Outside Economics

A Method To Optimize Retirement Income

Posted by Wendell Brock, MBA, ChFC on Fri, Apr 07, 2017

The question is often asked, “how does a person optimize their retirement income?” Most companies these days only provide limited resources to their employees in regards to retirement planning. Gone are the days of the large pensions, as fewer and fewer companies offer them. Most only offer a 401(k) type option, which is a contribution based plan; meaning that the only funds an individual will have when they retire is what they personally have saved in that account plus any employer matching contributions. 

bigstock-Retirement-Plan-1024052.jpg

Pension plans are formula driven, based on a person’s time employed and salary, which determines a benefit that would be paid to the person when they retire. These plans use actuarial science to determine the contributions the company makes to fund such a benefit in the future. The key being the actuarial science. 

Contribution plans rely solely on the contributions, which have legal limits, and the markets to produce an end result account value - if the winds are favorable (markets) you may end with a better retirement. If the winds are contrary your retirement may be in jeopardy. Like any storm they can come on the horizon at any time unannounced placing your retirement nest egg at extreme risk.

Due to such risks people who are withdrawing from those investment accounts are advised to only take out small amounts per year, in the range of 2.5%-3.5%. This small percentage will minimize the drain on the account so it would hopefully last through retirement. Meaning that withdrawal amounts would only be approximately $2,500 - $3,500 per $100,000 of investment dollars per year. Not a lot of money.

Enter in actuarial science - by employing a strategy that would use both an investment account and actuarial science a retiree may be able to significantly increase the annual income and never run out of money, never suffer due to the contrary winds of a bad market. In essence a retiree is able to create their own personal pension plan.

Actuaries are employed mostly by insurance companies to calculate rates and tables to offer benefits to their policy holders. Unlike investment services, which is an art, actuaries use science. Proven facts and mathematical formulas are used to determine a benefit for the policy holder, this is done to ensure that the beneficiary of the policy will never run out of money.

Because of the science involved, insurance companies through an annuity can create a private pension account. An annuity may pay out up to twice the amount of standard withdrawals from an investment account, effectively allowing the policy holder to be paid 5%-7% or more of the base amount of the deposit. Meaning that a retiree would receive, $5,000 to $7,000 per year for the rest of their life for the same $100,000 contribution.

Say a retiree has a $1,000,000 in a contribution type retirement plan, in a non-secure investment account and they set it up to withdraw 3.0%, each year they would withdraw, $30,000. If they split that amount and left half in the market and moved half to an annuity, they could be paid $45,000 per year ($15,000 market account + $30,000 annuity). That is a 50% increase in their income for the rest of their life guaranteed by the insurance company.

In today’s world retirement planning is challenging, but using the right tools can take some guess work out and provide some additional security over the long term. Providing retirees with some much needed and deserved peace of mind.

 

REMEMBER:

"The power to make and keep commitments to ourselves is the essence of developing the basic habits of effectiveness." ~Stephen R. Covey

Topics: annuity, retirement income, actuarial science

An Annuity - Why?

Posted by Wendell Brock, MBA, ChFC on Wed, Dec 18, 2013

When talking about annuities, over the years I have met with many people who get a glazed look on their faces and ultimately they throw their hands up and say, “I am so confused”. I will admit that some investments are confusing. But here is one that almost anyone can get their arms around – a retirement income contract, commonly known as an annuity. (Say "an annuity" 10 times really fast!)

annuity definition 500x500

 

When considering the many types of investment vehicles in the market place these days, one should consider a variable annuity.

 

Basically, an annuity is an income contract with an insurance company. You pay the insurance company money, either in a lumpsum or in payments over time. In return the insurance company contracts to pay you an income for a period of time, typically based on a set number of years or until death. (In this way you cannot out live the income benefit.)

Annuities are primarily used for funding retirement income, so they are a long-term savings vehicle. Depending on the annuity contract, the point at which they begin paying the income is up to you.

There are three basic types of annuities: fixed, indexed and variable. A fixed annuity behaves much like a CD (Certificate of Deposit). On the contract anniversary, the insurance company establishes a new interest rate the company will pay over the next twelve months.

The advantage is that the interest earned, growth and dividends compound income tax deferred.

A variable annuity is also an income contract, rather than investing in the fixed assets of the insurance company and receiving a fixed rate of return, you may invest in a combination of sub-accounts.

These sub-accounts behave almost identically to mutual funds. They can have many of the same objectives as investing in mutual funds, such as, US large cap stock, US bonds, non-US stock, non-US bonds, real estate, etc. Some mutual fund companies have created partnerships with insurance companies to offer copy-cat funds inside variable annuities. Most variable annuity contracts also have a fixed account that will work similar a fixed annuity.

All of these accounts grow tax deferred. It’s like having a tax deferred mutual fund. The tax deferral will result in a greater amount of available funds at retirement, which can greatly increase your income.

Because an annuity is a retirement income contract, it is subject to early distribution penalties by the IRS, similar to an IRA. Making a withdrawal before age 59 ½, creates a 10 percent income tax penalty.

And the risk? People rightly associate mutual funds with risk – after all, aren’t they invested in the stock and bond markets? Can’t I lose my money? Yes, but no more than you would in regular mutual funds. That is why investors should be wise in how they are managed. Never invest and leave the money there and forget about it.

This prompts a discussion about the indexed annuities – these annuities are good investment vehicles. One client had much of his retirement money in an indexed annuity before the market meltdown of 2008. Many of his neighbors lost thousands (maybe millions) during that time a few lost their homes. He was just fine, did not lose a nickel as he says.

An indexed annuity pays a fixed rate of return based on the returns of a particular investment index like the S&P 500. If the index goes up the annuity earns a percentage of the amount it increases. So if the index goes up 10 percent, the annuity may earn 6 percent. But when the index drops and goes down below a certain level the account value does not follow it down; the annuity simply earns 0% that period. Many people would rather earn nothing than lose money.

With an indexed annuity you get the upside but not the down side.

Each type of annuity has its place for different investors. You may consider each one for a part of your retirement nest egg.

One thing to be mindful of is the insurance company that is offering the contract. Each one may be a little different and their fees for managing the annuity contract may vary. One annuity contract may charge a low flat monthly fee of as little as $20 and another as much as three percent. It is important to read the information about the contract and ask questions so you understand; don’t end up confused! Do you own an annuity?

Topics: retirement, Annuities, annuity, investments, retirement income

120514_WWBrock_1

Wendell W. Brock, MBA, ChFC

Subscribe by Email

Follow Me

Most Popular Posts

Other Sites I Follow, hobbies, fun and info:

gold-vs-silver-1.jpg  Nauvoo Mint brokerage services for precious metals

 

john Mauldin chair

Note:

Outside Economics is not a registered investment advisory firm (RIA) and does not act as an RIA. Outside Economics does not provide any specific investment advice. Any information obtained from this website or through one of  Outside Economics' representatives should be reviewed by a professional.

Subscribers Note: We do not sell our email list. Period. Thank you for subscribing.

Recent Posts