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account and can defer your tax on that contribution and any growth that account may or may not have until the money is withdrawn voluntarily or at mandatory ages.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.

Will you and Your Spouse Need Long Term Care as you Age?

The shaken 8 ball says…………………”probably”
According to government statistics if you live to age 65 there is a 70% chance that you will need Long Term Care of some kind after that point.  According to research by the Office of Health and Human Services, the average person turning 65 will incur $138,000 in future LTC services. This could be anything from a family member helping you day to day at home, a nurse professional at home, all the way to full time care needed at a long term care facility.

This is not an easy topic to think about or discuss but with tens of millions of people who will find themselves in that position in the upcoming years it is mandatory to get over the uncomfortable nature of the topic and discuss options.  You basically have 3 options at your disposal:

  1. Do nothing and hope you are in the 30% that needs nothing of the sort or pray that if you are one of the 70% you won’t need “much” care and maybe a family member could help when the time comes
  2. Plan ahead and purchase a long term care insurance policy for you and your spouse and pay monthly premiums that would cover you both (to what degree is very much individual company and policy driven)
  3. Structure your existing assets to create a “hedge” or “cushion” that could pay for long term care or home health care expenses and possibly without any monthly premiums payable. Typically referred to as “Asset based long term care”

The first option is what most people choose and it’s hard to blame them because it’s without a doubt the easiest (currently) decision to make.  Most people decide by not deciding or being properly educated about the other two options that are available.  Surely, you and your spouse will fall into the minority group of 30% or into the “Not too expensive or long” group of people in the 70% majority that will need some type of care; right?

If you are correct with your hope and wish, and both you and your spouse don’t need long term care help in your later years, than you have dodged the proverbial bullet.  If, however, your bet is a loser then you run the real possibility of not receiving the care you need or receiving the care you need but at cost of draining all the assets you have worked so hard to accumulate during your lifetime.  You run the risk of leaving behind little to no estate for your family or cherished causes.

Many people who find themselves needing long term care, but haven’t planned for the possibility, end up attempting to transfer assets out of their names into family member’s names or trusts to appear poor so they can have their care paid for by the government.  This strategy is wrong on many levels.  First there are very specific time tables when those transfers will have had to occur BEFORE you knew you needed long term care (usually years before) and most people fall well short of meeting these time tables.  This will mean you will have to exhaust almost all your assets before any help from Uncle Sam kicks in to help.

If the government is involved and paying for your care, do you think you will get the best care available allowing you to extend your life; in time and in terms of quality of life?  Just look at the VA health system and realize you will likely be getting the same sub-standard care.

Also, I have always wondered why the government should have to pay for someone’s long term care? I am not talking about the truly poor and needy as I think we have enough wealth to provide needed safety nets to that group of people.  I am talking about people who have worked their entire lives and built up assets.  Those assets are meant to be used to make your life better and if you leave money behind to your family that is an added bonus.  We are not supposed to fleece the system because we refused to plan accordingly when we had the means and ability to do so just so we can leave our family behind a chunk of money.  If you want to pay for your care and leave money behind to your family then this will require knowledge and planning.

The second option is to take out long term care insurance policies for you and your spouse.  This can be a great way to plan ahead for the possibility of needing long term care in the future.  These premiums will not be inexpensive but neither is long term care or eventual poverty.  There are many variables to these plans based on the kind of coverage you’re looking to obtain.  The upside is you will have an insurance policy that will pay out monthly to help you and your spouse pay for long term care expenses (make sure you can use the policy for home health care as well as actual long term care facilities) should they occur.  Terms and amounts will vary widely so if this is the way you decide to plan for these expenses find an agent who has much experience and knowledge about these kinds of policies and has access to several of the top carriers in this arena.

The downside of this option is that many people can’t afford the premiums and even if they can afford them, if they never use the policy they don’t get the money back (in almost all cases) just like your car insurance.  If you don’t file a claim on a car they don’t send you back all your premiums because if they did the entire system would become insolvent.  It is very possible that you could pay tens and even hundreds of thousands in premiums and yet never need the coverage.  This is a thought that drives many crazy and causes some not to decide to use this option.

(If you would like more information on this topic visit www.perpetualltc.com for a short video presentation.)

The third option is called “Asset based long term care” and it has several variations.  Let’s talk about the most common use of this strategy.  A person might opt to take a sum of money and open up a specifically designed life insurance policy.  Most of these policies are opened up with a very specific goal of generating a death benefit but that “death benefit” can be accessed during the applicant’s lifetime to pay for long term care expenses.  The applicant put in a certain amount of money (could range from $50,000 to $200,000 per applicant) and buys a life insurance policy on themselves.  Let’s use $50,000 one time single premium into the policy that buys a $200,000 death benefit and that death benefit is guaranteed not to go away after that single premium.

This is not done to have the $50,000 premium actually perform and do anything except generate the bigger death benefit.  However, there will also be cash value generated that can be accessed should the policy owner choose to in the future.  Any loans taken from the policy will reduce the eventual long term care payout.   There is a rider built into this type of policy that allows you to access your death benefit early should you need long term care. (Make sure the policy will allow you to use the benefit for home health care as well as going to a facility)  So in this case you could draw up to $200,000 to pay for long term care expenses.  If you went into a facility this would be enough to pay for about 3 years of care (depending upon where you live and what kind of facility you enter) and if you can stay at home your money would typically last longer assuming it is part time nursing or family members coming in to help you live.

What happens if I live longer than the benefit?  You will then start using other assets or consider putting in more money up front to generate a bigger death benefit.  Maybe $100,000 would generate $350,000 worth of death benefit that could be drawn on later for long term care.  There are also certain policies that might have a “lifetime long term care benefit” after that initial period of coverage is spent you might be able to pay some nominal annual premium on top of the upfront premium already paid years beforehand.  There are many options depending on the company and product chosen.

What happens if I die and never need the long term care benefit?  Simple, this is a life insurance policy so the $200,000 death benefit is paid out tax free to your heirs.  So with that up front premium you either get a higher multiple to use for your eventual long term care or you leave that amount behind for your family.

We hope this article helps shine some light and makes you aware of the options for you and your family. If you would like more information on asset based long term care please visit www.perpetualltc.com for a short video presentation.