Category Archives: Retirement Planning

Ideas to help preserve and grow your money

The Monetary Illusion

Global Nominal GDP Growth, as Measured in Dollars, Is Projected to Decline

global-growthMy Comments: It has been argued that Wall Street is corrupt and greedy and doing its best to create further income inequality in this country and across the globe. And that as a result, we should hold Wall Street accountable, send people to jail and reform the system. It’s suggested that only the Democrats can do this if they control Congress and the White House. I’m a liberal, and it’s not that simple.

Wall Street is playing the cards it has been dealt. I’ll agree they have done their level best to get good hands, but the responsibility for this falls on us as voters. If you want a more level playing field, you cannot avoid the voting booth. They say ignorance is bliss, but ignorance in this case will also be painful.

Until recently, during my 50 years as a marginally productive citizen in these United States, I’ve enjoyed an increasing standard of living. I feel that standard is now eroding, and by the time I’ve died, the prospects for my children and grandchildren will be less promising than were my prospects when I was their age. I’ll do my best for them, but I’m running out of time.

March 27, 2015 by Scott Minerd, Guggenheim Partners

The long-term consequences of global QE are likely to permanently impair living standards for generations to come while creating a false illusion of reviving prosperity.

A version of this article first appeared in the Financial Times.

As economic growth returns again to Europe and Japan, the prospect of a synchronous global expansion is taking hold. Or, then again, maybe not. In a recent research piece published by Bank of America Merrill Lynch, global economic growth, as measured in nominal U.S. dollars, is projected to decline in 2015 for the first time since 2009, the height of the financial crisis.

In fact, the prospect of improvement in economic growth is largely a monetary illusion. No one needs to explain how policymakers have made painfully little progress on the structural reforms necessary to increase global productive capacity and stimulate employment and demand. Lacking the political will necessary to address the issues, central bankers have been left to paper over the global malaise with reams of fiat currency.

With politicians lacking the willingness or ability to implement labor and tax reforms, monetary policy has perversely morphed into a new orthodoxy where even central bankers admittedly view it as their job to use their balance sheets as a tool to implement fiscal policy.

One argument is that if central banks were not created to execute fiscal policy, then why require them to maintain any capital at all? Capital is that which is held in reserve to absorb losses. If losses are to be anticipated, then a reasonable inference is that a certain expectation of risk must exist. Therefore, central banks must be expected to take on some risk for policy purposes, which implies a function beyond the creation of a monetary base to maintain price stability.

Global Nominal GDP Growth, as Measured in Dollars, Is Projected to Decline
With a surging U.S. dollar and growth remaining sluggish in much of the world, Bank of America Merrill Lynch forecasts that world output measured in dollars could fall in 2015 for the first time since the financial crisis. Over the past 34 years, this has happened just five times.

What kinds of risk are appropriate for a central bank? Well, the maintenance of a nation’s banking system would plainly be in scope, given the central bank’s role as lender of last resort. The defense of the currency as a store of value and medium of exchange is another appropriate risk. This was the apparent motivation of Mario Draghi, European Central Bank president, for his famous promise to defend the euro at all costs in the summer of 2012. The central bank balance sheet has proven a flexible tool limited in use only by the creativity of central bankers themselves.

In response to those who argue against the metamorphosis of monetary policy into fiscal policy, one need only point toward the impact of quantitative easing (QE) on interest rates. The depressed returns available on fixed-income securities, largely as a result of QE, are acting as a tax on investors, including individual savers, pension funds, and insurance companies.

Essentially, monetary authorities around the globe are levying a tax on investors and providing a subsidy to borrowers. Taxation and subsidies, as well as other wealth transfer payment schemes, have historically fallen within the realm of fiscal policy under the control of the electorate. Under the new monetary orthodoxy, the responsibility for critical aspects of fiscal policy has been surrendered into the hands of appointed officials who have been left to salvage their economies, often under the guise of pursuing monetary order.

The consequences of the new monetary orthodoxy are yet to be fully understood. For the time being, the latest rounds of QE should support continued U.S. dollar strength and limit increases in interest rates. Additionally, risk assets such as highyield debt and global equities should continue to perform strongly.

Life Insurance and Retirement

rolling-diceMy Comments: This is not an easy idea to talk about. The article came from someone critical of Dave Ramsey and Suze Orman, who argue that premiums for life insurance in retirement are an extravagance.

Some of the assumptions made by the author can be questioned, but the overall theme is essentially correct. Personally, I’ve made a similar choice, as there is absolutely no way I can replicate the benefits to my wife and/or children, regardless of when I die. That’s assuming I die first, which is not a given. But it provides me with huge peace of mind, and the certain knowledge setting aside money today will contribute to the financial freedom of those I leave behind.

by Tom Martin on March 6, 2015

Dave Ramsey, Suze Orman and scores of other financial pundits in the media scorn the idea of having life insurance in retirement. Their rationale seems to make sense on the surface: Life insurance is designed to replace your earnings when you die. Once you retire (and have no earnings) you are living off your investments. When you die, your investments don’t die with you, so what is the purpose of using valuable funds to pay for unneeded coverage?

Life insurance clearly plays an important role for very wealthy clients to efficiently transfer their estate, but are the media pundits correct when they advise that the average family to dump their coverage in retirement? Probably not.

Let’s consider the following statistics:
• The average American approaching retirement has retirement assets to replace only 10 percent of his/her pre-retirement earnings.
• 55 percent of Americans over age 65 rely on Social Security to provide more than half of their income.
• The maximum monthly Social Security retirement benefit for a person reaching full retirement age in 2015 is $2,642.

These statistics clearly show that Social Security is a vital source of retirement income. When we view our Social Security benefits statements, we tend to discount the importance of this benefit, as benefits are expressed in “today’s dollars.” In reality, our actual benefits will be much larger due to inflation. By contrast, when we consider how much savings we will have at retirement, we often fail to consider that the values of those dollars will be similarly reduced due to inflation. Consider the following example.

John and Jane Doe, age 50 and 45 respectively, plan on working to John’s full retirement age of 67. John is making $150,000 per year and Mary earns $70,000 per year. John and Jane both contribute to a 401(k) plan and, based on their investment assumptions, they figure that they will have $1,000,000 in retirement funds by the time John reaches age 67. Assuming a 5 percent withdrawal rate, they will be able to withdraw about $50,000 per year.

John receives his Social Security statement and sees that his retirement benefit will be the maximum, which is $2,642 in today’s dollars. Jane’s benefit is projected to be $1,450 if she claims at age 62 (same year John retires). John and Jane incorrectly assume that Social Security will provide about half of their retirement income, which is $49,000 from Social Security and $50,000 from retirement accounts.

In reality, both will receive much larger Social Security checks, since these amounts will be indexed for inflation. If we assume 3 percent inflation, John’s actual benefit will be about $77,000 per year and Jane’s will be about $40,000 per year. In comparison, assuming a 5 percent withdrawal rate on their retirement assets, they will have $50,000 income from the retirement funds. In reality, despite a respectable retirement account balance, Social Security will actually provide about 70 percent of their income.

Since Social Security benefits continue to increase with inflation, by the time John is age 80, his Social Security benefit will have risen to $113,000, at which point Jane’s benefit will be about $59,000.

Let’s assume that John dies at age 80 and Jane lives to age 85. At John’s death, Jane will assume John’s benefit and lose her own benefit. The total Social Security benefit will drop by $59,000 per year. Since Jane will spend 10 years as a widow, this loss amounts to $590,000!

What’s more, consider if John dies at age 75 and Jane lives to age 90. John’s death would cost Jane well over $1,000,000 in lost Social Security benefits.

Even though they have a sizable retirement account, it only represents about 30 percent of their income. Such a substantial reduction in Social Security benefits is likely to cause a substantial reduction in Jane’s lifestyle.

The financial pundits would be quick to recommend that John purchases a term policy today to cover his “temporary” insurance need. They figure that once John retires, he has no earnings to protect. In reality, his death after retirement will cause a substantial reduction in household income. John should consider some form of permanent insurance for at least part of his insurance portfolio now in order to mitigate the eventual loss of the Social Security benefit. If Jane predeceases John, John would lose Jane’s benefit. Even if the permanent insurance was just on John’s life, he could still utilize his policy to replace the benefit he lost on Jane. He could use the policy to provide a tax-free income stream through withdrawals and loans. He could cash the policy in, replace it with an annuity, or even sell the policy as a life settlement. Either way, a permanent policy on John could create a useful cushion regardless of who dies first.

In summary, life insurance can play a critical role in helping couples meet their retirement goals, whether it is through utilization of the policy’s cash value or in having the death benefit replace the lost Social Security benefit.

Why Invest in Real Estate?

home mortgageMy Comments: This is a topic about which I know relatively little. But it’s real, people do make money, sometimes lots of it, and over the few years since the crash that started in 2008, some folks have made tons of money.

The dramatic opportunities are probably behind us for a while as after several years, life tends to move on. But I have clients who would like to allocate some of their money to real estate. This is a helpful introduction if this is you.

By John Miller, posted in Real Estate on 02/28/2015

Real estate is one of the most stable and wisest investments you can make for your personal finances. Unlike bonds and other non-material investments, land and homes are material products that don’t go away.

In fact, real estate values remain quite high, and their rates improve with time. Many people have become millionaires because of real estate investments.

It takes a lot of money and capital to start out in real estate. People with big real property investments usually start out with the profits they get from their own businesses, from the gains they get from the stock market, or from other sources of income.

Some people think that real estate investments are an easy way to make money. Some think that one can just sit back, relax, and watch the profits grow. On the contrary, real estate requires a lot of dedication, hard work, and patience. Real estate investments do not grow overnight; you need a lot of skill and dedication to make earn profits from a real estate investment.

Where to Get Real Estate Deals
Any property for sale that has land in it has a great potential to be a serious money maker. If you’re only starting out to invest in real estate, you would do well to consult with an experienced real estate broker or investor who can guide you through your first land purchases.

Books, magazines, and other print resources can help you greatly just in case you don’t know what you’re doing with your real estate investment. Like any investment, you shouldn’t put your hard-earned money on land that will not rake in good profits.

Keys to Success
The trick to making the most of real estate is to buy the best land at exactly the right place at exactly the right time. Remember that real estate purchases are relatively permanent. You should also consider how much you’re willing to spend. Land costs millions, and you don’t want to end up with a piece of real estate that doesn’t pay for itself very well.

5 Annuity Questions With Rational Answers

Piggy Bank 1My Comments: Every year, many BILLIONs of dollars flow from the pockets of Americans into a financial contract called an “annuity”. Originally, the idea was to give an insurance company some of your money, and they would agree to send it back to you, with interest, over time.

Over the years, the sophistication of these contracts has grown exponentially and they come in more flavors than seems possible. The latest have features that appeal to many of us who are increasingly older, fully understand the temporary nature of life, and are unwilling to simply curl up in a ball and hope for the best.

They are not always cheap, ie the internal costs can be serious, but we both know that most good things in life are not cheap. But you have to either know how to evaluate what you are paying for or find someone you trust to help you. The fact that so much money is flowing into them suggests there is are rational reasons to use them. (I’ve edited this slightly since it was written for advisors and not the general public.)

Jan 21, 2015 | By Chris Bartolotta

It’s no secret that there are a lot of misconceptions out there about annuity products. You make it clear that you’ve got some preconceived (and often incorrect) assumptions when you ask the following questions.

1. Aren’t fixed annuities bad for clients?

Let’s get this one out of the way first. Even setting aside the fact that there are numerous different types of annuities, and hundreds of products of each type, there is no such thing as a category of financial products that is inherently “bad.”

That’s not to say that annuities are right for everyone; that would be equally absurd. As with most things in life, the answer lies somewhere in between. What is good or bad for a client depends heavily upon their individual circumstances. The ideal client for a fixed annuity is typically at or near retirement age, has $100k or more in liquid assets, and has a low risk tolerance. Even within that subset of the population, though, there are myriad options available. Should they look at a SPIA? A DIA? An indexed annuity? Should they buy an income rider or not?

Saying that all annuities are bad is like saying all cars are bad. If you have a one-mile commute to work and don’t travel much, you probably shouldn’t be driving an SUV. If you’re a contractor who regularly hauls heavy equipment on the job, a coupe isn’t going to work well for you. The same principle holds true for annuities, or any other financial tool.

2. What’s the interest rate on this SPIA?
Somewhere, an actuary is reading this section header and laughing. Asking about the interest rate on a SPIA points to a fundamental misunderstanding of what a SPIA is and what it’s supposed to do, which makes it all the more unnerving to the annuity-savvy advisor that this question gets asked all the time.

A SPIA, shorthand for Single Premium Immediate Annuity, is what most people think of when they hear the word “annuity.” If you need to explain it in one sentence, it’s an exchange of a lump sum of cash for a stream of payments over a certain period of time, typically the client’s lifetime.

Since an insurance carrier doesn’t know the exact day you’re going to die, it would be extremely difficult — not to mention downright irresponsible — for them to try to price it for maximum earnings over the agreed-upon time period. It’s true that a carrier will sometimes try to be consistently the best in a certain client sweet spot — females aged 64 to 69, for example — but if you’re using SPIAs to try to earn tons of money, you’re not using them correctly. They should be used to cover known, fixed expenses. Accumulation of interest is best left to a deferred annuity or to investments.

3. How can I get a hybrid annuity?
The answer to this one is very easy. You can’t.

The term “hybrid” often gets thrown around by websites purporting to be about consumer advocacy, which typically tout market upside without any downside risk. While this technically does describe certain aspects of a fixed-indexed annuity, these are not “hybrid” products in any sense of the word. They are a well-defined class of annuities that are distinguished by certain features, just like any other product.

The theory these sources will claim is that, because the product is tied to a market index but protects against loss, you have a combination of the best parts of a fixed and a variable product. The reality is that while it’s true that a market index is used to determine gains in a given year, at no point is your money actually being invested into the stocks (or commodities, in some cases) in that index. They also often paint a rosy picture where the client can catch all of the booms in the market without suffering any of the busts. In reality, because it is still a fixed product, it can do better than a traditional fixed rate, but single-digit interest is still going to be the norm. This actually leads nicely into the next question you should immediately eliminate from your annuity lexicon …

4. How much should I invest in a fixed annuity?

Another easy answer here. Nothing.

That isn’t to say your clients shouldn’t buy annuities. It’s likely that some of them absolutely should. The issue here lies with thinking of fixed annuities as an investment, when in fact they are an insurance product. After all, you need a life license to sell them, not a securities license.

When your clients think of their fixed annuity as an investment, this creates the probability that they will begin comparing it to an actual investment, in which case the interest earned will start to look poor in a hurry. It behooves you to remind them that they are purchasing this product for guarantees, not to get rich. To put it another way, explain to them that fixed annuities are the mirror image of life insurance. Their life policy insures against the financial consequences of an early death; their annuity insures against the financial consequences of a long life.

5. Aren’t annuities expensive?
No trick question this time. The answer to this one is: It depends.

Annuities are often decried as being a poor choice due to the high fees involved. A base fixed annuity contract with no riders included, however, will have no fees at all.

Now, it’s true that a fixed annuity can have fees. Most indexed annuities and a handful of traditional fixed contracts have the option to add an income rider, and the vast majority of those carry an annual fee. It’s usually slightly under one percent, though some are more expensive, and some less or even free. Other types of riders, such as an enhanced death benefit option, may also be available and carry their own fees. It’s up to the agent or advisor to ensure the consumer knows what they are so they can decide if they’re worth the cost.

Medical Identity Theft Rising Fast

rolling-diceMy Comments: If ever there was a 21st century crime, this is it. We’ve all read about what happened to Target Stores and others where customer information was stolen. What we don’t often think about in this context are our own medical records, scattered across the health care landscape which we inhabit.

I’ve been aware of it’s significance since becoming aligned with a firm in Duval County called Caduceus Consulting. They’ve developed a professional liability policy that provides legal help for any physician or dentist exposed to a cyber threat. You can find an overview of it here:

The threat is real, and it can be expensive to remedy. Even if you only suspect a breach, EVERY possible patient whose name and records are in your records must be notified and advised. For the owners of a medical practice, to which law firm do you turn for help? Who has the technical undestanding and skills to help make the problem go away? Can you make it go away? How many thousands of dollars will it cost?

To the extent you are a physician or dentist in Florida, I have a very low cost solution to mitigate this threat to your future financial security.

Feb 25, 2015 | By Dan Cook

Medical identify theft increased by nearly 22 percent in 2014 compared to 2013. And this tough-to-contain realm of fraud will likely continue to grow due to conditions that have created fertile ground for this particular crime.

That’s one major takeaway from the fifth annual study of medical identity fraud released by the Ponemon Institute and the Medical Identity Theft Alliance, nonprofits dedicated to investigating the causes and ramifications of medical identify theft and finding ways to counter its spread.

The report does not take into account the Anthem hack, in which as many as 80 million consumers had their personal data stolen.

“Medical identity theft is costly and complex to resolve,” the groups’ study concludes. The study attempts to estimate that cost and outlines the reasons for its stubborn persistence.

Among the major outcomes of this study:
• Health care providers are not doing enough to secure patients’ medical records;
• Health care providers don’t respond in a consistent or timely manner when fraud is suspected or has occurred;
• Medical identify theft victims frequently don’t learn that their ID has been stolen until three months following the theft;
• Once they find out, it often takes months — and an average of 200 hours — to resolve a case;
• The cost to resolve the average incident is $13,500, a cost often paid by the victim;
• Many victims either don’t know who to report theft to, or are afraid to report it for a variety of reasons;
• Many victims report their identify was stolen by someone they knew, most likely a relative;
• Consumers and health care organizations believe the Patient Protection and Affordable Care Act has made medical identify theft more common due to insecure insurance websites;
• Theft generally occurs to access medical services and products, not to steal a patient’s identity for more general purposes.

The study’s authors said that, while such theft can’t be prevented, there are steps that can be taken to reduce its spread. They include:
• Monitoring of credit reports and billing statements for evidence of theft;
• Check in periodically with the primary care physician to ensure accuracy of medical records;
• When a consumer suspects identity theft, one should contact a professional identity protection provider for follow-up;
• Education of insured individuals about the risks of sharing medical identity information even with close relatives;
• Health care and other organizations that are responsible for securing patient information should have systems in place to authenticate all patients seeking services.

The full study, which is chock-a-block with details about this growing threat, can be found here

7 Social Security Mistakes to Avoid

SSA-image-2My Comments: Social Security payments are a critical financial component of many lives these days. When it began in 1935, there was much gnashing of teeth among the political parties since it represented a recognition by the government that some people needed help. This was in a world recovering from the Great Depression and watching the developing threat of Communism in the Soviet Union.

Today, many millions of us pay into the system monthly and many millions of us receive a check every month. Some of us, like a client of mine, has a permanent disability that he was born with and qualifies for help with living expenses. He has never been able to earn a living and few surviving family members to help him get by from day to day.

I readily admit to an element of socialism in this process. But I live in a world of rules imposed on us by society where society has deemed it to be in the best interest of the majority that those rules exist. Like making us all drive on one side of the road instead of at random. Think about that for a minute if you choose to believe that society should have no role to play in our lives or that socialism is inherently evil.

Okay, enough political chatter. Here’s useful information about claiming benefits from the SSA.

by John F. Wasik / FEB 17, 2015

Most clients get lost trying to navigate Social Security on their own. There are about 8,000 strategies available for couples and more than 2,700 separate rules on benefits, according to the Social Security Administration. Yet most couples don’t explore all the possibilities; as a result, they end up leaving an estimated $100,000 in benefits on the table, reports Financial Engines, an online money management firm.

For many advisors, talking to clients about Social Security often means having a brief conversation that ends with the traditional advice of “wait as long as you can until you file.” But Social Security, with its myriad filing-maximization strategies, should play a much larger role in a comprehensive planning discussion.

Consider these basic questions: How do you ensure a nonworking spouse reaps the highest possible payment? Should the higher earner wait until age 70 to receive payments? What’s the advantage of taking benefits at age 62? Should clients take benefits earlier if they are in poor health? How can divorcees claim a benefit based on an ex-spouse’s earnings?

Clearly, there are several right and wrong routes to maximizing Social Security benefits. Here are some of the most common mistakes and how advisors can address them.

1. Not planning for opportunity cost
What’s the cost of waiting to take Social Security? How will withdrawals from retirement funds impact clients’ portfolios?

Advisors need to understand how a Social Security claiming strategy will affect a client’s net worth, notes Ben Hockema, a CFP with Deerfield Financial Advisors in Park Ridge, Ill. “If you wait to take Social Security, that will mean withdrawing more money from a portfolio,” he says. “The Social Security decision involves trade-offs.”

Hockema runs Excel spreadsheets in conjunction with specialized Social Security software to show clients what opportunity costs look like in terms of lower portfolio values, displaying return assumptions with graphs.

Many financial advisors point out that the answer is not always to wait until 70 to take Social Security. You have to take a broader view.

2. Failure to consider family history
What are the client’s family circumstances? What do they expect in terms of life expectancy? Have other relatives been long-lived?

Even if answers are imprecise, the discussions can provide valuable insights into how to plan Social Security claiming, say advisors who are trained in these strategies. But it’s the advisor’s role to tease out that information, notes CFP Barry Kaplan, chief investment officer with Cambridge Wealth Counsel in Atlanta. “People often have no clue” about the best Social Security claiming strategies, Kaplan says. “It’s complicated.”

3. Not integrating tax planning

One key question to consider: What are the tax implications of a particular strategy, given that working clients will be taxed on Social Security payments?

Here’s how Social Security benefits taxation works: If your clients are married and filing jointly, and their income is between $32,000 and $44,000, then they may have to pay tax on half of their benefits. Above $44,000, up to 85% of the benefits can be taxed.

For those filing single returns, the range is from $25,000 to $34,000 for the 50% tax and 85% above $34,000. Be sure you can advise your clients on how to manage their income alongside their Social Security benefits.

4. Failing to ask about ex-spouses
Be sure to ask your clients about their marital history, understand what they qualify for and analyze how it will impact their cash flow. Was the client married long enough to qualify for spousal benefits? How much was the client’s ex making? Be sure to walk through different options with clients.

Kaplan offers the example of a 68-year-old woman who was twice divorced: “She was still working, and it had been 20 years since her last marriage,” Kaplan says. “I then discovered … a former spouse’s income that netted my client an immediate $6,216 — six months in arrears — and would result in an additional $1,036 per month until age 70, for a total [of] $30,000 in additional benefits.”

Kaplan’s divorced client was able to claim benefits based on her first spouse’s earnings, which boosted her monthly payment considerably.

5. Overlooking spousal options
A key question to ask: Does the “file and suspend” strategy make sense in your clients’ situation? In this case, the higher-earning spouse can file for benefits, then immediately suspend them, allowing the monthly benefit to continue to grow even if the other partner receives the spousal benefit.

The result: The lower-earning spouse can collect benefits while the higher-earning spouse waits until 70 to collect the highest possible payment.

6. Not taking advantage of new tools
Although specialized software packages can generate a range of benefit scenarios, only 13% of planners use subscription-based tools designed for Social Security maximization. (Most planners do have some comprehensive planning tools available, but they may not integrate Social Security scenarios.)

Most planners rely upon the free and often confusing calculators from the Social Security Administration, along with online calculators and general planning software, according to a survey by Practical Perspectives and GDC Research.

That’s despite the fact that only a quarter of planners “are comfortable enough to plan and recommend Social Security strategies to clients,” the survey noted.
A detailed conversation about Social Security may be even less likely to occur with high-net-worth clients, according to the survey.

When you approach Social Security with your clients, consider that there are multiple nuances within the system’s rules that few practitioners have studied, and these could result in higher payments. You may need some of the sophisticated tools now available.

7. Dismissing it altogether
There’s another reason clients — and often planners — don’t drill down into Social Security strategies: They don’t think it will be available in coming decades.

But don’t write it off altogether. The truth is that Social Security’s trust fund, the money held in reserve to pay for future retirees, is adequate to pay full benefits until 2033. If Congress does nothing to address the funding shortfall, the government will pay three-quarters of benefits until 2088.

And Social Security is one of the most successful and popular government programs in history, so it’s difficult to bet against its long-term survival.

David Blain, president of BlueSky Wealth Advisors in New Bern, N.C., suggests that, in addition to carefully reviewing benefit statements and earnings records, advisors should explore other aspects of Social Security, including spousal, death and survivor benefits.

“You need to take it seriously,” Blain says about integrating Social Security into a plan. “Clients may not understand it and think it’s not going to be there for them.”

John F. Wasik is the author of 14 books, including Keynes’s Way to Wealth. He is also a contributor to The New York Times and

Put Your Retirement Plan on Steroids

retirement_roadMy Comments: First, this assumes you have a retirement plan and that you have tried to answer the question “How Much Is Enough?”. Second, your answer to this question is still open to debate. And three, you actually have earned income that needs to be reported.

In a perfect world, we would have a way to set aside current income so that it was not treated as taxable income this year, would grow at a fast rate with the principal guaranteed, and when you were ready to spend it, there would still be no income taxes. You and I both know this is not going to happen.

But one way to get closer to this perfect world is known a cash balance pension plan. Or words to that effect. Read on to get a better understanding.

Frank Armstrong, III, CFP®, AIFA® | Friday, February 03, 2012

Would an extra $2.5 million come in handy at retirement? Would you like to defer taxes on over $200,000 of current income each year?

Whether you work in a solo practice or in a physician group practice (or some other similar work environment), you can turbo charge your retirement with a cash balance plan on top of your existing 401(k) plan.

Cash balance plans got a bad rap in 1999 when IBM terminated its traditional plan in favor of a cash balance plan that severely reduced benefits for a number of its long-term employees. The employee lawsuit went all the way to the Supreme Court, created an HR debacle and, in the process, generated lots of bad press. If that wasn’t bad enough, cash balance plans were in regulatory uncharted ground.

That’s not the case anymore. The regulatory issues have been resolved by the Pension Protection Act of 2006, and a typical cash balance/401(k) combo plan is a win-win for everybody.

Is this you?
You are at the top of your profession, in your peak earning years but are looking forward to eventually winding down and enjoying a more relaxed retirement lifestyle.

Your kids are through school, yours and their student loans are finally paid off, most of the big expenses are behind you, and you now have the ability to save more.

Unfortunately, when you look at your retirement accounts, you get an uneasy feeling that they may not support your lifestyle. Worse yet, at this rate, you are not likely to get there. Uncle Sam and his companion from your state government are deep in your pocket every year, and even though you have maxed out your 401(k) contribution, it’s just not enough.

Many Americans have hit a few bumps in the road. The financial meltdown of 2008 and 2009, a divorce, a few kids in grad school, a bad real estate deal, student loans, or just getting a late start on saving may put even high-income professionals behind in their retirement savings.

Two-and-a-half million dollars extra in your retirement piggy bank would help, especially if the account were tax deferred and creditor proof.

The solution
If the above professional sounds like you, then you may be the perfect candidate for a cash balance plan. Depending on your age a cash balance plan might allow you to put away an additional $200,000 each year into a tax deferred, qualified retirement plan. You can recover from a financial setback, or compress 25 years of savings into 10.

Simply put, a cash balance plan is a cousin of the defined benefit plan with more flexibility. In some respects it looks somewhat like a 401(k) that you probably already have. It’s an additional qualified plan which generally sits side by side with a profit sharing/401(k) plan. Because a cash balance plan is a type of defined benefit plan, it greatly favors its older and higher compensated participants. This makes it ideal for many professional practices.

Here is a quick view of the maximum contributions available with a combination of 401(k) and a cash balance plan. Of course, you could take any amount benefit level that meets your needs. And certainly not all participants will want to take the maximum. You can see that maximum contributions increase with age. But, the numbers really grab your attention when you pass age 50.

2012 tax deferral limitsLet’s take a second to discuss defined contribution and defined benefit plans in plain English:

• A defined contribution plan sets a formula based on compensation to determine the annual contribution for each participant’s account in the plan. Upon termination or retirement, the benefit is whatever value the account has attained. So, the final value is dependent on deposits, time, and rate of return. There is no guarantee of any particular benefit.

• On the other hand, a defined benefit plan sets a percentage of compensation as a benefit due at retirement, and then works backwards to determine annual contributions. The accrued vested benefit of contributions compounding at 5% is a guarantee by the plan and the plan sponsors, and in the event of a funding shortfall, the plan sponsor must make up the deficiency.

• While the cash balance plan is a defined benefit plan, the participant will see an account much like his/her 401(k) except that his/her contributions grow at a guaranteed 5%, and the participant does not exercise investment control. It’s all done for him/her.

• Defined contribution plans favor the younger worker because they have long time horizons for their deposits to grow. Younger workers with more time in the plan may attain higher account balances than their more highly compensated peers that have shorter time as participants. That’s good for workers with a long time horizon, but doesn’t address the problem of a worker with little time to go to retirement that needs a serious catch up program. You just can’t put away enough in a 401(k) in the next 10 or 15 years to solve a significant retirement shortfall.

• That’s where a well designed cash balance or defined benefit plan can save the day. If you are age 60, you can stash over $200,000-plus a year into your plan to accumulate an additional $2,500,000-plus at retirement. But, while it may look somewhat similar, it’s a completely different animal than a profit sharing/401(k). It’s the heavy duty, industrial strength catch up retirement plan for senior professionals.

Because most professionals and business owners have a fair understanding of a 401(k) but might never have encountered a cash balance plan, let’s go through some additional pros and cons.

• We target an exact amount at normal retirement date at a predetermined rate of return and then work backwards to calculate the annual deposit required to get to that amount. There is no reward for higher investment performance, but there is a penalty for a shortfall. Any shortfall must be made good by the plan sponsor. This calls for a very conservative asset allocation and investment policy, heavily or exclusively weighted to fixed income.

• Most plans — but not professionals — must pay an annual insurance cost to the Pension Benefit Guarantee Board (PBGC) for each participant to cover any shortfalls that the plan might have in the event of the failure of the plan sponsor. Even if you must pay it, the insurance cost is trivial in comparison to the potential tax savings and benefits. While PBGC insurance will cover much or all of the benefit of a rank and file worker it is capped at a low level so it will not cover a large part of the benefit for highly compensated professionals.

• Administrative costs which include actuarial certification of the plan are higher than a defined contribution plan, but again the costs are trivial when compared to the potential benefits.

• As few as 40% of the potential employees must participate, and there is a great deal of flexibility for professionals to opt out or take different levels of benefits. However, apportioning costs between professionals may have to be decided separately where benefit levels are significantly different.

• As a “qualified plan” certain testing requirements must be met. While these are designed to prevent discrimination, as a practical matter appropriate design may shift the vast majority of the benefits to the targeted professionals. In some cases the contribution to the defined contribution plan must be increased to allow the targeted professionals the maximum benefits. However, when looking at the combined plans most will see that the vast majority of the dollars spent will accrue to the targeted senior professionals.

• Like other qualified retirement plans, the funds are protected from creditors except for the two “super creditors”: a spouse or the IRS. In a litigious society, creditor proofing provides comfort to professionals that may feel targeted by the courts.

• Just as other qualified plans, the entire cost is tax deductible and tax deferred until distributed. At retirement, the proceeds may be rolled over in a lump sum to an IRA and the tax burden further deferred and spread over the remaining lives of the beneficiaries. Potentially these deferrals could extend to a third generation with appropriate estate planning.

Investment policy for cash balance plans

Investment policy for a cash balance plan is the inverse of that for a 401(k). The 401(k) plan maximizes benefits by maximizing rates of return on contributions over the career of the employee. The higher the balance of the plan, the higher the benefit. There is no downside to great performance.

The cash balance plan is an entirely different animal. The exact benefit is fixed in advance and excess funds are subject to an excise tax of 50%, while shortfalls must be made up by the sponsor. So, instead of a relative return policy we are all familiar with, we must adjust ourselves to an absolute return strategy. The investment policy has a one year time horizon. The best policy will generate exactly the target rate of return, no more, no less each year! Variations from target return on an annual basis can be very painful. So the funding mechanism relies not on equities to generate fat juicy returns, but a diversified bond portfolio generating as close to possible the exact target return with the smallest possible variation or risk.

Flexible design possibilities
Typically a cash balance plan will piggyback on top of a 401(k)/profit sharing plan. This arrangement greatly simplifies testing and offers extraordinarily flexible design possibilities.

No two law firms are alike. But, the cash balance plan may work equally well for a single practitioner, or a large, group practice.

As just one example a 300-person law firm with 50 partners might be able to benefit only the partners in the cash balance plan, while satisfying the cross testing requirements through a safe harbor 401(k) plan. Furthermore, some of those partners may opt out for all or part of their maximum possible benefit.

This quick, non-technical description is an informal introduction to this highly flexible retirement option. I’m not trying to turn you into an actuary, plan administrator, or investment adviser. Rather I’d like you to understand that there are some really powerful methods to augment a 401(k). While the rules are complex, the design possibilities are almost endless and a talented advisor may work economic miracles for you.

There is a chance that your practice may not benefit at all. Or, perhaps a traditional defined benefit plan will work better for you in your situation. However, most reputable investment advisors or pension design specialists will happily “run the numbers” for you with no obligation. When you see the costs and benefits laid out, you can determine if it’s right for you. And if it’s right for you, it could be the silver bullet that will save your retirement.