Merriman

While corporate pensions are on the decline for many younger workers, many clients nearing retirement still have pensions through their employers. One topic that often comes up with married clients is the question of a survivor option: Should you take a single life option and collect the highest monthly payout, or take a lesser amount and ensure that some percentage would go to your spouse if something were to happen to you?

One solution you might consider is something called pension maximization. The question that we are trying to address then is: Can you buy life insurance to replace the pension for less than the monthly “cost” of taking the survivor option?

We don’t sell insurance, but work with highly qualified professionals that do this full time. We don’t receive any compensation for any insurance our clients buy, but looking at coverage is part of our comprehensive approach to addressing all of our clients’ financial needs.

How does pension maximization work?

Here is a recent example where one client could take a single life pension of $6,041/month or a 100% survivor option for $5,401/month, a “cost” of $640/month ($6,041 – $5,401). When considering the insurance option, we would need to recreate this income stream based on him passing away in year one with the following policies:

• A 10yr term policy for $225,000 ($44/month)
• A 15yr term policy for $125,000 ($32/month)
• A 20yr term policy for $100,000 ($31/month)
• A 25yr term policy for $105,000 ($54/month)
• A 30yr term policy for $110,000 ($103/month)
• A no-lapse guarantee universal life policy for $275,000 ($274/month)

The reason you would layer policies in the above example is because you need less insurance as you get older since the time you need the insurance to last is shorter. When you add up the above policies, you get a monthly expense of $538/month, which is $102/month less than the “cost” of the 100% joint survivor option. After 10yrs, the $44/month policy will drop so you will get a raise of $44/month. By the time the 20yr policy has lapsed, you’d be receiving almost $1,300 more per year than when you started. Also, if the spouse passes away first, then this client could cancel the insurance and keep the premiums or keep some of the insurance to pass on to their heirs.

Who does this work well for?

• People who are in good health and can qualify for lower insurance premiums.
• People who have kids or family they want to leave money to. If both spouses passed way together early on, their heirs would receive no additional money under the pension and survivor options. However, by using the pension maximization strategy above, this couple’s heirs could receive $940,000 income tax free.
• People who are comfortable with a little added complexity. It is much easier to just take the survivor benefit from the company. Dealing with insurance policies and then having to either invest the money or buy immediate annuities (this is what the example above solved for using current annuity rates) with any proceeds takes additional time and effort. The example above had six different policies, but I’ve often seen it work with  only three or four.
• People who have some time before a decision needs to be made. The underwriting process can take a few months and you don’t want to make this type of decision before life insurance is fully in place.

Final thoughts

I’ve looked into this strategy for many clients, and it doesn’t always work out. Sometimes, the company pension option is the best choice and you don’t have to go through any underwriting like you would in the example above. It is important to work with professionals who have the resources and expertise to help you solve these complex financial issues. Here are Merriman, we work with a number of professionals who are experts in their field to help solve problems like this, and other complex issues, for our clients. Please reach out to your advisor if you would like to discuss this option for yourself.

We have all heard the expression, “back in my day…” followed by the amount a particular item used to cost. While it’s somewhat of a cliché, it does carry a lot of weight. The impact of inflation on your cost of living has real consequences, and factoring it into your retirement plan is of paramount importance.

Consider someone who is planning to retire at 66 years old. Current actuarial figures give them a retirement window of about 25 years. Using 3% for average annual inflation, the future value of a dollar 25 years out is $.48. Put another way, you can afford to buy less than half as many goods 25 years into retirement as you could when you started. Fortunately, that is not the end of the story.

There are several ways to insulate your retirement income from the effects of inflation.

One solution has to do with retirement pensions. Once the pension spigot is turned on, one thing that can increase the flow is a Cost of Living Adjustment, or COLA. A COLA increases annual pension amounts based upon the previous year’s rate of inflation. The important thing to know is whether your pension has a COLA. Without one, you will become increasingly dependent upon other assets as time goes on. Remember, 25 years from now a dollar will be worth less than half of what it is worth today. With a COLA, you will still need to understand how your increasing income stream fits in with your other assets and your specific retirement plan.

Another pension source most people have in retirement is Social Security Income, or SSI. The COLA for SSI is tied to the Consumer Price Index. As such, it varies from year to year.

The final piece to consider is your retirement accounts, such as IRAs, Roth IRAs and taxable brokerage accounts. These accounts do not provide a fixed income stream in the sense that a pension does. Typically, they are invested in an allocation of stocks and bonds controlled by you or your investment advisor. Distributions are on an as-needed basis.

Stocks have historically been the best long-term hedge against inflation. In a sense, they act as a super charged COLA for your retirement accounts. How much stock you allocate to these accounts and how the accounts will supplement your pensions requires careful consideration.

No two retirement plans are alike. Understanding how the unique pieces of your retirement puzzle fit together to meet your retirement goals is what’s important. If you have not already done so, take the time to sit down with a professional who can help you figure out where you are, where you want to go and most importantly, how to get there.

A few weeks ago, four Merriman advisors got together for a round table conversation to review themes that came up during meetings with their clients. Aaron Spencer, Mark Metcalf, Paresh Kamdar and Tyler Bartlett all provided insights on the most common questions that investors are asking. Over the 40 minute conversation, you’ll hear their take on the following themes:

• International exposure
• Diversification
• Bond rates being at an all-time low
• Inflation
• DFA and the value they add

Enjoy!

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Many people are not optimistic about the chances of being able to retire at the traditional age of 65. In one survey, 39% of those surveyed said that they would work past age 70 or never retire.

A more recent study published by the Center for Retirement Research at Boston College paints a more optimistic picture. It concludes that almost half of households can retire at 65 and maintain their standard of living in retirement. For those households whose members can’t afford to retire at 65, 23% would have to work another 1-3 years, and 17% of households would have to work an additional 4-6 years. The study concludes that 88% of households should be able to retire by age 70 and maintain their pre-retirement lifestyle.

Postponing retirement is a powerful way to improve your chances of not outliving your money. Each additional year you work means more savings, more chance for your investments to grow, fewer years to draw down your savings in retirement, and greater Social Security (which increases as you delay claiming it until the age of 70).

While you might not be enthusiastic about the prospect of having to work longer, the reality may not be as bad as you think.

I am asked this question often, which is good because if someone is not saving enough we can make adjustments and get them on the right track. The people I worry about are the ones who don’t ask this question, either of me or of themselves. Maybe they are afraid of what the answer might be or they figure their employer or the custodian of the plan is looking out for them. Well, typically they aren’t.

In 2006, the Pension Protection Act went in to place. This was a nice step towards increased retirement savings, even for the most complacent of employees. This Act allows employers to automatically enroll their employees in the company 401(k) plan. Everyone has the ability to opt out, but they have to request it. Due to human nature, we tend to follow the path of least resistance, so the results were a huge increase in 401(k) plan participation. According to a recent study done by Aon Hewitt Associates, the participation rate in company 401(k) plans is now at 85% compared with 67% for companies who do not have an automatic enrollment program.

So if you are automatically enrolled in to your company’s 401(k) plan, will you have enough money to retire? The answer is: Not likely. You will need to dig a bit deeper in to your personal situation.

The Pension Protection Act I mentioned also allows companies to set an initial default contribution amount. So a company could automatically enroll an employee in their 401(k) plan, designating for example, 3% of that person’s salary for deposit in to the 401(k) plan. This has turned out to be good and bad. The good news is that the complacent employee is participating in the 401(k) plan and automatically contributing 3% of their salary, unless they make the effort to opt out. The bad news is that 3% savings per year of your salary is not likely going to get you through retirement, unless you are expecting to really reduce your standard of living.

Let’s assume our complacent employee is named Larry. Larry makes $50,000 a year and is 35 years old. He plans to retire at age 65. If Larry adds 3% per year to his 401(k) plan (because he just can’t be bothered to opt out or add more), he will have added $45,000 over 30 years (this is before any investment gain).

If Larry made no investment selections for his 401(k) plan (which we know he probably wouldn’t, as he is Lazy Larry), then he would have automatically been invested in the money market. This would amount to about $45,000 in today’s dollars of spending money when he turns 65. Even with some Social Security, that isn’t going to last Larry long. (more…)

If you are like most of us, you likely visit your doctor’s office at least a couple of times a year. But when was the last time you had a check-up for your 401(k)?

It would not surprise me if you said, “not in quite a while”. But getting a financial check-up for your 401(k) account is extremely important, especially given the heightened economic issues and market turbulence over these last few years.

One of the many benefits of being a Merriman client is that we have the tools to help you align your 401(k) investments once a year. All you have to do is provide us with the mutual fund choices within your 401(k).

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As the old adage goes, it is best to focus on what you can control. The weather, for instance, is not worth fussing over. In the world of investing, two of the most important things we can control are our budget and how much we contribute to our retirement accounts. Fortunately, both of these items are very closely related. The more you save in your budget, the more you can afford to contribute to your retirement accounts.

We’ve all heard the old song and dance about how skipping your $4 dollar daily latte can have profound impact on your budget. Well, guess what? It’s true. That’s $120/month that could have been better spent. With 7% interest over a 30 year period that adds up to $147,000 dollars!

I don’t want to pester you over your daily decisions; rather I want to point you in the direction of a budgeting tool that will help you identify the “latte” expenditures in your budget.

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Have you ever heard the term “stretch IRA”? According to the IRS, there is no such thing. What has become known as a stretch IRA is really a withdrawal strategy geared to spread the tax-deferred status of your IRA assets across multiple generations. Basically this is a provision you can add to any traditional IRA, ROTH, SEP-IRA, or SIMPLE IRA by using a beneficiary designation form.

Typically, a spouse is named as the primary beneficiary of an IRA, with children as the contingent beneficiaries. In this approach, after your death your surviving spouse rolls the balance of your IRA into his or her own IRA. This will allow your spouse to use the money from your IRA to cover his or her living expenses.

Alternatively, if your spouse will not need the assets in your IRA for living expenses in retirement, then you may consider naming your children and/or grandchildren as the primary beneficiaries. This will create the “stretch IRA.” After your death, your beneficiaries would each acquire what’s known as an inherited IRA from which he or she would have to withdraw a required minimum distribution each year thereafter. Here is an example to illustrate:

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An article in the Wall Street Journal (Debt Hobbles Older Americans, 9/7/11) paints a sobering picture of the impact that rising debt levels have on people’s retirement plans.

Thirty-nine percent of households headed by people aged 60 through 64 had primary mortgages in 2010, up from 22% in 1994. The median value of mortgage and home loan debt, adjusted for inflation, for homeowners aged 60 to 62 also increased, from about $40,000 in 1994 to $80,000 in 2008.

Housing price declines have made it more difficult to pay off these mortgages, forcing people to work longer before retiring.

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Since their introduction in 1998, Roth IRAs have become an important part of the financial planning landscape. They offer the unique ability for investors to grow their money tax-free, not simply tax-deferred like traditional IRAs. They also avoid required minimum distributions so they can grow undiminished for many years. In fact, Roth IRAs are wonderful assets to pass along to the next generation, where they can continue to grow tax-free even longer.

Until recently, this unique retirement vehicle was available only to individuals with incomes below certain thresholds. “High-income” individuals could not contribute to Roth IRAs or convert traditional IRAs into Roth IRAs. Some of this changed in 2010, when the Roth conversion income limitations were permanently repealed. Now, anyone (regardless of income) can make a Roth conversion.  However, the Roth contribution limitation was not repealed. This means that if your income exceeds the levels in the table below, you cannot contribute directly to a Roth IRA—but you can achieve the same result by first contributing to a non-deductible traditional IRA and then converting it to a Roth IRA.

This presents an interesting opportunity for high income individuals, who perhaps yearn to save beyond their 401(k) or 403(b) retirement plans or who simply desire the account diversification that comes with adding a Roth vehicle to their retirement mix. (more…)