premium, or it can make the same payments for a smaller premium.

Some qualifying medical conditions

The following are examples of health conditions that may qualify for medical underwriting. The list has been compiled from various companies offering impaired risk annuities. It is not intended to be an exhaustive list.

Alzheimer’s Diabetes Muscular  Dystrophy
Alcoholism Heart Attack, Heart Disease, Angina Obesity with Complications
ALS (Lou Gehrig’s Disease) High Blood  Pressure Organ Transplant
Angioplasty or  Heart Surgery Hodgkin’s Disease Organic Brain Syndrome
Cancer (except  basal cell) Injury Due to Falls or Imbalance Paraplegia or Quadriplegia
Chronic Hepatitis/ Hepatitis C Leukemia Parkinson’s  Disease
Congestive Heart Failure (CHF) Liver Disease Renal Failure
Cirrhosis of the Liver Mental Illness Stroke

A 70-year-old man pays $100,000 as a lump-sum premium for an immediate annuity and receives $861 per month ($10,332 per year) for the rest of his life (life only option). But if he has a health condition (such as heart disease or diabetes) that changes his actuarial age to 75, his distributions increase to $1,003 per month ($12,396 per year) for the same $100,000 premium. As an alternative, he can reduce his single premium payment for a life only option from $100,000 to $85,865, and receive the original payout of $861 per month.

This hypothetical example is for illustration only and does not reflect actual insurance products or performance, nor is it intended to promote a specific company or product.

Some additional features

Impaired risk immediate annuity payments are almost always for life only, meaning the payments will continue as long as you live, but will end at your death. A few impaired risk immediate annuities include a return of premium rider (available at an additional cost) that ensures that if you don’t live long enough to receive the return of your premium payment, your beneficiary will continue to receive payments from the company until the total of all payments made equals your premium payment. As with ordinary immediate annuity payments, impaired risk immediate annuity payments generally do not change once they’ve begun. However, some companies offer impaired risk immediate annuities with an inflation rider (available at an additional cost) that increases the payments by a predetermined percentage each year.

Qualifying for an impaired risk annuity

In general, the issuer must determine that you have a demonstrable health condition that can result in a life expectancy that is shorter than normal. Most insurance companies that offer impaired risk annuities require that you provide medical information to document your health condition. Medical records and reports from your doctors and any facilities from which you receive treatment for your health condition are often all that is required, although some issuers may request an examination or interview with the company’s doctor.

Why should you buy an impaired risk immediate annuity?

  • The payments are larger than standard immediate annuity payments.
  • You can get standard immediate annuity payments for a premium that is less than the cost of a standard immediate annuity.
  • It can provide a guaranteed* income for the rest of your life, regardless of changes in interest rates, fluctuations in market performance, or increases in inflation.
  • The income stream can be used to pay long-term care or life insurance premiums.
  • The certainty of a guaranteed* income may allow you to assume more risk in allocating other assets for greater growth potential.
  • You can use the increased income to make charitable donations or gifts to grandchildren for education.
  • If you can’t qualify for long-term care insurance, yet face prolonged costs for such care, the increased payments offered by an impaired risk immediate annuity can be used to pay for some, if not all, of these medical expenses, preserving some of your other assets for your estate.
  • A portion of your payments may not be subject to income tax. Each immediate annuity payment is part nontaxable return of your investment in the contract and part payment of accumulated earnings (until the investment in the contract is exhausted). Generally, only that portion of each payment that represents accumulated earnings is subject to income tax.

*Payment guarantees are based on the claims-paying ability of the annuity issuer.

Is an impaired risk immediate annuity right for you?

Immediate annuities, including impaired risk immediate annuities, require that you relinquish control over a lump sum of money in exchange for a steady income. Before buying an impaired risk immediate annuity, you may want to be sure you have other savings available to cover unexpected expenses that may arise. Also, some impaired risk immediate annuities offer payments only for the duration of your life. While you won’t outlive the payments, you could die without receiving at least the return of your investment in the annuity. Weigh the advantages of the impaired risk immediate annuity against the potential drawbacks to determine if it’s the right choice for you.

Securities offered through FSC Securities Corporation, member FINRA / SIPC . Investment advisory services offered through The Retirement Group, LLC, a registered investment advisor which is not affiliated with FSC Securities Corp. Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

Posted in Retirement Planning | Comments Off

Maintaining Sustainable Withdrawal Rate in Retirement – by John Jastremski

What is a sustainable withdrawal rate?

A withdrawal rate is the percentage that is withdrawn each year from an investment portfolio. If you take $20,000 from a $1 million portfolio, your withdrawal rate that year is two percent ($20,000 divided by $1 million).

However, in retirement income planning, what’s important is not just your withdrawal rate, but your sustainable withdrawal rate. A sustainable withdrawal rate represents the maximum percentage that can be withdrawn from an investment portfolio each year to provide income with reasonable certainty that the income provided can be sustained as long as it’s needed (for example, throughout your lifetime).

Why is having a sustainable withdrawal rate important?

Your retirement lifestyle will depend not only on your assets and investment choices, but also on how quickly you draw down your retirement portfolio. Figuring out an appropriate withdrawal rate is a key factor in retirement planning. However, this presents many challenges and requires multifaceted analysis of many aspects of your retirement income plan. After all, it’s getting more and more common for retirement to last 30 years or more, and a lot can happen during that time. Drawing too heavily on your investment portfolio, especially in the early years, could mean running out of money too soon. Take too little, and you might needlessly deny yourself the ability to enjoy your money. You want to find a rate of withdrawal that gives you the best chance to maximize income over your entire retirement period.

A sustainable withdrawal rate is critical to retirement planning, but it can apply to any investment portfolio that is managed with a defined time frame in mind. It’s also fundamental to certain types of mutual funds that are managed to provide regular payments over a specific time period. For example, some so-called distribution funds, which are often used to provide retirees with ongoing income, are designed to distribute all of an investor’s assets by the time the fund reaches its targeted time horizon. As a result, the fund must calculate how much money can be distributed from the fund each year without exhausting its resources before that target date is reached.

Tip: Each distribution fund has a unique way of addressing the question of a sustainable withdrawal rate. Before investing in one, obtain its prospectus (available from the fund), and read it so you can carefully consider its investment objectives, risks, charges, and expenses before investing.

How does a sustainable withdrawal rate work?

Perhaps the most well-known approach is to withdraw a specific percentage of your portfolio each year. In order to be sustainable, the percentage must be based on assumptions about the future, such as how long you’ll need your portfolio to last, your rate of return, and other factors. It also must take into account the effect of inflation.

Example: John has a $2 million portfolio when he retires. He estimates that withdrawing $80,000 a year (adjusted for inflation) will be adequate to meet his expenses. John’s sustainable withdrawal rate is four percent, and he must make sure that his portfolio is designed so that he can continue to take out four percent (adjusted for inflation) each year.

Other approaches to withdrawal rates

A performance-based withdrawal rate

With this approach, an initial withdrawal rate is established. However, if you prefer flexibility to a fixed rate, you might vary that percentage from year to year, depending on your portfolio’s performance. Each year, you would set a withdrawal percentage, based on the previous year’s performance, that would determine the upcoming year’s withdrawal. In years of poor performance, a portfolio’s return might be lower than your target withdrawal rate. In that case, you would reduce the amount you take out of the portfolio the following year. Conversely, in a year when the portfolio exceeds your expectations and performance is above average, you can withdraw a larger amount.

Example: Fred has a $2 million portfolio, and withdraws $80,000 (four percent) at the beginning of his first year of retirement to help pay living expenses. By the end of that year, the remaining portfolio balance has returned six percent, or $115,200–more than the $80,000 he spent on living expenses. For the upcoming year, Fred decides to withdraw five percent of his portfolio, which is now worth $2,035,200 ($2 million – $80,000 + $115,200 = $2,035,200). That will give him $101,760 in income for the year, and leave his portfolio with $1,933,440. However, during December of that second year of retirement, his portfolio experiences a seven percent loss; by the end of the year, the portfolio has been reduced by the $101,7600 Fred withdrew at the beginning of the year, plus the seven percent investment loss. Fred’s portfolio is now worth $1,798,099. Fred reduces his withdrawals next year–the third year of his retirement–to ensure that he doesn’t run out of money too soon. (For simplicity’s sake, this hypothetical illustration does not take taxes in account, and assumes all withdrawals are made at the beginning of the year.)

Important: If you hope to withdraw higher amounts during good years, you must be certain that you’ll be able to reduce your spending appropriately during years of lower returns; otherwise, you could be at greater risk of exhausting your portfolio too quickly. And be sure to take inflation into account. Having other sources of reliable, fixed income could make it easier to cushion potential income fluctuations from a performance-based withdrawal rate, and handle emergencies that require you to spend more than expected.

A withdrawal rate that decreases or increases with age

Some strategies assume that expenses in the later years of retirement will be lower as a retiree becomes less active. They are designed to provide a higher income while a retiree is healthy and able to do more.

Example: Bill sets a six percent initial withdrawal rate for his portfolio. However, he anticipates reducing that percentage gradually over time, so that in 20 years, he’ll take only about three percent each year from his portfolio.

Caution: Assuming lower future expenses could have disastrous consequences if those forecasts prove to be wrong–for example, if health care costs increase even more sharply than they have in the past, or if a financial emergency late in life requires unplanned expenditures. Even assuming no future financial emergencies and no unexpected increases in the inflation rate, this strategy would require discipline on a retiree’s part to reduce spending later, which might be difficult for someone accustomed to a higher standard of living.

Other strategies take the opposite approach, and assumes that costs such as health care will be higher in the later retirement years. These set an initial withdrawal rate that is deliberately low to give the portfolio more flexibility later. The risk, of course, is that a retiree who dies early will leave a larger portion of his or her retirement savings unused.

Consider the impact of inflation

An initial withdrawal rate of, say, four percent may seem relatively low, particularly if you have a large portfolio. However, if your initial withdrawal rate is too high, it can increase the chance that your portfolio will be exhausted too quickly. That’s because you’ll need to withdraw a greater amount of money each year from your portfolio just to keep up with inflation and preserve the same purchasing power over time. For a retirement portfolio, that can become problematic, since the amount withdrawn is no longer available to generate income in future years. An appropriate initial withdrawal rate takes into account that inflation will require higher withdrawals in later years.

Example: Jean has a $1 million portfolio invested in a money market account that yields five percent. That gives her $50,000 of income that year. However, inflation pushes up prices by three percent over the course of the year. That means Jean will need more income–$51,500–the next year just to cover the same expenses ($50,000 x.03=$1,500). Since the account provides only $50,000 of income, the additional $1,500 must be withdrawn from the principal. That principal reduction, in turn, reduces the portfolio’s ability to produce income the following year. In a straight linear model, principal reductions accelerate, ultimately resulting in a zero portfolio balance after 25 to 27 years, depending on the timing of the withdrawals. (This example is a hypothetical illustration and does not account for the impact of any taxes.)

Inflation is one reason you can’t simply base your retirement income planning on the expenses you expect to have when you first retire. Costs for the same items will most likely continue to increase over your retirement years, and your initial withdrawal rate needs to take that into account to be sustainable.

There’s another inflation-related factor that can affect your planning. Seniors can be affected somewhat differently from the average person by inflation. That’s because costs for some services that may represent a disproportionate share of a senior’s budget, such as health care and food, have risen more dramatically than the Consumer Price Index (CPI)–the basic inflation measure–for several years. As a result, seniors may experience higher inflation costs than younger people, and therefore might need to keep initial withdrawal rates relatively modest.

What determines whether a withdrawal rate is sustainable?

  • Your time horizon: The longer you will need your portfolio to last, the lower the initial withdrawal rate should be. The converse is also true (e.g., you may have health problems that suggest you will not need to plan for a lengthy retirement, allowing you to manage a higher withdrawal rate).
  • Anticipated and historical returns from the various asset classes in your retirement portfolio, as well as its anticipated average annual return: Though past performance is no guarantee of future results, the way in which you invest your retirement nest egg will play a large role in determining your portfolio’s performance, both in terms of its volatility and its overall return. That, in turn, will affect how much you can take out of the portfolio each year without jeopardizing its longevity.
  • Assumptions about market volatility: A financial downturn that reduces a portfolio’s value, especially during the early years of withdrawal, could increase the need to use part of the principal for income. It could also require the sale of some assets, draining the portfolio of any future income those assets might have provided. Either of those factors could ultimately affect the sustainability of a portfolio’s withdrawal rate.
  • Anticipated inflation rates: Determining a sustainable withdrawal rate means making an assumption about changes in the cost of living, which will likely increase the amount you’ll need the portfolio to provide each year to meet your expenses.
  • The amounts you withdraw each year: When planning your retirement income, your anticipated expenses will obviously affect what you need to withdraw from your retirement portfolio, and therefore affect its sustainability. However, because this is one aspect over which you have at least some control, you may find that you must adjust your anticipated retirement spending in order to make your withdrawal rate sustainable over time.
  • Any sources of relatively predictable income, such as Social Security, pension payments, or some types of annuity benefits: Having some stability from other resources may allow greater flexibility in planning withdrawals from your portfolio.
  • Your individual comfort level with your plan’s probability of success.

As with most components of retirement income planning, each of these factors affects the others. For example, projecting a longer lifespan will increase your need to reduce your withdrawals, boost your returns, or both, in order to make your withdrawal rate sustainable. And of course, if you set too high a withdrawal rate during the early retirement years, you may face greater uncertainty about whether you will outlive your savings.

Example: Mary’s financial professional tells her that given her current withdrawal rate and asset allocation strategy, there is an 80 percent chance that her retirement savings will last until she’s 95 years old. Mary has several choices. If she wants to increase her confidence level–maybe she prefers a 95 percent chance of success–she might reduce her yearly spending, try to increase her portfolio’s return by changing her asset allocation, direct a portion of her portfolio into an investment that offers a guaranteed lifetime income, or some combination. On the other hand, if she’s a risk taker and is comfortable with having only a 75 percent chance that her portfolio will last throughout her lifetime, she might decide to go ahead and spend a bit more now. (This is a hypothetical illustration only, not financial advice).

Income-only withdrawals vs. income and principal

Many people plan to withdraw only the income from their portfolios, intending not to touch the principal unless absolutely necessary. This is certainly a valid strategy, and clearly enhances a portfolio’s sustainability. However, for most people, it requires a substantial initial amount; if your portfolio can’t produce enough income to meet necessary expenses, an income-only strategy could mean that you might needlessly deprive yourself of enjoying your retirement years as much as you could have done. A sustainable withdrawal rate can balance the need for both immediate and future income by relying heavily on the portfolio’s earnings during the early years of retirement, and gradually increasing use of the principal over time in order to preserve the portfolio’s earning power for as long as possible.

Planning to use both income and principal requires careful attention to all the factors mentioned above. Also, in establishing your strategy, you should consider whether you want to use up all of your retirement savings yourself or plan to leave money to heirs. If you want to ensure that you leave an estate, you will need to adjust your withdrawal rate accordingly.

Your decision about income versus income-plus-principal should balance the need for your portfolio to earn a return high enough to sustain withdrawals with the need for immediate income. That can provide a challenge when it comes to allocating your assets between income-oriented investments, and investments that have the potential for a higher return but involve greater volatility from year to year. You may need to think of your portfolio as different “buckets”–for example, one “bucket” for your short-term living expenses, another bucket that could replenish your expenses bucket as needed, and another bucket invested for the long term.

Estimating lifespan

In general, life expectancies have been increasing over the last century. Life probabilities at any age are listed on the Social Security Administration’s Period Life Table, available under the Actuarial Publications section of its web site.

Regularly updated longevity estimates are published in the National Center for Health Statistics’ National Vital Statistics Reports.

However, be aware that averages are not necessarily the best guide when determining how long an individual portfolio may need to last. By definition, many people will live beyond the average life expectancy for their age group, particularly those who have a family history of longevity. Also, average life expectancies don’t remain static over an individual’s lifetime; a 30-year-old may have an average life expectancy of 76, while a 76-year-old may have a life expectancy of 85.

Couples will need to consider both individuals’ life expectancies when planning a sustainable withdrawal rate.

Establishing a comfort level with uncertainty

As noted previously, setting a sustainable withdrawal rate requires many assumptions and forecasts about what will happen in the future. Changing any of the variables may increase or decrease the level of certainty about whether your portfolio will last as long as you need it to. Increasing certainty about the outcome may require reducing your withdrawal rate or revising your investment strategy. Conversely, increasing your withdrawal rate, especially in the early years of retirement, may also increase the odds that your portfolio will be depleted during your lifetime.

The challenge is to balance all factors so that you have an acceptable level of certainty about the portfolio’s longevity consistent with providing the level of income needed over your expected lifetime and the risk you’re willing to take to provide it.

One increasingly common method for estimating the probability of success is the Monte Carlo simulation. This technique uses a computer program that takes information about your portfolio and proposed withdrawal strategy, and tests them against many randomly generated hypothetical returns for your portfolio, including best-case, worst-case, and average scenarios for the financial markets. Based on those aggregated possibilities, the program calculates your portfolio’s probability of success. Monte Carlo simulations also allow you to revise assumptions about lifespan, withdrawal rates, and asset allocation to see how changing your strategy might affect your portfolio’s chances. Though the process offers no guarantees, it does take into account potential fluctuations in your portfolio’s year-to-year returns. The result is a more sophisticated analysis than simply establishing a withdrawal rate based on a constant rate of return on your investments over time.

Some retirement income strategies tackle the question of uncertainty by including not only income sources that pay variable amounts, but also sources that provide relatively fixed or stable income, or lifetime income that is guaranteed. Just remember that the purchasing power of any fixed payment amounts can be eroded over time by inflation.

Once you’ve established an initial withdrawal rate, you probably should revisit it from time to time to see whether your initial assumptions about rates of return, lifespan, inflation, and expenses are still accurate, and whether your strategy needs to be updated.

Conventional wisdom about withdrawal rates

The process of determining an appropriate withdrawal rate continues to evolve. As baby boomers retire and individual savings increasingly represent a larger share of retirement income, more research is being done on how best to calculate withdrawal rates.

A seminal study on withdrawal rates for tax-deferred retirement accounts (William P. Bengen, “Determining Withdrawal Rates Using Historical Data,” Journal of Financial Planning, October 1994), looked at the annual performance of hypothetical portfolios that are continually rebalanced to achieve a 50-50 mix of large-cap (S&P 500 Index) common stocks and intermediate-term Treasury notes. The study took into account the potential impact of major financial events such as the early Depression years, the stock decline of 1937-1941, and the 1973-74 recession. It found that a withdrawal rate of slightly more than four percent would have provided inflation-adjusted income for at least 30 years. More recently, Bengen used similar assumptions to show that a higher initial withdrawal rate–closer to five percent–might be possible during the early, active years of retirement if withdrawals in later years grow more slowly than inflation.

Other studies have shown that broader portfolio diversification and rebalancing strategies can also have a significant impact on initial withdrawal rates. In an October 2004 study (“Decision Rules and Portfolio Management for Retirees: Is the ‘Safe’ Initial Withdrawal Rate Too Safe?,” Journal of Financial Planning), Jonathan Guyton found that adding asset classes, such as international stocks and real estate, helped increase portfolio longevity (although these asset classes have special risks). Another strategy that Guyton used in modeling initial withdrawal rates was to freeze the withdrawal amount during years of poor portfolio performance. By applying so-called decision rules that take into account portfolio performance from year to year, Guyton found it was possible to have “safe” initial withdrawal rates above five percent.

A still more flexible approach to withdrawal rates builds on Guyton’s methodology. William J. Klinger suggests that a withdrawal rate can be fine tuned from year to year using Guyton’s methods, but basing the initial rate on one of three retirement profiles. For example, one person might withdraw uniform inflation-adjusted amounts throughout their retirement; another might choose to spend more money early in retirement and less later; and still another might plan to increase withdrawals with age. This model requires estimating the odds that the portfolio will last throughout retirement. One retiree might be comfortable with a 95 percent chance that his or her strategy will permit the portfolio to last throughout retirement, while another might need assurance that the portfolio has a 99 percent chance of lifetime success. The study (“Using Decision Rules to Create Retirement Withdrawal Profiles,” Journal of Financial Planning, August 2007) suggests that this more complex model might permit a higher initial withdrawal rate, but it also means the annual income provided is likely to vary more over the years.

Don’t forget that all these studies are based on historical data about the performance of various types of investments, and past results don’t guarantee future performance.

Market volatility and portfolio longevity

When setting an initial withdrawal rate, it’s important to take a portfolio’s volatility into account. The need for a relatively predictable income stream in retirement isn’t the only reason for this. According to several studies in the late 1990s by Philip L. Cooley, Carl M. Hubbard, and Daniel T. Walz, the more dramatic a portfolio’s fluctuations, the greater the odds that the portfolio might not last as long as needed. If it becomes necessary during market downturns to sell some assets in order to continue to meet a fixed withdrawal rate, selling at an inopportune time could affect a portfolio’s ability to generate future income. And a steep market downturn, or having to sell assets to meet unexpected expenses during the early years of retirement, could magnify the impact of either event on your portfolio’s longevity because the number of years over which those investments could potentially have produced income would be greater.

Withdrawal rates and tax considerations

When calculating a withdrawal rate, don’t forget the tax impact of those withdrawals. For example, your withdrawal rates may need to cover any taxes owed on that money. Depending on your strategy for providing income, you could owe capital gains taxes or ordinary income taxes. Also, if you are selling investments to maintain a uniform withdrawal rate, the tax impact of those sales could affect your withdrawal strategy. Minimizing the tax consequences of securities sales or withdrawals from tax-advantaged retirement savings plans could also help your portfolio last longer.

Posted in 401(k), Financial Planning, Investing and the Markets, Investment, Ira Rollover, John Jastremski, Pension, Pension Plan, The Retirement Group John Jastremski, The Retirement Group LLC | Comments Off

Active vs. Passive Portfolio Management – by John Jastremski

One of the longest-standing debates in investing is over the relative merits of active portfolio management versus passive management. With an actively managed portfolio, a manager tries to beat the performance of a given benchmark index by using his or her judgment in selecting individual securities and deciding when to buy and sell them. A passively managed portfolio attempts to match that benchmark performance, and in the process, minimize expenses that can reduce an investor’s net return.

Each camp has strong advocates who argue that the advantages of its approach outweigh those for the opposite side.

Active investing: attempting to add value

Proponents of active management believe that by picking the right investments, taking advantage of market trends, and attempting to manage risk, a skilled investment manager can generate returns that outperform a benchmark index. For example, an active manager whose benchmark is the Standard & Poor’s 500 Index (S&P 500) might attempt to earn better-than-market returns by overweighting certain industries or individual securities, allocating more to those sectors than the index does. Or a manager might try to control a portfolio’s overall risk by temporarily increasing the percentage devoted to more conservative investments, such as cash alternatives.
An actively managed individual portfolio also permits its manager to take tax considerations into account. For example, a separately managed account can harvest capital losses to offset any capital gains realized by its owner, or time a sale to minimize any capital gains. An actively managed mutual fund can do the same on behalf of its collective shareholders.
However, an actively managed mutual fund’s investment objective will put some limits on its manager’s flexibility; for example, a fund may be required to maintain a certain percentage of its assets in a particular type of security. A fund’s prospectus will outline any such provisions, and you should read it before investing.

Passive investing: focusing on costs

Advocates of unmanaged, passive investing–sometimes referred to as indexing–have long argued that the best way to capture overall market returns is to use low-cost market-tracking index investments. This approach is based on the concept of the efficient market, which states that because all investors have access to all the necessary information about a company and its securities, it’s difficult if not impossible to gain an advantage over any other investor. As new information becomes available, market prices adjust in response to reflect a security’s true value. That market efficiency, proponents say, means that reducing investment costs is the key to improving net returns.
Indexing does create certain cost efficiencies. Because the investment simply reflects an index, no research is required for securities selection. Also, because trading is relatively infrequent–passively managed portfolios typically buy or sell securities only when the index itself changes–trading costs often are lower. Also, infrequent trading typically generates fewer capital gains distributions, which means relative tax efficiency.

Before investing in either an active or passive fund, carefully consider the investment objectives, risks, charges, and expenses, which can be found in the prospectus available from the fund. Read it carefully before investing. And remember that indexing–investing in a security based on a certain index–is not the same thing as investing directly in an index, which cannot be done.

Blending approaches with asset allocation

The core/satellite approach represents one way to employ both approaches. It is essentially an asset allocation model that seeks to resolve the debate about indexing versus active portfolio management. Instead of following one investment approach or the other, the core/satellite approach blends the two. The bulk, or “core,” of your investment dollars are kept in cost-efficient passive investments designed to capture market returns by tracking a specific benchmark. The balance of the portfolio is then invested in a series of “satellite” investments, in many cases actively managed, which typically have the potential to boost returns and lower overall portfolio risk.

Note: Bear in mind that no investment strategy can assure a profit or protect against losses.

Controlling investment costs

Devoting a portion rather than the majority of your portfolio to actively managed investments can allow you to minimize investment costs that may reduce returns.
For example, consider a hypothetical $400,000 portfolio that is 100% invested in actively managed mutual funds with an average expense level of 1.5%, which results in annual expenses of $6,000. If 70% of the portfolio were invested instead in a low-cost index fund or ETF with an average expense level of 0.25%, annual expenses on that portion of the portfolio would run $700 per year. If a series of satellite investments with expense ratios of 2% were used for the remaining 30% of the portfolio, annual expenses on the satellites would be $2,400. Total annual fees for both core and satellites would total $3,100, producing savings of $2,900 per year. Reinvested in the portfolio, that amount could increase its potential long-term growth. (This hypothetical portfolio is intended only as an illustration of the math involved rather than the results of any specific investment, of course.)
Popular core investments often track broad benchmarks such as the S&P 500, the Russell 2000® Index, the NASDAQ 100, and various international and bond indices. Other popular core investments may track specific style or market-capitalization benchmarks in order to provide a value versus growth bias or a market capitalization tilt.
While core holdings generally are chosen for their low-cost ability to closely track a specific benchmark, satellites are generally selected for their potential to add value, either by enhancing returns or by reducing portfolio risk. Here, too, you have many options. Good candidates for satellite investments include less efficient asset classes where the potential for active management to add value is increased. That is especially true for asset classes whose returns are not closely correlated with the core or with other satellite investments. Since it’s not uncommon for satellite investments to be more volatile than the core, it’s important to always view them within the context of the overall portfolio.

Tactical vs. strategic asset allocation

The idea behind the core-and-satellite approach to investing is somewhat similar to practicing both tactical and strategic asset allocation.

Strategic asset allocation is essentially a long-term approach. It takes into account your financial goals, your time horizon, your risk tolerance, and the historic returns for various asset classes in determining how your portfolio should be diversified among multiple asset classes. That allocation may shift gradually as your goals, financial situation, and time frame change, and you may refine it from time to time. However, periodic rebalancing tends to keep it relatively stable in the short term.

Tactical asset allocation, by contrast, tends to be more opportunistic. It attempts to take advantage of shifting market conditions by increasing the level of investment in asset classes that are expected to outperform in the shorter term, or in those the manager believes will reduce risk. Tactical asset allocation tends to be more responsive to immediate market movements and anticipated trends.

Though either strategic or tactical asset allocation can be used with an entire portfolio, some money managers like to establish a strategic allocation for the core of a portfolio, and practice tactical asset allocation with a smaller percentage.

Note: Asset allocation and diversification are methods used to help manage investment risk; they do not guarantee a profit or protect against investment loss.

 

Securities offered through FSC Securities Corporation, member FINRA / SIPC . Investment advisory services offered through The Retirement Group, LLC, a registered investment advisor which is not affiliated with FSC Securities Corp. Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

 

Posted in Retirement Planning | Comments Off

The Benefits of Tax-Advantaged Savings Vehicles – by John Jastremski

Taxes can take a big bite out of your total investment returns, so it’s helpful to look for tax-advantaged strategies when building a portfolio. But keep in mind that investment decisions shouldn’t be driven solely by tax considerations; other factors to consider include the potential risk, the expected rate of return, and the quality of the investment.

Tax-deferred and tax-free investments

Tax deferral is the process of delaying (but not necessarily eliminating) until a future year the payment of income taxes on income you earn in the current year. For example, the money you put into your traditional 401(k) retirement account isn’t taxed until you withdraw it, which might be 30 or 40 years down the road!

Tax deferral can be beneficial because:

  • The money you would have spent on taxes remains invested
  • You may be in a lower tax bracket when you make withdrawals from your accounts (for example, when you’re retired)
  • You can accumulate more dollars in your accounts due to compounding

Compounding means that your earnings become part of your underlying investment, and they in turn earn interest. In the early years of an investment, the benefit of compounding may not be that significant. But as the years go by, the long-term boost to your total return can be dramatic.

Taxes make a big difference

Let’s assume two people have $5,000 to invest every year for a period of 30 years. One person invests in a tax-free account like a Roth 401(k) that earns 6% per year, and the other person invests in a taxable account that also earns 6% each year. Assuming a tax rate of 28%, in 30 years the tax-free account will be worth $395,291, while the taxable account will be worth $295,896. That’s a difference of $99,395.

This hypothetical example is for illustrative purposes only, and its results are not representative of any specific investment or mix of investments. Actual results will vary. The taxable account balance assumes that earnings are taxed as ordinary income and does not reflect possible lower maximum tax rates on capital gains and dividends, as well as the tax treatment of investment losses, which would make the taxable investment return more favorable, thereby reducing the difference in performance between the accounts shown. Investment fees and expenses have not been deducted. If they had been, the results would have been lower. You should consider your personal investment horizon and income tax brackets, both current and anticipated, when making an investment decision as these may further impact the results of the comparison. This illustration assumes a fixed annual rate of return; the rate of return on your actual investment portfolio will be different, and will vary over time, according to actual market performance. This is particularly true for long-term investments. It is important to note that investments offering the potential for higher rates of return also involve a higher degree of risk to principal.

Tax-advantaged savings vehicles for retirement

One of the best ways to accumulate funds for retirement or any other investment objective is to use tax-advantaged (i.e., tax-deferred or tax-free) savings vehicles when appropriate.

  • Traditional IRAs – Anyone under age 70½ who earns income or is married to someone with earned income can contribute to an IRA. Depending upon your income and whether you’re covered by an employer-sponsored retirement plan, you may or may not be able to deduct your contributions to a traditional IRA, but your contributions always grow tax deferred. However, you’ll owe income taxes when you make a withdrawal.* You can contribute up to $5,500 (for 2016 and 2017) to an IRA, and individuals age 50 and older can contribute an additional $1,000 (for 2016 and 2017).
  • Roth IRAs – Roth IRAs are open only to individuals with incomes below certain limits. Your contributions are made with after-tax dollars but will grow tax deferred, and qualified distributions will be tax free when you withdraw them. The amount you can contribute is the same as for traditional IRAs. Total combined contributions to Roth and traditional IRAs can’t exceed $5,500 (for 2016 and 2017) for individuals under age 50.
  • SIMPLE IRAs and SIMPLE 401(k)s – These plans are generally associated with small businesses. As with traditional IRAs, your contributions grow tax deferred, but you’ll owe income taxes when you make a withdrawal.* You can contribute up to $12,500 (for 2016 and 2017) to one of these plans; individuals age 50 and older can contribute an additional $3,000 (for 2016 and 2017). (SIMPLE 401(k) plans can also allow Roth contributions.)
  • Employer-sponsored plans (401(k)s, 403(b)s, 457 plans) – Contributions to these types of plans grow tax deferred, but you’ll owe income taxes when you make a withdrawal.* You can contribute up to $18,000 (for 2016 and 2017) to one of these plans; individuals age 50 and older can contribute an additional $6,000 (for 2016 and 2017). Employers can generally allow employees to make after-tax Roth contributions, in which case qualifying distributions will be tax free.
  • Annuities – You pay money to an annuity issuer (an insurance company), and the issuer promises to pay principal and earnings back to you or your named beneficiary in the future (you’ll be subject to fees and expenses that you’ll need to understand and consider). Most annuities have surrender charges that are assessed if the contract owner surrenders the annuity. Annuities generally allow you to elect to receive an income stream for life (subject to the financial strength and claims-paying ability of the issuer). There’s no limit to how much you can invest, and your contributions grow tax deferred. However, you’ll owe income taxes on the earnings when you start receiving distributions.*

Tax-advantaged savings vehicles for college

For college, tax-advantaged savings vehicles include:

  • 529 plans – College savings plans and prepaid tuition plans let you set aside money for college that will grow tax deferred and be tax free at withdrawal at the federal level if the funds are used for qualified education expenses. These plans are open to anyone regardless of income level. Contribution limits are high–typically over $300,000–but vary by plan.
  • Coverdell education savings accounts – Coverdell accounts are open only to individuals with incomes below certain limits, but if you qualify, you can contribute up to $2,000 per year, per beneficiary. Your contributions will grow tax deferred and be tax free at withdrawal at the federal level if the funds are used for qualified education expenses.
  • Series EE bonds – The interest earned on Series EE savings bonds grows tax deferred. But if you meet income limits (and a few other requirements) at the time you redeem the bonds for college, the interest will be free from federal income tax too (it’s always exempt from state tax).

Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans. More information about specific 529 plans is available in each issuer’s official statement, which should be read carefully before investing. Also, before investing consider whether your state offers a 529 plan that provides residents with favorable state tax benefits. The availability of tax and other benefits may be conditioned on meeting certain requirements. There is also the risk that the investments may lose money or not perform well enough to cover college costs as anticipated. For withdrawals not used for qualified higher-education expenses, earnings may be subject to taxation as ordinary income and possibly a 10% federal income tax penalty.

The information in these materials may change at any time and without notice.Securities offered through FSC Securities Corporation, member FINRA / SIPC . Investment advisory services offered through The Retirement Group, LLC, a registered investment advisor which is not affiliated with FSC Securities Corp. Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. 

Posted in Retirement Planning | Comments Off

Teach Your Children Well: Basic Financial Education – by John Jastremski

Even before your children can count, they already know something about money: it’s what you have to give the ice cream man to get a cone, or put in the slot to ride the rocket ship at the grocery store. So, as soon as your children begin to handle money, start teaching them how to handle it wisely.

Making allowances

Giving children allowances is a good way to begin teaching them how to save money and budget for the things they want. How much you give them depends in part on what you expect them to buy with it and how much you want them to save.
Some parents expect children to earn their allowance by doing household chores, while others attach no strings to the purse and expect children to pitch in simply because they live in the household. A compromise might be to give children small allowances coupled with opportunities to earn extra money by doing chores that fall outside their normal household responsibilities.
When it comes to giving children allowances:

  • Set parameters. Discuss with your children what they may use the money for and how much should be saved.
  • Make allowance day a routine, like payday. Give the same amount on the same day each week.
  • Consider “raises” for children who manage money well.

Take it to the bank

Piggy banks are a great way to start teaching children to save money, but opening a savings account in a “real” bank introduces them to the concepts of earning interest and the power of compounding.
While children might want to spend all their allowance now, encourage them (especially older children) to divide it up, allowing them to spend some immediately, while insisting they save some toward things they really want but can’t afford right away. Writing down each goal and the amount that must be saved each week toward it will help children learn the difference between short-term and long-term goals. As an incentive, you might want to offer to match whatever children save toward their long-term goals.

Shopping sense

Television commercials and peer pressure constantly tempt children to spend money. But children need guidance when it comes to making good buying decisions. Teach children how to compare items by price and quality. When you’re at the grocery store, for example, explain why you might buy a generic cereal instead of a name brand.
By explaining that you won’t buy them something every time you go to a store, you can lead children into thinking carefully about the purchases they do want to make. Then, consider setting aside one day a month when you will take children shopping for themselves. This encourages them to save for something they really want rather than buying on impulse. For “big-ticket” items, suggest that they might put the items on a birthday or holiday list.
Don’t be afraid to let children make mistakes. If a toy breaks soon after it’s purchased, or doesn’t turn out to be as much fun as seen on TV, eventually children will learn to make good choices even when you’re not there to give them advice.

Earning and handling income

Older children (especially teenagers) may earn income from part-time jobs after school or on weekends. Particularly if this money supplements any allowance you give them, wages enable children to get a greater taste of financial independence.
Earned income from part-time jobs might be subject to withholdings for FICA and federal and/or state income taxes. Show your children how this takes a bite out their paychecks and reduces the amount they have left over for their own use.

Creating a balanced budget

With greater financial independence should come greater fiscal responsibility. Older children may have more expenses, and their extra income can be used to cover at least some of those expenses. To ensure that they’ll have enough to make ends meet, help them prepare a budget.
To develop a balanced budget, children should first list all their income. Next, they should list routine expenses, such as pizza with friends, money for movies, and (for older children) gas for the car. (Don’t include things you will pay for.) Finally, subtract the expenses from the income. If they’ll be in the black, you can encourage further saving or contributions to their favorite charity. If the results show that your children will be in the red, however, you’ll need to come up with a plan to address the shortfall.
To help children learn about budgeting:

  • Devise a system for keeping track of what’s spent
  • Categorize expenses as needs (unavoidable) and wants (can be cut)
  • Suggest ways to increase income and/or reduce expenses

The future is now

Teenagers should be ready to focus on saving for larger goals (e.g., a new computer or a car) and longer-term goals (e.g., college, an apartment). And while bank accounts may still be the primary savings vehicles for them, you might also want to consider introducing your teenagers to the principles of investing.
To do this, open investment accounts for them. (If they’re minors, these must be custodial accounts.) Look for accounts that can be opened with low initial contributions at institutions that supply educational materials about basic investment terms and concepts.
Helping older children learn about topics such as risk tolerance, time horizons, market volatility, and asset diversification may predispose them to take charge of their financial future.

Should you give your child credit?

If older children (especially those about to go off to college) are responsible, you may be thinking about getting them a credit card. However, credit card companies cannot issue cards to anyone under 21 unless they can show proof they can repay the debt themselves, or unless an adult cosigns the credit card agreement. If you decide to cosign, keep in mind that you’re taking on legal liability for the debt, and the debt will appear on your credit report.
Also:

  • Set limits on the card’s use
  • Ask the credit card company for a low credit limit (e.g., $300) or a secured card to help children learn to manage credit without getting into serious debt
  • Make sure children understand the grace period, fee structure, and how interest accrues on the unpaid balance
  • Agree on how the bill will be paid, and what will happen if the bill goes unpaid
  • Make sure children understand how long it takes to pay off a credit card balance if they only make minimum payments

If putting a credit card in your child’s hands is a scary thought, you may want to start off with a prepaid spending card. A prepaid spending card looks like a credit card, but functions more like a prepaid phone card. The card can be loaded with a predetermined amount that you specify, and generally may be used anywhere credit cards are accepted. Purchases are deducted from the card’s balance, and you can transfer more money to the card’s balance whenever necessary. Although there may be some fees associated with the card, no debt or interest charges accrue; children can only spend what’s loaded onto the card.
One thing you might especially like about prepaid spending cards is that they allow children to gradually get the hang of using credit responsibly. Because you can access the account information online or over the phone, you can monitor the spending habits of your children. If need be, you can then sit down with them and discuss their spending behavior and money management skills.

 

NoteThe Consumer Financial Protection Bureau’s mortgage rules restrict certain interest-only mortgage loans and loans that result in negative amortization.

Securities offered through FSC Securities Corporation, member FINRA / SIPC . Investment advisory services offered through The Retirement Group, LLC, a registered investment advisor which is not affiliated with FSC Securities Corp. Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

 

 

Posted in Retirement Planning | Comments Off

How Secure Is Social Security? – by John Jastremski

If you’re retired or close to retiring, then you’ve probably got nothing to worry about–your Social Security benefits will likely be paid to you in the amount you’ve planned on (at least that’s what most of the politicians say). But what about the rest of us?

The media onslaught

Watching the news, listening to the radio, or reading the newspaper, you’ve probably come across story after story on the health of Social Security. And, depending on the actuarial assumptions used and the political slant, Social Security has been described as everything from a program in need of some adjustments to one in crisis requiring immediate, drastic reform.
Obviously, the underlying assumptions used can affect one’s perception of the solvency of Social Security, but it’s clear some action needs to be taken. However, even experts disagree on the best remedy. So let’s take a look at what we do know.

Just the facts

According to the Social Security Administration (SSA), over 60 million Americans currently collect some sort of Social Security retirement, disability or death benefit. Social Security is a pay-as-you-go system, with today’s workers paying the benefits for today’s retirees. (Source: Fast Facts & Figures About Social Security, 2016)
How much do today’s workers pay? Well, the first $127,200 (in 2017) of an individual’s annual wages is subject to a Social Security payroll tax, with half being paid by the employee and half by the employer (self-employed individuals pay all of it). Payroll taxes collected are put into the Social Security trust funds and invested in securities guaranteed by the federal government. The funds are then used to pay out current benefits.
The amount of your retirement benefit is based on your average earnings over your working career. Higher lifetime earnings result in higher benefits, so if you have some years of no earnings or low earnings, your benefit amount may be lower than if you had worked steadily.
Your age at the time you start receiving benefits also affects your benefit amount. Currently, the full retirement age is in the process of rising to 67 in two-month increments, as shown in the following chart:

Birth Year Full Retirement Age
1943-1954 66
1955 66 and 2 months
1956 66 and 4 months
1957 66 and 6 months
1958 66 and 8 months
1959 66 and 10 months
1960 and later 67

If you were born on January 1 of any year, refer to the previous year to determine your full retirement age.

You can begin receiving Social Security benefits before your full retirement age, as early as age 62. However, if you retire early, your Social Security benefit will be less than if you had waited until your full retirement age to begin receiving benefits. Specifically, your retirement benefit will be reduced by 5/9ths of 1 percent for every month between your retirement date and your full retirement age, up to 36 months, then by 5/12ths of 1 percent thereafter. For example, if your full retirement age is 67, you’ll receive about 30 percent less if you retire at age 62 than if you wait until age 67 to retire. This reduction is permanent–you won’t be eligible for a benefit increase once you reach full retirement age.

Demographic trends

Even those on opposite sides of the political spectrum can agree that demographic factors are exacerbating Social Security’s problems–namely, life expectancy is increasing and the birth rate is decreasing. This means that over time, fewer workers will have to support more retirees.
According to the SSA, Social Security is already paying out more money than it takes in. However, by drawing on the Social Security trust fund (OASI), the SSA estimates that Social Security should be able to pay 100% of scheduled benefits until fund reserves are depleted in 2035. Once the trust fund reserves are depleted, payroll tax revenue alone should still be sufficient to pay about 77% of scheduled benefits. This means that in 2035, if no changes are made, beneficiaries may receive a benefit that is about 23% less than expected. (Source: 2016 OASDI Trustees Report)

Possible fixes

While no one can say for sure what will happen (and the political process is sure to be contentious), here are some solutions that have been proposed to help keep Social Security solvent for many years to come:

  • Allow individuals to invest some of their current Social Security taxes in “personal retirement accounts”
  • Raise the current payroll tax
  • Raise the current ceiling on wages currently subject to the payroll tax
  • Raise the retirement age beyond age 67
  • Reduce future benefits, especially for wealthy retirees
  • Change the benefit formula that is used to calculate benefits
  • Change how the annual cost-of-living adjustment for benefits is calculated

Uncertain outcome

Members of Congress and the President still support efforts to reform Social Security, but progress on the issue has been slow. However, the SSA continues to urge all parties to address the issue sooner rather than later, to allow for a gradual phasing in of any necessary changes.
Although debate will continue on this polarizing topic, there are no easy answers, and the final outcome for this decades-old program is still uncertain.

In the meantime, what can you do?

The financial outlook for Social Security depends on a number of demographic and economic assumptions that can change over time, so any action that might be taken and who might be affected are still unclear. But no matter what the future holds for Social Security, your financial future is still in your hands. Focus on saving as much for retirement as possible, and consider various income scenarios when planning for retirement.

It’s also important to understand your benefits, and what you can expect to receive from Social Security based on current law. You can find this information on your Social Security Statement, which you can access online at the Social Security website, socialsecurity.gov by signing up for a my Social Security account. Your statement contains a detailed record of your earnings, and includes retirement, disability, and survivor’s benefit estimates that are based on your actual earnings and projections of future earnings. If you’re not registered for an online account and are not yet receiving benefits, you’ll receive a statement in the mail every five years, from age 25 to age 60, and then annually thereafter.

 

 

Securities offered through FSC Securities Corporation, member FINRA / SIPC . Investment advisory services offered through The Retirement Group, LLC, a registered investment advisor which is not affiliated with FSC Securities Corp. Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

Posted in Retirement Planning | Comments Off