Can You Retire Early? The Key Things You Need to Consider

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Wanting to retire early is relatively common. Even if your goal was to stick it out until 67, your circumstances may have changed, or you might feel different about work than you did a couple of years ago.

And that’s OK. We speak to lots of people who are in the same scenario – looking for a viable way out that won’t jeopardize their quality of life in retirement.

In this guide, we’ll take you through the process of early retirement, including how it works, what to consider, and whether it’s the best option for you.

You can watch the video on this topic above, or to listen to the podcast episode, hit play below. Or you can read on for more…

Why do some people want to retire early?

There are lots of reasons why you might be considering early retirement. You may be feeling stressed and exhausted at work or have a new boss that you don’t get along with.

A wish to retire early isn’t always based on negative aspects of work, either. You may want to spend more time with your grandkids or start that round-the-world trip a few years earlier than you planned.

The question is: can you make it happen without endangering your financial freedom in retirement?

Retiring early – what it looks like and how it works

Retiring early may be something you can think about, but it does all depend on your finances and assets.

To show you how retiring early works, we’ve put together a detailed example which covers our process and all the things you’ll need to consider. But before we get on to that, allow us to introduce our character for this particular scenario, Cindy.

Cindy is 62 and looking to retire. She had planned to work until social security starts at 67, but she’s no longer happy in her job and wants to call it a day.

Does that sound familiar? Many of our clients are in a similar situation, so we thought it would be useful to look at whether Cindy could take early retirement.

Finances and spending

First, we need to get a picture of Cindy’s finances, assets, and spending. We want to find out:

  • Does she have any savings?
  • Does she have a pension?
  • Does she have any other forms of income?
  • What is her spending plan, and how much money will she need in retirement?

In Cindy’s case, it turns out she doesn’t have a pension or any other forms of income. But she does have a healthy savings pot, with about $1.1 million in a 401k.

She’s also projected to receive $3,000 a month in social security at 67, so that’s a good source of income to include in her retirement plan.

But what about her spending? Well, Cindy needs around $5,000 a month to cover both her essential needs and her “wants”. That could be money to spend on her grandchildren or to put towards regular vacations.

From here, we can create Cindy’s retirement income plan. This is a detailed document that sets out how she’ll use her money and how far it will stretch in retirement.

Creating a retirement income plan

Until you know what your finances will look like in retirement, it can be difficult to plan ahead and look forward to finishing work. That’s where a retirement income plan comes in.

After talking through Cindy’s finances, we’re now in a position to create her bespoke retirement income plan. To do this, we use specialist software that allows us to input all her information and make quick changes – like her chosen retirement age.

Let’s say Cindy already had an income plan which was set up for a retirement age of 67. By changing it to 62, this will affect the numbers and how much money Cindy has in leftover assets.

When creating a retirement income plan, it’s important to account for a person’s entire life – regardless of existing medical conditions or other factors. That’s why we calculate retirement assets up to age 90.

Based on Cindy’s circumstances and projected spending ($5,000 a month), this would leave her with only $100,000 at 90 if she were to retire at 62. For us, that’s not a reasonable enough buffer to say, “yes, you can retire right now”.

The problem with Cindy’s situation is that she’s too reliant on her savings assets. Even with $3,000 a month in social security (which doesn’t start for another five years), she’s drawing a lot from her savings pot each month to get by.

It’s impossible to predict what unexpected costs our retirement years will bring. That’s why Cindy’s $100,000 isn’t adequate for us to confidently say that now is the right time to retire.

And there are other things to consider too, like the cost of inflation. The inflation rate may be low at the moment, but history tells us that the average is around 3% – so that’s the figure we use when projecting retirement income and expenditure.

Consider that Cindy’s average monthly spending is around $5,000. Taking the 3% inflation rate into account, that rises to $6,800 by the time she turns 72, and over $9,000 when she’s in her 80s – meaning she be could be using more and more of her savings in later life.

What are the options?

This might sound like bad news for Cindy, but there are a few things we’d recommend.

First, she could wait it out for a couple more years. This would reduce her reliance on savings in the years before receiving social security, but it wouldn’t solve the problem of feeling dissatisfied at work.

Second, Cindy could look to reduce her spending. Again, this would reduce the draw on her assets, but it’s not ideal if she’s been looking forward to a retirement free from financial worries.

The third option, and one we’d recommend, is for Cindy to look at alternate income streams. Is there anything she’s always wanted to do that would pay an income, even if it means taking a significant pay cut compared to her current job?

Whether it’s selling artwork or becoming a part-time gardener, Cindy could quit her job and still earn income elsewhere. This would protect her savings and give her a greater safety net in later life.

Say, for example, she started a new part-time position which brought her $3,000 a month in regular income. This would be of huge benefit to her retirement income plan, even if she only did it for a few years until social security kicks in.

A final word on early retirement

Taking early retirement can feel like the only way out when you’re through with work and ready to put your feet up. But often, having the security of knowing what your finances will look like in retirement is enough to get you through those final years.

Having seen their retirement income plan, many of our clients reconsider early retirement. It changes their mentality towards work, showing them that there is a light at the end of the tunnel.

That’s not to say you shouldn’t retire early if your finances allow. But if you’re concerned that doing so might jeopardize your financial freedom, we would encourage you to get a retirement income plan and find out how you’re set for the future.

If you’re ready to take control of your finances, we can help you create a bespoke retirement income plan that puts your money into perspective. Remember, if you need any advice or expertise, our financial specialists are here to help. Book a complimentary 15-minute call with a member of our team to discuss your retirement goals today.

Reverse Mortgages Explained

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Reverse mortgages are a hot topic among retirees. Some retirees want to have access to a reverse mortgage for financial security, while others are still unsure of how they feel because of some of the practices in the industry in the 60s, 70s and 80s that gave these types of mortgages a bad name.

If you’re considering a reverse mortgage, it’s important to know what these mortgages offer you, their benefits and your obligations when taking out a reverse mortgage.

Traditional vs Reverse Mortgage

A traditional mortgage is what you likely used when you purchased your home. You’ll go through a mortgage company that has a lien on your home and will have to pay the mortgage note for 15, 20 or 30 years (terms can vary).

When you make a payment, you’ll be paying down your principal and interest.

Reverse mortgages are different because there are no payment obligations, but there will be a lien against the property. The loan will be paid at some time in the future where interest and principal are repaid, but the loan has no monthly obligation.

Since a reverse mortgage is only allowed for someone 62 or older, the lender often only recuperates their money when the last borrower passes away and the home is sold.

Reverse Mortgage Example

Confused?

Let’s look at an example:

  • You own a $500,000 home.
  • You own the home outright and no longer have a mortgage.
  • You want to take money out of the home through a reverse mortgage.

In this scenario, you’ll typically opt to take out money via a line of credit. You’ll likely be able to take out $275,000 if you’re 70 years old. You can take money out of this line of credit where the repayment is made at some time in the future.

With a reverse mortgage line of credit, there’s no repayment obligation, and these lines of credit cannot be:

  • Frozen
  • Reduced
  • Cancelled

A reverse mortgage line of credit can only be cancelled if the borrower doesn’t meet their obligations. During COVID-19, a lot of home equity lines of credit were frozen, leaving a lot of older homeowners unable to access money that could have potentially helped them navigate the pandemic.

Scenarios Where a Reverse Mortgage Makes Sense

A lot of people choose to do a reverse mortgage when they’re in retirement and still have a mortgage payment to make. The mortgage payment causes a cash flow problem, which causes a lot of people to take out a reverse mortgage to free up some cash.

Other people want to create a new source of income, while others open a line of credit for when they need long-term care insurance. Need to make a down payment for a continuous care retirement community? A reverse mortgage can help you generate the cash to make this payment.

There are also others that want to downsize, so they’ll use this mortgage to make a second or vacation home purchase.

Using the previous example, let’s say that you a $500,000 home and want to take $200,000 out for the down payment on a continuous care retirement community buy-in with the expectation that you’ll be able to move into the community in two years.

So, in two years, you’re able to move in and take out $200,000 in a reverse mortgage line of credit,

What happens?

  • Closing costs were rolled in.
  • Interest accrued for two years.
  • Loan balance is $240,000.

If the home is sold for $500,000, you would have net proceeds of $260,000 leftover. The sale of the house pays off the reverse mortgage, which doesn’t require any payments during the two-year period.

Baby Boomers Transitioning Into New Homes

Over a million baby boomers have decided to transition into a new home. The transition may be because the homeowner wants to:

  • Avoid having to do maintenance and move into a retirement community.
  • Downsize because their home is too big for them now.

A reverse mortgage can also be used in this scenario. The homebuyer can choose to use a reverse mortgage to invest money or to pay for the down payment for the new home. You can also opt to use the reverse mortgage money as a down payment, move into the retirement home and then sell off the other property to repay the reverse mortgage.

There are a lot of options to use the reverse mortgage to make money.

Now, when you’re reaching end of life and pass away, what happens to your heirs? Your heirs will have to pay the loan balance. Traditionally, the home’s appreciation will outpace the reverse mortgage loan balance interest growth.

The heirs would sell the home at the appreciated value and pay off the reverse mortgage.

Let’s assume that over a 10-year period, the home’s value rose $80,000. The loan value will, in most cases, rise less than this amount, allowing the heirs to sell the home with a net profit.

Using a Reverse Mortgage for Cash Flow When You Have Investments

COVID-19 is a prime example of when investors can use a reverse mortgage line of credit when the market’s conditions aren’t optimal. At the start of the pandemic when the markets dipped, a lot of people relied on their reverse mortgage because it’s:

  • Tax-free
  • Doesn’t require the sale of assets
  • Made more sense to use at the time

You don’t want to sell when the market is on a dip because you’ll be losing money. Instead, a lot of people used their reverse mortgage to allow the market to rebound before selling off the investments you have.

If you need $500 a month to pay your bills, you can draw from the line of credit much like an annuity.

#1 Misconception About A Reverse Mortgage

If you’re considering a reverse mortgage, the largest misconception is that the bank now owns the home. You still own your home, but the reverse mortgage lender has a lien on the home that allows them to be repaid when the home is sold.

Practices in the 60s through 80s did foster this misconception, but times have changed for the better.

Once you sell the home, you will receive 100% equity you have in the home minus the reverse mortgage repayment. So, once the reverse mortgage is repaid, you or your heirs will receive all of the remaining equity.

Can the Home Be Underwater?

No. The loans are backed by the FHA and insured for the borrowers and their heirs. For example, if a market collapse occurred and your $500,000 home is now worth $200,000 and your reverse mortgage was $300,000, you or your heirs would:

  • Sell the home for $200,000
  • Repay the $200,000
  • Not have to repay the remaining $100,000 balance

Essentially, your heirs would not be inheriting a debt that they cannot afford to repay with a home that has a reverse mortgage.

The heirs nor the estate would have to repay any excess debt beyond the price of the home at the market value at the time of sale of the home.

Steps to Taking Out a Reverse Mortgage

If you’re thinking about a reverse mortgage, you should sit down with a local representative of a reverse mortgage broker who can discuss your goals with you. Local representatives can see where you live and better understand what your needs are.

Local loan officers can run calculations to see if a reverse mortgage is a good option for you.

Counselors will request a meeting with you, which lasts about an hour, and ensures that the loan officer walked you through all of the steps in the mortgage process. If you decide the mortgage is a good option for you, an appraisal is done, and then closing takes about 30 days to complete.

Your money is then available for you to access after closing.

When you meet with a counselor, they do not have an opinion on the mortgage. Instead, the counselor answers all of your questions and provides you with all of the fine details relating to the reverse mortgage. These individuals make sure that you understand a reverse mortgage 100%.

Credit history is considered, but the lender wants to reduce the risk that you’ll go into default rather than make sure you have a high credit score.

A lot of homeowners want to enjoy a better retirement, and a reverse mortgage can help fund this goal. Yes, your heirs will not receive the full value of the home because the mortgage needs to be repaid, but you’ll be able to enjoy a better retirement.

And a lot of children are happy with their parent’s decision to take money out of their home to fund the retirement that they envisioned.

If you want more information about preparing your finances for the future or retirement, check out our complimentary Master Class, ‘3 Steps to Secure Your Retirement’. 

 In this class, we teach you the steps you need to take to secure your dream retirement. Get the complimentary Master Class here.

Continuous Care Retirement Community – Understanding Your Options

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Becoming a member of a continuous care retirement community (CCRC) is something people nearing retirement should be considering. These communities are often called life plan communities because you’re making a decision today for your future living and healthcare needs.

What is a Continuous Care Retirement Community?

A CCRC is a community that you enter when you’re still in good health but getting older. The idea is that you join these communities and effectively secure your spot as your care needs increase.

Perhaps you’re in the community for 10 years, but then your hips or knees continue to get a little worse, and you could use some additional care.

As a member of the community, you would be able to secure one of these care spots as they become available so that you can get the care you need. You’ll have peace of mind that as a resident, you can be confident that your care needs will be met for life.

5 CCRCs Contract Types

1. Extensive

An extensive contract has a higher upfront price, but no matter your care needs, the costs never increase. You’ll be buying into a contract, and you can be confident that your costs will remain the same despite potentially increasing medical concerns and needs.

2. Modified

A modified contract has an entrance fee, which is typically smaller than an extensive contract, but the costs will change as your care needs change. So, if you need a skilled nurse, you will have to pay for the care.

The care may be offered at a discounted rate, or you may receive a certain number of care days for free each year.

The modified contract does have an upfront cost, but you will risk potentially higher medical costs as you age.

3. Fee for service

This contract has an entrance fee, but it’s typically cheaper. This option allows you to secure your CCRC, but you will pay a standard fee for any service that you do need.

4. Equity

An equity share is a very important type of CCRC because you’ll actually purchase the property in which you reside. The equity share differs from a contract because you own the property, which will then become an asset.

5. Rental

As a rental, you’ll rent the home, and care may or may not be provided to you. This option is the most affordable, but you’re also taking a major risk because there may or may not be care available when you need it.

One of the things that is important to understand is that all of these options have risks. If you pay more, you reduce your risk in most cases. High upfront costs allow you to have the comfort in knowing that your risks are rather low.

For most people, they’ll often choose:

  • Modified
  • Fee for service

Rental properties are also rising in popularity, as people are considering their options when retiring.

Wait Lists and Continuous Care Retirement Communities

Every community has a different commitment to join a wait list for a community. The population is getting older and living longer, so the demand for CCRCs is very high. Joining one of these lists will vary from community to community, but it will typically require:

  • Application
  • Deposit

The deposits are often refundable or will go to your costs if you do decide to join a community in the future.

With waitlists being long, it’s important to consider joining one as soon as possible. The waitlist can be years – sometimes 4 to 5 years. It’s worth considering joining a waitlist early, especially when you’re in good health, so that you can secure a spot if you want to join in the future.

Good Health and Qualifying for a CCRC

A continuous care retirement community will often recommend joining when you’re in good health. The term “good health” can be subjective. What usually occurs is that when you’re ready to join a community, you’ll be asked to have an exam to better understand what your health needs are today.

Communities are only able to provide a certain level of care, and they safeguard members by ensuring that their care needs can be met.

As a general rule of thumb, if you can live independently, you’re in good health.

Members may be able to join a community if they need assisted living or skilled nursing. Each community is different, so it’s important to ask the community upfront what options are available for new members.

CCRCs are built to help independent members, those that pay a lot upfront, if they have medical issues. A lot of CCRCs don’t allow people that are not independent to join because the commitment is to the independent individuals that joined the community when they’re healthy.

When Should You Join the Community?

A CCRC is a community that you can join and be amongst like minded people. While a lot of members are over 70, this figure is starting to come down. Many communities have a minimum age of 62.

When it comes to couples, one person may be older than the other, and this can cause some conflicts. There is often a lower age requirement for one spouse, but it’s only a few years, making it difficult for couples to enter into a CCRC.

Some people join waitlists in their 50s in preparation that they’ll have a spot available in the community when they need it.

Understanding Entrance and Monthly Fees

A continuous care retirement community will often have an entrance fee and a monthly fee. The entrance fee is sort of like an insurance that allows you to become a part of the community. This fee will have some potential medical costs rolled into it.

The monthly fee is for all of the additional perks, such as:

  • Meal plan
  • Housekeeping
  • Utilities
  • Amenities
  • Fitness center
  • Classes
  • Transportation 
  • Maintenance, etc.

Monthly fees cover virtually everything with the exception of Internet. The monthly service fee at a CCRC covers everything so that you can relax and not worry about fixing a roof or mowing the lawn.

Specific Situations Within a CCRC

CCRCs have had to adapt with the times. There was a time when everything was standard, and meal plans couldn’t be adapted based on a person’s dietary needs or desires. Today, a lot of these retirement communities are offering made-to-order meals to adhere to the dietary differences of their members.

In addition to food concerns, another concern is how the fee structure may be different for couples when one is healthy, and one has higher care needs.

If a community can serve these individuals, they’ll often work with you. Members are different because if they enter as an independent, these communities understand that one individual may have more needs, while others don’t.

One spouse would move into the assisted living while one remains in independent living.

There are also options where an outside agency may send someone to care for the spouse so that the couple can stay together for longer.

A continuous care retirement community is a great option for anyone that wants to cover their bases as they age and grow older in a community that is more like a resort than a traditional retirement home. If you need additional care in the future, the CCRC can offer you the care you need at a place that you’ve long called home.

If you want more information about preparing your finances for the future or retirement, check out our complimentary Master Class, ‘3 Steps to Secure Your Retirement’. 

 In this class, we teach you the steps you need to take to secure your dream retirement. Get the complimentary Master Class here.

2021 Tax Deductions and Tips

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Tax professionals offer the best option for learning about 2021 tax updates. A good CPA can provide you with updates that can affect you when filing your taxes and can hopefully reduce the taxes you owe or increase the refund you’re owed.  Here are some suggestions from a CPA that we know and trust.

2021 Tax Updates You May Have Overlooked

Charitable Tax Deductions

Charity tax deductions are still available, allowing you to take advantage of giving away some of your money. One of the main differences this year is that you’ll need to itemize your charitable tax deduction, which is an unexpected change for a lot of people.

You can deduct at least $300 for an individual or $600 for a couple.

Itemizing your deductions only makes sense when you have more than the standard deduction of $12,500 or $25,000 for couples. For example, it makes more sense not to itemize your deductions when the itemized deduction comes out to less than the standard deduction.

Straight donations are mostly the same, so it’s important to get a receipt. You should be itemizing deductions to really leverage straight deductions which may include:

  • Cleaning out your attic
  • Donating items to Goodwill or another charity

When you’re donating to charity, you can donate up to 60% of your adjusted gross income for tax purposes. Most individuals will not hit this threshold because it’s high, but it is something high net worth individuals may want to think about.

Bonus: Qualified Charitable Distributions (QCDs) are for people older than 70.5, and it allows you to take money out of your IRA and donate directly to charity. This can be done on top of your standard deduction and must be made out directly to the charity. When you do this, you’re not taxed on the withdrawal and you can deduct the donation on your taxes to offer a double benefit to you.

Medical Deductions

When you’re older, closer to retirement or have had to pay for medical procedures in the past year, medical deductions are something that you should be considering. A lot of medical deductions can be made:

  • Insurance
  • Prescriptions
  • Direct doctor costs

If you have a major deduction, you may want to itemize to leverage these deductions. The $12,500 or $25,000 deduction will need to be considered because there’s really no reason to itemize if you’re not trying to deduct higher than this amount.

Reaching a high enough threshold to itemize your medical deductions is often only possible when you’ve had major medical procedures performed. A few of the procedures that may be included are:

  • Dental implants
  • Nursing care
  • Other major issues

Earned Income Tax Credit

The earned income tax credit is based on how much you earn and how many qualifying children that you have. You need to be between 25 and 65 years old and have qualified earned income. A person must earn $16,000 as a single person or $22,000 as a couple to maximize this credit.

When you hit $51,500 as a single person and $57,500 as a couple, this is when the earned income tax credit starts to really phase out for you.

If you have no children, you can expect up to $543, and with three children, $6,700.

Child Tax Credit

A $2,000 tax credit is given to a qualified child between the age of 0 and 16. Once they hit 17 and older, this credit drops to $500, which is quite a jump. The year that the child turns 17, the credit is lowered.

There is also an income threshold for this credit:

  • $200,000 for a single person
  • $400,000 for a couple

Home Office Deductions

A lot of people are working from home this year. COVID has changed a lot of people’s working situations, and there are a lot of questions surrounding home office deductions. Employees that receive a W2 are no longer able to deduct their home offices.

Business owners can write off their home office if it remains their primary place of business.

You can deduct $5 per square foot, or you can itemize your deductions. The itemization is only beneficial if you can deduct more than the square foot value of your office. Remember to keep receipts on all of your expenses from your home office to ensure that you can maximize your deductions and have proof of your expenditures.

If you only work from your home office once or twice a week, you won’t be able to claim this deduction because it’s not your principal place of business if you’re working more days per week outside of your home.

Unemployment Benefits and Your Taxes

All of your unemployment income is viewed as wages. The income is reported on a 1099G, which you will use to claim all of these benefits on your taxes.

Bonus: Stimulus Check and Claiming It as Income

You do not need to claim your stimulus check on your tax return.

Tips When Thinking About Your 2021 Taxes

A few of the tips that we want you to know about when thinking about your taxes in 2021 are:

  • Financial management to manage your portfolio can help you leverage capital gains rates at the current rate.
  • Employee benefits should be managed, such as HSA, 401(k) and other options. Maximize your 401(k) and consider an HSA to use for your health expenses. The HSA can be funded and grow, and by the age of 65, you can take out the money while enjoying tax benefits. Otherwise, the HSA withdrawals all need to be medical related.
  • Review federal withholdings early in the year to ensure that your withholdings are proper. Recent changes to the withholding rate have left many people paying more at the end of the year than they expected. Use the IRS.gov Tax Withholding Estimator to properly adjust your rates at the beginning of the year so that you have fewer surprises at tax season.
  • Try and donate $300 to $600 to a charity this year for additional savings.
  • If you’re going to itemize, consider giving more to charity if you can. Double up on donations to maximize your deductions.
  • Mortgage interest rates can also be deducted on the itemized deductions.

On a final note, be sure to be compliant and file your taxes on time or get an extension. Also, make all of your estimated payments and pay what you think you’ll owe on April 15 because you’ll be penalized otherwise even if filing an extension.

 If you want more information about preparing your finances for the future or retirement, check out our complimentary Master Class, ‘3 Steps to Secure Your Retirement’. 

 In this class, we teach you the steps you need to take to secure your dream retirement. Get the complimentary Master Class here.

How to Implement an Annuity into Your Portfolio

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You understand what an annuity is, how it works, and what the advantages are, but do you know how to implement it into your portfolio?

In this eighth and final installment of our “Annuities – Why Ever Use Them” series, we’re sharing how to use an annuity as part of your retirement portfolio.

You can watch the video on this topic above. To listen to the podcast episode, hit play below, or read on for more…

A quick summary

Before we dive into how you can incorporate an annuity into your portfolio, there are some things to be aware of. We’ve already covered these points in detail in other articles within this series, so do visit our blog to find more information about anything covered below.

Here’s a quick recap:

  • Our focus for the “Annuities – Why Ever Use Them” series is on fixed index annuities only.
  • We prefer fixed index annuities over variable annuities because you can lose money in a variable annuity.
  • Fixed index annuities protect your principal, so your investment is guarded against market volatility.
  • Fixed index annuities are linked to an index, such as the S&P 500 – they earn interest depending on how the index performs.
  • You can choose from a range of strategies for how you want to receive interest, for example a cap or a participation rate strategy.
  • If you use a cap strategy set at 5%, for example, and your index earns 10% over an annual point-to-point reset, your annuity will earn a maximum of 5% interest.
  • If you use a participation strategy set at 50% and your index earns 10% over the reset period, you’ll earn 50% of the index’s 10% growth (5% interest on your annuity).
  • There are liquidity restrictions, so we recommend using an annuity as part of a more diverse portfolio.
  • Most annuities allow you penalty-free access to 7-10% of your money in any given year.
  • Annuities often have a surrender charge that applies for a set number of years.

Why choose a fixed index annuity?

Most people use an annuity as part of their retirement portfolio for two reasons. First, a fixed index annuity gives you complete safety and still grows your investment at a good rate of return. A fixed index annuity is not affected by market downturns and is protected against risk. So, if your main concern is safety, an annuity would be a good option for your portfolio.

The second reason is income planning. There are a few ways to get guaranteed income in retirement, including taking a pension and Social Security. A fixed index annuity is a straightforward addition you can make to your guaranteed income sources that lasts for the rest of your lifetime.

Implementing an annuity in your portfolio

We’re going to use an example to demonstrate how to build an annuity into your retirement portfolio. In this example, we’re going to be using hypothetical figures and a fictional retiree, Mary. Please bear in mind that while these figures are representative of fixed index annuities, these are not accurate rates.

Mary is 60 years old and has $1 million of IRA/401k savings. She wants to retire in 7 years time, at the traditional retirement age of 67. She’s calculated how much she spends on her essential needs, wants, and legacy money each month, and discovered that she needs $4,000 of guaranteed income a month to cover her essential needs alone.

Social Security will give Mary $3,000 a month. She doesn’t have any other forms of guaranteed income, so Mary is looking for a way to get an extra $1,000 a month.

What is your risk tolerance?

One thing we talk to all of our clients about is risk. Knowing what your risk tolerance is can help you make decisions about your portfolio that you’re comfortable with. So, before we can advise Mary about finding that additional $1,000 per month, we need to understand how much risk she’s willing to take.

There are a few different ways that you can make a return and manage risk. Banks, for example, have essentially no risk, but the rate of return is very low. Money markets in general are well below 1% currently. So, while there is no risk, there is also hardly any return.

However, if you look at the stock market, this is the complete opposite. There is potential for incredible returns, but also huge losses. Annuities, on the other hand, give a good rate of return, but there are liquidity issues. Your total investment won’t be easily accessible to you. This is something to be aware of in case liquidity is a concern for you.

Let’s go back to Mary. To find out Mary’s risk tolerance, we’d have a conversation with her about how much she’s prepared to lose. Take her $1 million, for example. If we’re talking in percentages, a 10% gain or loss might be something Mary is willing to accept. But if we convert that into dollars, a $100,000 loss may be too much for Mary. In this case, we would keep discussing figures until we land on a percentage that Mary is comfortable with.

Once you understand how much risk you’re prepared to take, then you can decide how to build a portfolio that suits you.

How to construct your portfolio

Mary’s risk tolerance helps her decide that she wants to invest 50% of her $1 million in the stock market and 50% in a fixed index annuity. This gives her roughly $550,000 of liquidity. Mary still needs that extra $1,000 of guaranteed income a month, so she puts $150,000 into an income-based annuity. At age 67, this will start providing her with a lifetime monthly payout of $1,000. Now, she has complete peace of mind that her essential income needs will be covered when she reaches retirement age.

In terms of Mary’s portfolio, she still has $850,000 left. So, to achieve that 50/50 split, Mary could invest $350,000 into another fixed index annuity. She’s got the guaranteed income coming from her first annuity, the second one will be to give her that risk-free growth that she wants. The remaining $500,000 will go towards the stock market as she wishes.

So, where will Mary’s portfolio get her by the time she retires? If the $350,000 in her annuity earns 4%, it will grow to around $480,000. Meanwhile, if the $500,000 that she invested in stock market earns 7%, it will have grown to over $1 million.

The final piece to this portfolio is her remaining annuity, which will start generating $1,000 a month of guaranteed income to add to the Social Security payments of $3,000.

However, one thing that we need to consider is inflation. Mary’s expenses are now $6,500 a month. So that original $4,000 of guaranteed income no longer completely covers her essential income needs. But, thanks to Mary’s growing investment portfolio, she can afford to withdraw from her accounts to cover that extra cost.

Inflation and other costs can drastically impact your retirement plan, but we can use our system to adjust numbers and show you exactly how your funds could play out in different scenarios. We can illustrate what happens to your money if you want to withdraw more at the beginning of your retirement than you do later on, or if you want to purchase a second home, for example.

Overall, Mary’s retirement plan shows that her funds last throughout her retirement, and well into her 90s. Constructing a portfolio that’s safe, liquid, and has income, can give you this same security and peace of mind that you don’t need to worry about your retirement finances. But, please remember, this is based on an illustration only.

If you want to learn more about using an annuity as part of your portfolio, please do reach out to us by booking a complimentary 15-minute call. We can give you individualized advice about annuities and constructing a portfolio that’s right for you.

Documents for Estate Planning and Retirement

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Documents Every Person Needs for Estate Planning

     Is Estate Planning on your priority list? A common misconception about estate planning is that it is only necessary if you have a big estate, many assets, or a complicated family situation. 

The reality is, estate planning ensures that decisions that would be difficult to make in the moment are made in advance to make things easier in the future. 

    By making these decisions in advance and setting them out in writing or in some other way, you can ensure that the wishes of you or a loved one are preserved and that there is a concrete plan for what happens if someone needs to make a decision on your behalf after you die.

     Estate planning also governs what comes next after you die, from what happens to your property to how your funeral will be handled. At its core, estate planning is giving yourself the peace of mind that the people you leave behind will know what to do and will be taken care of, a concept that is very comforting for many. This can be part of your Retirement Planning Checklist.

Estate Planning Documents

      A number of legal documents must be prepared as a part of the estate plan. It is important that these documents are prepared correctly to ensure that your intent is reflected, that nothing slips through the cracks, and of course, that your will and other related documents are validly executed so you do not die intestate. 

      When Preparing for Retirement with estate planning, there are generally three main documents that attorneys advise families to prepare: A will, a durable power of attorney, and a healthcare power of attorney with a living will component. These three documents allow others to legally act for you, which is a powerful, invaluable tool when it comes to managing your end-of-life affairs.

  • Will
  • A will is a legal document that tells readers your wishes after your death, from the distribution of your property to the management of your estate to your intentions for how your children will be raised, in some situations. 
  • While, in some states the law recognizes handwritten/holographic wills, working with a seasoned estate planner or attorney will ensure that your estate is distributed exactly as you would like it to be. 
  • Some wills benefit from the inclusion of specialized clauses that allow for others to act on behalf of the estate, which can come in handy if the language of a will is unclear or if the way a certain property is set to be distributed is impracticable. 
  • For example, wills can include a power of sale provision, which allows the executor of the estate to sell a given property and distribute the funds among the will’s beneficiaries. 
  • Healthcare Power of Attorney
  • A healthcare power of attorney is a legal document that allows an established person to make healthcare decisions on the behalf of another. 
  • This kind of estate planning document is particularly helpful in situations where you or a loved one are unable to make healthcare decisions on your own behalf, like if you are in a medically induced coma or experience a lack of capacity. 
  • A living will is often part of the healthcare power of attorney document. The living will expresses what a person wants, while the healthcare power of attorney states who is authorized to be a decisionmaker.
  • Durable Power of Attorney
  • Durable power of attorney is similar to the healthcare power of attorney but is much broader. Durable power of attorney allows a person to entrust another with virtually all legal decisions. 
  • Someone who has durable power of attorney can make healthcare and financial decisions and even sign legal documents on behalf of another in the event that the person who gave them the power is incapacited or otherwise cannot act on their own behalf. 
  • Power of attorney is a powerful tool to entrust someone with, and can be used to make changes and allow access to bank accounts, various assets, and even change the beneficiaries of a will or similar legal document.

      With the help of these three key estate planning documents, you can feel confident that your loved ones will be taken care of and that it will be as simple as possible for your wishes to be respected after you die.

      If you want more information about preparing your finances for the future or retirement, check out our complimentary Master Class, ‘3 Steps to Secure Your Retirement’. 

      In this class, we teach you the steps you need to take to secure your dream retirement. Get the complimentary Master Class here.

The Retirement Planning Checklist

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As you start to think about retirement planning, you might quickly feel overwhelmed or unsure about what to plan for. Retirement is made up of many different elements, and you’re going to have to make decisions about all of them – but where do you start?

We realized that many people approaching retirement don’t know what they should be thinking about or what questions they should be asking. So, we’ve put together a checklist of the nine most important things you need to consider before retirement.

You can watch the video on this topic above. To listen to the podcast episode, hit play below, or read on for more…

In this post, we walk you through each of these nine elements and help you better understand some key retirement planning aspects. You can make notes on these yourself, use them to talk to your financial advisor, or even see them as retirement planning conversation starters between you and your family. Let’s dive in.

List your retirement goals

You only retire once, so make sure you’re prepared for it! You might have lots of big plans and ideas about what you want to do in retirement. This might include going on a trip, spending more time with grandkids, or anything that you’re initially very excited to do. But often, people don’t plan beyond their first year of retirement. We call this the “retirement honeymoon phase.”

You need to think about what you want to be doing in retirement long-term. We’re talking for 10-20 years! After that first year or “honeymoon phase,” what would you like to be doing regularly, or what would you like to accomplish? Take a pen and paper and write some ideas down in a list or create a retirement journal. Here are a few questions to get you thinking.

  • Do you want to work part-time or volunteer? Are there any organizations that you’d like to work with?
  • Where do you want to live? Perhaps you want to downsize, move into your retirement transition home, or look into other retirement accommodation.
  • Do you want to travel? If so, will it be one long trip, annual vacations, or frequent getaways to places nearby?

Having a list of all the things you want to do in retirement is a great way to get excited about your future. It can also help you make the right choices so that you get to live your dream retirement.

Know your numbers

You may have opened many different bank accounts throughout your life. Perhaps you have multiple 401ks or have various assets. One of the first steps to preparing for retirement is gathering up all of this financial information.

When you’ve consolidated these accounts, you’ll be able to see how much you’ve got, and start building your financial retirement plan. From here, you can find out how much guaranteed income you can expect to receive when you retire.

Your incomings are one thing to know, but you should also be aware of your spending. If you’re working, you may be less worried about how much you’re spending month-to-month, but after you’ve retired, you’ll no longer have money coming in the door. It’s important to know what your fixed expenses will be so you can budget accordingly.

Ideally, your guaranteed income (e.g., your Social Security and pension) will cover all of your fixed expenses. But remember, the unexpected can happen. Sudden healthcare costs or inflation, for example, can affect your retirement plan. So, while we can make illustrations and help get your finances in a good place, we can’t predict the future.

Social security: look at the big picture

People usually want to know how they can get the most money from Social Security. While this is completely understandable, we want to urge you to look at the big picture.

If you wait and start taking Social Security at age 70, then you will receive more money in total – if you live into your 90s. However, if you’re withdrawing more on your assets because you’re not taking Social Security yet, this could have a massive impact on your finances 10-15 years down the road.

It can be easy to fall into the trap of wanting more from Social Security, but we strongly advise you to look at what waiting will do to your assets in the long-term. A comprehensive, written retirement plan can show you and help you understand how something like this will affect your overall finances.

Take an interest in your investing

You don’t need to be a stock-guru, but we recommend that you find out what strategy best suits your money goals and risk tolerance. There are many different ways to invest, but we break these down into two main categories: passive and active.

The passive, or buy-and-hold strategy, is more suited to those who want to invest their money and leave it. This is typically a long-term strategy, where you’ll invest over many years and (hopefully) your money will accumulate. However, when the stock market is volatile, you need to have a high-risk tolerance to weather the storm.

For those approaching retirement, we advocate a more active strategy. This is where you make adjustments depending on market shifts. It’s more suitable for those with a lower risk tolerance, as it attempts to protect against any downturns or crashes that may have a big impact on your retirement savings.

If you’re not sure where to start, consider what your risk tolerance is. If you lost 5% of your invested money today, for example, how would that make you feel? What percentage would you be comfortable with losing?

Understand your Medicare options

You will start receiving Medicare at age 65. However, there will be many, many options to consider. We suggest that you don’t wait until the last minute.

A year before you’re due to receive Medicare (around age 64), start finding out what options will be available to you and get an idea of what to expect. This way, you won’t be as overwhelmed when the time comes. We also recommend speaking to an expert, if you can.

On the Secure Your Retirement podcast, we spoke to Medicare specialist Lorraine Bowen about navigating its complexity. To hear Lorraine answer some of our questions, please listen to the podcast episode “Navigating Medicare in Retirement.”

Get your legal documents in order

It’s imperative to update all of the legal documents you may have before you retire. There can be complications if your documents don’t match up or if there is conflicting information in them, so make it a priority to get these in order.

Check that your power of attorney, will, and account beneficiaries are all correct. If these are not aligned with each other, one may usurp the other in case of an event. For example, a beneficiary form can be more powerful than a will – so it’s necessary to make sure that these are all in line with your wishes.

If you have trust documents or think you may need a trust, you should also start having a conversation about if this is a good option for you.

Plan your long-term care options

You may already know that you need long-term care insurance, but, again, there are many options, and it can be complicated.

You could opt to self-insure, or you could purchase traditional long-term care insurance or hybrid insurance. Traditional long-term care insurance has previously presented problems with sharp rate increases making it less affordable for many. Meanwhile, hybrid insurance premiums do not increase, but the insurance model itself can be a combination of many things. It could be part annuity, part life insurance, and part long-term care.

To learn more about long-term care and the differences between hybrid and traditional insurance, read our post “Long-Term Care Insurance: Traditional vs. Hybrid.”

Understand your taxes

Taxes will always be a part of your finances, so you need to plan for them. When you’re consolidating your accounts, it’s a good idea to note how each one will be taxed.

Many account types are taxed differently. For example, if you take withdrawals from a pre-tax IRA, that will be considered taxable income, so you’ll need to plan for this. If you have a Roth IRA, this will grow tax-free and can be a big tax advantage in the future. Annuities and brokerage accounts are taxed differently again – it’s up to you to find out the implications of each on your retirement plan.

Get your retirement income plan in writing

Finally, we strongly recommend putting your retirement income plan in writing. This can give you peace of mind about your financial freedom in retirement. It can show you an estimated projection of multiple scenarios and help you decide how you’re going to approach your future.

We often have clients approach us who feel uncertain about what’s possible for them in retirement. After seeing their “what ifs” played out and how we take different parts of your finances into consideration, they leave feeling far less stressed and optimistic about their future.

So, those are the nine key things you should think about when planning your retirement. We hope that this checklist comes in useful and helps you on the road to retirement.

If you want to learn more about preparing for retirement, consider getting our complimentary online masterclass, 3 Keys to Secure Your Retirement. You’ll learn how to create your own Lifetime Retirement Income Plan and start your journey to a confident financial future.

Retirement Planning Checklist to a Worry Free Life

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Retirement should be worry-free, but many in the United States don’t have any retirement savings. Your goal should be to retire with as little stress and worry as possible.

It’s possible, but you’ll need to make sure that you begin securing your retirement today.

We’re going to outline an eight-point retirement planning checklist to help you retire worry-free.

8-Point Retirement Planning Checklist

1. List All of Your Retirement Goals

You can’t know where you’re at in reaching your goals if you haven’t defined them yet. Planning starts with your goals. Make a list of answers to the following questions:

  • What is your definition of a happy retirement?
  • Want to travel? Which destinations will you go to?
  • Want to spend time with family? How often will you travel to see them?
  • Would you like to move closer to family?
  • How much money do you want to spend or give away during retirement?
  • Will you help pay for a grandchild’s college education?

While this step may seem tedious, it can really put your retirement into perspective.

2. Know Your Numbers

Retirement is all about numbers. Money is a number’s game, and throughout your lifetime, you likely have made and contributed to a lot of accounts. You need to know how to access these accounts, how much money you have in them and where your money is allotted.

You may have an IRA, 401(k), annuity, brokerage and several other accounts.

When you have all of these accounts available and know their numbers, you need to consider your spending. Spending habits will typically have three main parts:

  1. Needs, or money to live
  2. Wants, or money to use for vacation, etc.
  3. Legacy, or money you would like to give away

You’ll need to consider that your money will come from your IRAs and 401(k)s, and then consider your income from Social Security, pension or other income streams.

Inflation will also play a role in your retirement planning because you’re not earning anymore, yet prices are still going up. All of these numbers will help you better know your financial situation when retiring.

3. Social Security’s “Big Picture”

When’s the best age to retire? Most places will tell you 70 – that’s a long time to wait. You can retire at 62, 67 or 70. Sure, the earlier you retire, the less you’ll receive. There’s a lot more to consider.

The moving parts may mean taking your Social Security earlier is more beneficial.

4. Educate Yourself on How to Invest Your Savings

Retirement savings should be invested. You’ll find two main forms of investing: active and passive. The main differences are:

  • Passive. You’ve likely been doing this for a long time. A 401(k) is passive in that you buy, hold and don’t do anything else. People that bought into Amazon back when it IPO’d, for example, have likely held on to it and reaped the benefits. Rebalancing may occur where you change up your asset allocation slightly, but it’s not on the level of an active investor.
  • Active. You manage the portfolio daily based on the current market. This is a time-consuming strategy, but you can hedge your losses and control your risk tolerance best.

Educate yourself on these two methods of investing your retirement savings, and you’ll have greater control of your retirement planning.

5. Understand Medicare

An integral part of your retirement planning checklist is to understand Medicare. Your health is so important, and we recommend talking to a Medicare expert. You need to have a plan to take care of Medicare.

There are a lot of options available, and they’re very complex with gaps.

At least one year prior to retirement, sit down with an expert that can help you understand your Medicare options, what’s covered, what’s not covered and how you can cover some of these gaps.

6. Put Your Legal Documents in Order

Estate planning is an essential part of retirement planning. Sit down and look over your estate planning documents. We’re talking about your:

  • Wills
  • Trusts
  • Power of Attorney, etc.

Have an attorney overlook your will. Have things changed since you’ve had these documents drafted? Update your legal documents to have the beneficiaries up to date. Do this with all of your documents.

7. Long-term Care Planning

People are living longer. Hopefully, you never have to go into a long-term care facility, but if you do, it’s a major expense. There are different layers of expenses:

  • Assisted living
  • Nursing care

You can self-insure these expenses, or you can take out an insurance policy that rises throughout your lifetime. Hybrid plans also exist, which will have long-term care plans and possibly life insurance in one.

Deciding how to cover the costs of long-term care will help you sleep well at night knowing that you can have a basic plan if you need help in the future.

8. Write Out a Retirement Income Plan

A written retirement income plan seems daunting, but it’s an integral part of every retirement planning checklist. Your retirement relies on your plan. There are a lot of items included in your plan that you’ll outline:

  • Retirement accounts
  • Expenses
  • Future expenses
  • Renovations
  • Car purchases
  • Inflation
  • Paying for your grandkid’s childhood expenses

When you think through almost everything that you can before retiring, you’ll have a plan to refer to and update as needed. You’ll also be able to see how your current actions are impacting your retirement.

If you follow these eight points, we’re confident that you’ll be on the path to a worry-free retirement. 

Need extra help or want to follow a proven program for retiring with peace of mind. Our 4 Steps to Secure Your Retirement mini course can help.

Click here to learn more about our course and how we’ll help you secure your retirement.

What Limitations Are There to an Annuity?

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Annuities can be a safe way to grow your money – but they’re not without their limitations.

In our “Annuities – Why Ever Use Them” series, we’ve talked a lot about the advantages of using a fixed index annuity. However, there are always drawbacks. So, what do you need to be aware of?

If you’re thinking about purchasing an annuity, there are two main limitations to consider. The first is how liquid your annuity is, and the second is surrender charges. In this post, we’re going to explain how both of these limitations work, how to avoid them, and what you can do to balance your portfolio.

You can watch the video on this topic at the top of this post, to listen to the podcast episode, hit play below, or read on for more…

Annuities: the need-to-knows

Here’s a quick review of what we’ve covered about annuities in our series so far:

  • There are two different types of annuities, deferred and immediate. Immediate annuities can provide you with income from the moment you set them up, whereas deferred puts your money aside to grow. In this series, we’re talking exclusively about deferred annuities.
  • Deferred annuities can be either variable (where you invest in mutual funds, so there is risk involved) or fixed (principal guaranteed with no risk). Our focus is on fixed annuities.
  • You can get a traditional fixed annuity, similar to a CD, where the insurance company gives you a fixed rate for a set number of years.
  • Or you can get a fixed index annuity. Here, your interest is linked to the performance of an index, such as the S&P 500.
  • A fixed index annuity earns interest through a cap or a participation rate.
  • If you use a cap, and set it at 5%, for example, then if your index increases to 10% over an annual point-to-point reset, your annuity will increase by your cap amount of 5%.
  • If you use a participation strategy and set it at 50%, then, if your index increases by 20% over the reset period, your annuity will increase by 50% of the index’s 20% growth (so, 10%).
  • There are three reasons why people choose a fixed index annuity: safe accumulation, guaranteed income, and death benefit.

We’ve explained these points in greater depth in previous episodes of our “Annuities – Why Ever Use Them” series. To find out more about any of the points above, read the posts on our blog, listen to the episodes on the Secure Your Retirement podcast, or watch them on our YouTube channel.

How liquid is an annuity?

When an annuity is part of your portfolio, you need to know how accessible your money is. An annuity should never be the be-all and end-all of your portfolio. It should be one part that’s helping your money grow safely and securely, while other parts give you access to your money if you need it.

Annuities are not entirely restrictive. Most annuities allow you a penalty-free withdrawal. For the majority of annuities we recommend, this is usually between 7-10%, but it can vary. So, if you have $100,000 in an annuity, up to 10% of that ($10,000) is easily accessible to you.

But if 10% of your annuity isn’t enough to cover you in an emergency or you need frequent access to more liquid funds, what are your options?

We never suggest that you put all of your savings into an annuity because of their limited liquidity. Having unrestricted access to a fair amount of funds is paramount in retirement, so instead, we suggest splitting your money as part of a wider strategy. You could put 50% of your savings into an annuity, and the other 50% into stocks, bonds, ETFs, mutual funds, or another completely liquid asset.

So, if you have $1 million of savings and split it equally between an annuity and a fully liquid asset, you could have $550,000 of easily accessible cash. This equates to your $500,000 as a liquid investment and 10% available from your annuity.

How surrender charges affect your annuity

If you need more money than your penalty-free withdrawal amount allows, you may be subjected to a surrender charge. This is a period where you will have to pay a penalty to withdraw more than your limit. Let’s use an example to demonstrate.

Say you have $100,000 in your annuity, with a free withdrawal amount of 10% (so, $10,000), but you need access to $11,000. The 10% that you withdraw will be penalty-free, but that extra $1,000 will be subject to the surrender charge.

Insurance companies use surrender charges because they’re giving your investment guaranteed protection against market volatility. This comes at a cost to them as, to do this, they have to make long-term investments of their own. If you need to withdraw more money than they’ve prepared for, they will incur penalties. In essence, a surrender charge is a way of passing this penalty to you.

Most annuities that we work with have a surrender charge schedule lasting anywhere between seven and twelve years. Typically, these charges decline over time until they no longer apply, but this means they will be much higher in the initial years. So, if your annuity has a 10-year surrender charge schedule, you might face a surrender charge of 12% in the first year, 8% in the seventh year, and 0% in the eleventh year – as you’ll be out of surrender.

Your overall portfolio must ensure you have enough liquid assets so that you don’t have to worry about accessing cash or these surrender charges impacting your finances. There are pros and cons to every investment and limitations to how they work. So, how can you build a balanced portfolio?

The three elements to investing

There are three main elements to any investment strategy, safety, liquidity, and growth. No investment can suitably provide you with all three, but most investments give you two. So, how can different investments satisfy each element?

  • If you’re concerned about safety and liquidity, then a money market might be the right investment for you. Bear in mind that it will not give you substantial growth.
  • If you want liquidity and growth, the stock market could be a suitable solution. It has lots of growth potential but isn’t going to give you safety because there’s also the chance that you could lose money.
  • If you prefer growth and safety, we recommend fixed index annuities. As we’ve seen in this post, they have limited liquidity, so it would be wise to use an annuity alongside another type of investment in order to give you a better amount of liquidity.

Remember that every investment has its limitations. But by thinking about these three elements, you can decide what is most important to you. You should keep these elements in mind when picking your own investments or work with a financial advisor to build a portfolio that covers all three bases.

If you want more information about preparing your finances for the future or retirement, check out our complimentary video series, “4 Steps to Secure Your Retirement.” In just four short videos, we teach you the steps you need to take to secure your dream retirement. Get the free series here.

5 Things You Should Do 5 Years Before Retirement

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Retirement planning is more than just putting money into an investment account and hoping you have enough money to retire. You need to plan your retirement, and you need to keep revisiting this plan throughout your lifetime.

If you’re getting closer to retirement, there are five main things that you can do five years before retirement to ensure you’re able to reach your retirement goals.

1. Gather Your Important Documents

You should start gathering all of your important documents to have them ready to overview before retirement. We’re talking about documents relating to:

  • 401(k) plans
  • 403(b)
  • Annuity paperwork
  • Brokerage accounts
  • Estate planning documents
  • IRAs
  • Pension
  • Savings
  • Social Security

If you’re going to have a pension, call your company and ask them about the pension plan and what you can expect to be paid at certain ages. You might be able to take a lump sum.

You’re going to need all of these documents before retirement, so gathering them early on allows you to see where your retirement stands five years out from your actual retirement.

Note: Social Security pays out different amounts depending on your age. You can check this information on SSA.gov, but generally, you can retire at 62, full retirement age and 70. Early retirement, or age 62, will result in a 75% reduction in your benefit amounts.

2. Get Real About Your Spending

There needs to be a link between how much you save for retirement and how much you plan to spend when retiring. Retirement planning should never be left to chance by simply choosing a random monetary goal that you would like to achieve.

You might be fine living off of $2,000 a month during retirement, while others easily spend $10,000 a month when they retire.

We recommend breaking your down spending into three categories so that you really know what your spending will look like in retirement:

  • Essential income. Mortgages, food, bills, subscription services, gym memberships, etc.
  • Wants. Travel, spending time with grandkids or family members, golf club or other subscriptions. This category is really what you envision for your retirement.
  • Legacy/Giveaway. Charities, money left to family members, etc.

Try and factor in everything a good retirement means for you. You might need to cut back on some of your plans to reach your goals, but this is okay.

3. Write Down Your Goals

You know what your spending habits may look like, so now it’s time to really have some goals in place. The first year is fairly easy because you’re transitioning to a life without a 9-to-5 schedule. You’re free to do what you want, and this is an awakening feeling.

But the next few years are really where your retirement planning will be a success or failure.

Sit down today and write down:

  • Where you want to live
  • Where you want to travel
  • Goals of things you want to do in retirement

Be as specific as you can when writing down your goals. You may want to spend time with grandkids or go to Italy for a year. Whatever your goals are, write them down.

4. Learn About Investment Strategies and Risk Tolerance

You’re five years out from retirement, and you’ll need to be very cautious about your risk tolerance. Now is not the time to invest in high-risk investments because you don’t have the luxury of being in your 20s and taking these risks.

Investing has two main categories:

Passive Management

A passive investor puts their money into a stock and holds it over the long-term, or the person can be investing through other investment vehicles where no active management occurs. In all cases, even if the portfolio is diversified, there is a level of risk.

Google may be going strong today, but it could be the JC Penny of tomorrow where stock prices in 2011 were $35 to $40 a share and are $0.11 a share today.

Active Management

A strategy that shifts with the current markets. If the stocks are slumping, more precious metals may be purchased or stocks to hold your retirement fund’s money steadier, even if the possibility of returns may be lower. Managers will be working to mitigate potential losses and will be actively monitoring investments.

Risk tolerance changes, and you may not be able to afford risking 40% of your retirement before retirement begins. Educate yourself on your risks and the strategies you can take to lower them.

5. Come Up with an Income Plan

Retirement planning needs to be put down on paper. You need to think about:

  • Inflation
  • Long-term care
  • Healthcare
  • Remodeling
  • Home repairs
  • New car purchases

When your plan is well-developed, you’ll have “what if” scenarios in place that you can follow during retirement. It seems like a lot of work, but an income plan can give you peace of mind in knowing that you can confidently leave the workforce and finally retire.

Whether you plan to retire five years from now or 20, you don’t have to go at it alone.

Click here to follow our 4 Steps to Secure Your Retirement course.

How Much Money You Need to Retire?

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When can you afford to retire?

Our clients often come to us wanting to know a set figure or amount to save that will mean they can retire. But it’s more complicated than just how much you have in your savings. There are lots of different factors to consider when creating a financial plan for a stress-free retirement.

In this post, we’re going to look at two example scenarios to show you what other variables impact your retirement savings and why the amount you’ve saved doesn’t necessarily mean you’ll have a better or longer retirement.

You can watch the video on this topic above or, to listen to the podcast episode, hit play below, or read on for more…

How much money do I need to retire?

The amount you need to have saved to retire is entirely dependent on your situation. No fixed amount or formula applies to everyone. Even if you had saved a million dollars, you’d still have to work through all the different variables to find out if it was enough for you to retire.

There are many variables and things to consider, including:

  • What age you want to retire
  • Your spending
  • Inflation
  • Healthcare costs
  • Your guaranteed income

When you want to retire has a huge impact on how much you need to save. You should consider both your savings and your spending habits whether you want to retire early or closer to retirement age, around 66 or 67 when you’ll receive Social Security.

Your spending is one of the biggest factors influencing your financial retirement plan. Living within your means before and after retirement is crucial to managing your money with longevity in mind.

Inflation also plays a part in how much you’ll need to retire. It’s been relatively low over the last decade, but inflation can change at any time. We set inflation at 3% for our retirement plans. This is the average inflation rate over the last 100 years. If inflation rates do rise higher than average, this typically only lasts for a short period and then readjusts. But it’s something to be aware of, as it will impact your spending and your savings.

Another factor that we cannot necessarily plan for is future healthcare costs. If you need long-term care or face health challenges in the future, it could take a chunk of your savings. While you can’t always prepare for these things in advance, you can take financial precautions, such as taking out insurance.

The one variable you can count on is how much guaranteed income you’ll have in retirement. Most people will have a pension or Social Security. Knowing how much guaranteed income you have in place helps you figure out how much extra you’ll need to save to cover your expenses.

How much you should save for retirement

We’re going to show you two scenarios to better understand how some variables affect savings and why it’s important to manage your money properly in retirement.

In the first scenario, there is Mary. Mary is 60 and has saved one million dollars ($1,000,000).

In the second scenario, there is Susan. Susan is 67 and has saved half a million dollars ($500,000).

Which do you think is going to have a longer retirement based on their age and savings?

Let’s run through these scenarios without changing any factors other than the amounts that each have saved and their ages. In both scenarios, the retirees will get $3,000 of Social Security each month, starting at age 67.

Scenario one: can I retire with a million dollars?

At age 60, Mary retires with one million dollars in IRA assets and has a spending plan of $6,500 a month. That means she needs $6,500 of guaranteed income coming into her bank account every month to pay the bills and live the life she wants to lead.

In both scenarios, the retirees are facing an inflation rate of 3%. This means that Mary’s spending is increasing by 3% a year. After ten years of retirement, inflation alone pushes Mary’s $6,500 up to $9,000 of spending each month.

Mary has invested her one million dollars, so it’s increasing at 5% on an annual average basis. This grows her savings at a decent rate of return, but she is withdrawing these funds to cover her rising costs. Mary has to rely solely on her savings immediately after retiring, as her Social Security payments won’t start until she’s 67.

There are some other factors at play, but to keep this simple, based on Mary’s spending and inflation, it will take only 13 years for her assets to run out. Mary will still have her Social Security payments, but these aren’t nearly enough to cover the lifestyle she’s built and grown accustomed to.

So, even though Mary retired with one million dollars at age 60, which seems like a powerful position to be in, she only makes it to age 73 before she has no more savings.

Scenario two: how much do I need to retire at 67?

Now let’s look at the second scenario. Susan retires at age 67 with half a million dollars saved in an IRA. Susan immediately gets $3,000 of Social Security each month, just like Mary did at 67. But Susan also has a pension of $500, taking her guaranteed income up to $3,500 a month.

Susan wants a different lifestyle from Mary. She plans to spend only $4,000 a month – $2,500 less than Mary. By the time Susan is 80, inflation will push her monthly spend up to $6,000 a month, still less than Mary’s original monthly spending.

In both scenarios, inflation does make a big impact. But for Susan, inflation isn’t as detrimental to her savings. Susan needed to take less out each month than Mary to supplement her guaranteed income and so it’s a more manageable withdrawal over the long-term.

In this scenario, Susan’s spending habits mean she can comfortably maintain her lifestyle in retirement past age 90 before she runs out of her assets.

How to manage your money in retirement

Retiring later, having a pension (even if it’s small), and reducing your spending can make a significant impact on how long your assets will last you. Even though Susan had saved half the amount Mary had, she had a far longer retirement plan because she retired seven years later, took a small pension, and reduced her spending budget.

If Mary had reduced her monthly spending by $1,500 to $5,000, it would have added almost ten more years to her retirement plan. This reduction alone would mean that she’d be 82, instead of 73, before her assets run out.

Your spending is arguably one of the easier factors to change within a retirement plan. It can be very helpful to take a good look at your spending habits now and consider what they’ll be in the future so that you can get an idea of what your retirement could look like.

How to plan your savings for retirement

If someone has saved more money than you for retirement – don’t panic. People have very different circumstances. They may need more money to cover costs or plan to spend more in retirement. Having more savings doesn’t necessarily mean a longer, more worry-free retirement.

A written retirement plan can help you understand how all of these factors will affect your situation and prepare accordingly. It gives you peace of mind that your finances are set for your future.

We’ve put together a complimentary video course to help you prepare for retirement financially. If you want to put a strategy in place for your retirement savings and spending, the free mini-video series is available to access here: Four Steps to Secure Your Retirement.

How to Retire Comfortably and Be Happy

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Retirement planning should allow you to retire comfortably and be happy. You should find a comfortable medium, where you can retire and maintain the lifestyle that you want to enjoy. The lifestyle you live, and your spending habits will have a major impact on your ability to be comfortable in retirement.

Today, we’re going to outline a five-step process to follow so that you can retire the way you want.

5-Step Process to Retire Comfortably and Be Happy

1. Defining “Comfortable” for You

What is your definition of “comfortable?” Some people want to hit a monetary goal of $1 million before retiring. Once these individuals hit this milestone, they’ll retire. For other people, they want to have the income they need to pay their bills or travel.

Identifying what you want to do in retirement will help you define what comfortable is for you:

  • Do you want to be able to travel whenever you want?
  • Do you want to give money to charity or to your family members?

A lot of people are comfortable when they’re able to pay their bills and put food on the table. You might not want to travel or give money away to grandchildren – that’s perfectly fine. The goal here is to understand what you envision for retirement and what would make you comfortable exiting the workforce.

Knowing your definition of comfortable will help you prepare for retirement.

2. Know Your Risk Tolerance

Investments always have risks, but there are safer ways to allocate your assets as you age. The typical way people approach risk tolerance is:

  • Invest in riskier investments when you’re younger – you have time
  • Slowly start adjusting your portfolio for less risk as you get closer to retirement

Oftentimes, we find that people don’t adjust their investment portfolios, leaving them open to a high level of risk exposure. Could you risk your retirement losing 20% to 30% of its value because of high risks?

For some people, they have more than enough money and can afford to keep the majority of their investments in stocks. But there are ways to lower your risk tolerance and still retire comfortably without worrying about stock market fluctuations or volatility in the markets.

3. Write Down Your Plan

Make your retirement plan real by putting it in writing. A lot of people have plans in their heads, but they don’t put their plans to paper. When you create a retirement income plan on paper, it helps you:

  • Refer to the retirement plan
  • Make adjustments easily to your plan
  • Visualize your ability to retire

If you don’t know where to start when writing your plan, work with a professional that can help you devise a successful retirement plan.

4. Educate Yourself on Retirement Income Strategies

You’ve worked towards your retirement by putting money into IRAs, 401(k) and other investment vehicles. The tax consequences are different for each option. For example, some IRAs are tax-free, and some are pre-taxed.

A traditional IRA is basically ordinary income. Roth IRAs are tax-free.

There are a lot of ways to withdraw money from these accounts. You need to have a plan so that you can withdraw the money you need without suffering from major tax burdens or financial strain in the process.

And there’s also different streams of income, such as Social Security or a pension, which is guaranteed income. Dividend stocks that are income generating may be part of your portfolio, but the stock market isn’t guaranteed income. There are risks and advantages to stocks, and this is really what you need to educate yourself on.

Creating a retirement plan that is comfortable and that you can depend on is the key to a stress-free retirement.

5. Focus on Your Retirement Plan – Not Everyone Else’s Plan

Life is stressful enough, and comparing your retirement plan to someone else’s plan only makes it more stressful. Don’t start comparing your plan to your neighbor’s, brother’s, sister’s or other person’s retirement plan.

Why?

Your lifestyle may be different. Your neighbor may have $300,000 saved but no pension plan to rely on. You may be comfortable living on $40,000 a year and have already paid off your mortgage, but Joe down the street may struggle to get by on $120,000 a year because he needs the newest vehicles, takes expensive vacations and always has the “best of the best.”

When you compare your retirement to other people’s retirement, you need to look at the entire picture. You might not have the same savings or amount stashed away in a 401(k) as someone else, but your retirement may be a lot more secure.

Want to take your retirement planning to the next level? We’ve created a mini course called 4 Steps to Secure Your Retirement that you can follow to retire comfortably and happy.

If you want to discuss your retirement goals or make sure that you can comfortably retire, one of our team members will be more than happy to help you.

Click here to schedule a 15-minute complimentary call with us today.

How to Get Guaranteed Income with a Fixed Indexed Annuity

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If your Social Security benefit or pension won’t provide you with enough guaranteed monthly income to keep you comfortable in retirement, an annuity can help.

You can watch the video on this topic further down, to listen to the podcast episode, hit play below, or read on for more…

 

There are often limited resources for securing guaranteed income in retirement, but if you have or are considering opening an annuity, you may be able to access an “income rider”. An income rider is an additional annuity feature designed to guarantee income for the rest of your life.

 

In this post, we continue our “Annuities – Why Ever Use Them” series by diving into how a fixed index annuity provides guaranteed income using the income rider.

 

Our annuities series is a comprehensive guide to this complex product. If you want to learn more about annuities, we encourage you to read the posts on our blog, listen to the episodes on the Secure Your Retirement podcast, or follow the links below to watch them on our YouTube channel:

 

Why choose a fixed index annuity? A quick summary

We believe there are three reasons why you would want to add a fixed index annuity to your portfolio. The first is good accumulation. Fixed index annuities accumulate similar to a bond, but with the added benefit of no downside risk. The second is the death benefit, and the third is guaranteed income.

 

Before we discuss how to get guaranteed income from your annuity, here is some high-level information to help you understand how annuities work, the different types, and why we recommend a fixed index annuity.

 

  • Deferred annuities are either fixed or variable.
  • Variable annuities are linked to market investment through buying mutual funds. The rates are often high for variable annuities, and they come with risk. To make a decent return on your variable annuity, you have to overcome these fees and more.
  • Fixed annuities have guaranteed principals, meaning you cannot make a loss, which is why we prefer them.
  • There are two types of fixed annuity, traditional and indexed – both guarantee your principal.
  • The traditional annuity is similar to a CD (certificate of deposit). You give your principal to an insurance company, and they provide a return based on a fixed rate for a number of years.
  • With an indexed annuity, your return is linked to an index such as the S&P 500 or the NASDAQ. Even though indexes can fall, your principal is guaranteed, so the worst a fixed index annuity can earn in a year is zero.
  • The crediting methods for fixed annuities are based on a point-to-point annual reset. For example, if you open an annuity on January 1st, 2021, you’ll earn your interest on January 1st, 2022.
  • If you have a fixed index annuity, your interest will be calculated depending on what strategy you use. This could be a cap or participation strategy. To learn more about caps and participation rates, read our blog post, Fixed Index Annuities: How They Work and Things to Consider, or watch the podcast episode.

Our “Annuities – Why Ever Use Them” series covers many of these points in much greater depth, so if you have any questions about how annuities work, please visit the other articles on our blog.

 

A fixed index annuity is our recommended option, especially for retirees who need access to a higher guaranteed income.

 

Why guaranteed income is important in retirement

When planning for your retirement, you want to ensure that you have enough guaranteed income to cover all of your essential income needs. Your income needs fall into one of three categories:

  • Essential: anything you need to pay for, e.g., your water bill
  • Wants: anything that isn’t necessary but gives you a better quality of life, e.g., vacations
  • Giveaway money: for gifting to your children or a charity

We believe that at least your essential outgoings should be covered by your guaranteed income.

 

Most retirees have two guaranteed income sources, their pension and Social Security. Beyond this, there are limited options to secure guaranteed income. One option is to add an income rider to your fixed index annuity.

 

The cost of a fixed index annuity income rider

Adding an income rider to your annuity gives you a lifetime income benefit. This is a powerful tool to help you take care of your essential income needs and grant you continued access to your principal. But, if you’re aiming for your highest guaranteed income, you’re going to have a fee.

 

There can be two different types of fees with an income rider. The first is a clear-cut fee, where the insurance company will charge you a percentage of your principal. This is usually around 1%. The second is a built-in fee, where you won’t be charged directly, but you will see a reduction in return.

 

 

How a fixed index annuity income rider works

A fixed income annuity already accumulates money for a death benefit. The income rider income generation is separate from this. Bear in mind that this income value is not lump sum money. If an insurance agent tells you that their annuity can give you 6% growth, this rate is for income purposes and isn’t available as a lump sum.

 

Let’s use an example to demonstrate. If you have $100,000 in a fixed index annuity with an income benefit growing at 6%, in roughly ten years, your annuity will be worth around $200,000. You cannot take this as a lump sum – this figure is a calculation based on how much income the annuity generated. That 6% growth-rate of $200,000 equates to $12,000 a year of guaranteed income. That’s $1,000 a month guaranteed income for the rest of your life, generated by the fixed index annuity income rider alone.

 

Suppose you’ve calculated your essential income needs at $4,000 per month, but your Social Security will only give you $3,000. In that case, we can work out how much you should put in a fixed index annuity with an income rider to guarantee that extra $1,000.

 

The income rider creates, in essence, a pension that you cannot outlive. Even if your annuity account’s value decreased to zero, you would continue to receive payments through the income rider.

 

 

Why an income rider could suit your future

If you’re married, you may want the guaranteed income to last for the entirety of both yours and your partner’s lives. You can choose to have survivorship, but this will decrease your monthly income, similar to a pension.

 

You do not have to decide whether your annuity income rider is dual or single life until you start taking income. This is a plus point for annuity income riders as it offers flexibility for the future. If you set up an income rider today but won’t need your income for the next five or ten years, you won’t have to choose dual or single income until you’re ready to take it.

 

In most cases, you can start taking income from your annuity after a year. But, just like a Social Security benefit or pension, the longer you wait, the higher your income will be.

 

How could an income rider increase your guaranteed income?

We understand that annuities are a complex and often confusing product and visualizing how they suit your situation can be difficult. If you’d like to see how an annuity could benefit your specific retirement plan, we can help.

 

 

Our advisors can show you how an income rider could impact your guaranteed income when you book a complimentary 15-minute phone consultation. On the call, we can discuss how an annuity would work for you and how it could help you meet your essential income needs. If you want to speak to a team member, book your call today.

Long-Term Care Insurance: Traditional vs. Hybrid

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Which long-term care insurance plan is right for you?

 

If you want to protect against the financial strain of future healthcare challenges, you might be considering buying a long-term care insurance plan.

 

There are many different types of long-term care insurance policies. They vary from how much your premium is, to the benefit they provide, so it’s important to understand which plan best suits your financial situation.

 

You can watch the video on this topic at the top of this post, to listen to the podcast episode, hit play below, or read on for more…

In this post, we share a high-level overview of traditional long-term care insurance, the differences between the traditional and hybrid models, and how you can adjust the options to fit your needs.

What is long-term care?

 

Long-term care is when you need continuing assistance in your daily life. This includes help with getting around, bathing, and other requirements within your home or assisted living facility. It also covers full-time medical care, such as a nursing home.

 

If you’re paying for long-term care insurance, both traditional and hybrid models have the same qualifier. A doctor would need to verify that you need help with two out of the six Activities of Daily Living for your insurance policy to start paying out. The six activities are bathing, dressing, eating, transferring, toileting, and continence.

 

Regular health insurance and Medicare don’t cover long-term care, so insurance could be a good idea if you want to protect your assets.

 

Buying long-term care insurance

 

Insurance for long-term care is similar to any other insurance. It’s a personal decision to transfer risk from yourself to an insurance company so that they can cover any unexpected costs.

 

Think about your car insurance, home insurance, or life insurance. You buy it to protect yourself in case something happens – but you may never use it. Long-term care insurance works in the same way.

 

There are two different types of long-term care insurance plans: traditional and hybrid. They both transfer risk from yourself to an insurance company and have the same qualifiers but have very different costs and benefits.

 

Understanding traditional long-term care insurance

 

Traditional long-term care insurance is a standalone policy, and it includes customizable options to better suit your needs.

 

Like any other insurance, you can pay monthly or annually to keep your insurance plan in force (active). You’ll also have to make decisions on the following items to ensure that your long-term care plan is right for you.

1. Your benefit

 

If you need long-term care, you can decide whether to take your benefit on a monthly or daily basis. Typically, your benefit can range from around $3,000 to $12,000 a month. Depending on how much benefit you want, your premium will change. If you want less benefit, your premium will be lower, and it will be higher if you want more.

 

2. Your benefit period

 

Your benefit period is how long your insurance will cover your long-term care needs. You can choose to have your policy cover your bills for a set number of years or cover you for the rest of your life.

 

3. Your inflation rate

 

It’s vital to keep up with the rising cost of care, so inflation is crucial to bear in mind when choosing a long-term care insurance policy. Many traditional policies have inflation protection built-in, and you can choose from a 3, 4, or 5% compound inflation rate.

 

If you qualify for a policy that covers $3,000 a month, for example, but you don’t need long-term care for another 10, 20, or 30 years, your policy may no longer cover your needs without inflation protection.

 

However, if you have inflation protection at a 5% compound rate and need long-term care next year, the insurance company will cover around $3,150, versus the original $3,000 you signed up for.

 

4. Your waiting period

If you need long-term care and have been approved to receive your insurance money, you’ll need to cover your expenses for a certain period. This is called the ‘waiting period’ and is typically 30, 60, or 90 days.

 

This is very similar to the deductible on your car insurance. For example, you may have to pay the first $500 for any damages to your car, and then your car insurance will pay for anything above that. The waiting period is when you have to use your own assets to cover a set amount of time before your insurance company will pay.

 

It’s important to consider how much risk you want to cover, as costs can mount quickly in your waiting period.

 

The pros and cons of a traditional long-term care insurance policy

 

One of the main positives of a traditional long-term care insurance policy is that you can manipulate each of these four factors to build the policy you want. However, they all affect your premium.

 

But a drawback to the traditional plan is that there is no cash value. Like car insurance, you pay to stay in force, but you don’t build up any cash reserves. So, if you start your policy in your early 50s and never need long-term care, you could pay thousands of dollars for peace of mind alone.

 

Some insurance companies will allow you to pay part of the premiums upfront, but the majority are paid on an annual basis and continue for as long as you’re using the policy. Once you’ve been approved for a policy, companies can’t reject or turn-off your insurance, so long as you continue to pay your premiums.

 

However, premiums can rise. In the past, they’ve risen every 3-5 years, and this may eventually put a strain on your cash flow. If this happens, and you want to adjust your premium, you can reduce your service based on the four factors above. Otherwise, you can cancel your policy and cover any long-term care costs that may arise using your own assets.

 

Understanding hybrid long-term care insurance

 

Hybrid long-term care insurance is designed for those who feel unsure about paying for insurance premiums when they may never need long-term care. These policies allow you access to your money and provide other benefits alongside covering long-term care.

 

In this post, we’ll detail two of the hybrid long-term care insurance models.

 

Long-term care annuity hybrid

The long-term care annuity hybrid combines an annuity and long-term care benefit. With this hybrid, your cash grows in an annuity with the added benefit of long-term care insurance. You also have an interest rate, and you can access those funds whenever you need to.

Let’s use an example. If you put $100,000 into your long-term care annuity hybrid, that $100,000 is still your money and accessible to you. You can earn interest on this money and grow your cash as if it’s in a regular annuity.

 

Depending on your age and your situation, the long-term care side will determine how much of your annuity can be used for long-term care. For example, you might be able to use three times the amount you put into the annuity. In this example, that’s $300,000 of long-term care benefit.

 

If you don’t need long-term care, then your $100,000 will continue to grow through the interest rate. You can also add it to your estate plan and distribute it to your beneficiaries at the end of your life.

With the annuity hybrid, you won’t have to worry about rate increases on long-term care insurance, and your money always stays accessible to you.

 

Triple hybrid – long-term care, cash value, and life insurance

 

If you’re unsure about what cover you might need in the future but want to keep your cash flow options open, then a triple hybrid insurance policy provides comprehensive cover and has a cash value.

The triple hybrid is similar to the long-term care annuity hybrid but offers life insurance as an extra.

Let’s use another example. If you put $100,000 into a triple hybrid insurance plan, you could have:

  • $300,000 for long-term care
  • $250,000 instantly of death benefit which can go to your heirs tax-free
  • Cash value close to $100,000, accessible to you

An advantage of both hybrid policies is that your beneficiaries can receive their benefits if you don’t need long-term care. Also, you won’t need to worry about rate increases as insurance premiums on hybrid policies are fixed.

Hybrid long-term care insurance is often favored over the traditional plan, but there’s lots to think about before deciding which plan is right for you. You may opt not to buy an insurance plan at all and instead finance any long-term care using your own assets.

If you want to talk to an expert about which long-term care insurance plan is right for you, our team can help. Book a complimentary 15-minute call with us, and we can explore what insurance solutions suit your unique situation and answer your questions about long-term care.

How Fixed Index Annuities Grow Your Money With Low Risk

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Money accumulation is paramount as you approach retirement. However, high-risk, high-reward strategies may no longer suit your approach, as many retirees become increasingly risk-averse.

If you have savings that you want to grow risk-free, there are some options available to you. CDs, bonds, and money markets are safe, low-return ways to increase your savings over time. But fixed index annuities could provide a much greater return and are entirely risk-free.

In this post, we share the benefits of a fixed index annuity and explain how insurance companies avoid risk while growing your money.

Annuities are complex; however, they can be beneficial to a retirement portfolio if you understand them. That’s why we’ve created our “Annuities – Why Ever Use Them” series, to answer all the common questions about the pros and cons of annuities.

You can watch the video on this topic at the top of this post, to listen to the podcast episode, hit play below, or read on for more…

 

This post is the fourth installment in the series, so we encourage you to listen to the first three episodes to learn more about annuities. Find them on our Secure Your Retirement podcast, read the posts on our blog, or follow the links below to watch the episodes on our YouTube channel:

1. Annuity types – a quick recap

As we dive into the details of how annuities work, it can be useful to have a foundational knowledge of different annuity products. For a quick, high-level overview, here are the main types of annuities and their key characteristics:

  • Immediate annuity: is a quick and simple way to get an immediate income stream. You give money to an insurance company, which redistributes it back to you as income. For example, if you bought a $100,000 immediate annuity, the insurance company could begin giving you $500 a month for the rest of your life.
  • Deferred annuity: is tax-deferred with some surrender penalties. Deferred annuities can be either variable or fixed and must be committed to for a certain period.
  • Variable annuity: you can use a variable annuity to invest in the stock market. Typically, variable annuities are used to buy mutual funds. There are fees, and a lot of risk involved as the market can fluctuate and so can your annuity’s value.
  • Fixed annuity: is tax-deferred with a principal guarantee, so unlike a variable annuity, you cannot lose any money. However, your money can still grow. Fixed annuities can be broken down into two types, traditional and index.
  • Traditional fixed annuity: similar to a CD, you lock your money in a traditional fixed annuity for a set period at a fixed interest rate. It’s a risk-free way to grow your money.
  • Fixed index annuity: this grows your money using market links. You may be tied to an index like the S&P 500 or the NASDAQ. You’ll receive a portion based on the index’s performance over an annual point to point reset. This means if you start your annuity on January 1st 2021, how the index performs between January 1st 2021 and January 1st 2022 will determine what interest will be credited to your annuity.

We’re going to focus on fixed index annuities in this post. We’ll break down how insurance companies can guarantee your principal even when your annuity is linked to market performance and explain why it’s a win-win for you and insurance companies.

 

2. How to earn interest on fixed index annuities

There are two ways to earn interest on a fixed index annuity, either through a cap or a participation rate.

A cap prevents your principal from reducing due to market volatility. So, if you set a cap at 5%, and your annuity’s index earns 10%, then your annuity will only grow up to 5% in that year. However, if the market falls, you cannot earn a negative rate of return, meaning that your money will not decrease below your guaranteed principle or any increases from previous years.

Participation rates are similar, but instead of using a cap, they increase your principal by a percentage of how the index performs. For example, if your index earns 10% and your participation rate is 50%, then you’ll earn a 5% rate of return.

We dedicated an entire podcast episode to explaining how caps and participation rates work in detail. To learn more about earning interest on fixed index annuities, please watch the episode.

 

3. How insurance companies guarantee your principal risk-free

Caps, participation rates, and a guaranteed principal mean that fixed index annuities can look almost too good to be true, and you may question how they benefit the insurance company.

Some of the most popular questions we get about fixed index annuities are, “If the index drops 20%, does the insurance company have to me back the equivalent of my loss? or “If my cap is 5%, and the index earns 10%, then does the insurance company keep the extra 5%?”

The answer to both questions is no. So how do insurance companies guarantee a rate of return on your principle without putting themselves at risk?

Here’s an example. You have $100,000 to put into an annuity with an insurance company. The insurance company manages billions of dollars and earns 3% on its total assets. They want more people to invest with them, so they try to attract new policyholders with a return rate of 2.5%. This might not be the most attractive rate to all potential investors, so they take the 2.5% and create a futures contract.

A futures contract is a legal agreement to buy or sell an asset at a predetermined price in the future. For example, if you wanted to buy a company’s share at $100, but the current price is $150, you could set up a futures contract to only buy a share when the price hits $100.

In the case of an index fund annuity, the insurance company takes the 2.5% and puts it into a futures contract related to your index. This futures contract might state that if the index increases, then the insurance company will participate. So, if the index goes up, then the insurance company can provide you with your agreed participation rate. However, if the index is down, then that 2.5% is lost, but it has no negative impact on your principal.

Caps work in a very similar way. If your cap is 5%, then the futures contract will expire at 5%. This will give your annuity a 5% rate of return, and the insurance company will not participate above 5%, meaning that they won’t be pocketing any extra money if the index continues increasing.

If the index is down in either case, then neither you nor the insurance company will lose anything, but you won’t earn a rate of return that year. The worst an index fund annuity can do is earn a zero rate of return, but there’s potential to earn a much greater amount, risk-free.

 

4. Why we recommend fixed index annuities for retirees  

Compared to bonds, CDs, and money markets, fixed index annuities are a good alternative to safely accumulate your money. They have no-risk and are much safer than investing in the stock market, but they have more earning potential than lower-rate products or accounts.

We highly recommend adding a fixed index annuity to your retirement portfolio, but only if you understand how they work.

 

We appreciate that annuities are complex and can be difficult to fully understand. If you have any questions, please reach out to us. We can discuss how annuities can work for your individual retirement plan and answer any further questions you may have. Start by booking a complimentary 15-minute call with a member of our team today.