The Plight of the Rational (Investor)

For those of you who may not know what rational choice theory is, the behavior of picking what is right for you when it comes to your retirement plan creates what many are seeing as the greatest hurdle. The leap between what is right and what is most cost-effective, is the result of how we compare one move to another. This thinking which gave rise to behavioral studies that made Daniel Kahneman famous has proven to be less reliable than economists previously thought.

Consider the annuity. There is no doubt in anyone's mind that the concept of a steady stream of reliable income in retirement is what we all want and stive for. Knowing what we can expect gives us the much needed push to place a single monthly amount as the focal point in our plans for a post-work life. From a rational point of view, knowing what we can live on should drive us to pick this sort of product over any other method. But this is where rational choice theory fails.

If you knew you could determine the amount of income a certain investment could provide the logical (rational) choice would be to gravitate towards that choice. But those that do buy annuities are not governed by that thinking. And those who don't choose annuities for even a portion of their retirement investments seem to be ignoring what would be considered the most rational choice.

Perhaps we should first look back on the way we used to think. There was a time when pensions dominated the landscape. This sort of plan, referred to as the defined benefit plan had its drawbacks: it wasn't portable (you couldn't take it with you if you decided to change jobs) and it was at its most beneficial in the last years of employment (essentially a trade-off for years of sweat equity which became capital equity at retirement). The introduction of plans such as the 401(k) or defined contribution plan changed that thinking giving workers greater mobility (you could take your contributions and any matching employer contributions with you when left provided you worked for a certain amount of time called the vesting period) and of course the much advertised ability to self-direct your investments according to who you are.

These pre-401(k) days also saw a focus amongst workers of paying down mortgage debt in order to gain home equity. While this is still a good idea, it has fallen out of favor over the last three-to-four years for what could be called obvious reasons. Economic troubles aside, we view the pension as prohibitive and full ownership of our homes as all but unattainable.

Three decades later, after numerous bull markets and more bear markets than we feel should have occurred, we are back to thinking that this pre-retirement knowledge of how much we will actually have at when we stop working is not such a bad idea. And while paying down your mortgage hasn't gained the same attention, our thinking about retirement income is gradually shifting.

This shift is based on knowing how much you will actually receive rather than continually trying to calculate how much you can withdraw. But does the annuity provide the best offset between worrying about drawing down your retirement savings too fast and potentially outliving your "nest egg" or learning to live within the confines of a set amount paid to you year-over-year. Some of the decision is based on the ability to adjust spending while you are working, usually with the adoption of a "spend what you make" thinking which upon retirement become a "spend what you can [afford]". Neither work well.

While we are working, our spending increases to meet our income. That option disappears once you are retired replaced by spending that adjusts to you ability to optimize your portfolio to meet the needs you might have. You have no way of knowing what those needs are when you are working and only a slightly better idea what they are once you retire.

According to a recent paper titled "Annuitization Puzzles" Schlomo Bernartzi, Alessandro Previtero and Richard H. Thaler, the the conceptually difficult question of how much is available to spend is answered with the annuitization of retirement savings. In other words, annuities take the calculations out of the mix. Studies have revealed a certain type of withdraw (or drawdown mentality) that many attribute to two basic ideas: fear of health costs and the wish to bequest. These 401(k) retirees focus not so much on how much they will need to spend but how much they will have left to spend should something happen medically and if that doesn't occur, how much they will leave to their estate once they are gone.

The paper makes it clear that conservative withdrawal rates at retirement are usually attributed to wealthier retirees and quicker drawdown rates that are mostly done by poorer retirees are not the problem: it is the calculation of how much is enough. The bequest motive, the authors point out is confusing considering most of those who focus on leaving money behind live on less to leave more for children who quite possibly don't need it and in more instances than not, are more affluent than their parents. Poorer retirees entertain the bequest motive as well but usually find that they need the money in greater quantities sooner than they anticipated.

Can annuities fix this "hard" calculation? Possibly but there are some psychological hurdles. One is the focus on retirement at 65. The less educated you are, the more you focus on this age even if you know that by waiting you will gain even more spendable income in retirement. But also ironically, the better educated retiree is more focused on leaving something to their heirs and in doing so, underspend.

While the choice of annuitizing is difficult, in part because our biases are so strong, the benefits of knowing should come to the forefront. Researchers suggest that if annuities were part of your retirement options in a 401(k), we would use them. Research has also pointed to the pivot point, when we retire and how the markets are doing at that point, as playing a role in the decision. If markets are robust, we don't buy annuities. When we feel less confident in the markets, we tend to purchase annuities.

Annuities do have cost hurdles with a great many people suggesting the fees and expenses as a reason to look the other way. Perhaps the best way to beat these biases is to plan with an annuity long before you make the decision to retire and having the choice inside your retirement plan at an early age could make your future plan more clear. It is no easy choice and it certainly shouldn't be your only choice, but for a portion of your retirement savings it could be the single easiest idea to take the worry out of retirement. Knowing also by default, focuses your savings as well.

Learn more. You can even get approved for no credit loans.

FIFRadio: A conversation about annuities and long-term care insurance

On Monday, we had Steve Cooperstein on the Financial Impact Factor Radio show with Paul Petillo, managing editor of BlueCollarDollar.com/Target2025.com and Dave Kittredge and Dave Ng of FinancialFootprint.com. Steve's recent book was the topic for today's show: “Implications of the Perceptions of Post Retirement Risk for the Life Insurance Industry: Inside Track Marketing Opportunity, But Requiring Focused Retooling”.

It may have been written for advisors and academics and the insurance industry, but in doing so it offers us some interesting insights into how these folks think about us: the end user. Did I mention that Steve is an actuary?

 We talked to him about annuities and Long Term Care Insurance, the impact both of these products have on all age groups, what is wrong with them and how they can be improved. We solved a great deal in the hour we had together!



   

Listen to internet radiowith

Paul Petillo of Target2025.com/BlueCollarDollar.com

and Dave Kittredge and Dave Ng

of FinancialFootprint.com

on

The Financial Impact Factor

at Blog Talk Radio

The Good, the Bad, the Annuity

Nothing that is good for you can be considered bad and vice versa. Except perhaps when asking a five-year old about broccoli. But the vast majority of adults, fifty years hence wouldn't even consider an annuity for their retirement and if they did, would almost certainly regret the decision at some point soon after. How can annuity be both regrettable and not, good and sometimes bad, bad and almost the best option?

First, a disclaimer: I am not a big fan of annuities - too complicated and too costly and too much insurance. Secondly, as if that weren't enough of reason to dislike them, they are quickly becoming an idea with a certain allure, almost mystique. They have done little to reinvent what they are - aside from some product tweaks along the way, they are essentially exactly what they always were. So why the sudden interest? Okay, it's not really sudden. The thought that is currently being bandied around by many of my cohorts is worth considering. After I tell you what they are.

If I were to offer you a "guaranteed income for life" that grew at 4%, you'd think to yourself that this was too good to be true. If it were free of fees and locked in penalties and all sorts of hidden costs, it would be too good. But this is an insurance product. And I'd be willing to wager you have never met, over the course of your lifetime, an insurance product that is free of some small print just waiting to rear its ugly head the moment you need it. Then they tack an investment portfolio into the mix and you have a recipe for problems. Kinda sorta.

First off, you need to buy the product. When you buy it has more to do with it than the actual need or desire. Annuities come with salespeople in tow and when they begin talking, most of the information you might need to know later gets pushed to later. What stands out is the fixed number, the income for life. Secondly, you will not be the same person ten-years from now and this makes this sort of purchase subject to those shifts in not only who you are but where you are financially.

MetLife explains the difference between the two most common types: the fixed and the variable. A fixed annuity "earn[s] a guaranteed rate of interest for a specific time period, such as one, three, or five years. Once the time period is over, a new guaranteed interest rate is set for the next period. A fixed annuity guarantee is subject to the financial strength and claims-paying ability of the insurance company that issues the annuity."

In other words, you know exactly what it is your are getting into - if only it were that simple. The fixed rate often offered is just barely beating inflation and won't beat taxes. Yes it will be fixed but this also depends on your age and your sex. If you are a woman, you will receive less compared to a man because you will live longer - the insurance side of the deal in the equation.

If you meet a retiree who regrets their decision once they have bought and annuity, it will be because the stock market is doing well. Studies have shown that if the markets are good in the months preceding retirement, the retiree will more than likely opt for investing on their own; if they are bad, they buy an annuity.

When MetLife describes variable annuities, they roll their eyes and shrug their shoulders, knowing that even as the markets are doing better, you still want safety. They describe these products: "Variable annuities typically offer a range of funding options from which you may choose. These funding options may include portfolios comprised of stocks, bonds, and money market instruments. The account value of variable annuities can go up or down based on market fluctuations. Your purchase payments and earnings are not guaranteed; they depend on the performance of the underlying investment options."

But believe it or not, there is a place in your retirement plan where these products belong: inside your 401(k). When asked about them in 401(k) plans: "Eleanor Blaney, consumer advocate for the Certified Financial Planning Board, is blunt, "This is categorically a bad idea."" Of all people, women benefit the most from annuities in these plans. They don't discriminate based on sex. They give women the conservative approach many say they want - and the knowledge of knowing what they will have - and it gives them the opportunity to educate themselves about other potential investments available to them. Plus, it eliminates the choice at retirement that most people can't make. Stuffing them in every 401(k) can help men make the right choice for their wives - who will live longer and benefit from them.

Behind the Retirement Curve

There is still a great deal of discussion surrounding the fact the women are further behind the retirement curve than they should be. It is estimated that women will need $240,000 in retirement funds compared to $170,000 needed by men. These estimates, in my opinion need some fine tuning. Nonetheless, even if current 401(k) balances are taken into consideration, both groups are still far behind where they should be.

Consider this: Amongst the facts available concerning retirement, one number stands out. The cost of healthcare, the unknown possibility that at some point during your retirement you will need much more than Medicare can provide, will be close to $100,000. This means that both men and women will be left with far fewer dollars to subsist on than they have anticipated.


Consider this: Women still face individual hurdles in the workplace. This gap in pay is closing but not for the reasons you might think. Men faced the biggest problems during the recent downturn and women saw the biggest opportunities in landing any newly created jobs. But were those jobs as good as they should have been?

It has long been a fact that the vast number of women entering the workforce do so at a lower pay grade than their male cohorts. They will find more jobs in smaller businesses and because of that and those employers, they may find the options to save for retirement smaller. In many instances, these smaller businesses have less than adequate 401(k) plans, some merely a shell of of what larger corporations offer.

It is also a problem for women employed in larger companies with adequate 401(k) plans in part because the plan matches are smaller and are not expected to return to pre-2008 levels anytime soon.

It is also well-known that women will not be paid as much as men are or have been paid for similar jobs. USA Network founder Kay Koplovitz suggested recently that women simply don't ask for what they feel they deserve. It might have something to do with the fact that women "lean back" in the initial stages of their careers, looking toward the possibility that they will eventually take time off to begin a family. This false start often gives them fewer chances to achieve a robust retirement and to ask for the money they think and should deserve. Ms. Koplovitz suggests they take the reins of their plans "first, harder, and faster". Taking time off: use an IRA to keep invested.


Consider this: The auto-enrollment of new hires, the majority of which seem to be women, has seen the participation levels in 401(k)s increase. But studies have shown that these new participants invest too conservatively when they are young, giving up some of the much needed risk they should be taking in the early stages of their careers.


Consider this: Women will live longer and even more frightening, may live longer alone.
There are no easy remedies. Yet some come to mind. Yes, women need to invest more and more often. They shouldn't let any career interruption keep them from investing. They should be requesting their employers add annuities to their 401(k)s in part because these products, tucked inside these plans cannot discriminate based on the sex of the contributor. This isn't so outside the plan where actuaries step in and calculate this potential longer life into their equations.

Yes, first, harder, faster is a good mantra to embrace when looking to the future. But women need to ask for better pay, more education about the investments they need, a little more risk and more importantly, retirement plans tailored to their specific needs.

Retirement Planning: Are You Acting on Your Own?

Your ability to make the choice of which investment to purchase depends on who you listen to. You may think you are an independent thinker, willing and able to parse all information available to you in a way that complies with who you think you are. But psychological experiments prove otherwise. Faced with which investment in your 401(k) portfolio (we'll use this tax-deferred retirement account in part because most of us have access to them and only some of use them well) you will invest in what someone else has told you to invest in.

You may think you are acting independently. But experiments have shown that you will act against your own morals or perhaps better judgement) in many instances. Consider this: if you are a long-time reader of what I have written over the years, you have grown to disdain annuities and repel target date funds.

You know that I think annuities are a product that costs too much and despite the peace of mind it might offer you and yours, you could do better on your own in something just as conservative without involving an insurance company.

You know that I am not a fan of target date funds in part because they are not all created equally, do not have a good track record that suggests they can do as advertised and if they fail to do as advertised, you might have missed a decade or two of substantial portfolio gains because of it.

So as a non-fan of those two products (there are others but for the sake of this discussion, we'll keep to products you are most likely to confront at some point in your financial lives - target date funds in your 401(k) and annuities at the end of your career), you might think twice about what these offer and if they will do what they suggest they will or I have claimed they might.

Yale University psychologist Stanley Milgram measured the willingness of study participants to obey an authority figure who instructed them to perform acts that conflicted with their personal conscience. While some of his experiments seemed somewhat abusive, they drove home the point that once confronted by the voice of authority, you will not follow what you know is right.

Consider the Halloween experiment for a moment. A trick-or-treater is told by the person answering the door to take one piece of candy and after instructing them of that, leaves the room. 34% took more than one. But put a mirror with the candy and the number of children who took more than one piece despite being directed not to, dropped to 12%.

We are subject to influences even if the person who is influencing us is the person in the cubicle next door or the neighbor across the street. You have no idea whether either of these tow people are lying when they reveal their investment secrets - and most people understanding that fact do in part because there is no moral obligation to tell the whole truth (which might be that they have a great 401(k) balance but huge credit obligations). They speak with authority and looking for guidance, we gravitate towards their expertise.

Your level of intelligence has little to do with it. So what do you do knowing that you are susceptible to suggestions that may go against what you know might the opposite of what you think you stand for? Professor Milgram suggests the following (from Wikipedia):

The first is the theory of conformism, based on Solomon Asch conformity experiments, describing the fundamental relationship between the group of reference and the individual person. A subject who has neither ability nor expertise to make decisions, especially in a crisis, will leave decision making to the group and its hierarchy. The group is the person's behavioral model.
The second is the agentic state theory, wherein, per Milgram, "the essence of obedience consists in the fact that a person comes to view himself as the instrument for carrying out another person's wishes, and he therefore no longer sees himself as responsible for his actions. Once this critical shift of viewpoint has occurred in the person, all of the essential features of obedience follow".

Here is the difference between authoritarian expertise and common sense. If you are told by someone that such-and-such an investment is a good choice, that they have it and have been thrilled by the performance, their authoritarian tone will suggest that you need to do very little research because they have and they have given it their stamp of approval. You have absolutely no idea whether they are going to sell it tomorrow because whatever the investment was, it has run its course. And they have no obligation to tell you.

If a mutual fund suggests that it has a trillion dollars worth of investor dollars under its management, the perception is that there are a lot of people who trust the managers authority to do the right thing. But suppose that money - which we always think does the right thing even if the sell on the downside and buy on the upside - is doing only what the previous person has done. Think Ponzi. Think Madoff.

So what do you do? The morally correct choice is relatively simple when it comes to investments for retirement. You will one day retire and that means you are dreaming of a day when you will no longer work. You may live 20-30 years after that moment and you will need to finance that time. You will need to explore how you will spend that time and how you will pay for it.

You will need to put money away. I can say that you need to contribute the maximum amount the law allows to that 401(k) account, but you won't. You will feel bad because you haven't and in many cases simply work longer to make up the shortfall. But you know you need to invest more than you are.

On the Radio about Annuities

Today on the Financial Impact Factor Radio show, we had as out guest, Joe Tomlinson of Tomlinson Financial Planning. Joe is no slouch when it comes to the world of finance, annuities and retirement planning products. He joined the host of the show Paul Petillo, Dave Kittredge and Dave Ng for lively discussion that traveled from a discussion about what planners/advisors/brokers were to annuities and other retirement planning products to a discussion about whether college was worth the enormous cost.

You should give it a listen. Better yet, click on the little iTunes button at the bottom of the player and never miss an episode (you will automatically be subscribed to each show as a podcast allowing you to take the show wherever you go).

Listen to internet radio with

Paul Petillo of Target2025.com/BlueCollarDollar.com

and Dave Kittredge and Dave Ng

of FinancialFootprint.com

on

The Financial Impact Factor

at Blog Talk Radio

Retirement Planning: The Annuity Answer is a Question

You can't escape it.  You are having your choices about retirement and your plan diced and splayed and discussed in any number of forums.  None of the outcomes from these conversations are suggesting what you want to hear. So here's a flash: you're worried.

Insured Retirement Institute President and CEO Cathy Weatherford recently wrote "Unfortunately, as the promise of Social Security continues to be on unsure footing, working Americans are coming to realize that they will need more than just that paycheck to sustain them throughout their retirement." Even when the Employee Benefits Research Institute released its most recent report, concerns about retirement were, as they could only be expected to be, were the top concern.

And with that comes the numbers.  Now I tend to agree with Steven Strogatz, professor of applied mathematics at Cornell and the author of "The Calculus of Friendship when he suggests that although we are easily duped by words, numbers "brook no argument," he writes suggesting that they "are the best kind of facts."  he describes them as cold, hard, and objective. So when the EBRI reports that 69% of those recently surveyed believed that retirement accounts were extremely important, most of us agreed. Three out five the EBRI concludes from their question don't believe in Social Security and almost two-thirds say they lack confidence in the program enough to begin saving more.

Now to Ms. Weatherford's defense, she sells annuities.  So when she adds that "Increasingly, they [the working folks] are looking for ways of securing their retirement income through annuities, retirement savings accounts and other insured retirement strategies. Employers can play an important role in helping to connect employees with available benefits that can lead to a financially sound future."  I am left to ask the question: wasn't it the employers who got us to this point?

Although as the report, which was commissioned by Project 2010 suggests that 94% of the employers offer a plan of some sort, the less than surprising number is the actual participation.  With three-quarters of the employees that have access us them, it is the fourth that don't is the more troublesome number. And tucked inside these numbers is the fiduciary fib that these employers have done everything they could do to get their employees involved.

Employers are directly responsible for encouraging their employees to invest for their own futures.  Some incentivize their plans with matching contributions. Matching contributions do not have to be high in order to get their workers to participate in the plan.  In fact, studies have shown that a more modest matching contribution might actually spur the employee to put additional funds into their accounts. In the latest economic downturn, companies dropped or greatly reduced their matching contributions and are slow in returning to them.

The matching contribution does a great deal in getting the employee to do right by their own future.  But more important is the period of time between initially beginning the job and the actual beginning of their participation in the plan.  Some employers hold their matching contributions for a longer (than is necessary or even in some cases, realistic) vesting period giving the employee less incentive to invest if they feel as though they don't expect to remain at the job that long.

Some employers do offer plans that are both robust but well-supported with information and educational materials. But no plan is the be-a;;-to-end-all offering that would create the perfect scenario for everyone: employers, employees or the plan administrators. And also included in the report was the fact that 17% of the plans now offered annuities. Is this just an attempt at getting to that perfect "everything" plan?

This lack of what the investment industry refers to as a holistic approach, or decumulation, has professionals practically drooling in anticipation of of what these products can hold for their industry.  I don't really worry that my opinion about annuities will alter simply because this product has begun to emerge as the next big element in your retirement plan.  An annuity will always be an annuity and because of that, will always have more unanswered questions that concrete evidence that it is a better product as a whole instead of its parts.

Annuities are hybrids, born in the insurance industry as part insurance and part investment.  They are costly and unwieldy, ripe with fees and special ta situations for your heirs, hard to get rid of if you change your mind and don't necessarily do for women the way they provide for men.  That last part about women versus men is an actuarial adjustment for the longer lives women have. No other "investment" makes such a distinction.

Then there are the idea of guarantees. Annuities make certain promises, the largest of which is that they will never go out of business. Never is a really long time. And depending on the potential you might have for living longer than you anticipated, it would be nice to think that a company could never falter, never be affected from some unforetold expectation and never consider closing its doors for good. But it happens. It doesn't happen with your equity mutual funds and some bonds might default in your bond funds, but insurers are not forever. This is risk that is grossly understated.

What makes people so fearful about Social Security is the very thing that makes it work.  Whenever you can pool risk, you eliminate more than you create.  The fixes to Social Security are rather simple and even if you are decades from retirement, the program has the legs to continue on even in the face of the Boome onslaught (a wave that may effectively be not much more than swell in this post-recession economy). Annuities can't do what Social Security does and for good reason: there is no money to made.

In the name of fiduciary responsibility, plan sponsors will be begin to offer this sort of product with questions on cost, viability and suitability all left unanswered.  Even a simple CD could do the same sort of thing an annuity would, come with FDIC insurance and promise to never lose a penny.  A well paid CD tucked inside a retirement portfolio but outside the tax-deferred plan would help ease those fears just as well.

But the biggest fear is that when they do become available in your 401(k), they won't be one annuity, but a succession of small, mini-products, each with differing contracts. So far, no retirement plan has been able to answer the question of liquidity and security. Until those can be answered with any certainty the annuity will languish as an option, even with government support.

Paul Petillo is the Managing Editor of Target2025.com

Is Knowing How Much Important to Your Retirement Plan?

It no longer is how much you have.  Now it is whether what you have will be enough.  From the age of accumulation, the twenty or so years prior to this, when growth was rampant, portfolio values seem to take on an endles stream of gains, and the opportunity to retire seemed within everyone's grasp, we now have the age of decumulation.  This newer word in the retirement planning world applies to the simplest of concepts: how much will I need each month.

Decumulation, as described in a recent New York Times article by Jennifer Saranow Schultz, is the ability to pay for a "similar quality of life, keeping financial autonomy, leaving money to children, philanthropy, hanging on to money to cover health expenses or a combination of these options or others". It's not that we weren't focused on those things before, running simple calculations in our heads and using online calculators.  But with so many of us seeing portfolio declines that we hadn't expected, and entertaining the possibility that we would see them again, possibly at the very moment we retired, knowing exactly what we could expect has suddenly popped to the front and center of every discussion.

There is much more to consider than in the previous decades.  Without ever swelling balances, the predictions of what may happen have become much more difficult.  News reports suggesting that we will live longer, that the cost of health care in retirement will eat away at those balances, and the potential of declining cognitive abilities all need to be considered -even if we can't put a price tag on any of them.  Simply suggesting that we will work longer or even work in retirement if needed do not satisfy the question of decumulation with any accuracy.

Does that mean we will all need an annuity?  According to Eric Johnson, a professor of marketing at Columbia Business School, annuities are still a hard sell to retirees who do o=not want to hand over a huge chunk of their retirement portfolio to one firm in exchange for a steady check.  If their annuity is to cover your spouse in any way, the cost goes up while the monthly payout goes down.

What do we know about annuities aside from the hybrid investment, part-insurance, part mutual fund aspect of the purchase?  There is also the actuarial element - how long you will live is calculated into the payout and if you include your wife, with her potential to live longer than the husband, the payout drops even further.

There is a behavioral aspect to the purchase of an annuity, most often bought at retirement when the defined contribution plan pay the retiree in a lump sum.  What many economists who study this event have found is not really surprising.  People make their decision of whether to buy or not using the last six months of the stock market as their best indicator.

The mention of cognitive decline also worries financial professionals and the government as well.  The older you get, the less likely you will be able to make the right decisions with whatever remaining wealth you might have. This sort of problem can occur only ten-years after retirement and with anyone overseeing the decisions - which get more complicated - there is good chance that the wrong one will be made.

Annuities are a hard sell based on what experts call mental accounting.Once you begin thinking in terms of different baskets for your money, spending what is needed often becomes a question of selling more investments than might be prudent.  Your retirement budget will change with time.  Studies have begun to suggest that in the first years, liesure spending will be far higher than it willbe just ten-years after you retire.  Annuities don't address this, often giving retirees too little money in the beginning and too much when they don't often have the ability to spend it.

Some believe that a self-examination of what you see in the future - based on who and what you are now - might be helpful.  Others disagree suggesting that if that were the case, and everything about the future seems to be not-so-bright, retirees might take an opposite stance and spend it now.

The best solution, which seems to be gaining ground it building the purchase of annuity right into the person's 401(k) plan.  This would allow them to see exactly how much they would get if they retired.  This would induce them to invest more, learn to budget now and possibly enter into retirement with fewer financial burdens. It would also benefit women who retire allowing them to get a clearer picture of what they will get based on what they have invested for the future.

Without a Clue about Money, Retirement and Investing

By now, most of my regular readers know what I do not like in the world of financial products. The annuity galls me (a mix of insurance and mutual funds that doesn’t do either well), the ETF (which mimics the indexed mutual fund but allows you to trade it just like a stock and pay for the privilege of trading just like a stock) and any tool that gives you the impression that you can set it and forget it.  There are others, but at the top of that list is the target-date fund.

The products are all hyped and re-hyped by the those that sell them as the easiest way to wealth.  The belief that sales people from the world of finance care about your well-being or what is known as fiduciary responsibility, may be the biggest mistake the vast majority of us make.  And the folks who make these mistakes are often wary of every other type of sales approach in every other facit of their lives.

So why, when it comes to target date funds do they simply believe the following: pick a date in the future and our mutual fund manager will adjust and readjust the underlying holdings of the account to protect your hard earned money, so, that when you retire, you will have a conservative allocation of funds that will serve you well into the future?

Click here to read more about target date funds from Paul Petillo, managing editor Target2025.com

Should You use Annuities in Retirement?

Annuities are back in the news.  And the insurance industry is jumping for joy.  Should you?

The Obama Middle Class Task Force is looking to annuities as a way to make retirement just a little more secure.  While they have come up with numerous incentives, they should also consider a fixed lifetime tax on all retirement income up to a certain amount.  They have discussed this for the first $10,000 of annuity income but they could also extend this incentive to IRAs as well.  If the retiree (or future retiree) could determine how much of a bite taxes would take, they could better estimate how much they will actually get when they retire.  Currently, the assumption is that retirees will earn less and therefore be taxed at a lower rate.  Guaranteeing that rate will enable folks to project better. 

Unless you or the insurer passes away!  More on annuities at Target2025.com

Variable Annuities of a Different Sort

Older investors may have a new annuity to examine in 2010. It may be simply a better-for-the-insurer version of the old variable annuity mouse trap. Younger investors also need to take note of this variable annuity product as well.

Annuities come in all sorts of flavors. Single premium annuities are an all-in type that is purchased in a lump sum. Flexible annuities spread the payments over a period of time. Sometimes these are deferred until a later date whereby the investor can withdraw money all at once or in scheduled payments. Investments grow in a tax-deferred environment. Fixed annuities offer the investor the lowest risk (in part because the insurance company invests in bond funds) which insures your principal is never lost. Immediate annuities are also lump sum investments that begin distributions immediately.

But there is a new variable annuity product coming to market that will attempt to lure a wide range of investors into its trap. Everyone should take notice of what this investment/insurance product offers in large part because the sales pitch is designed to play off your fear of losing what you already have gained.. Question is whether you understand what this trap means to your retirement and whether it is worth paying the high cost.

Paul Petillo is the Managing Editor of Target2025.com

Adding Less Risk: The Safe Harbor Option

There is no easy answer for how much risk is too much risk or too little. In the aftermath of this past year, plan sponsors are looking for a way to insure that those close to retirement have the money they invested over their careers there when they need it. The key word is insure. And it is the industry that offers this sort of product that is being considered as a possible option. But are annuities the option worth considering?

One of the most difficult things to do is provide protection for already accumulated money in a defined contribution plan. Currently, even in what the industry refers to as megaplans, the options are limited to targeted-dated funds or some sort of option that offers fixed income protections. These types of options adjust the level of stock market exposure as the employee ages, shifting from more aggressively invested dollars to more conservative investments.

The reason for the increased popularity of these products is the result of a Congressional mandate. Target-dated funds were made the default investment for those entering the workforce replacing other less retirement oriented funds such as money market accounts. This allowed the worker to begin investing for their retirement in what the industry called the best option for those who do not know what to choose.

But now, with the focus on asset preservation rather than the typical asset accumulation, a particular concern for older workers nearing retirement, the pension industry is considering annuities. There are several problems with this, first and foremost being the involvement of the insurance industry.

Annuities are designed to be purchased as a stand alone product that provides guaranteed income. The insurance company makes certain commitments to how much you will receive in retirement from accumulated assets. The cost of this quasi-investment/insurance product is high in the first seven years of the purchase and the underlying investments made by the insurer are designed to provide the insured with a lifetime income.

The introduction of such a product in your defined contribution plan presents all sort of problems, not only for plan administrators but for the participants as well. According to Pensions and Investments Online, this would involve tweaking the already suspect target-dated funds. (I say suspect in large part because they have yet to prove they are able to do what they were designed to do.)

PIonline suggest that these target-dated funds could allow their investors to buy "slivers" of an annuity from several insurers. This would keep some of their money invested even after they retire and some of it as guaranteed income.

The second option and probably the most costly would be to offer a "guaranteed lifetime withdrawal benefit". This would essentially allow the investor to roll the assets they have accumulated in the annuity where the insurer would offer income based on a high water mark withdrawal based on a certain percentage. This would, insurers suggest, provide income even when the market moves in unsavory directions during retirement.

Robert Reynolds, chief investment office at the conservative Putnam Fund has been making noise since taking over the once powerful investment house. Among his proposals:

Mr. Reynolds would like to create "a national insurance charter and an FDIC-like fund to back up lifetime income guarantees". This will essentially force employers and employees to consider this option. The FDIC-like fund, not federally insured but instead insurance company guaranteed would offer protections for assets already accumulated.

Involving Washington is the trickiest part of his proposals. He would like Congress to add tax incentives to both employees that participate and employers who offer matching contribution "that would require "employers to offer a lifetime income option, either through annuities or other insured methods".


Of course for such a move to pass muster, the insurers would need to have set "caps on the equity exposure in target-date funds as they become mature". Such action would need the support of legislation that would "require employers to enroll all of their workers in 401(k) plans automatically and increase their contributions over time." This would put pressure on the smallest of firms to comply, a costly maneuver and force the largest firms to take away what some feel is the most important aspect of the 401(k) plan: choice.

This would also jeopardize the portability aspect of the plan. Few insurers would continue to cover an employee after they leave a firm and would probably not participate in a rollover to an individual retirement account (IRA). The reason: no former employee would continue to pay the outsized costs on an individual basis which could be spread over a large group inside a 401(k) plan.

“Usually after a tough period like this you're presented with an opportunity to make the system better,” Mr. Reynolds said in an interview. “We need to fix 401(k)s, which have become the retirement plan of this country. At Putnam, we want to get out in front of the issues.”

This is scary talk indeed.

Retirement Planning: The Annuity as a New Idea?

When the new ideas seem complicated, they are not workable for the average investor/employee. Pensions were simple. You worked and when that long career was over, you were rewarded. The advent of the 401(k), a Wall Street invention unlike any other profit generating idea ever created, was offered to the most captive group of investors, add a little fear of the future and you have the perfect income producing vehicle.

And then, say it could be better. Say it needs to be improved. Say it is not really our fault – we are smart enough just not as logical as previously thought. There are far too many of us not using these tools and far too many potentially profitable fees left uncollected.

Which gives folks like Professor Merton, the John and Natty McArthur University Professor at Harvard Business School and a winner of the 1997 Nobel Memorial Prize in Economic Sciences an opportunity.

Its just too bad Prof. Merton mentioned annuities. He actually had my attention until that point. Perhaps I should begin with the thinking about retirement allocation that he so deftly describes as" "But that knowledge won't qualify you to decide how much mid-cap European stock you should have in your portfolio, any more than it would enable you to perform surgery on yourself." True enough, but removing a splinter is simple surgery; transplanting a heart on the other hand is not.

If knowledge and time truly are the only obstacles - although I believe that the ever complicated financial products that are available are designed to make us feel less than qualified to remove even a simple splinter, then Wall Street should demystify the process.

If annuities were truly the solution, then businesses could once again create a pension with guarantees. Why they don't is quite easy to answer: They do like the cost structure.

Retirement, as we have come to dream about, is a time in life when we can rely on an income that we worked hard for and the time to enjoy it. Granted, this has been redefined with every passing day - each uptick in inflation, each economic downturn and each political misstep with taxes and spending, keep that dream from fully developing.

But I should emphasize that the single biggest drag on any retirement savings is the cost of getting there. We can play "minimum/maximum needed income" games all day but the simplest solution would be to give the employee a financial review on the same day businesses take the time to give them appraisals. Having the employee opt for channeling their next pay raise or bonus into a long-term plan might be all the incentive they need to continue to work harder all while giving the employee a sense that the company is more than just a "gatekeeper" and closer to the good old days of pensions, when the company seemed to actually care about loyalty and rewarded it with a defined benefit.

Now I fully realize that we will never be able to go back to those days, but annuities - an investment/insurance hybrid of dubious nature and questionable need is not the answer.

Retirement Planning: Mutual Funds vs. Annuities

Most of you who have been following my writing and reading my books over the years know exactly how I feel about annuities. I believe that they are an insurance product not an investment, and unless you have absolutely no other choice, should be avoided.

But those calls for restraint sometimes fall on deaf ears. There is, as some point out, too many attractive features despite the downside costs.

Some retirees are faced with a payout in one lump sum as they exit the work place. And because you no longer have a steady and reliable stream of income, immediate annuities provide some measure of how much you have to spend each month.

The downside risks in annuities are something to consider and if you don’t, the attraction these instruments have can be problematic. If you decide to sell the annuity, the escape fees can be sizable although they diminish over time. The costs of managing the underlying investment, which is usually a relatively conservative mutual fund, often comes with higher than industry average fees for similar funds. And should you die early, the money is gone.

There are additional downside risks, even as the annuity industry attempts to convince you that, over time and providing you live a longer-than-average length of time, you could conceivably receive up to 40% more than you would have had you invested in mutual funds without the insurance factor.

One of those downside risks is inflation. Once your income is fixed, it will never increase as time drifts past. Each year it will buy less as the dollars you receive are worth less. To offset these problems, you can of course, add riders to your policy extending the payments to a spouse in the event of your death or even protecting against that inflation factor but these cost money – which is subtracted from – you guessed it – your monthly payout.

Now the mutual fund industry has stepped up its efforts at attracting these soon-to-be retirees with a payout fund, offering regular income checks and the ability to leave the remaining balance to whomever you wish as part of your estate.

But these products come with warning from the very industry that is promoting them. They worry, that the markets could not provide the guaranteed income that the investor might expect and because of that, many fund families are suggesting that you buy an annuity any way. Another major concern that fund offering these payout investments warn about is a change in investment strategies.

Normally, a payout fund will offer a stream of income over a set period of time – 20-30 years. And while your assets may appreciate, they will drop due to regular withdrawals. The money is inheritable should you meet an early demise.

Probably the best suggestion would be to keep your money where you want it in a Roth IRA. You may face the same market-decline possibilities, but the fees (if you choose an index fund) will be considerably lower and that makes all the difference over the long-term.