Turn Your Old 401k or IRA Into A Lifelong Paycheck Machine

When the modern definition of retirement planning came of age in the United States there were two main accounts that were used to give Americans the opportunity to retire with income.  These accounts were Social Security which was signed into law during Franklin Roosevelt’s administration in 1935 and a pension which has its roots as far back as 1776 and was originally designed for soldiers of the Military (http://www.ssa.gov/history/briefhistory3.html)

Since their inception, these plans have had many changes on the way to their modern-day forms.  Both of these programs provide income to people who get older and/or become sick or disabled and lose the ability to create their own income via their own labor.  A pool of money is created from contribution or taxation of many people to form a large amount of money that in theory will grow over time and then as the contributors begin to stop working full-time “retire” or become disabled, they can start to draw a monthly income to pay their bills and maintain a decent lifestyle.

There will come a time for almost all people where they will exit the full-time workforce and enter the non-working class or the part-time workforce.  When this happens their income will usually dramatically decrease. So during their working lifetime, they will contribute (mandatory) to social security (most professions contribute but not all are required to contribute to social security) and many will contribute to a pension or now the much more popular 401k or IRA and other similar qualified accounts.  There are other types of qualified accounts and the qualifications are governed by Uncle Sam.  Many times the name of the account references the section of the IRS code that covers the rules and qualifications for these types of plans ex: 401k and the 403b.

Most of these accounts give the contributor the ability to set aside a certain amount of money annually into these qualified plans and offer tax-advantaged status.  With traditional qualified plans, you put money inside of the account and can defer your tax on that contribution and any growth that account may or may not have until the money is withdrawn voluntarily or at mandatory ages.  The newer Roth accounts don’t qualify for the tax deferral on the contribution but all growth of the account is tax-free for life and withdrawals are tax-free as well.

These qualified accounts have taken over as the main retirement vehicles for American workers and replaced a traditional pension.  Companies have embraced these accounts and run away from traditional pensions.  In doing so, they have shifted the risk of retirement from the company over to the employee.  The Old Style Traditional PensionWhen I speak to people about retirement planning, many of them long for the old days of the pension plan.  This type of plan is called a defined benefit program which simply means the pension fund and the employer guarantee the retiree a certain amount of income every month regardless of the pension.

The Old Style Traditional Pension

When I speak to people about retirement planning, many of them long for the old days of the pension plan.  This type of plan is called a defined benefit program which simply means the pension fund and the employer guarantee the retiree a certain amount of income every month regardless of the pension funds performance over time.  So it might look like this:  Joe works for ABC Company, ABC union, or ABC municipality for 25 years and contributes from every check along with his employer into the pension fund.  He is promised that when he retires he will be paid $3,000 per month every month for the rest of his life (and usually his spouse’s life but not always it will depend on options the plan administrator offer and what options you take) from the pension fund.

If the pension fund does not perform well in the market or other investments during those 25 years it does not affect Joe’s income because his benefit is guaranteed. This guarantee is only solid if the overall pension fund remains viable.  One of the big financial stories a couple years ago was the municipal bankruptcy of Detroit where a portion of those pension payments are in jeopardy. (http://www.latimes.com/nation/la-na-detroit-bankruptcy-20140222,0,3941443.story#axzz2w34XwofH)  If the funds don’t perform as projected then it is up to the plan sponsor to put in more of their money into the plan to keep it funded properly.  When you hear the term underfunded pensions it usually does not mean that the proper money was not put in the account but rather the contributions did not grow as planned thus creating a shortfall in total pension funds to be able to pay retirees.  Sounds good for the worker but they have some serious flaws such as:

1) Workers are usually not qualified to receive income until after many years of working for the same company, union or municipality.  If they leave and go elsewhere that pension and the amount they contributed are generally not portable and transferable.  A real downside for the modern “free agent economy”.

2) The worker’s ability to get the actual cash before retirement is very limited and impossible for some accounts.  This will depend on the plan administrator and how the account was set up at inception. 3) The employee does not control the cash generating the income but rather the pension fund has all the control.  So if you and your spouse pass away relatively early then the pension income stops and your estate receives no cash from the pension fund In 1981 the 401k and other qualified plans were born and even the man who is widely credited with their invention says they are failing most Americans. (http://www.marketplace.org/topics/sustainability/consumed/father-modern-401k-says-it-fails-many-americans)  These plans are referred to defined contribution plans.  In these

3) The employee does not control the cash generating the income but rather the pension fund has all the control.  So if you and your spouse pass away relatively early then the pension income stops and your estate receives no cash from the pension fund.

In 1981 the 401k and other qualified plans were born and even the man who is widely credited with their invention says they are failing most Americans. (http://www.marketplace.org/topics/sustainability/consumed/father-modern-401k-says-it-fails-many-americans)  These plans are referred to defined contribution plans.  In these plans, the worker contributes to these accounts on a voluntary basis as does the employer also on a voluntary basis.  The growth of these accounts are not guaranteed.  The eventual incomes from those accounts are not guaranteed as they are with the traditional pension.  So retirement income is totally in the hands of the account owner and how they allocate those funds.  The income is very much dependant on how the stock market performs for most workers because the stock market is where the lion’s share of all the money in those funds is invested.  So if you withdraw money as income and pay your required taxes (in the case of traditional accounts) the balance is left for you to spend to live your life.  If your money remains in the market during retirement and the market goes bear then you must sell more shares of your investment to achieve your desired income.

Many people are familiar with dollar cost averaging during their working years but almost nobody is familiar with the dirty little secret of reverse dollar cost averaging.  Reverse dollar cost averaging will cannibalize your retirement (click here for more information on both dollar cost averaging and reverse dollar cost averaging) and must be handled to have a successful retirement.  One of the best ways to combat dollar cost averaging and set up your own stable income stream for life is to set up your own “private pension” by utilizing your old 401K or existing IRA.

This can be done by the proper rolling over of those accounts from risky market accounts to a properly designed annuity contract.  As with any financial product, there are always upsides and downsides.  Purchasing an annuity is no different.  We will cover the benefits and pitfalls of annuities next week in part two of this article.  For now, understand that there are 3 basic structures of annuities:

1) Fixed Annuities

2) Variable Annuities

3) Fixed Indexed Annuities

These 3 types of annuities have the same basic name but have wide variations of how they work.  Then once you know how each work there are many different varieties and terms offered and by a wide range of providers. The fees will also vary based on product and provider.

One of the biggest benefits of many annuities is the ability to structure the contract for guaranteed lifelong income once purchased. Also, you can use qualified funds such as IRA’s and 401k’s to purchase the annuity and accomplish this via a tax-free rollover in most cases.

One of the biggest downsides of annuities is the non liquidity of the money beyond a certain percentage of the total account.  Most annuity contracts come with steep penalties for early withdrawals beyond a certain amount (usually around 10%) of money withdrawn out of the account during a certain period of time.

Please read my next article when we will discuss in more depth how to successfully turn your IRA and 401k into a paycheck machine for life while at the same time avoiding the costly pitfalls.

Lock in your recent profits now

Since the election of Donald Trump the stock market has had an incredible run up.  Regardless of your political views the facts are the facts and your money and wealth don’t really care who is president.  Our job is to play the cards as they are dealt regardless of who is in charge at the White House.

The old saying is in play, “what goes up is sure to come down” unless we take steps to lock in our gains and protect against future loss.  If you are in mutual funds you have no doubt experienced the ups and downs of the market.  Many people think that’s just the way it is, and to some extent they are correct.  However, there is no law that says you have to play by those rules with your money.

There are strategies that allow you to participate in most of any market gains but none of the market losses.   You can accomplish this through a strategy called indexing.  One of the most popular ways to practice indexing is through the product of a fixed indexed annuity.  This is one of three major classes of annuities (with thousands of products between hundreds of companies available) with the other two classes being a fixed annuity and a variable annuity.

A fixed annuity will guarantee your money against any downside and promise to pay you more than you will be able to get at a bank.  Now many fixed annuities are paying 2.75% to 3.25% depending on the actual terms and carrier offering the annuity.  The upside is you know you will never lose money and that your money will grow every year regardless of what the stock market does.  The downside is that during large run ups, like we are currently experiencing, your account will not experience the big run ups but rather a much smaller gain.  There are also early withdrawal fees for pulling money out of the annuity early (this will be true for every class of annuity so be sure that you understand how much and how long those penalties exist).  Fixed annuities can be a great play for very conservative investors who want protections but need more return than a savings account or CD’s at the bank.

A variable annuity will track the stock market and its ups and downs.  Many will have floors and ceilings as far as how much you can lose or how much you can make.   Being as these are generally heavily traded accounts the fees associated to variable annuities are usually greatest of the three classes of annuities.  The variable annuities are for more aggressive investors who believe the carrier can do better with their money than they can personally and are aware of the fees and penalties for early withdrawal.

A fixed indexed annuity will be a kind of hybrid between the other two classes.  Your principal balance will be protected against any downside loss and your upside will be determined by tracking of an index. (Many indexes are available but most are tied to the stock market performance in some way)  When the indexes go up your account will be credited accordingly and many accounts have caps for how much you can make in a year and others don’t have caps on profits.  If they don’t have a cap on profits they will generally have a “spread” which determines how much of total index gain you receive minus the spread.  A simple example is the index has a 10% run up but there is a 2% spread on the product.  This means your account is credited 8% of gain that year.  Your index level is now locked in and the next year “resets” as far as gain or loss.  If the index comes down 10% the next year your money will not go down at all but will also not go forward at all either.  In short, when markets go up you participate at some level in the ups but never in the downs of the market.

With many of these annuities you can also add a lifetime income rider on top of the base contract.  These riders will usually guarantee that your eventual income you start drawing out of the account (kind of like your own private pension) will be guaranteed no matter how long you live regardless of what happens to the cash in the account.  So if you live to be a ripe old age you will receive the agreed upon income amount until your death.  If you pass away and there is still money in the account verify that your particular product has a death benefit that would assure any remaining monies go to your loved ones.  The income rider will come with an annual fee but will usually guarantee your income rider value will rise every year even if your cash does not increase.  In short, your eventual income increases every year regardless if your cash does or not that year.

For the right investor these can be attractive places to put money as long as you understand the rules going in and use them to your advantage.  If you would like a free chapter from my book on this very topic and or to watch a video presentation about this program, just visit www.perpetualpensions.com and download these two great resources for free.

Note, not all products and features are the same and will vary state to state.

How to Turn Your IRA or 401k into a Paycheck Machine for Life

crankmoney

Since the early 1980s, 401(k)s and individual retirement accounts have become the dominant way that workers save for retirement. Yet many workers long for the days of traditional pensions when you could set your watch by how much income you could count on every month after your retired. Many people like that the pension fund (if it did as promised) would pay them and their spouses for the rest of their lives. To be fair, those old-style pensions had some serious flaws:

  • It was difficult and sometimes impossible to port with you when you left the company. Depending on the program and how it was administered, you could be left without a pension and without the money in the pension fund if you left the company before a certain number of years.
  • You didn’t control the asset base that created the income. After you and your spouse pass away, the income stream from the pension fund stops, and your estate gets no cash from the fund. This was even if both spouses passed away early and collected very little of the pension.
  • It was difficult to impossible to access any of the cash inside of the pension prior to actual retirement.

With the 401(k) and most other qualified plans, the flaws of the pension were in large part put to bed.

Now you have the full right to withdraw or roll over your portion of your 401(k) when you leave the company. You control the asset base, so when you and your spouse die, any remaining balance left inside of your qualified plan will go to your estate. It is easier to access your account via loans — assuming you abide by terms laid down by your plan administrator and your employer.

As is often the case when you fix a flaw in something, that repair caused a new set of flaws to emerge. With 401(k)s and IRAs, the burden of guaranteeing income and performance is shifted to the employee. This means that if you are invested in the market, then in good markets you could win, and bad markets you could lose.

Wouldn’t it be great if you could combine the benefits of pensions, 401(k)s and IRAs? Consider annuities. Annuities are offered through insurance carriers to take in big chunks of money and guarantee a payout over a certain period, based on that sum used to purchase the annuity. There are two types of income structure:

  • In the immediate annuity, income is started from the lump sum immediately after the annuity purchase.
  • In the deferred annuity, your lump sum can grow before you activate the annuitization phase. This structure will result in more monthly income from the extra growth and the number of years the insurance company will have to pay out on the contract.

Once you decide on what kind of payout you want, then you have three basic choices:

  • The fixed annuity will guarantee your principle never loses money in the market and guarantee modest growth during the growth phase. That rate might be 2 to 3 percent, so this is for the extremely conservative investor who believes in the old saying “I am more concerned about the return of my money than the return on my money.”
  • The variable annuity will go up and down based on the movements of the chosen market (usually the stock market). This product is more for the market player who believes we are in for a bull market during the annuity contract years.
  • The fixed indexed annuity will guarantee your principle is not lost, but your growth is not guaranteed. The growth will depend on which market index or indexes your annuity follows, such as the Standard & Poor’s 500 index (^GPSC).

With many annuities, you can add riders. The most common is the lifetime income rider, which for an annual fee will guarantee your future retirement income will increase every year regardless of the market’s rise or fall. As the name implies the insurance company will also guarantee your annual income for the rest of yours and your spouse’s life. This income will be guaranteed even if the underlying funds in the annuity are drawn down to zero.

Your 401(k) and IRA can be used to purchase an annuity with no taxes or penalties. Annuities do have potential pitfalls.

  • They are not very liquid. There can be substantial penalties if you withdraw the original purchase price from the contract during a certain period. This penalty will usually graduate downward to zero. This penalty will be determined by the carrier and the product, and it will vary by state.
  • Potential annual fees are inherent. Many fees can be reasonable and bring value (such as the lifetime income rider), but some fees buy you very little value and get prohibitive. Fees are generally higher with variable annuities due to their active money management. Make sure you are comfortable with the fees and know what you receive in return.