Retirement (3)

Thursday, 20 October 2011 22:04

How Annuities Work

Written by John Van Dekker

Well of course, this question is too broad to have an answer that is both simple and comprehensive.  The details of how an annuity works very much depend on the specific type of annuity that you are considering. In an effort to make you a more informed investor, lets first look at the basic concept of an annuity contract.

In general an annuity is an investment vehicle offered by a financial institution (usually an insurance company), into which one makes either a single lump sum payment or series of payments. In return the financial institution will make payments to you (the annuitant), beginning either immediately (called an immediate annuity) or beginning at some future date (called a deferred annuity).

Annuities offer the opportunity to guarantee an income stream, in some cases for the rest of your life. In essence they can work as an inverse life insurance policy. While a life insurance policy is designed to provide a benefit in the event that one does not live to their life expectancy, an annuity can provide protection in the event that you live longer than your life expectancy.

Types of Annuities:

In order to provide you with more information below is an overview of a few different types of annuities. These are meant to facilitate your ability to have an informed conversation with your insurance agent, broker, financial planner or other financial professional, when considering your investment options. Annuities come in a myriad of different types, and have different benefits, features and risks. Ask your financial professional for a prospectus on the annuities you are researching and consider the specifics of the particular annuity contracts that you are considering to determine whether or not they meet your investment needs.

Immediate Annuities: are those that begin to pay out immediately after funding.

Deferred Annuities: are those that do not begin to pay out until a future date.

Both immediate and deferred annuities can be broken down further into Fixed or Variable annuities.

Fixed Annuities: guarantee your principal and a rate of return while your account is invested. The financial institution offering the annuity contract manages the funds in a fixed annuity, generally investing these funds very conservatively. The payments from a fixed annuity are guaranteed to be a certain amount per dollar invested. The timeframe over which annuity payments occur can be a pre-defined period (for example 5, 10 or 15 years), or an open-ended period, generally your lifetime (or the lifetime of you and your spouse or other beneficiary in the case of a “joint and survivor annuity”). Fixed annuities are generally considered to be a low-risk investment option. Fixed annuities are the most popular type of annuity contract because they are such stable investment vehicles, especially in times of high volatility for other investment classes. It is important to fully research the fixed annuity contract that you are considering; fixed annuities may come with age restrictions, and penalties should you need to access your principal before maturity. Fixed annuities have many different variations, including; “equity-indexed annuities”, “life annuities”, “joint annuities”, “joint and survivor annuities”, and “life annuities certain”, to name just some of the options that are available.

Variable Annuities: allow you to invest your annuity assets among a range of investment options, rather than have the assets managed by the financial institution. A primary advantage of a variable annuity is that you can benefit from higher than expected performance of your investments. Conversely the primary drawback of a variable annuity is the principal risk and lack of certainty as to the amount of annuity payments that you will receive. Variable annuities carry higher risk than fixed annuities, based on the risk of the underlying investments, which are generally mutual funds (of equities, bonds, or money markets).  Other features of variable annuities include tax deferral and death benefits. Variable annuities (and fixed annuities) are tax deferred investments, which means that you will not have to pay taxes on the investment gains of your annuity account until your receive payments from your variable annuity*. Variable annuities also carry a death benefit, which means that in the event of the annuity holder’s death before annuity payments begin your beneficiary will receive a death benefit payment. Typically the death benefit of a variable annuity is at least equal to the total annuity premiums paid less any withdrawals, even if the annuity account has lost value.

* It is important that you fully understand the tax-deferred nature of annuities when considering this feature. Funds withdrawn from a variable annuity (including normal periodic payments) are taxed at ordinary income tax rates, which will often exceed capital gains rates. The benefit of the tax-deferred nature of a variable annuity will likely only be realized if the annuity contract is a long-term investment. You may want to consult a tax advisor as well as your financial professional when considering these features.

While considering an annuity, remember that you will pay for the features and benefits of any annuity contract, as you would with any normal product or service purchase you make in your everyday life. Annuities will typically carry administrative fees, mortality and expense risk charges, and surrender charges. You will also likely incur the fees associated to the underlying investments in your annuity account (mutual fund expense fees as an example). Additionally withdrawals from your annuity account before the age of 59 ½ may result in a 10% federal tax penalty in addition to ordinarily applicable taxes on income and investment gains.

Thursday, 20 October 2011 22:00

Retirement Planning in Your 50's

Written by John Van Dekker

Couple using laptopMost experts will agree that retirement planning is an absolutely essential consideration for people in their 50’s. You’re at a phase in your life where your earning potential is excellent, and many opportunities to help your retirement nest egg grow are still very much at your disposal. Many experts will also be quick to point out though, that when you’ve reach your 50’s it’s a good time to begin to think about your retirement investing options a little more conservatively.

Retirement planning is something that is best started earlier rather than later. However, if you’re reading this because you didn’t start earlier, and you’ve begun to feel desperate, don’t! Stop, take a deep breath, and above all, keep your cool. Retirement planning is something that should be done judiciously and with great care. Making foolish investment decisions out of desperation is a good way to turn a small fortune into an even smaller one.

In general one should think of investing their retirement nest egg as an exercise in wealth preservation and not wealth generation. Certainly you should be able to expect a reasonable rate of return for your investments, but the days of retirement calculators that predicted regular annual returns of 8% or 9% died with Lehman Brothers and the last boom economy some time back in 2008.

Here are some simple steps to follow in creating a sound retirement investing strategy, and making retirement something to look forward to, instead of something to dread.

Assess your current financial situation.  Much like when you are planning a car trip, the first step in plotting your course is to know your starting point. Begin by taking a full financial inventory, both assets and liabilities. There are several reasons for this step; you’ll need this information whether you plan to go it alone or engage a financial planner, it will help you identify assets that aren’t generating appropriate returns, and it will identify places where you may have ‘bad debt’ that should be addressed sooner rather than later.

Look at your current lifestyle. Another excellent early planning step is starting to make adjustments now, instead of putting them off until later. If you are concerned about whether or not you’ll be able to afford your lifestyle after retirement, consider your lifestyle now. Reducing unnecessary expenses now has a twofold benefit. It will allow you to shift more of your current income into savings, and it will lessen the impact of later lifestyle transitions, if they turn out to be necessary at all.

Determine your retirement goals. This step is all about figuring out where you want to end up. Retirement goals are as diverse as the people that set them. Figuring out how and where you want to spend your retirement is a key step in smart retirement planning. If you plan to live somewhere where the cost of living is relatively high, you had better make sure you plan accordingly ahead of time. Along with the basics, like; where do you plan to live, how much do you want to travel, and how long of a retirement are you planning for, make sure to consider other factors; what about the costs of insurance and healthcare, taxes that will be deducted from retirement income and the like. This shouldn’t be a daunting task, but it is one that should be done carefully and probably with the benefit of professional advice.

Get professional advice. The fact of the matter is that this is no time to go it alone. Think about it this way, would you rather be independent now while you do your financial planning, or would you rather be financially independent once you retire. Let’s be clear about what this advice means though, do your research, walk into the conversation with a financial planner well informed and ready to interview them. You probably wouldn’t marry the first person you went on a date with, neither should you assume it’s a good idea to place your financial future in the hands of the first person willing to manage your money.

Don’t stop there. Simply finding a financial planner, even one that you are very satisfied with shouldn’t be a final step; it should be a first step. Expect to take a role in the planning process as well as in what comes after you’ve got a plan. How active of a role you take will depend on your comfort level and expertise, and your specific situation. But whether you want to drive the car, or help navigate from the passenger seat, this is your journey. Don’t fall asleep in the back seat of the car and just hope you arrive at your destination.

Thursday, 20 October 2011 21:43

What is a Reverse Mortgage?

Written by John Van Dekker

A reverse mortgage is a type of home loan that allows homeowners 62 years of age or older to convert some of the equity in their home into a stream of tax-free income. There are a number of options available when looking for a reverse mortgage. There are non-FHA options, typically known as proprietary reverse mortgages, and there are government insured FHA approved reverse mortgages called a Home Equity Conversion Mortgage (HECM)*.

Be cautious when considering any reverse mortgage that is not FHA insured, and beware of any service or counselor that charges a fee to help connect you to an approved borrower; these services are often scams that take advantage of seniors and seek to charge significant fees for providing a service that can be found elsewhere for little or no charge. Non-FHA mortgages may be absolutely legitimate, and may meet your needs better than an FHA-HECM (for instance if you need to access more equity than the FHA limits will permit), however reverse mortgages can be extremely complex arrangements, and the FHA guidelines provide a measure of oversight that should not be overlooked.  As with any significant financial transaction, do your research, and seek the advice of a trusted financial professional.

Features of FHA Reverse Mortgages:

  • You do not make monthly payments to the lender as you do with a traditional mortgage or home equity loan
  • Remaining equity in your home DOES become an asset of your estate in the event of death
  • Proceeds from a reverse mortgage can be taken as a lump sum, through a line of credit, or as payments over time (lifetime or fixed term).
  • Proceeds from a reverse mortgage can be used for any purpose

Requirements of FHA Reverse Mortgages:

  • Borrower must be age 62 or older
  • Residence must be the borrowers primary residence
  • Borrower must receive HUD approved counseling prior to loan origination
  • Residence must be a single-family home, a 2 to 4-unit home where the borrower occupies one of those units, or a condominium or manufactured home that meets FHA requirements
  • You must own your home or have a low mortgage balance that can be paid off by the proceeds of the reverse mortgage
  • Residence must be properly maintained
  • Hazard Insurance and Property taxes must be kept up to date by homeowner
  • Repayment in full is due at the time of death of the borrower, in the event that the home is sold, or if the homeowner fails to adhere to the terms of the mortgage contract (for example failure to pay property taxes or hazard insurance premiums)
  • Borrower fails to live in the residence for a twelve (12) consecutive months

The Federal Government provides more information on reverse mortgages and FHA approved lenders on their website:

* In Canada a similar type of vehicle to a reverse mortgage exists called a Canadian Home Income Plan (CHIP).  Note that some rules and limitations of a CHIP vary from those of an HECM.