CFP Board eNewsletter
October 2007
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CFP Board eNewsletter |
| Saving for Retirement: Better Late than Never |
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| Getting to Know Annuities |
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| Financial Alerts | |
| Starting Out: Time Is on Your Side |
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| Save Time, Save Money |
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| About This Newsletter |
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| Saving for Retirement: Better Late than Never |
It’s well into the fourth quarter and your team needs a couple of quick touchdowns and a field goal to get back in the game. The key is to retain possession, to adopt a more aggressive style of play without taking too many big risks that could backfire. Time is running out, but you’re still not anywhere near the two-minute warning. So, with the right planning and execution, you could still end up winning. Sounds like a pretty exciting finish to a Monday Night Football game, doesn’t it? It is also a pretty exact description of the situation many forty- and fifty-somethings find themselves in when they get a late start to saving for retirement. The good news is, if you act now you’ve still got time to play catch up — and eventually, to get ahead. The Guidebook to Help Late Savers Prepare for Retirement, available from the National Endowment for Financial Education (NEFE) Web site, provides a comprehensive overview of tips and strategies for retirement savers who come late to the game. "Remember that your investment time horizon is the rest of your life — not your retirement date," the Guidebook states. "This means that, if you are 45 years old today and live to age 90, you have 45 years for your money to grow." The Pension Protection Act of 2006 has made it possible for more of your money to grow. The legislation allows workers over the age of 50 to make additional contributions to their Individual Retirement Accounts (IRAS) and 401(k) plans. This year, for example, the maximum contribution to a 401(k) is $15,500; for individuals aged 50 or older, it is $20,500. In 2008, the maximum contribution to an IRA will be $5,000; for individuals aged 50 or older, it will be $6,000. Maxing out your catch-up contributions — and taking full advantage of any matching funds from your employer — are effective ways to make up lost ground. The Web site of 401khelpcenter.com has a helpful list of frequently asked questions about this savings strategy: "The Basics On Catch-Up Contributions Allowed In 401(k) Plans." There are plenty of other ways to move towards your retirement savings goal. The Guidebook lists a dozen different strategies, and includes worksheets, action steps and references to books and other online resources related to saving. Here are some highlights:
The Guidebook makes clear that there is still a lot you can do to get ready for retirement, even though it’s getting late. There are other online resources that can help with ideas and initiatives, too. "A Late-Starter’s Guide to Saving for Retirement," available on the Web site of online media and direct marketing firm ThirdAge Inc., offers additional tips, as does "Retirement Planning Catch-Up Strategies" on the Web site of the Financial Planning Association. Of course, always consult a qualified professional financial advisor before making any major financial or investment decisions. "If you’re discouraged about what you haven’t done to prepare for retirement, it’s time to stop, review, and take action to create a secure future," the NEFE Guidebook concludes. So huddle up with your financial planner. There’s still time to get back in the game!
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| Getting to Know Annuities |
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Making sure you have enough money for retirement is kind of like going to a tailor to be measured for a new suit. The clothes you need depend on the life you lead. If you plan to be active, you’ll want something a bit loose with room to maneuver; if you plan to kick back and relax, then cotton will do just as well as silk. An annuity — a financial product traditionally designed to provide a tax-deferred sum as the basis for a regular income over a fixed period — can often mean the difference between a retirement fund that fits you comfortably and one that’s too tight. But annuities come in so many different shapes and styles and sizes that consumers are often confused about which one, if any, to buy. So here is a brief shopper’s guide to what annuities are and how they might work for you. Annuities can be purchased from insurance companies and other financial institutions with taxable dollars as well as with funds from a 401(k), an IRA, or other retirement savings account. In return for an initial up-front (and/or on-going) investment, you receive a tax-deferred return, from which you can then receive an income (usually monthly) for a specified amount of time. That amount of time can be a specific number of years, your lifetime, or the joint lifetimes of you and your spouse. With certain types of annuities, your investment is guaranteed to earn a fixed rate of return for as long as the annuity lasts. The amount of money you actually receive will depend on your age, the amount of your original investment, and whatever special provisions you may decide to include in your policy. Once you invest in an annuity, you may be subject to surrender charges and income tax penalties if you access the funds too soon. Usually, an annuity is held until retirement (at least after the age of 59½). Annuities can be divided into four types: fixed or variable, and immediate or deferred. An immediate annuity starts paying out a monthly income right away; a deferred annuity starts paying out at some future time, usually a person’s retirement date. A fixed immediate annuity pays out a specific, or "fixed," amount of money per month based on the amount of the initial deposit, the guaranteed interest rate, and the payout period or life expectancy (or a combination of both). In a fixed deferred annuity, your money accumulates in the same way but you start taking the payouts at a later date. In a variable deferred annuity, your money accumulates based on the sub-accounts you choose, in much the same way as a 401(k) plan, but typically with no guarantees. The future payout of a variable deferred annuity varies based on the investment results of your sub-accounts, which you can change at any time. Both variable deferred and variable immediate annuities can also have a fixed payout, though, if a special provision (discussed below) is added to the policy. Here is more detail on how the different types of annuities work. Fixed Annuities "A fixed immediate annuity provides a guaranteed income for a certain period," says Herbert K. Daroff, CFP®, an annuity specialist with Baystate Financial Planning in Boston, Mass. "You invest an initial amount up front, and the annuity immediately pays you a specified monthly income for a specified amount of time, say 10 years. If you live longer than 10 years, you’re out of luck — the payments stop after 10 years. That’s the risk you take. As a result, most people take a life annuity, but that too has risks." One such risk is dying before you can claim the full amount of your annuity. If you die two years into a life annuity, for example, the unclaimed funds could end up going to the company that sold you the policy. One way to minimize the risk of that possibility is through a variable annuity combined with a guaranteed withdrawal benefit (GWB) to ensure that you or your heirs get back at least as much as you put in. Another way to address the risks of outliving your money or dying before you can claim it all, Daroff suggests, is through a "continuous and certain" (C&C) annuity. "If you take out a C&C annuity for 10 years," Daroff explains, "you receive a monthly income for that period. But if you live longer than 10 years, you continue to receive the monthly income until you die. (That’s the ‘continuous’ part.) If, however, you die before the ten years are up, your designated beneficiary will continue to receive the monthly income until the end of the tenth year. (That’s the ‘certain’ part.)" If you want a high degree of continuity and certainty in retirement, then a C&C might be worth looking into. In a fixed deferred annuity, the monthly payments are postponed until some time in the future, normally on or about a person’s retirement date. "The advantage of a fixed deferred annuity," says Daroff, "is that you are able to put away money today and have it grow tax-free until you need to take it out. The problem is, we have some of the lowest interest rates in history. That means you risk locking away your money at a low rate of return, and having inflation eat away at your purchasing power." Investors are rightly concerned about losing the money they initially invest, known as their "principal." As the disclaimer on every investment prospectus reads: The value of your investments can go up as well as down. But another risk, one that is especially acute for people saving over the long term for retirement, is the loss of "purchasing power," or how much you can actually buy with your money. Inflation is the biggest enemy of purchasing power. If, for example, you have a fixed deferred annuity growing at 4% while inflation is running at 2%, you are really only getting a meager 2% return on your investment. Price increases due to inflation eat away the other 2%. The result: Over time, you can buy less and less with your money. This is a risk to beware of when thinking about annuities. "Most people fear losing their principal," Daroff says, "but their biggest concern should be losing their purchasing power." Variable Annuities A variable deferred annuity has the same tax advantage as a fixed deferred annuity: Your money grows tax-free, until you take it out. When you do decide to start taking income, the monthly amount will vary based on the performance of the underlying investments. "With variable annuities, your income depends on how your investments are doing," Daroff says. "But there are ways to benefit from the higher potential for growth while also protecting yourself against the risk of a downturn in the market." One way to build in some extra security is through a guaranteed minimum income benefit (GMIB). With a fixed annuity, you lock in an income ceiling. If you fix the interest rate at 6%, then that is the highest rate you will earn, even if the stock market soars. "A variable deferred annuity with GMIB locks in a floor of income instead of a ceiling," Daroff explains. "If you’ve locked in an interest rate of 6%, then that is your minimum return. But if your investments earn 8%, then you can lock in future monthly payments at that highest anniversary value." Say, for example, that you are 50 years old and have invested $100,000 in a variable deferred annuity with GMIB at a rate of 6%. In 2019, when you’re 62 and ready to retire, your annuity will have doubled in value to $200,000. But say that after a couple of good years on the market, the annuity peaks in value at $250,000 in 2015. The GMIB allows you to base your monthly income on $250,000 rather than $200,000. Let’s take a less rosy scenario. Say, for example, that after a downturn in the market, your portfolio is worth just $150,000 in 2019 when you’re ready to retire. The GMIB still allows you to base your monthly income on the guaranteed figure of $200,000, even though your investments did not end up performing that well. "The GMIB is a risk-management tool," Daroff says, "and an attractive alternative for investors who are risk-adverse." Because of this risk-management feature, though, annuities with a GMIB are more expensive than other types of annuities. If you are looking for income sooner rather than later, and want to take advantage of greater opportunities for growth, then a variable immediate annuity might be worth investigating. Your monthly income will still depend, however, on the performance of your investments. That’s why Daroff often recommends a GMIB with variable immediate annuities as well. "This generates income immediately," he says, "but still has the upside of protecting you against a market downturn. It gives you a fixed floor, below which your income cannot fall, and the ceiling is as high as the market can go." As even this brief overview makes clear, annuities are extremely complex products. That’s why it is crucial to seek advice from a qualified professional financial advisor before deciding whether to purchase one. If you do decide that an annuity is right for you, Daroff suggests treating your policy the same way that you would treat delivery of a new car. "If you ordered leather seats," he says, "make sure the seats are actually leather, and not cloth, before you drive the car away. Read the annuity contract carefully to ensure that the provisions you agreed on are actually there. The most important thing is to make a well-informed decision." In other words, make sure your annuity is tailored to your needs — and that it fits you to a T! Online Resources If you want to find out more about variable annuities, the Web site of the U.S. Securities and Exchange Commission (SEC) has a comprehensive overview called "Variable Annuities: What You Should Know". The Actuarial Foundation and the Women’s Institute for a Secure Retirement (WISER) have collaborated to produce the booklet, Making Your Money Last for a Lifetime: Why You Need to Know About Annuities, which details the ins and outs of immediate annuities. The Web site of AnnuityShopper.com features an Immediate Annuity Calculator, which provides free online quotes and links to insurance companies and other financial institutions that sell annuities. If you want to be sure you’re dealing with a reputable and properly credentialed broker, the SEC site also features "Protect Your Money: Check Out Brokers and Investment Advisers," which enables you to research individual brokers or firms and provides tips for evaluating investment advisers. The Web site of the Financial Industry Regulatory Authority (FINRA) offers a similar tool: "Check the Background of Your Investment Professional."
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| Financial Alerts |
Deceptive Mortgage Ads: What They Say; What They Leave Out If you’re hoping to buy a home or refinance your current mortgage loan, the Federal Trade Commission (FTC) strongly suggests you pay careful attention to what is stated by advertisements that offer low rates – and what the ads don’t state. Whether you see tempting ads on the Internet or in a newspaper, some use creative phrases that don’t clearly disclose the true terms of the offer. Learn how to interpret these flawed ads at: www.ftc.gov/bcp/edu/pubs/consumer/alerts/alt023.shtm 51 Ways to Save Hundreds on Loans and Credit Cards The Federal Deposit Insurance Corporation (FDIC) invites you to learn about different ways to utilize loans and credit cards to your benefit at the lowest possible costs. Get practical tips on topics from taking control of your credit cards and loans to saving money to help your small business grow, and read about simple strategies for cutting loan and credit card costs and keeping yourself from falling prey to scams. Learn more at: www.fdic.gov/consumers/consumer/news/cnsum07/index.html Life Insurance: Securing Your Family's Financial Future in Case of Unexpected Death A recent study conducted for the National Association of Insurance Commissioners (NAIC) has shown that in more than 50 percent of young families, both spouses have no life insurance they have purchased on their own. Because improper planning for unexpected life events such as a death in the family could leave survivors in financial turmoil, NAIC recommends looking at your financial situation and family composition and determining what your life insurance needs are. Learn more about how much life insurance you may need, how to identify the right policy type, what to consider before purchasing life insurance, and much more at: www.naic.org/documents/consumer_alert_life_insurance.htm Read more financial alerts.
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| Starting Out: Time Is on Your Side |
When you’re just beginning to earn a regular paycheck, saving for future goals is often the last thing on your mind. Saving for retirement may not even have crossed your mind. But when there’s a long stretch of time between your present situation and a future goal, it’s the best time to take action. Get an early start, and you can help your money grow by taking advantage of the time on your side. Investing savings for a long period of time in an account or investment product that generates interest gives you the advantage of compounding. With compounding, you earn interest on the money you originally invested, and as that interest is added to your other savings, you also begin to earn interest on that paid interest. As time goes on and paid interest accumulates, compounding can cause your savings to increase dramatically. Say you have $1,000 to invest and can leave it invested at a 4% rate of return. After 10 years, your investment will be worth $1,481. If you can leave that same investment for 30 years at the same 4% rate of return, you’ll have more than twice that amount: $3,243. If your investment produces a higher rate of return, the effect of time is even more dramatic.
If you manage to double your rate of return from 4% to 8%, the value of your investment after 30 years is three times what you would have accumulated with a 4% return. So, for every ten years you delay before starting to save, you will need to save almost three times as much each month to catch up. Even if you are able to save only a small amount, putting that savings away now can let you take advantage of compounding and help you reach your goal without the strain of last-minute efforts to establish an aggressive savings plan later in life.
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| Save Time, Save Money |
For money that is set aside and left to grow, time is its best friend. But let time slip by, and a future goal can be whittled down to a missed opportunity. Procrastination isn’t the only way we lose valuable time – there are also interruptions and distractions that can drain minutes and hours away. And there are tools that can show you the value of your time and resources that can help you hold on to your valuable time. Estimating the financial value of your time seems like an easy thing, especially if you’re paid hourly or charge an hourly rate to clients. If you’re on salary and know your annual income, it’s also easy to divide that amount by the number of hours you’ll work in a year (approximately 2000 hours per year for a 40-hour week) and come up with a similar number. Those numbers show you the estimated worth of one of your working hours. But as hard as you may work, you also spend time on other activities not directly tied to your paycheck. Your non-work hours have value, too, even if they aren’t contributing directly to your paycheck. The Time Value Calculator on the MSN Money Web site was designed to give you an estimate of the value of your leisure time. After you’ve taken out some of the costs related to work, and after you’ve taken a look at how many non-work hours can be considered leisure time, the calculator will show you an estimate of the financial value of each leisure hour. It also displays how many hours you work to obtain each of those precious leisure hours. Knowing the value of your time can help you make decisions about whether it makes sense to hire assistance for certain projects – if the assistance will cost you less than the value of the leisure hours it would take you to do the project yourself, you may benefit from paying someone to do it for you. Not all hours are made the same. When you do have time to focus on an activity you enjoy, it feels wonderful to put your full focus on that activity and get it done to your complete satisfaction. But in today’s fast-paced world, you’re likely to run into distractions. Even after a distraction ends, it may take some time to get back to your activity. A study conducted by researchers at the University of California, Irvine found that their subjects experienced frequent interruptions in the workplace, and the average time taken to resume a previously-interrupted task was around 25 minutes. If you know the value of your time, you’ll be aware of how much those interrupted minutes can cost. And it often doesn’t take much of an interruption to break someone’s attention – even something as simple a phone call or a pile of paperwork waiting to be sorted. While you can’t control all interruptions, there are some easy ways to reduce some of the unwanted distractions that can keep you from doing what you enjoy. Reduce telemarketing calls: The national Do Not Call registry allows you to avoid many unsolicited telemarketing calls. Although it won’t stop all calls (charities, political organizations and companies with which you have established business relationships are not covered by the registry), it may cut them down dramatically. To put your phone number on the Do Not Call registry, call 888-382-1222 or visit www.donotcall.gov. Reduce credit and insurance offers: Many of us come home each day to mailboxes stuffed with offers for “pre-approved” or “pre-screened” credit or insurance offers. Many of these offers are based on information and lists supplied by some of the major consumer credit reporting companies, and those companies have coordinated a way to opt out of those lists. Call 888-567-8688 or visit www.optoutprescreen.com to request an end to many unwanted credit and insurance offers. Reduce junk mail: If sorting through your mailbox is a chore and you’re tired of recycling unwanted mail that you wish hadn’t been sent to you in the first place, you can save time by opting out of direct-mail marketing. The Direct Marketing Association allows people to register to opt out of direct-mail marketing from many national companies. This opt-out registration requires a $1 payment, and it can be completed online at www.dmachoice.org/MPS. Time is a precious commodity. Being aware of the financial value of your time can help you spend your hours more wisely and focus them on the things that bring real satisfaction to you and your loved ones.
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| About This eNewsletter |
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CFP Board's "It's Your Turn" eNewsletter is sent monthly to those who have subscribed through CFP Board's Web site, www.CFP.net/learn. CFP Board exists to make people aware of the benefits of financial planning and to encourage people to seek out individuals who can help them apply the financial planning process to improve their financial lives. This eNewsletter is designed to provide information about financial planning, financial planning tools and resources, consumer alerts and more. Suggestions and feedback are welcome at mail@CFPBoard.org.
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