The Money Class (30 page)

Factors to consider if you take an annuity:

• If you want an ongoing monthly payment from the pension your employer will ask you to choose from a variety of payment options. The two most common types of pension options are:

1. Single life only
   . This will provide the payout to the retired worker. When that retiree dies, no beneficiary will receive a payout.
   
2. Joint and survivor
   . The monthly annuity will be paid to the retired worker, and a surviving spouse as well. You can typically choose a joint-and-survivor benefit that pays the surviving spouse 50%, 75%, or 100% of the employee’s benefit. The lower the survivor benefit, the larger your monthly check. So if you opt for a 50% survivor benefit, your current monthly check will be larger than if you opt for the 100% survivor benefit.
   

• If you are married and you decide to opt for the annuity payout, I strongly recommend you choose the 100% joint-and-survivor benefit. This always elicits howls from couples who want the higher payout that comes from a 50% or 75% survivor benefit. But carefully think this through with me: If the pension will be a large part of your retirement income, could the surviving spouse live comfortably if the pension payment were cut by 25% or 50%? Remember, your spouse will also likely have less Social Security income at that time; if both of you were drawing Social Security checks, when one spouse died the survivor would be entitled to the higher of the two checks, but not both. If at that time they also lost 50% of the pension that you were getting that would make it very very rough unless you had serious sums of money. Choosing the 100% joint and survivor is a smart way to ensure the surviving spouse will have as much income as possible.

• If you decide you want to receive a monthly income check, please take the annuity directly from your pension. Do not let a financial advisor convince you to take the lump sum in a rollover that he can then invest in an annuity for you. The annuity from your employer will be a fixed guaranteed payment. An advisor can sell you an annuity that does the same thing if you take a lump sum, but in my experience many of the annuities sold by advisors have high fees, and sometimes you are steered into an annuity where your payment will vary based on the performance of investments. I think it makes more sense to go with the known rather than the unknown: Stick with the guaranteed fixed annuity from your employer.

• I also want you to have your antennae up for any advisor who tells you to take the higher single-life-only benefit and then use the extra amount of the payout to purchase life insurance that the survivor would receive. I don’t like that advice at all. It’s an opportunity for the advisor to sell you an expensive life insurance policy that no doubt earns him a large commission.

A note on pop-up provisions:
Some pensions offer a provision that goes like this: If the spouse dies before the employee, the employee may be able to switch (pop up) to a higher pension payout. This is another issue to discuss with a fee-only financial advisor.

COMPARING THE LUMP SUM TO THE ANNUITY

To help you create an apples-to-apples comparison, let’s see how much monthly income you might be able to withdraw from your lump sum and compare that to the monthly annuity option:

1. Take the amount of your lump sum that you could roll over into an IRA and multiply it by 4%. This is what you could afford to initially withdraw annually from your rollover without having to worry about running out of money if you were to live a long life.

Enter that figure here: $____________________

2. Enter the annual amount of the annuity you could receive. Choose a 100% joint-and-survivor option if you are married, or the life-only if you are single.

$____________________

I think you will be surprised to see that you will be getting considerably more by taking the annuity. That said, one important consideration is that most annuity payouts do not include an inflation adjustment: The payout you receive in year 1 will be the same as year 5, year 10, and so on. If you took the lump sum and invested it wisely you would have the opportunity for gains that would effectively allow you to keep pace with inflation. That is another factor a financial advisor can help you weigh.

Your Estimated Monthly Pension Annuity

or Annual Income from Your Rollover IRA:
$____________________

Is Your Pension Safe?

It is no secret that some pensions—both private and public—are facing financial challenges. But I want you to understand two important points: It is highly unlikely that any public or government pension will change the benefit formula for anyone near retirement. The rules, if they change, would affect new employees; there will likely be a grandfather clause for current employees, especially those near retirement age.

If you have a private-sector pension, you may wonder what happens if your company goes bankrupt or it can’t fulfill its pension obligations. Please understand that the money your firm has in its pension accounts is kept separate from its other operations. And the plan is required to report each year whether it has enough money to pay its future obligations. This is called its “funded status.” You have a right to receive an annual statement showing your plan’s funded status. Request a summary plan description (SPD) to find this information.

So let’s say your plan is in fact underfunded. Time to panic? No. Check the SPD to confirm if the pension plan is covered by the Pension Benefit Guaranty Corporation (PBGC). Most plans are. This is a federal agency that guarantees the payments for member firms. Its job is a lot like the FDIC for banks or the NCUA for credit unions: They step in and cover payments when member firms fall into trouble and can’t make their pension payment.

Just as with FDIC or NCUA insurance, there are limits to what you can receive from the PBGC. If you are already receiving a benefit from your pension, the PBGC limit is set by your age at the time it took over your plan. In 2011 the maximum monthly benefit for someone age 65 is $4,500; for a joint-and-survivor benefit the maximum payout is $4,050. If you are under age 65 the PBGC benefit will be lower than those amounts; if you are older the maximum will be higher. At the PBGC website (
www.pbgc.gov
) there is a table of maximums based on age. If your plan is taken over by the PBGC before you retire, your maximum benefit will be tied to the age at which you begin to receive your benefit.

The bottom line is that even if you are concerned about your employer’s future, as long as it is part of the PBGC and your expected payout is below the agency’s limits, you should rest easy.

Now let’s add up your various sources of retirement income.

Your Total Estimated Monthly Retirement Income:

Please remember that any money you withdraw from a traditional IRA or 401(k), as well as pension payouts and Social Security (to a limited extent based on your overall income), is taxed as ordinary income in the year it is paid. Federal income tax rates vary from 10% to 35% depending on your total income, and some states tax retirement income as well. Just keep in mind that the figure above is going to be lower once you settle your tax bill.

ONCE AGAIN, IT IS TIME TO STAND IN YOUR TRUTH

Now compare this figure to your current expenses—the figure you arrived at in Class 2, when you used the expense tracker tool on my website. Of course we need to adjust your current expenses for inflation. You can use the compound interest calculator in The Classroom at my website to get a rough estimate. In the Initial Investment box input your current annual expenses. Leave the Monthly Addition box empty and then for the interest rate plug in 4%. That is actually slightly higher than the long-term inflation rate over the past few decades, but I think given what is going on in our economy and with our fiscal deficit we could in fact see above-average inflation in the coming years. Finally, input 10 years past the date you expect to retire. Why so long? Well, if we just plan to the date you retire we won’t know what your expenses might be down the road in retirement.

Note:
if you plan to pay off your mortgage before you retire, remember to deduct that current expense from your calculation.

Okay, now you have a rough idea what your expenses might be in retirement. I hope you’re smiling because your expected retirement income is plenty to cover your anticipated expenses. But if that’s not the case, and you see a shortfall, please do not panic. You have time to figure this out. That’s why we are doing this exercise now, in your 40s and 50s. You have 15 or more years to make up ground. It can also help you focus on some priorities, such as working longer and delaying when you begin to draw Social Security. And perhaps you might recognize that my advice to focus on your retirement rather than saving for your child’s college costs makes a ton of sense.

Or let’s take a different approach: Maybe your next few vacations are to different parts of the country—or the globe—where the cost of living is lower than where you live today. Start scoping out possible places you might consider retiring to. There’s no pressure; just make this an enjoyable adventure where you explore your options. Now is the time to do that exploring and planning. I am confident you can indeed reach your new retirement dream, but we are committed to standing in the truth that there may be some adjustments necessary between then and now to get you there.

Next I want to discuss one more important way you can increase your retirement security: Save more, and save smart.

LESSON 5.
SAVING MORE, AND INVESTING STRATEGIES IN YOUR 50S

Obviously, one of the surest ways to improve your retirement picture is to save more over the next 10 to 15 years. In fact, the annual contribution limits for your 401(k) and IRA savings are higher once you turn 50. In 2011:

• 401(k)s:
  If you are at least 50 years old, you can contribute $22,000. The maximum for younger employees is $16,500.
  
• IRAs:
  If you are at least 50 years old, you can contribute $6,000. The maximum is $5,000 for younger savers.
  

I think it is a smart time to consider saving more in those accounts. Don’t expect HR or your 401(k) plan sponsor to send you a note on your 50th birthday informing you of this great opportunity. It’s up to you to take the initiative here. My one caveat, as you have already learned, is that if you currently live in a home that you intend to retire in, and you can honestly afford to stay in that home, then it can make sense to divert some of your retirement savings to accelerate paying off your mortgage.

HOW TO INVEST SMART

It is so interesting to me that people in their 50s tend to take extreme positions when it comes to investing their retirement money. At one end of the investing spectrum are the people who realize they are way behind in their savings. Therefore they decide they should put all their money in stocks; they think that is the only way to have a shot at the big gains they need to make in order to amass what they want by their targeted retirement date.

At the other extreme is the conservative bunch. They think that because they are retiring in 10 or so years they can’t afford to own any stocks. After watching what happened in the bear market that began in 2008, they feel it would be a huge mistake to risk having any of their retirement savings lose value.

The truth is that neither camp is correct.

It was very frustrating to me in the wake of the 2008 financial crisis to see people in their 50s shell-shocked that their portfolio was down 40% to 50% or more. The only way that could have happened was if their portfolios had been 100% invested in stocks. If they had owned a more appropriate mix of stocks and bonds, the losses, while still steep, would have been far less devastating. While the S&P 500 stock index lost 37% in 2008, the leading index tracking the bond market gained 5% for the year. Someone who simply had an even split between stocks and bonds might have come out of 2008 with a cumulative loss of 16%, or less than half of what so many of you told me you experienced.

Now I realize that the 16% loss may not sound so good either. Because you are in your 50s you feel as if you don’t have time on your side, so you can’t afford to have any losses in your portfolio. I agree—as you near retirement you should definitely become more cautious with your investments, favoring bonds over stocks. But that does not mean you can afford to completely shun stocks. Remember, a 65-year-old today will on average still be alive into his or her 80s. That means anyone in their 50s today must consider that some of their retirement savings will not be used for another 25 to 30 years, and possibly longer. It is a mistake to look at your retirement date as your investing stop point. You must consider how long you will need your money to support you. In your 50s you should invest with the awareness that some of that money will not be touched for another 25 years at least. And that raises a potential problem if you were to prematurely move all your money into bonds or cash. The long-term trend tells us that those investments, while earning a steady return, won’t typically earn enough to keep pace with inflation.