Nest Egg Repair

If you are like most investors, you have probably seen losses in your retirement accounts of anywhere from 15 to 50 percent in the past year. This has probably caused you a great deal of concern about your financial future.

What if we could show you how you can protect yourself from any further losses, still have the chance to participate in at least some of the gains of the markets in the future when they do recover without having to figure out when a lasting bottom had occurred? What if we could even show you how to receive up to 20 percent credited to your retirement income account value to help offset some of your losses immediately? Would you be interested enough to read the rest of this article?

We certainly hope so. However, like any investment strategy, it does take some time and study to understand. We hope you will start with reading this entire article. Ready?

Background

Since late 1999, we have been very good at picking all the major tops in the U.S. stock markets and noting that strong sell signals were being sent before they became obvious to the average investor. However, our ability to pick bottoms is not nearly as refined. Knowing when to get out is fairly easy, but knowing when to get back in is tricky.

This time is no different. Last year, in November, 2007, we told everyone who would listen that a major market top had again occurred. Now, here we are over 35 percent down in the Dow Jones Industrial Average, but we are not sure a bottom has been formed. And the only thing sure at this point is that we are in for even more economic uncertainty.

Let’s be blunt about this:

A year ago, would you have even considered that the market would tumble this hard and reach a point with this extensive government and Federal Reserve involvement in our banking system and Congress plotting even more action even at this time? We knew we were headed for a credit crunch based on the rapidly deteriorating fundamentals of the credit system during the last quarter of 2007. However, the eventual depth of that crunch was not clear, and it may not  be clear even at this time.

So, what is the average retirement investor supposed to do?
When “Buy and Hold” Doesn’t Work

In the course of the past year, many nest eggs have been severely damaged, and many good people are having to seriously rethink their retirement strategy, or even their projected retirement dates for that matter. In fact, if you invested in a basket of Dow 30 blue chips in late 1999 and held them through today, you’re pretty much back where you started. That’s not good.

There is no question that, given enough time, the stock markets are the place to be to obtain the greatest growth. However, in exchange for this growth potential, the possibility of loss also exists, as we have been reminded of late. And if your time frame is short (less than 10 years), or you are already in retirement, losses are something that you simply cannot afford to take.

We know the market will probably eventually recover, but will it go down further first, and how soon will it recover and start going up again on a fairly reliable basis? When is the time to get back in or add to your positions? Can you time the market better than the professional fund managers who are taking billions of dollars of losses right now?

Let’s face it: The rules have changed, and it’s time for a new strategy.
Three Keys to Retirement Investing

The typical investor who is putting money away into a retirement nest egg or is drawing from that nest egg now has to balance a number of considerations, some of which appear to be in conflict with each other. The three main issues are growth, safety, and income. We’ll take them one at a time.

Growth

Growth potential of retirement savings is very important, even in the pre-retirement window of the last 10 years of work and into retirement. We are living longer, and as a result, we are going to need to have access to much more money in the retirement years than just two generations ago. In fact, as financial planners, we used to work with a time frame of 10 to 15 years of retirement, but now we are being urged to think in terms of up to 30 years of retirement. For example, did you know that, if you make it to age 65, you have about a 50/50 chance of making it to at least age 85?

And then there is inflation to consider. Even at today’s relatively moderate rates of inflation, one can lose about half their buying power over the course of the average retirement on a fixed income.

In order to produce enough money to last the rest of your life, you will need to continue to have growth of your retirement funds well into retirement. The best place for growth potential is unquestionably the stock markets.

Safety

At the same time the need for safety of retirement funds increases as we age, as well. We teach our clients the Rule of 100 as a reliable means of determining how much of one’s assets need to be in a safe, capital preservation strategy. With less time to add additional funds to the retirement nest egg, the effects of losses can be particularly devastating.

So, in order to preserve capital, one has to consider vehicles with no downside risk, giving up growth for safety. A prime example of safety with limited growth potential is certificates of deposit. At current interest rates, it is questionable that one could even keep pace with inflation if a significant portion of one’s nest egg were to be placed in CD’s.

Income

This brings us to income, which is normally the primary aim of retirement planning. There are a variety of strategies to produce income. One is to have sufficient capital to draw out gains (interest) and keep the original capital in place. Another is to spend interest and capital down, hopefully having enough to last until the end of one’s life. Of course, this would require a crystal ball that tells us exactly how long we will live. Birth certificates do not come with expiration dates. Another strategy is to place the money into an annuity and have a guaranteed income for life. In some cases, these annuities lock in your funds, however, meaning you lose all control and are required to live on a fixed amount for life with no adjustments for inflation.

Enter the New Strategy for the 21st Century

The insurance industry, back in the mid-1990′s, realized that its stodgy traditional fixed annuities were no longer competitive in the marketplace for those who needed income, growth, and safety from their retirement products. Traditional annuities were and are still great for guaranteed income and safety, but they lack flexibility and growth options.

As a result, the concept of the Equity Indexed Annuity (EIA) was born. EIA’s sought to tie the gains of the stock market to an insurance product, allowing greater upside potential than fixed annuities which paid at a little better than CD rates of return.

Since the purpose of this article is to explain a strategy for EIA’s and not to explain them in detail, please see our article, Equity Indexed Annuities Explained, for a detailed explanation of how these contracts work.

Growth

Equity Indexed Annuities allow the owner to participate in at least some of the gains of the stock market. Being able to participate in the gains of the stock market is critical to growth over time. However, downturns in the market can erase years of progress in a very short period of time. EIA’s allow for growth based on a number of strategies tied to stock market indexes. For example, one can select growth based on the S&P 500, the DJIA, or even the Hang Seng.

However, because of the way EIA’s are designed, they only go up with the rise of the stock market indexes; they do not go down. This makes them different from mutual funds or other market-based instruments. Each year, the gains of the market are credited and locked in. If the market were to go down in subsequent years, those gains are never lost, and the negative performance of the market yields no loss in the contract.

Also, even if the market were to go down for a protracted period of time, many EIA’s have minimum interest guarantees which will be added to the account in down years.

So, to summarize the growth feature of EIA’s, if the market goes up, you gain contract value. If the market goes down, you lose nothing and may even get a minimum guaranteed interest rate.

Safety

EIA’s are backed by the insurance company’s assets, which are closely monitored by state insurance departments. If a bank is required to have 20 percent reserve, this means that the bank has 20 cents on hand for every dollar of deposits. On the other hand, if an insurance company is required to have 20 percent reserve, it means that it has on hand a full $1.20 for each dollar of obligations. This is quite a difference.

Second, as stated in the section on growth above, capital is preserved, regardless of market conditions. There is no potential of loss due to market performance.

And finally, insurance companies have proven to be among the safest and long-lived businesses. One of the companies we offer has roots going back to before the American Revolution and most were major players before Ford produced its first car. Insurance companies have survived a number of depressions, even more recessions, and of course, wars.

Income

All of the EIA’s we offer have guaranteed income features for life. However, unlike traditional annuities, one is not locked in to receive a fixed amount for life. Many of the EIA’s offer increasing benefits over time to offset, at least in part, inflationary pressures. Also, there is the option to make additional withdrawals in the event of a significant need or emergency. These withdrawals may affect future income draws, but they are available if needed. Some EIA’s even come with a checkbook, allowing the owner to have complete control over withdrawals.

There are a number of income strategies available which vary from contract to contract. Some allow for husband and wife to draw for as long as at least one of them is alive. Others allow for one to draw as long as they are alive, and any remaining balance to transfer in a lump sum to the surviving spouse at the time of death of the contract owner.

The income options are very attractive, and these are growing in variety and flexibility all the time as companies work to compete for clients.

Estate

With traditional fixed annuities, the death of an annuitant could mean the ending of all payments and no remaining value to be paid to an estate. For example, if an annuitant on a traditional annuity elected a lifetime income only benefit and paid in $50,000 in a single premium, they would receive regular payments guaranteed as long as they lived. However, if they were to die within a year or two and received far less than the $50,000 they put into the contract, nothing would pass on to the estate of the annuitant.

With EIA’s this issue is handled differently. As long as they payments out of the income account have not exceeded the contract value, any remaining balance in the contract value would pass on to the beneficiary designated in the contract. Using the previous example, the single annuitant received payments for about two years out of the $50,000 they put into the contract. Upon death, the contract value, less the payments received, would be paid to the beneficiary.

And like other insurance contract benefits, the transfer of funds to the beneficary does not have to go through probate, meaning a quick payment to the beneficiary.

Bonuses

Most EIA’s we offer have premium bonuses paid on the income account. These bonuses range anywhere from 5 percent to 15 percent which is credited to the income account value of the EIA. One offers a 15 percent premium bonus to the income account with an additional 5 percent credited if the income option is triggered within 5 years of contract date. This means that a current or near-term retiree could actually have 20 percent more money to live on the rest of their lives. This one option alone could offset losses sustained or be used to offset capital gains taxes which might be incurred during the liquidation of stocks to participate in an EIA.

Future Uncertainty

The greatest enemy of those planning for retirement or in retirement is future uncertainty. We all crave a certain measure of security. One has to consider a number of risks in planning their retirement. These risks also include political risk. What will be the effect of a potential Obama presidency on retirees, especially in light of his stated intent to raise capital gains taxes? What are the prospects for other taxes that might be raised or levied? Annuties offer tax-deferred benefits which can be used to protect the growth of one’s account value, even during times of uncertain future tax policy. Please see our article, Tax Deferred Growth, to see how this feature can benefit you personally.

Other Benefits

Equity Indexed Annuities can be used for Traditional IRA’s, Roth IRA’s, Rollover IRA’s, or unqualified (regular) savings.If they are used for IRA’s, all the normal rules of the IRA apply as to taxes, withdrawals, eligibility, etc.

Equity Indexed Annuities also come with a number of riders available. Some examples are a terminal illness benefit rider which allows full withdrawal in the event of terminal illness, nursing home rider allowing additional withdrawals for nursing home care, and even guaranteed high interest rates on income account values as high as 7.2 percent. Riders vary by contract and should be discussed thoroughly before selecting a company.

Of course, there are other benefits which EIA’s offer which are common to all annuities. Please see our article, Annuities Have S.T.Y.L.E. for a more detailed explanation.

Summary

EIA’s offer the opportunty to participate in stock market gains without the potential for market loss, ratcheting gains up and locking them in during periods of market downturn. They offer significant tax benefits. EIA’s are safe and reliable, allowing for planning one’s future income needs. They by-pass estate probate issues, allowing rapid transfer to beneficiaries. They can be used in IRS approved retirement accounts. And finally, they offer a variety of benefit plans, riders, and bonuses, each allowing for a plan to be completely tailored to the owner’s present and future, unforeseen needs.

Please call us at 334-685-1805 for a no-obligation consultation to see if this strategy can be used effectively for your retirement planning.

NOTE: Like any financial product, there are issues of suitability which must be determined prior to entering into an EIA contract. While these contracts provide significant benefits which are difficult to match in other financial products, they are not suitable for everyone and every situation. We do not advocate placing all of one’s assets into any single product. Also, this article is designed to present the general concepts of an Equity Indexed Annuity strategy to potential clients. The actual contracts vary from company to company, and a full reading of the disclosure statements of each contract is highly recommended prior to committing any resources to such a contract. There may be tax and estate ramifications which should be discussed with a qualified tax professional and/or estate attorney.