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Closing a Retirement Income Gap

Ken Himmler — Tue, 29 Nov 2011 23:43:59 +0000

When you determine how much income you'll need in retirement, you may base your projection on the type of lifestyle you plan to have and when you want to retire. However, as you grow closer to retirement, you may discover that your income won't be enough to meet your needs. If you find yourself in this situation, you'll need to adopt a plan to bridge this projected income gap.

Delay retirement: 65 is just a number

One way of dealing with a projected income shortfall is to stay in the workforce longer than you had planned. This will allow you to continue supporting yourself with a salary rather than dipping into your retirement savings. Depending on your income, this could also increase your Social Security retirement benefit. You'll also be able to delay taking your Social Security benefit or distributions from retirement accounts.

At normal retirement age (which varies, depending on the year you were born), you will receive your full Social Security retirement benefit. You can elect to receive your Social Security retirement benefit as early as age 62, but if you begin receiving your benefit before your normal retirement age, your benefit will be reduced. Conversely, if you delay retirement, you can increase your Social Security benefit.

Remember, too, that income from a job may affect the amount of Social Security retirement benefit you receive if you are under normal retirement age. Your benefit will be reduced by $1 for every $2 you earn over a certain earnings limit ($13,560 in 2008, up from $12,960 in 2007). But once you reach normal retirement age, you can earn as much as you want without affecting your Social Security retirement benefit.

Another advantage of delaying retirement is that you can continue to build tax-deferred funds in your IRA or employer-sponsored retirement plan. Keep in mind, though, that you may be required to start taking minimum distributions from your qualified retirement plan or traditional IRA once you reach age 70½, if you want to avoid harsh penalties.

And if you're covered by a pension plan at work, you could also consider retiring and then seeking employment elsewhere. This way you can receive a salary and your pension benefit at the same time. Some employers, to avoid losing talented employees this way, are beginning to offer "phased retirement" programs that allow you to receive all or part of your pension benefit while you’re still working. Make sure you understand your pension plan options.

Spend less, save more

You may be able to deal with an income shortfall by adjusting your spending habits. If you're still years away from retirement, you may be able to get by with a few minor changes. However, if retirement is just around the corner, you may need to drastically change your spending and saving habits. Saving even a little money can really add up if you do it consistently and earn a reasonable rate of return. Make permanent changes to your spending habits and you'll find that your savings will last even longer. Start by preparing a budget to see where your money is going. Here are some suggested ways to stretch your retirement dollars:

· Reduce your housing expenses by moving to a less expensive home or apartment.

· Sell one of your cars if you have two. When your remaining car needs to be replaced, consider buying a used one.

· Access the equity in your home. Use the proceeds from a second mortgage or home equity line of credit to pay off higher-interest-rate debts.

· Transfer credit card balances from higher-interest cards to a low- or no-interest card, and then cancel the old accounts.

· Ask about insurance discounts and review your insurance needs (e.g., your need for life insurance may have lessened).

· Reduce discretionary expenses such as lunches and dinners out.

Earmark the money you save for retirement and invest it immediately. If you can take advantage of an IRA, 401(k), or other tax-deferred retirement plan, you should do so. Funds invested in a tax-deferred account will generally grow more rapidly than funds invested in a non-tax-deferred account.

Reallocate your assets: consider investing more aggressively

Some people make the mistake of investing too conservatively to achieve their retirement goals. That's not surprising, because as you take on more risk, your potential for loss grows as well. But greater risk also generally entails greater reward. And with life expectancies rising and people retiring earlier, retirement funds need to last a long time.

That's why if you are facing a projected income shortfall, you should consider shifting some of your assets to investments that have the potential to substantially outpace inflation. The amount of investment dollars you should keep in growth-oriented investments depends on your time horizon (how long you have to save) and your tolerance for risk. In general, the longer you have until retirement, the more aggressive you can afford to be. Still, if you are at or near retirement, you may want to keep some of your funds in growth-oriented investments, even if you decide to keep the bulk of your funds in more conservative, fixed-income investments. Get advice from a financial professional if you need help deciding how your assets should be allocated.

And remember, no matter how you decide to allocate your money, rebalance your portfolio now and again. Your needs will change over time, and so should your investment strategy.

Accept reality: lower your standard of living

If your projected income shortfall is severe enough or if you're already close to retirement, you may realize that no matter what measures you take, you will not be able to afford the retirement lifestyle you've dreamed of. In other words, you will have to lower your expectations and accept a lower standard of living.

Fortunately, this may be easier to do than when you were younger. Although some expenses, like health care, generally increase in retirement, other expenses, like housing costs and automobile expenses, tend to decrease. And it's likely that your days of paying college bills and growing-family expenses are over.

Once you are within a few years of retirement, you can prepare a realistic budget that will help you manage your money in retirement. Think long term: Retirees frequently get into budget trouble in the early years of retirement, when they are adjusting to their new lifestyles. Remember that when you are retired, every day is Saturday, so it's easy to start overspending.

Minimizing Estate Taxes

Ken Himmler — Wed, 09 Nov 2011 04:14:54 +0000

What is minimizing estate taxes?

The act of giving away your property, either during life or at death, will probably be subject to one or more of several types of taxes (collectively referred to here as estate taxes), either on the federal level, state level, or both. These tax liabilities may be the largest potential expenses you or your estate may have to pay; federal estate tax alone may reach as high as 45 percent of your estate if you die in 2011. This also means that property you intend to go to your loved ones or others when you die may go instead to the IRS or to your state. Therefore, understanding how these taxes can be minimized is vital if you want to preserve your estate for others.

What are estate taxes?

Estate taxes are actually transfer taxes. Transfer taxes are imposed when you give your property to someone else. This can be done during life (this kind of transfer is called a gift) or at death (this kind of transfer is called a bequest or legacy if you leave a will, and intestate succession if you don't leave a will). There are five transfer taxes that may affect your estate: (1) state gift tax, (2) state death taxes, (3) state generation-skipping transfer tax (GSTT), (4) the federal gift and estate tax, and (5) the federal GSTT.

State gift tax
Currently, Connecticut, Louisiana, North Carolina, Tennessee, and Puerto Rico impose a gift tax. A gift is a transfer of property you (the donor) make during your lifetime. The person or organization you give to is called the donee. When you make a gift, it is in exchange for nothing or in exchange for property of lesser value (in other words, it is not a bona fide sale). Generally, gifts must be reported, and gift tax paid in the year following the year in which the gift is made. If your state imposes a gift tax and you intend to make lifetime gifts, you should contact your state's department of revenue to find out what gifts need to be reported, how to compute the gift tax, and when and how to file a gift tax return.

State death taxes
State death taxes are imposed on property distributed after your death. You should be especially aware of state death taxes because they may affect even the smallest estates. There are three types of state death taxes: inheritance tax, estate tax, and credit estate tax (commonly referred to as a sponge tax or pickup tax). Every state imposes at least one type.

State generation-skipping transfer tax (GSTT)
Currently, some states impose a GSTT. The GSTT is imposed on property transferred to a family member who is two or more generations below you (e.g., a grandchild or great-nephew). You can contact your state's department of revenue to find out what transfers may be subject to state GSTT, and when and how to file a return.

Federal gift and estate tax
Generally speaking, the federal gift and estate tax is imposed on property transferred to others either while you are living or at the time of your death. Unlike the individual states which impose at least one type of death tax, and some of which impose a separate gift tax, the federal tax system is unified. In other words, the IRS adds lifetime and deathtime transfers and treats them the same. This is how the unified tax system works:
Before 1976, the federal tax system worked much like that of the states. Gifts made during life (taxable gifts) were reported, and any gift tax owed was paid on an annual basis. After death, estate tax was imposed only on property owned at death (gross taxable estate). Since 1976, generally, taxable gifts are still reported, and any gift tax owed is paid annually (generally, you must file a gift tax return and pay gift tax due, if any, by April 15 of the year following the year in which you make a taxable gift). But upon death, all taxable gifts are added to your gross taxable estate for estate tax calculation purposes, even though a gift tax return may already be filed and gift tax paid (gift tax paid is deducted from the estate tax owed). The IRS unified the gift tax and estate tax systems so that: (1) you can't avoid estate tax by giving your wealth away before you die, and (2) you pay tax on the cumulative amount of wealth you give away (this pushes your estate into a higher tax bracket).

The federal generation-skipping transfer tax (GSTT)
Like the state-imposed GSTT, the federal GSTT is a tax imposed on property you transfer to a family member who is two or more generations below you (e.g., a grandchild or great-nephew). The IRS wants to levy a tax on property as it is passed from generation to generation at each and every level. The purpose of the GSTT is to keep families from avoiding estate tax by skipping an intermediate generation. A flat tax rate equal to the highest estate tax rate is imposed on every generation-skipping transfer you make over a certain lifetime amount ($3.5 million in 2009).
Tip: The GSTT rate is the same as the maximum estate tax rate, and the GSTT exemption is the same amount as the estate tax applicable exclusion amount.
You can minimize estate taxes by: (1) taking advantage of certain allowable tax exclusions, deductions, and credits, (2) using an estate freeze technique, or (3) employing post-mortem planning.

Exclusions, deductions, and credits
Under the federal tax system, individuals are generally allowed to make gifts of up to $13,000 (2009 figure, up from $12,000 in 2008) per donee each year gift tax free under the annual gift tax exclusion.
In addition, individuals are allowed to exempt a certain amount of property from the gift and estate tax.
Further, transfers of property between U.S. citizen spouses are fully deductible, as are transfers of property to qualified charitable organizations.
There are many exclusions, deductions, and credits that if effectively used can minimize estate taxes. You need to understand what these exclusions, deductions, and credits are, and how they work in order to take full advantage of them.
Tip: States also have their own exclusions, deductions, and credits, although they may not be the same as the federal system.

Estate freeze
An estate freeze is any planning device that allows you to freeze the present value of your estate and shift any future growth (or potential growth) to your successors.
Example(s): You give land valued at $100,000 to your children. Twenty-five years later, you die. The land is valued at $500,000 on the date of your death, but only $100,000 is included in your taxable estate because the value of the land froze on the date you gave it to your children.
There are many ways you can freeze the value of property. Estate freezing techniques range from relatively simple (e.g., installment sale or private annuity) to the more complex (e.g., gift- or sale-leaseback). You need to know what these techniques are and how they are used in order to know which, if any, is best for you.
Tip: This generally works for state taxes also.

Post-mortem planning
There are many post-mortem (i.e., "after death") techniques that can help keep the value of your property as low as possible in order to minimize federal estate taxes. There are 10 post-mortem techniques in particular that you should know about. Even though these techniques are implemented after your death, you should understand each of them now because if you believe your estate might benefit from them, there may be things you need to do now to ensure that your estate will qualify for these elections after your death.

Avoiding Investment Scams

Ken Himmler — Thu, 06 Oct 2011 16:37:13 +0000

In the light of the present recession, everyone is looking for ways to make safe investments. Unlike in previous generations, today’s primary resource for conducting the much needed investment research is none other than the Internet. Unfortunately, there are a lot of dishonest people who have caught on to the fact that everyone is looking for a way to make a easy, safe investments. These dishonest individuals have set up several elaborate scams to swindle honest, hardworking individuals like you out of their hard earned money. You will need to equip yourself with the information you need to avoid such scams when doing your own investment research.

One of the most common scams comes in the form of unqualified individuals who claim to be reputable investment advisors. These are sometimes easy to spot because they make unrealistic claims about your money. Unfortunately there are also many well thought out scams that are hard to spot. Sometimes scammers assume the identities of actual, licensed investment planners with outstanding credentials. If you are not careful you can lose a lot of money in a short amount of time.

The best way to avoid these types of scams is to double-check all of your references. Never send anybody money for investment services until you are absolutely sure they are who they claim to be. Most reputable investment planners have only a select few websites that they operate with, and these websites are usually well documented by services that specialize in this kind of research. When in doubt, do a google search with the name of the individual or service in question followed by the word ‘scam’ to find complaints other people have had. When in doubt, follow this golden rule of Internet investing: If it sounds to good to be true it probably is. There are many legitimate investment services out there just waiting for you to find them.

Cash Value Life Insurance

Ken Himmler — Thu, 01 Sep 2011 16:34:22 +0000

Cash value, or permanent, life insurance is life insurance that is designed to be kept until your death–whenever that may be. Part of your premium pays for the "pure" insurance coverage and expenses, and the balance is held by the insurance company in a cash value account. The type of permanent life insurance you buy (e.g., whole, universal, variable) will influence the pace at which the cash value portion of your policy grows. The interest and earnings grow tax deferred until you withdraw the funds, and are part of the income-tax-free death benefit if you die. However, these policies may require a higher cash outlay than term life policies.

Who should consider cash value life insurance?
Cash value life insurance is well suited to cover long-term needs, because coverage continues for the rest of your life. You won't need to renew your policy periodically, nor will you need to provide proof of insurability (e.g., a medical exam) once the policy is in place. Cash value insurance allows you to lock in a premium schedule, so you won't have to worry about rising premiums as you get older or your health deteriorates.

Advantages of cash value life insurance
As with any life insurance policy, the purpose of cash value insurance is to provide adequate financial resources for your surviving loved ones in the event of your premature death. Knowing that this protection is in place may allow you to sleep a little easier at night. A cash value policy is similar to an annuity in this respect. All of the interest and earnings on the policy's investments are allowed to grow free from income taxes until you surrender the policy or begin to withdraw your funds. Depending on the amount credited to the cash value account, you can accumulate a substantial amount of equity in your cash value policy over a period of years.

Generally, you'll have the right to take a loan from the insurance company, secured by the cash value in your policy. A fixed or variable interest rate will be charged. Keep in mind, however, that if you take a loan against your cash value, the death benefit available to your survivors will be reduced by the amount of the loan. In addition, policy loans may reduce available cash value and can cause your policy to lapse. Finally, you could face tax consequences if you surrender the policy with an outstanding loan against it.
With most cash value life insurance, you can take withdrawals from your cash value account. Policy withdrawals may be tax free up to your basis in the policy (the amount you've paid into the policy in premiums). As with loans, the amount of the withdrawal from your cash value account will reduce the death benefit available to your survivors, as well as the available cash value,n some cases by an amount greater than the withdrawal amount. Different tax rules apply to withdrawals and loans from cash values if the policy is a Modified Endowment Contract. In that case, withdrawals and loans are considered made from earnings first, and would be subject to income tax.

Disadvantages of cash value life insurance
The premiums for cash value insurance usually cost more than for a comparable amount of term insurance in the early years of the policy. The reason is that with a cash value policy, you're initially paying more than is currently needed to pay for the insurance, so that you can build a fund (the cash value account) to help offset the higher insurance costs you'll need to pay when you're older.

If you buy a variable life insurance policy, the underlying investments in the cash value account expose you to the possibility of financial loss as well as financial gain. It all depends on how those investments fare. Any losses will cut directly into your cash value account and may affect the amount of the death benefit, although a minimum death benefit is usually guaranteed. (Guarantees are subject to the claims-paying ability of the insurer.) Now with the invention of the Equity Linked Life Insurance there is now a way to participate with the potential upside of the market without the downside.

DOL Begins Crackdown on 401(k) Providers for Fee Bundling Abuses

Ken Himmler — Tue, 02 Aug 2011 15:41:52 +0000

Federal agency hopes to squeeze plan sponsors and custodians for leaner fees and more disclosure on qualified retirement accounts. Experts warn that Washington retirement plan cops won't tolerate schemes to hide fees any more. After the disasters of the recent recession, the regulators are cracking down on retirement plans that trick workers into buying more expensive mutual funds or paying big hidden administration fees.

The opening salvo: business owners who sponsor 401(k) plans now have until next June to itemize every cent their employees pay third-party service providers and prove that it was the best deal they could get. Otherwise, they're looking at audits and potentially crippling fines.

As a result, service providers who were traditionally unwilling to break down their opaque "bundled" pricing — the all-in-one administrators, record keepers and custodians — are now staring down the barrel of a gun. "New fee disclosure regulations will erase much of the advantage on bundling fees," says Louis Harvey, head of financial industry benchmarking firm DALBAR.

The new rules requiring 401(k) sponsors to know and disclose what their participants pay were initially set to take effect on July 16. But the Labor Department had to keep pushing back the deadline because the service providers spent most of their time arguing that the transition would take too much work.

The most recent extension, issued just three days before the rules were originally set to take effect, pushes the formal start date all the way to April 1 of next year and gives everyone — vendors and employers alike — an extra 60 days after that to roll out their new account statements

Click HERE to read more.

How Grandparents Can Help Grandchildren with College Costs

Ken Himmler — Thu, 10 Mar 2011 16:48:02 +0000

As the cost of a college education continues to climb, many grandparents are stepping in to help. This trend is expected to accelerate as baby boomers, many of whom went to college, become grandparents and start gifting what's predicted to be trillions of dollars over the coming decades. Helping to pay for a grandchild's college education can bring great personal satisfaction and is a smart way for grandparents to pass on wealth without having to pay gift and estate taxes. So what are the best ways to accomplish this goal?

Outright cash gifts
A common way to help with college costs is to make an outright gift of cash or securities. But this method has drawbacks. If you gift the money directly to your grandchild, he or she might spend it on something other than college. Also, a gift of more than the annual federal gift tax exclusion amount–$13,000 for individual gifts, $26,000 for joint gifts–might have gift tax and generation-skipping transfer tax (GSTT) consequences (GSTT is an additional gift tax imposed on gifts made to someone who is more than one generation below you). Note that the $13,000 figure is for 2010. The exclusion is indexed for inflation, so this figure may increase in future years.

Another drawback to outright gifts is that a gift becomes an asset of the student, and the federal government treats student assets more harshly than parent assets for financial aid purposes. Students must contribute 20% of their assets each year toward college costs, compared to 5.6% for parent assets. Fortunately, there are better options available.

529 plans
A 529 plan can be an excellent way for grandparents to contribute to a grandchild's college education, while simultaneously paring down their own estate. Contributions to a 529 plan grow tax deferred, and withdrawals used for the beneficiary's qualified education expenses are completely tax free at the federal level (and at the state level too).

There are two types of 529 plans: college savings plans and prepaid tuition plans. College savings plans are individual investment-type accounts offered by nearly all states and managed by financial institutions. Funds can be used at any accredited college in the United States or abroad. Prepaid tuition plans allow prepayment of tuition at today's prices for the limited group of colleges–typically in-state public colleges–that participate in the plan.

Grandparents can open a 529 account and name a grandchild as beneficiary (only one person can be listed as account owner, though), or they can contribute to an existing 529 account. Grandparents can contribute a lump sum to a grandchild's 529 account, or they can contribute smaller, regular amounts.

Regarding lump-sum gifts, a big advantage of 529 plans is that under special rules unique to 529 plans, individuals can make a lump-sum gift of up to $65,000 ($130,000 for joint gifts by married couples) and avoid federal gift tax. A special election must be made to treat the gift as if it were made in equal installments over a five-year period, and no additional gifts can be made to the beneficiary during this time.
Example: Mr. and Mrs. Brady make a lump-sum contribution of $130,000 to their grandchild's 529 plan in Year 1, electing to treat the gift as if it were made over 5 years. The result is they are considered to have made annual gifts of $26,000 ($13,000 each) in Years 1 through 5 ($130,000 / 5 years). Because the amount gifted by each spouse is within the annual gift tax exclusion, the Bradys won't owe any gift tax (assuming they don't make any other gifts to their grandchild during the 5-year period). In Year 6, they can make another lump-sum contribution and repeat the process. In Year 11, they can do so again.

Significantly, this money is considered removed from your estate, even though one grandparent can still retain control over the funds if he or she is the 529 account owner. There is a caveat, however. If the donor were to die during the five-year period, then a prorated portion of the contribution would be "recaptured" into the estate for estate tax purposes.

Example: In the previous example, if Mr. Brady were to die in Year 2, his total Year 1 and 2 contributions ($26,000) would be excluded from his estate. But the remaining portion attributed to him in Years 3, 4, and 5 ($39,000) would be included in his estate. The contributions attributed to Mrs. Brady ($13,000 per year) would not be recaptured into the estate.

Another attractive feature of 529 plans is that under current law, grandparent-owned 529 accounts are excluded by the federal government's financial aid formula–only parent-owned 529 plans count. So a grandparent-owned 529 plan won't impact a grandchild's chances of qualifying for federal aid.

However, if you need the money in your 529 account for something other than the beneficiary's college expenses–for medical expenses or emergency purposes, for example–you'll face a double consequence: the earnings portion of the withdrawal is subject to a 10% penalty and will be taxed at your ordinary income tax rate. Also, note that funds in a grandparent-owned 529 plan may still be factored in when determining Medicaid eligibility, unless these funds are specifically exempted by state law.cifically exempted by state law.

Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. 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.

Pay the college directly
Another excellent way for grandparents to help their grandchildren with college costs is to pay the college directly. Under federal law, tuition payments made directly to a college aren't considered taxable gifts, no matter how large the payment. So you don't have to worry about the $13,000 annual federal gift tax exclusion. But this is true only for tuition–room and board, books, fees, equipment, and other similar expenses don't qualify. Aside from the obvious tax advantage, paying tuition directly to the college ensures that your money will be used for education, plus it removes the money from your estate. And you are still free to give your grandchild a separate tax-free gift each year up to the $13,000 limit.

However, colleges will often reduce a student's financial aid by the amount of the grandparent's payment. Before sending a check, ask the school how it will affect your grandchild's eligibility for school-based aid. If your contribution will adversely affect your grandchild's financial aid package, another option is to give the money to your grandchild after graduation to help him or her pay off student loans.

Private elementary/secondary school
Finally, if you're interested in contributing to your grandchild's private elementary or secondary school education, a Coverdell education savings account (ESA) can help. Up to $2,000 per beneficiary can be contributed to a Coverdell ESA each year. Like funds in a 529 plan, the money grows tax deferred and is tax free at both the federal and state levels if used to pay the beneficiary's qualified education expenses, including private elementary and secondary school as well as college. But there are income limitations on who can contribute to an ESA. Specifically, married couples with a modified adjusted gross income over $220,000 ($110,000 for individuals) can't contribute.

Funding Your Future with a Fixed Annuity

Ken Himmler — Wed, 02 Mar 2011 20:39:53 +0000

A fixed annuity is a contract between you and an annuity issuer, usually an insurance company. In its simplest form, you pay money to the annuity issuer; the issuer invests the funds and pays the principal and its earnings back to you or to your named beneficiary. What's fixed about a fixed annuity? The issuer guarantees (subject to its claims-paying ability) a minimum rate of interest on your investment and a fixed benefit amount if you elect to annuitize.

When is an annuity appropriate?
Annuity contributions are made with after-tax dollars and are not tax deductible. That's why it's often advisable to fund other retirement plans first. However, if you've already contributed the maximum allowable amount to other plans and want to save more toward your retirement, an annuity can be an excellent choice. There's no limit to how much you can invest in an annuity, and the funds grow tax deferred until you begin taking distributions.

Once you begin withdrawing from your annuity, you'll pay taxes (at your regular income tax rate) only on the earnings, since your contributions to principal were made with after-tax dollars. Like a qualified retirement plan, a 10% tax penalty may be imposed if you withdraw from an annuity before age 59½.

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. However, many companies allow options for withdrawals or distributions without incurring a charge. As long as you're sure you won't need the money until at least age 59½ and you understand the costs (including fees) involved, an annuity is worth considering.

Two distinct phases to an annuity
There are two distinct phases to an annuity contract: the accumulation phase and the distribution phase. In the accumulation phase, you're putting money into the annuity. You can choose to pay your premiums in one lump sum, or you can make a series of payments over time. These payments can be of equal amounts made at equal intervals, or of variable amounts at irregular intervals, depending on the terms of the contract.

Annuities may be either immediate or deferred; the terms simply refer to when the distribution phase begins. Immediate annuities are typically purchased with a single payment and the distribution phase usually begins within a year of the purchase. While deferred annuities may be purchased with a single lump sum premium payment, they are most often purchased with a series of periodic payments. The distribution period is deferred until some time in the future.

In the distribution phase, you begin taking money out of the annuity. You may withdraw some or all of the money in lump sums, or you may annuitize. Subject to the claims-paying ability of the issuer, annuitization provides a guaranteed income stream for either a specified period or for life.

How a Fixed Deferred 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. These payments are made with after-tax funds, and you may invest an unlimited amount.
2. The annuity issuer places your funds in its general account.* Your annuity contract specifies how your principal will be returned as well as what rate(s) of interest you'll earn during the accumulation phase. Your contract will also state what minimum interest rate applies.**
3. The compounding interest on your annuity accumulates tax deferred. You won't be taxed on these earnings until funds are withdrawn or distributed.
4. The issuer may collect fees to manage your annuity account. You may also have to pay the issuer a surrender fee if you withdraw money in the early years of your annuity.
5. Your annuity contract may contain a guaranteed** death benefit or other provisions for a 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.)
6. If you make a withdrawal from your deferred annuity before you reach age 59½, you'll not only have to pay tax (at your ordinary income tax rate) on the earnings portion of the withdrawal, but you may also have to pay a 10 percent premature distribution tax, unless an exception applies.
7. After age 59½, you may make withdrawals from your annuity without incurring any premature distribution tax. Since annuities have no minimum distribution requirements, you don't have to make any withdrawals. You can let the account grow tax deferred for an indefinite period. However, your annuity contract may specify an age at which you must begin taking income payments.
8. To obtain a guaranteed** fixed income stream for life or for a certain number of years, you could 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.
9. You'll have to pay taxes (at your ordinary income tax rate) on the earnings portion of any withdrawals or annuitization payments you receive.

* These funds are invested as part of the general assets of the issuer and are therefore subject to the claims of its creditors.
** All guarantees are subject to the claims-paying ability of the issuing company.

A Closer Look at REITs

Ken Himmler — Wed, 16 Feb 2011 05:32:20 +0000

While REIT is an acronym for "real estate investment trusts", they aren't the same as owning real estate. Simply explained, a REIT is a company that buys, develops, manages, and sells various real estate investments. Through a REIT, participants can invest in a professionally-maintained portfolio of various real estate properties. Some REITs will specialize in certain areas of investment while others are more diversified with the properties they invest in.

A REIT qualifies as what's known as a 'pass-through' entity through which companies are able to distribute a majority of its cash flow to its investors without facing taxation at the corporate level. Certain conditions need to be met for this to happen, including the fact that it must:

- Pay at least 90% of its taxable income to its shareholders annually
- Have at least 100 shareholders
- Have at least 75% of its total assets invested in real estate properties
- Generate at least 75% of its income from rent or mortgage interest from portfolio properties

The big difference between investing in a REIT and owning real estate outright is liquidity and the fact that you won't have to individually manage the properties invested in. As with other investment options, they aren't always safe investments but they have inherently shown to be less risky over the years when compared on a grand scale to conventional stocks.

While providing investment advice as to whether or not you should invest in REITs is outside the scope of this article, it should be said that because REITs must pay out high dividends in order to enjoy the tax benefits of their status, they can produce stable returns over time.

It's important to mention that analyzing a REIT and understanding its trends requires an understanding of how depreciation and market fluctuations can impact the investment. It is highly recommended that you speak with an investment advisor before determining if REITs are a smart investment for those undergoing retirement planning.

Should You Pay Off Your Mortgage or Invest?

Ken Himmler — Wed, 05 Jan 2011 02:46:30 +0000

Owning a home outright is a dream that many Americans share. Having a mortgage can be a huge burden, and paying it off may be the first item on your financial to-do list. But competing with the desire to own your home free and clear is your need to invest for retirement, your child’s college education, or some other goal. Putting extra cash toward one of these goals may mean sacrificing another. So how do you choose?

Evaluating the opportunity cost

Deciding between prepaying your mortgage and investing your extra cash isn’t easy, because each option has advantages and disadvantages. But you can start by weighing what you’ll gain financially by choosing one option against what you’ll give up. In economic terms, this is known as evaluating the opportunity cost.

Here’s an example. Let’s assume that you have a $300,000 balance and 20 years remaining on your 30-year mortgage, and you’re paying 6.25% interest. If you were to put an extra $400 toward your mortgage each month, you would save approximately $62,000 in interest, and pay off your loan almost 6 years early.

By making extra payments and saving all of that interest, you’ll clearly be gaining a lot of financial ground. But before you opt to prepay your mortgage, you still have to consider what you might be giving up by doing so–the opportunity to potentially profit even more from investing.

To determine if you would come out ahead if you invested your extra cash, start by looking at the after-tax rate of return you can expect from prepaying your mortgage. This is generally less than the interest rate you’re paying on your mortgage, once you take into account any tax deduction you receive for mortgage interest. Once you’ve calculated that figure, compare it to the after-tax return you could receive by investing your extra cash.

For example, the after-tax cost of a 6.25% mortgage would be approximately 4.5% if you were in the 28% tax bracket and were able to deduct mortgage interest on your federal income tax return (the after-tax cost might be even lower if you were also able to deduct mortgage interest on your state income tax return). Could you receive a higher after-tax rate of return if you invested your money instead of prepaying your mortgage?

Keep in mind that the rate of return you’ll receive is directly related to the investments you choose. Investments with the potential for higher returns may expose you to more risk, so take this into account when making your decision.

Other points to consider

While evaluating the opportunity cost is important, you’ll also need to weigh many other factors. The following list of questions may help you decide which option is best for you, also visit http://kenhimmler.com/ for more strategies.

· What’s your mortgage interest rate? The lower the rate on your mortgage, the greater the potential to receive a better return through investing.

· Does your mortgage have a prepayment penalty? Most mortgages don’t, but check before making extra payments.

· How long do you plan to stay in your home? The main benefit of prepaying your mortgage is the amount of interest you save over the long term; if you plan to move soon, there’s less value in putting more money toward your mortgage.

· Will you have the discipline to invest your extra cash rather than spend it? If not, you might be better off making extra mortgage payments.

· Do you have an emergency account to cover unexpected expenses? It doesn’t make sense to make extra mortgage payments now if you’ll be forced to borrow money at a higher interest rate later. And keep in mind that if your financial circumstances change–if you lose your job or suffer a disability, for example–you may have more trouble borrowing against your home equity.

· How comfortable are you with debt? If you worry endlessly about it, give the emotional benefits of paying off your mortgage extra consideration.

· Are you saddled with high balances on credit cards or personal loans? If so, it’s often better to pay off those debts first. The interest rate on consumer debt isn’t tax deductible, and is often far higher than either your mortgage interest rate or the rate of return you’re likely to receive on your investments.

· Are you currently paying mortgage insurance? If you are, putting extra toward your mortgage until you’ve gained at least 20% equity in your home may make sense.

· How will prepaying your mortgage affect your overall tax situation? For example, prepaying your mortgage (thus reducing your mortgage interest) could affect your ability to itemize deductions (this is especially true in the early years of your mortgage, when you’re likely to be paying more in interest).

· Have you saved enough for retirement? If you haven’t, consider contributing the maximum allowable each year to tax-advantaged retirement accounts before prepaying your mortgage. This is especially important if you are receiving a generous employer match. For example, if you save 6% of your income, an employer match of 50% of what you contribute (i.e., 3% of your income) could potentially add thousands of extra dollars to your retirement account each year. Prepaying your mortgage may not be the savviest financial move if it means forgoing that match or shortchanging your retirement fund.

The middle ground

If you need to invest for an important goal, but you also want the satisfaction of paying down your mortgage, there’s no reason you can’t do both. It’s as simple as allocating part of your available cash toward one goal, and putting the rest toward the other. Even small adjustments can make a difference. For example, you could potentially shave years off your mortgage by consistently making biweekly, instead of monthly, mortgage payments, or by putting any year-end bonuses or tax refunds toward your mortgage principal.

And remember, no matter what you decide now, you can always reprioritize your goals later to keep up with changes to your circumstances, market conditions, and interest rates.

Social Security: What Should You Do at Age 62?

Ken Himmler — Thu, 14 Oct 2010 02:17:11 +0000

Is 62 your lucky number? If you’re eligible, that’s the earliest age you can start receiving Social Security retirement benefits. If you decide to start collecting benefits before your full retirement age (which ranges from 65 to 67, depending on the year you were born), you’ll be in good company. According to the Social Security Administration (SSA), approximately 73% of Americans elect to receive their Social Security benefits early. (Source: SSA Annual Statistical Supplement, June 2007)

Although collecting early retirement benefits makes sense for many people, there’s a major drawback to consider: if you start collecting benefits early, your monthly retirement benefit will be permanently reduced. So before you put down the tools of your trade and pick up your first Social Security check, there are some factors you’ll need to weigh before deciding whether to start collecting benefits early.

What will your retirement benefit be?

The exact amount of your Social Security retirement benefit is based on the number of years you’ve been working and the amount you’ve earned. Your benefit is calculated using a formula that takes into account your 35 highest earnings years. If you earned little or nothing in several of those years (if you left the workforce to raise a family, for instance), it may be to your advantage to work as long as possible, because you’ll have the opportunity to replace a year of lower earnings with a higher one, potentially resulting in a higher retirement benefit.

Each year, you’ll receive a Social Security Statement from the SSA that summarizes your earnings history, and estimates the benefits you may receive based on those earnings. If you begin collecting retirement benefits at age 62, each monthly benefit check will be 20% to 30% less than it would be at full retirement age. The exact amount of the reduction will depend on the year you were born. (Conversely, you can get a higher payout by delaying retirement past your full retirement age–the government increases your payout every month that you delay retirement, up to age 70.)

However, even though your monthly benefit will be 20% to 30% less if you begin collecting retirement benefits at age 62; you might receive the same or more total lifetime Social Security benefits as you would have had you waited until full retirement age to start collecting benefits. That’s because even though you’ll receive less money per month, you might receive more benefit checks.

The following chart shows how much an estimated $1,000 monthly benefit at full retirement age would be worth if you started taking a reduced benefit at age 62.

Birth Year Full Retirement Age Benefit
1937 and earlier 65 years $800
1938 65 years, 2 months $791
1939 65 years, 4 months $783
1940 65 years, 6 months $775
1941 65 years, 8 months $766
1942 65 years, 10 months $758
1943-1954 66 years $750
1955 66 years, 2 months $741
1956 66 years, 4 months $733
1957 66 years, 6 months $725
1958 66 years, 8 months $716
1959 66 years, 10 months $708
1960 and later 67 years $700
Source: Social Security Administration

Have you thought about your longevity?

Is it better to take reduced benefits at age 62 or full benefits later? The answer depends, in part, on how long you live. If you live longer than your "break-even age," the overall value of your retirement benefits taken at full retirement age will begin to outweigh the value of reduced benefits taken at age 62.
You’ll generally reach your break-even age about 12 years from your full retirement age. For example, if your full retirement age is 66, you should reach your break-even age at 78. If you live past this age, you’ll end up with higher total lifetime benefits by waiting until full retirement age to start collecting; otherwise, collecting benefits at age 62 may be better. The SSA has a break-even calculator on its website if you want to learn more.
Of course, no one can predict exactly how long they’ll live. But by taking into account your current health, diet, exercise level, access to quality medical care, and family health history, you might be able to make a reasonable assumption.

How much income will you need?

Another important piece of the puzzle is to look at how much retirement income you’ll need, based partly on an estimate of your retirement expenses. If there is a large gap between your projected expenses and your anticipated income, waiting a few years to retire and start collecting Social Security benefits may improve your financial outlook. If you continue to work and wait until your full retirement age to start collecting benefits, your Social Security monthly benefit will be larger. What’s more, the longer you stay in the workforce, the greater the amount of money you will earn and have available to put into your overall retirement savings. Another plus is that Social Security’s annual cost-of-living increases are calculated using your initial year’s benefits as a base–the higher the base, the greater your annual increase.

Do you plan on working after age 62?

Another key factor in your decision is whether or not you plan to continue working after you start collecting Social Security benefits at age 62. That’s because income you earn before full retirement age may reduce your Social Security retirement benefit. Specifically, if you are under full retirement age for the entire year, $1 in benefits will be withheld for every $2 you earn over the annual earnings limit ($13,560 in 2008). Example: You start collecting Social Security benefits at age 62. You continue working, and your job pays $30,000 in 2008. Your annual benefit would be reduced by $8,220 ($30,000 minus $13,560, divided by 2).

A higher earnings limit applies in the year you reach full retirement age, and the calculation is different too–$1 in benefits is withheld for every $3 you earn over $36,120 (in 2008). Once you reach full retirement age, you don’t need to worry about your earnings. You can earn as much as you want without affecting your Social Security benefit. Note: If your monthly benefit is reduced in the short term due to your earnings, you’ll receive a higher monthly benefit later. That’s because the SSA recalculates your benefit when you reach full retirement age, and omits the months in which your benefit was reduced.

Are you eligible for retiree health benefits?
Even if you start collecting Social Security benefits at age 62, keep in mind that you still won’t be eligible for Medicare until you reach age 65. So unless you’re eligible for retiree health benefits through your former employer or your spouse’s health plan at work, you’ll probably want to pay for a private health policy until Medicare kicks in. In addition to the factors discussed here, other personal considerations may influence whether you start collecting Social Security benefits at age 62. Is your spouse already retired or planning to retire early too? Do you plan on traveling, volunteering, going back to school, starting your own business, pursuing hobbies, or moving to a new location? Do you have grandchildren or elderly parents whom you want to help take care of? Every person’s situation is different.
For more information: The nuances of Social Security can be complex. For more information about Social Security benefits, visit the Social Security Administration website at www.ssa.gov, or call (800) 772-1213 to speak with a representative. You may also call or visit your local Social Security office.
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