Category Archives: Retirement Planning

Dealing with topics relevant to retirement needs and approaches to reach long term goals. We aim to help you find ways in which you can reach your goals and make a difference

Guaranteed income at what price? – An introduction to annuities – a tool to provide guaranteed income but not to replace your portfolio

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Retirement planning entails finding ways to cover expenses for the rest of our lives when we ultimately cease or reduce our working income. The goal is to ensure that we don’t outlive our assets, regardless of our longevity. Although Social Security is our best guaranteed income another tool can also provide guaranteed income: Annuities.

 Annuities are a contract that you enter into with a company (an annuity carrier such as an insurance company). You provide the payment and they guarantee a certain amount of ‘income’ for a period of time or for life. This is not the same as purchasing a CD or buying a mutual fund since once the annuity is purchased the assets used for the purchase are no longer yours.

 It is clear that annuities can’t beat a well-diversified portfolio in projected performance but they do provide a guaranteed cash flow that a portfolio can’t provide. For example, when you decide to take a lifetime-income stream from an annuity, you are in essence betting against the annuity carrier that you will live longer than they think you will live. This transfer of risk is the true value proposition of any annuity that is based on guaranteeing a lifetime income. It is therefore most important that we use only the guaranteed aspects of an annuity when deciding its place in a retirement plan. It is equally important that we consider the importance of actual purchasing power for the annuity.

 Annuities come in many flavors but can be classified as either fixed or variable types. These types differ in many ways including how the assets in the annuity will grow and how the benefits will be calculated. Annuities can be purchased with a lump sum (immediate annuities) or with regular contributions (deferred annuities). The benefits are received within a year in the first case and at a much later time in the second. Immediate annuities can be useful to fill a specific role in the very near future that requires a guaranteed income stream. Whereas deferred annuities are used when we want to guarantee income at a later date, like retirement (we find this necessary when Social Security is lacking or missing).

 The tax nature of annuities can differ BUT most annuities today are funded with tax deferred dollars so the gain will be taxed at ordinary tax rates. When planning to receive benefits from an annuity prior to age 59 ½ make sure you let us review it to ensure that the 10% IRS penalty doesn’t apply.

 Although annuities can be a useful tool in certain scenarios, too often unpleasant surprises reveal themselves (to annuity owners) within the fine print. If you’re considering purchasing an annuity talk to us and let’s review the contract before making your purchase.

 There is NEVER a need to RUSH into buying an annuity. Take the time to determine what will be the best way to deploy your assets and use the best available tools before and after retirement. The goal is to meet your specific goals and have your assets last you through your entire retired life.

 

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Tax Season and the Retiree

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Tax Season and the Retiree

There are a lot to contemplate when considering the state in which to retire. Most want to be close to family and friends, the weather to be suitable for them, and what they hope to do in terms of activities.  A consideration this time of year are taxes — one of life’s two certainties and, one often a large expense in retirement.  It is never a good idea to seek out a retirement state based solely on tax burden but it is good to be aware which states fit your plans best for retiement.

So, find out how each state taxes your income and plan accordingly. Also consider how the state taxes your property and your consumption and you might want to consider how it taxes your estate.  That should give you a state tax burden that you’ll need to cover during retirement.

Older Americans who planned for retirement often generate income from several sources during retirement, including income from wages or self-employment; Social Security; pensions; and personal assets, including taxable and tax-deferred accounts. Taxes on those sources of income, mean less money for your care and enjoyment.  But don’t forget state and local property taxes, state and local sales and use taxes. You might pay plenty in property taxes and sales taxes.

Remember, what you save on income taxes in one state you might pay in property taxes or sales taxes. And vice versa. What you save on property and sales taxes in one state you might pay in income taxes – so calculate for your specific retirement situation.

One more note, for those who itemize deductions, there are five types of deductible non-business taxes, including state, local and foreign income taxes; state, local and foreign real estate taxes; state, and local personal property taxes; state and local sales taxes, and qualified motor vehicle taxes.

Your specific tax burden, will depend on whether you can take advantage of these deductions.

The states are listed in order of tax friendliness from an overall tax burden point of view:

1. Alaska:  Alaska doesn’t tax personal income, including Social Security benefits and pension income. And, there’s no state-imposed sales tax. This is not to say that you won’t pay any taxes in Alaska – You’ll pay other types of taxes, such as property taxes.

2. Nevada: This state doesn’t tax income, Social Security benefits or pension income. And its property taxes are reasonable, too. Its sales tax, however, is higher than the national average.

3. South Dakota: The state doesn’t tax individual income, Social Security benefits or pension income. And the overall tax burden is among the lowest in the nation.

4. Wyoming: There’s no individual income tax on Social Security benefits or pension income in Wyoming but property taxes and sales taxes tend to be higher than the national average.

5. Texas: In Texas, there’s no individual income tax. But property and sales taxes tend to be higher than the rest of the nation.

6. Florida: There are plenty of reasons why people choose to retire to the Sunshine state, the low tax burden being among those reasons. There’s no individual income tax on Social Security benefits or pension income with high property and sales taxes.

7. Washington: There’s no individual income tax on Social Security benefits or pension income. But if you plan on spending lots money while in retirement watch out for the high sales tax.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Wealth with meaning – Keys to building wealth

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A healthy work ethic is necessary to becoming wealthy, managing cash flow and savings are at the core of this strategy. But it is an ability to change and adapt that are key to staying wealthy, according to a recent survey by wealth management firm SEI (1).

An overwhelming majority (80%) of wealthy families say hard work was either the most important quality or a very important quality in their achieving financial success. SEI’s report was based on a survey of 100 families with more than $20 million in assets.

An even larger percentage (95%) agreed that innovation—an ability to adapt to changing conditions and reinvent business or financial strategies—is important to staying wealthy from one generation to the next. The results clearly suggest that innovation is important to sustaining wealth over the long-term, but survey respondents were divided on where they expect innovation to come from.

Professional advisors were credited with being the most likely source of innovation by 41%, while 37% say innovation will come from those in business. Thirty-six percent

“Wealthy families are craving new ways of communicating and collaborating with their advisors and new strategies for building and sustaining wealth,” said Michael Farrell, managing director for SEI private wealth management. “After everything that has gone on in recent years, they understand that sometimes it takes a different approach to be successful.”

The most innovation has been in investment products, according to 11% of respondents. However, investment advice was named as the area of wealth management that has seen the least innovation by 14% of respondents, followed by reporting (12%) and education and family communications (11%).

Advice is being tailored to individuals and individual situations rather than being based on just a simple number calculation, and investments are being designed to meet specific lifestyle, retirement and charitable giving objectives. Also, reporting is becoming all-inclusive, including all investments, progress toward goals and any overlap that might exist between portfolios managed by different investment managers.

This is nothing new to a comprehensive, fiduciary wealth practice like Aikapa – this is what we believe in.  Our role is to align our clients with their goal so that they can build and retain wealth that they need for their specific goals.  Total wealth is not as important as sufficient wealth to meet their specific goals.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

How insiders can legally profit from insider information

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 Insight on how company insiders can still profit from insider information

Despite efforts by the Senate and president to reduce profiting from inside information there remain loopholds for corporate insiders that may be useful to those who are observant. Corporate insiders whose companies are about to be bought by rivals are forbidden from buying shares ahead of time to profit from the price jumps that takeover announcements often bring. But they accumulate plenty of shares just the same.
That’s because company managers are often paid partly in stock. Many sell these shares at regular intervals, whether to use the cash for other purposes or to keep their personal assets from becoming too concentrated in a single stock.
For this reason, managers who decline to buy their companies’ shares ahead of takeovers may nonetheless accumulate them if they also halt their typical selling.

Anup Agrawal of the University of Alabama and Tareque Nasser of Kansas State University studied 3,700 takeovers announced between 1988 and 2006. They compared trading in the year before takeover announcements (the “informed period”) with the year before that (the “control period”).  They found that insiders tended to reduce their buying during the informed period, but they reduced their selling even more. The result was an increase in net buying. Over the six months prior to deal announcements, the dollar amount of net purchases for officers and directors at target firms rose 50% relative to ordinary net purchase levels.

This “passive insider trading,” as the authors call it, is legal. But it is profitable? Agrawal and Nasser didn’t look at returns, but a study published a year ago in the Journal of Multinational Financial Management offers clues. Researchers from Australia’s Commonwealth Bank and Deakin University looked at U.S. takeovers between 2001 and 2006. They found that shares of target firms tended to outperform by nearly seven percentage points during the 50 trading days preceding deal announcements.

Nothing illegal in these situation just good old fashion financial planning can yield a net gain if properly structured.

*Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

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*Inspired by “An Insider Trading Loophole Congress Didn’t Close” by Jack Hough | SmartMoney | March 23, 2012

Pershing on creating a common vision

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The key to creating a common vision

Information for this post derived primarily from an Investment News interview with Brian T. Shea, CEO, Pershing, LLC, “The key to creating a common vision,” Jan. 1, 2012: http://www.investmentnews.com/article/20120101/REG/301019997?template=printart

As we reviewed brokerage firms to custody our client assets we landed with two very different brokerage firms that have a similar attitude.  Below is a summary of an interview with the lead at one of these brokerage firms, Pershing.

Brian T. Shea is interviewed often since he became the chief executive of Pershing LLC (in 2010), which, with $910 billion in assets under custody, is the biggest brokerage and clearing firm that most investors have never heard of. Owned by The Bank of New York Mellon Corp., Pershing employs more than 7,000 and provides services to more than 1,500 financial organizations and 100,000 investment professionals.

AIKAPA has considered the usual brokerage firms but has instead decided to custody our client assets at either Pershing or Scottrade – In our evaluation both of these firms provide the most service for the least cost.

Pershing’s Shea believes in creating a leadership environment where people can be successful and where you can get people to work together. The most important thing a leader has to do is create a shared vision, or mission, for the team.  He prides his leadership style as one that emphasizes communication.

The No. 1 person was his father who was an executive in the insurance industry. His father taught him that any profession can be a good profession but we need to do it with a passion every day – I could not agree with him more.

His comments that his father instilled a really strong work ethic in all of his children.

He said that he is really comfortable in an environment where people are open and engaged. He believes that it is really important to surround yourself with people who will share their opinion no matter what — even if they know you won’t like it.

As we move into 2012 we’ll engage more with Pershing as we transfer our clients from their current brokers to either Pershing or Scottrade.  I’m certain that as the year progresses I will be better able to comment on how well his vision translates to what advisers and our clients experience using Pershing to custody assets.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

 

 

Self Employed Individual 401K Plan Loans

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Who said you can’t have your cake and eat it too?

Self employed small business owners have an opportunity to not only save maximally through retirement plans but also build a safety-net through their ability to borrow from their individual 401K accounts.  Properly structured they can borrow from their retirement plan when the need arises without incurring the usual 10% penalty for early withdrawal.

In addition, 401k Loans for the Self employed business owners provides a loan, while allowing them to pay back interest to their own 401K rather than a financial institution.

An Individual 401k loan is permitted using the accumulated balance of the Individual 401k as collateral for the loan. Individual 401k loans are permitted up to 1/2 of the total balance of the 401k (but not exceed $50,000). A loan from an Individual 401k is received tax free and penalty free. There are no penalties or taxes if loan payments are paid on time.

Individual 401K Loans

  1. Can be used for any purpose.
  2. There are no income or credit qualifications to receive the loan.
  3. The monthly loan payments of principal and interest are repaid back into your own Individual 401k – you borrow and grow your retirement at the same time.

In addition, the assets can be from prior employer or IRA accounts that are rolled over to your individual 401K account.

Individual 401k are available to self employed individuals and small business owners with no full time employees other than a spouse. Your business can be a Sole proprietorships, LLC, S and C corporations,

The terms are set by the employer (yourself) but the 401k usually has a 5 year maximum repayment term for most loans, except it can be longer, for home purchase. There are no income or credit qualifications although you must charge yourself a competitive interest rate.

Although simple and fast to execute you  should remember that you are borrowing on your retirement nest egg.  It is only a valid action when you know you will have the ability to pay it back – default results in a withdrawal that can carry a 10% penalty.  The loan facilitates borrowing when it might be too difficult or too expensive to go through banks and lending institutions.

As good as it sounds consider that unlike a mortgage or a home-equity loan, if you use a 401(k) loan to buy or improve your home, you won’t get a tax deduction on the interest you pay. You may have to pay a one-time fee to the plan administrator for the cost of originating a loan; the fee is usually $50-100. Your retirement plan will also miss future targets if you don’t continue making annual contributions while you have this outstanding loan.  Though most self-employed who borrow from their 401K often pay their loans early it is important not to misuse your hard-earned retirement assets.

As can be seen the 401K Loan, like all tools, has advantages in disadvantages.  The advantages for the self employed should  encourage anyone who is or is planning to have their own business to begin saving in a tax deferred manner maximally.  By using an individual 401K account you can have your tax deferred savings and simultaneously build a safety net.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Taxes – Unintended Consequence of Trust on Home Sale

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No Capital Gain Exclusion for Residence that is Held in Family Trust

IRS recent ruling shows unintended consequence of trusts used to hold personal assets. This ruling reminds us that tax rules change after a trust can’t be changed, making trusts sometimes inflexible in dealing with changing tax opportunities.

In this case the sale of a home, in which an individual resided for many years but to which title was legally held by a family trust, did not qualify for the Tax Code’s new capital gains exclusion on the sale of the house. The exclusion would for most home owners provide a $250K per person tax free gain.  The IRS concluded that the individual’s inability to control the assets of the trust prevented her from being deemed an owner of the trust for tax purposes.  The intention was that her largest asset held in a revocable trust would give her ultimate tax advantage while protecting her on the downside – the reality is that if her trust converts to a irrevocable trust she is no longer able to sell her property and obtain the $250K tax free gain.

Family trusts are a common estate planning tool and often place assets, such as a home, into a trust. The income beneficiary has rights to any income from the trust and may even have use of the assets but has no control to sell, mortgage or dispose of the assets of the trust. Since only the trust’s designated trustees have the power to make decisions related to the encumbrance or disposal of the trust’s assets then the IRS deems that the beneficiary has preferential estate tax treatment only if they have the ability to continue living in the home.

Planning for the smooth transition of your assets to your family upon death can be complicated and can have serious tax ramifications. ALWAYS review all tax documents with financial advisor, estate planner and tax advisor.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Dec 15th deadline: Kaiser Permanente Make-Up Payment

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Your Kaiser Retirement: TPMG’s Physician Benefits and Compensation Plan 2 November Make-Up Payment Letter

December 15th is the due date for responding to this letter but the decision is usually reached in late October anticipating the November Plan 2 direct deposit.  This letter addresses an over funding that occurs for some Plan 2 deferred compensation participants.  Kaiser refunds this amount to you and gives you until December 15th to contribute up to this amount in additional Plan 3 contribution.

To help our clients make this annual decision we review their family tax profile, current retirement savings, family goals, family financial exposures, and available cash flow.

It is our experience that the majority our clients select to make a voluntary contribution to Plan 3 of at least some of their Plan 2 make-up payment.

Although this is true for most clients it is not always the right choice for all.  When cash flow is tight, there is low tax liability, or their retirement goal is fully funded we find that clients tend to choose to apply the Plan 2 make-up payment to other wealth building purpose.

If you would like to prepare for next year’s voluntary payment decision reach out to your Wealth Planner.  If you are working with a professional Wealth Planner they should understand your specific situation before they provide advice – only accept fiduciary advice.  Finally, give yourself enough time to evaluate your tradeoffs so that you prioritize and fund all of your family goals.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Raymond James Poorly Managed Elderly client Contractor

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Raymond James Financial Services over will need to pay fines for poorly supervising a former independent contractor because of how he handled the finances of an elderly Texas man and the estate of his deceased wife.*  The elderly couple portfolio included life insurance and variable annuities. It is seldom best to switch from annuities to other investments and back.

The former employee had apparently switched the couple out of their municipal bond portfolio entirely, and put them into high-commission variable annuities and life insurance policies. Without their knowledge, he then moved them from one variable annuity to another, costing the couple large surrender fees and commissions. He also orchestrated loans against the insurance policy and used the proceeds to buy other annuities.

Raymond James previously said that the couple actually turned an $800,000 profit on their investments while the former employee remained at the broker-dealer. The couple willingly followed the employee when he changed jobs and joined LPL in 2006, and brought their accounts with them. Subsequent trading at LPL incurred the losses at the heart of the complaint, the company said. The couple has settled damages with LPL before the arbitration with Raymond James.

“Raymond James continues to believe that the award in this matter is a miscarriage of justice,” according to an email statement from Robert M. Rudnicki, the firm’s vice president and director of litigation. “Raymond James believes the panel erroneously held Raymond James responsible for those losses.”

*Material for this post is mainly from “Appeal Denied: Raymond James Must Pay $1.7 Million to Elderly Investor” by Donna Mitchell, Financial Planning, Dec. 1, 2011

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

 

Fixed Annuities – apply them with care

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Fixed Annuities
– A limited but essential role in some retirement plans

Fixed annuities represent a contract between an individual and an insurance company. Annuities provide a contractual way for an individual to guarantee that he or she receives income for life or for a set period of time. Other liquid financial products like equities, can pay dividends that can be used as retirement income the income is not guaranteed. A fixed annuity will guarantee an individual a stream of income as long as he or she lives or for a set number of years.

Sometimes you can start with Deferred Fixed Annuities

Like all annuities, except those that are immediate, deferred fixed annuities have two phases. The first phase is the accumulation phase. During this phase, which can be as short as a few years or as long as several decades, the annuity owner makes regular deposits into the account. These deposits are known as premiums.

All premiums contributed to a deferred annuity grow tax-deferred which means that the growth income received at retirement will be taxed as ordinary income.

When an annuity owner, who is known as the “annuitant”, decides to have distributions start, the annuity is “annuitized”. This is a critical process that converts it to an immediate annuity and you begin receiving payouts. The distributions can be paid monthly, quarterly or annually, depending on the preferences of the annuitant. An annuitant should think about his or her distribution schedule very carefully, because once it starts, it cannot be changed. An insurance company will also typically let the annuitant choose the length of time over which the distributions are paid. Guaranteed payments can be taken for life or for a specific number of years. This selection will affect the amount of each payment.  Life annuities are the only ones that will give the promised guarantee life long income.  Consider that life long income may not support your current lifestyle particularly in high inflationary periods.

Under current federal tax law, an annuity owner cannot begin taking payouts on a tax-deferred annuity prior to age 59 ½ without incurring a 10% penalty. Any tax-deferred annuity must begin in the year in which the annuitant turns age 70 ½.

What are Immediate Fixed Annuities?

An immediate fixed annuity is funded with a single premium. The premium is typically after-tax money paid as one lump sum. You can also set this up from a mandatory distributions taken on a qualified account. The distributions made by the life insurance company begin immediately, typically within 12 months of the start of the contract.

Immediate Fixed Annuities Pros and Cons

The return % paid on fixed annuity is always fixed. It could change year over year, but once it’s set for the year it will not change regardless of stock market fluctuations. This can be of great help to those on a tight retirement budget unless the market rises and therefore inflation rises. The advantage will be that you’ll know exactly the amount of each payment that will be made. While the rate paid on a fixed annuity could vary from year to year, most insurance companies will guarantee a rate of between 3% and 5%. It’s important to note, however, this guaranteed amount might not be enough to offset any cost of living increase. Inflation is a real and significant threat to retirement savings.  It is best to do immediate annuities when interest rates are high.

You could purchase a COLA (cost of living adjustment) rider that adjusts with inflation to retain some of your future purchasing power. The COLA rider is a costly component of  a fixed annuity contract, but it will increase the amount of money that is paid out each year. The amount should be enough to counteract measured inflationary pressures.  If you can afford the COLA you might consider it or consider leaving a portion of your assets in an equity portfolio so that it growth with the economy and provides a real inflation hedge.

For some, another risk factor associated with a fixed annuity is the premature death of the contract owner. If an annuitant dies before he or she has been repaid the amount he or she paid in premiums, the insurance company will keep the balance. To offset this, most insurance companies now give a guarantee of some sort on the premium.  For example, if the annuitant has an annuity worth $300,000 and dies after having only received $50,000 back, the beneficiary will receive the remaining $250,000. Or, the annuitant can choose an option called “period certain”. If he or she chooses a period of 20 years but dies during year 10, the beneficiary will receive payouts for the remaining 10 years.

I only consider premature death an important risk factor if you have beneficiaries or a legacy you want funded.  Even so, there are other ways to cover this risk factor than to purchase this type of rider – particularly if you still qualify for life insurance.

Who Should Buy Fixed Annuities?

Retired investors who need to guarantee income for life or for a set amount of time are often advised to consider a fixed annuity. Retirees who rely on equity dividends for most of their income may also want to consider a fixed immediate annuity. Dividends can provide substantial income but are not guaranteed. They can be cancelled by the company at any time should it need to conserve cash.

A retired investor may also fear that he or she will outlive the money he or she has saved. An immediate fixed annuity will also provide financial security. The payouts will be guaranteed for as long as the annuitant is alive, regardless of the amount of the premium. Even when the amount of the payouts exceeds the premium, the insurance company is obligated to make the payouts. For those in good health with few liquid assets, a fixed annuity could make a difference in their standard of living BUT they are extremely costly and impossible to exit gracefully if your situation changes.

A fixed annuity investor should always make sure he or she has enough cash for emergencies. As outlined earlier, an annuity contract cannot be cancelled except under the extreme circumstances. Once the contract is signed, the only way an investor can receive his or her money is through the payouts.

Consumers are strongly encouraged to purchase annuities only after a thorough analysis by a NON annuity sales financial professional.  This is a major investment that once signed can’t be undone – read the fine print and understand the nuances and their impact on your entire retirement before you sign.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com