Annuities Deferred Income Annuities Income Tax Planning Qualified Longevity Annuity Contract (QLAC)

Is a QLAC Right for You?

2014 marked the introduction of qualified longevity annuity contracts, or QLACs. For those of you not familiar with them, a QLAC is a deferred fixed income annuity designed for use in retirement plans such as 401(k) plans and traditional IRAs (a) that’s limited to an investment of the lesser of $125,000 or 25% of the value of a retirement plan and (b) requires that lifetime distributions begin at a specified date no later than age 85. QLAC investment options are currently limited to deferred income annuities, or DIAs.

The purchase of deferred fixed income annuities in retirement plans for longevity protection isn’t a new concept. What’s unique about QLACs is the ability to extend the start date of required minimum distributions (RMDs) from April 1st of the year following the year that you turn 70-1/2 to up to age 85. This provides potential income tax planning opportunities for QLAC holders subject to the purchase cap.

Potential Income Tax Savings

A lot of individuals are selling QLACs short due to the purchase cap. While on the surface, $125,000 may not represent a sizable portion of a retirement plan with assets of $750,000 or more, the potential lifetime income tax savings can be significant.

The amount of savings is dependent on six factors: (a) amount of QLAC investment (b) age at which QLAC investment is made, (c) deferral period from date of QLAC purchase until income start date, (d) rate of return, (e) income tax bracket, and (f) longevity.


I have prepared the attached exhibit to illustrate potential income tax savings achievable by investing $125,000 at three different ages in a QLAC by comparing it to a non-QLAC investment that’s subject to the RMD rules. Assumptions used in the preparation of the exhibit are as follows:

  1. $125,000 is invested in a non-QLAC vehicle at one of three different ages: 55, 60, or 65.
  2. Rate of return is 5%.
  3. RMD’s are taken from age 71 through 85, the range of ages between which RMD’s and QLAC distributions, respectively, are required to begin.
  4. Income tax brackets are 2015 federal income tax brackets plus 5% for assumed state income tax.

In addition to assumed rates of return and income tax brackets, a key assumption is the age at which the QLAC investment is made. All else being equal, purchases at earlier ages avoid greater amounts of RMDs and associated income tax liability. Per the exhibit, the amount of projected income tax savings over 15 years ranges from approximately $20,000 to $97,000 depending upon assumed QLAC investment date and income tax bracket.


Reduction of RMDs and associated income tax liability is an important goal, however, it may not be the best strategy for achieving the overriding goal of retirement income planning, i.e., making sure that you have sufficient income to meet your projected expenses for the duration of your retirement.

There are several questions you need to answer to determine the amount, if any, that you should invest in a QLAC:

  • What are your projected federal and state income tax brackets between age 71 and 85?
  • What are the projected rates of return on your retirement funds between 71 and 85 taking into consideration the likelihood of at least one bear market during this time?
  • What is your, and your spouse, if married, projected life expectancy?
  • Which years between age 71 and 85 can you afford to forego receipt of projected net RMD income, i.e., RMD less associated income tax liability?
  • Will you need to take retirement plan distributions in excess of your RMDs, and, if so, in which years and in what amounts?
  • What other sources of income do you have to replace the projected RMD income you won’t be receiving?
  • What is the projected income tax liability you will incur from withdrawing funds from other sources of income?
  • What is the amount of annual lifetime income that you will receive from a QLAC beginning at various ages between 71 and 85 assuming various investment amounts, with and without a death benefit with various payout options?
  • Does it make more sense to invest in a non-QLAC longevity annuity such as a fixed index annuity with an income rider?
  • Should you do a Roth IRA conversion instead?

Given the fact that opportunities to reduce RMDs and associated income tax liability are limited, QLACs are an attractive alternative. Projected income tax savings are just one factor to consider and can vary significantly from situation to situation, depending upon assumptions used. There are a number of other considerations that need to be analyzed before purchasing a QLAC to determine the best strategies for optimizing your retirement income.

Retirement Income Planning

Don’t Fall Into the Short Longevity Trap

Whenever I’m doing retirement income planning for a client, one of the most, if not the most, important decisions that needs to be made is the duration of the plan, or plan timeframe. The starting point, i.e., today, can be easily defined; however, the termination date is unknown in all cases.

This topic typically begins with a discussion of my client’s parents’ and grandparents’ longevity. I’m always surprised how people attempt to correlate their life expectancy directly to that of their parents or grandparents, particularly when one or more of their ancestors may not have lived a long life. They do this without acknowledging the fact that (a) the average life expectancy has increased significantly for someone born today compared to when their parents or grandparents were born and (b) our health is not necessarily controlled by genetics.

Increased Life Expectancy

Let’s take a look at the change in United States life expectancies for females who have traditionally enjoyed a longer life expectancy than males. Assuming your grandmother was born in 1900, her life expectancy was 48.3 years. The life expectancy for women born in 1950 increased dramatically to 71.1 years. Girls born in 2010 have an average life expectancy of 81.0 years.

When males turned 65 in 1950, they were expected to live another 12.8 years on the average, or until age 77.8. This has increased five years, with males turning 65 in 2010 expected to live another 17.7 years on the average, or until age 82.7. A male who reached age 75 in 2010 has an average life expectancy of 11.0 years, or until age 86.

Our Health Goes Beyond Genetics

Although it has been demonstrated that longevity has a genetic component, genetics, in and of itself, doesn’t necessarily control the health issues you will experience during your lifetime or how long you will live. While family health history is important, it is only one factor in determining your longevity.

If you haven’t heard about it, I would strongly urge you to read about the emerging field of epigenetics. Bruce Lipton, PhD, one of the leaders in this field, defines epigenetics as “the study of inherited changes in phenotype (appearance) or gene expression caused by mechanisms other than changes in the underlying DNA sequence.”

According to Dr. Lipton, our health is not controlled by genetics. Instead, the mind, toxins and trauma impact the fate of individual cells and our ultimate health. The mind plays a critical role, with “…your thoughts and perceptions having a direct and overwhelmingly significant effect on cells.”

Impact on Retirement Income Planning

The basic goal of retirement income planning is not to outlive our assets. Given increased life expectancies today that continue to increase, combined with the knowledge that our health and longevity goes beyond genetics, we cannot afford to simply look in the rearview mirror and use our parents’ and grandparents’ life expectancies as the basis for projecting our lifespan. To the extent we do this, we run the risk of falling into the short longevity trap in many cases, underestimating our life expectancy, and potentially making decisions that result in the premature depletion of our assets.

Annuities Deferred Income Annuities Fixed Index Annuities

Invest in DIA to Fund LTCI Premiums When Retired – Part 4 of 4

The first three posts in this series discussed five differences between fixed index annuities (“FIA’s”) with income riders and deferred income annuities (“DIA’s”) that will influence which retirement income planning strategy is preferable for funding long-term care insurance (“LTCI”) premiums in a given situation. If you haven’t done so already, I would recommend that you read each of these posts.

This week’s post presents a sample case to illustrate the use of a FIA with an income rider vs. a DIA to fund LTCI premiums during retirement.


As with all financial illustrations, assumptions are key. A change in any single assumption will affect the results. The following is a list of assumptions used in the sample case:

  1. 55-year old, single individual
  2. Planned retirement start age of 68
  3. Life expectancy to age 90
  4. Current annual LTCI premium of $4,000 payable for life
  5. Need to plan for infrequent, although potentially double-digit percentage increases in LTCI premium at unknown points in time
  6. Given assumptions #4 and #5, plan for annual pre-tax income withdrawals of approximately $6,000 beginning at retirement age
  7. Solve for single lump sum investment at age 55 that will provide needed income
  8. Investment will come from a nonqualified, i.e., nonretirement, investment account
  9. One investment option is a fixed index annuity (“FIA”) with an income rider with lifetime income withdrawals beginning at age 68.
  10. Second investment option is a deferred income annuity (“DIA”) with no death benefit and lifetime income payout beginning at age 68.
  11. FIA premium bonus of 10%
  12. FIA annual return of 3%
  13. FIA income rider charge of 0.95% of income rider value otherwise known as the guaranteed minimum withdrawal benefit (“GMWB”)
  14. No withdrawals are taken from the FIA other than the income withdrawals.
  15. All investments are purchased from highly-rated life insurance companies known for providing innovative and competitive retirement income planning solutions.

Investment Amount

The first thing that needs to be solved for is the amount of investment that must be made at the individual’s age 55 in order to produce lifetime annual income of approximately $6,000 beginning at age 68. The goal is to minimize the amount of funds needed for the investment while choosing a strategy from a highly-rated insurance company that’s known for providing innovative and competitive retirement income planning solutions.

It turns out that an investment of $50,000 to $65,000 is needed to produce lifetime annual income of approximately $6,000 beginning at age 68. Given the fact that my goal as a retirement income planner is to use the smallest amount of investment for a fixed income annuity to produce a targeted income stream in order to preserve the remainder of a client’s investment portfolio for my client’s other financial goals, the amount of the investment needed is $50,000.


There are three items we will examine to compare the results between investing $50,000 in a FIA with an income rider vs. a DIA to fund LTCI premiums during retirement. They are as follows:

  • Annual gross income
  • Annual taxable income
  • Value/death benefit

Annual Gross Income

Per the Exhibit, the annual payout, or gross income, from the FIA is $5,764, or $236 less than the annual gross income of $6,000 from the DIA. This equates to a total of $5,428 for the 23 years of payouts from age 68 through age 90.

Annual Taxable Income

If the investment was made in a retirement account like a traditional IRA and assuming there have been no nondeductible contributions made to the IRA, 100% of the income would be taxable. This would be the case for both the FIA or DIA.

As stated in assumption #8, the investment will come from a nonqualified, i.e., nonretirement, investment account. Per Part 2 of this series, this makes a difference when it comes to taxation of the withdrawals. Per the Exhibit, 100% of the annual FIA income of $5,764 is fully taxable vs. $3,066 of the DIA income. This is because the DIA, unlike the FIA, is being annuitized and approximately 50% of each income payment is nontaxable as a return of principal. Over the course of 23 years of payouts, this results in $62,054 of additional taxable income for the FIA vs. the DIA.

The amount of income tax liability resulting from the additional taxable income from the FIA will be dependent upon several factors that will vary each year, including (a) types, and amounts, of other income, (b) amount of Social Security income, (c) potential losses, (d) adjusted gross income, (e) itemized deductions, (f) marginal tax bracket, and (g) applicable state income tax law.

Value/Death Benefit

While the present value of the future income stream of a DIA represents an asset, you generally won’t receive an annual statement from the life insurance company showing you the value of your investment. In addition, while some DIA’s will pay a death benefit in the event that the annuitant dies prior to receiving income, per assumption #10, this isn’t the case in this situation. Consequently, the DIA column of the “Value/Death Benefit” section of the Exhibit is $0 for each year of the analysis.

On the other hand, there’s a projected value for the FIA from age 55 through age 79. This value is also the amount that would be paid to the FIA’s beneficiaries in the event of death. There’s a projected increase in value each year during the accumulation stage between age 55 and 67 equal to the net difference between the assumed annual return of 3% and the income rider charge of 0.95% of the income rider value.

Per the Exhibit, the projected value/death benefit increases from $56,278 at age 55 to $68,510 at age 67. Although the assumed premium bonus of 10% is on the high side these days, this is reasonable given the fact that FIA values never decrease as a result of negative performance of underlying indexes, the assumed rate of return of 3% is reasonable in today’s low index cap rate environment, and the assumed income rider charge of 0.95% of the income rider value is on the upper end of what’s prevalent in the industry. The projected value/death benefit decreases each year from age 68 to age 79 until it reaches $0 beginning at age 80 as a result of the annual income withdrawals of $5,764.


As discussed in Parts 1 – 3 of this series, there are five important differences between FIA’s with income riders and DIA’s that will influence which retirement income planning strategy is preferable for funding LTCI premiums during retirement in a given situation. Two of the differences, income start date flexibility and income increase provision, haven’t been addressed in this post.

In addition to the five differences, the amount of the investment required to produce a targeted lifetime annual income amount to pay LTCI premiums, including potential increases, will differ depending upon the particular FIA or DIA strategy used. In the illustrated case, which isn’t uncommon today, an investment of $50,000 resulted in an almost identical lifetime income payout whether a FIA with an income rider or a DIA is used.

As illustrated, the taxable income associated with a DIA in a nonqualified environment is much less compared to a FIA. As previously discussed, the amount of tax savings resulting from the reduced taxable income will depend upon an analysis of several factors and will vary each year. Ignoring the potential income tax savings resulting from the tax-favored DIA payouts, the FIA with income rider would be the preferred investment choice for many individuals in this case given the presence, duration, and projected amount of, the investment value/death benefit.

The FIA edge is reinforced by the fact that, unlike most traditional DIA’s, the income start date and associated annual lifetime income payout amount for FIA’s is flexible. This would be an important consideration in the event that the year of retirement changes. Furthermore, this is quite possible given the fact that the individual is 13 years away from her projected retirement year.

As emphasized throughout this series, the purchase of LTCI needs to be a lifetime commitment. Planning for the potential purchase of a LTCI policy should be included as part of the retirement income planning process to determine the sources of income that will be used to pay for LTCI throughout retirement. Whether it’s a FIA with an income rider, a DIA, or some other planning strategy that’s used for this purpose will depend on the particular situation.

Annuities Celebration Income Tax Planning IRA Retirement Income Planning Roth IRA Social Security

Retirement Income Visions™ Celebrates 2-Year Anniversary!

Thanks to all of my subscribers and other readers, Retirement Income Visions™ is celebrating its two-year anniversary. Since its debut on August 16, 2009, Retirement Income Visions™ has published a weekly post each Monday morning, the theme of which is Innovative Strategies for Creating and Optimizing Retirement Income™.

As stated in the initial post two years ago, Retirement Income Visions™ Makes Its Debut, the importance of retirement income planning as a separate and distinct discipline from traditional retirement planning was magnified during the October, 2007 – March, 2009 stock market decline. Although the stock market experienced three positive and encouraging days this past week, the market volatility the last three weeks has only served to emphasize the need for a comprehensive retirement income plan.

Add to the mix the increasing instability of the Social Security and Medicare programs and the rapid decline of traditional pensions as a source of retirement income. Not to mention increasing life expectancies, soaring health care costs, and an economic situation ripe for inflation. Retirement income planning is no longer an option – it has quickly become a downright necessity.

Since inception, Retirement Income Visions™ has used a themed approach, with several weeks of posts focusing on a relevant retirement income planning strategy. This past year was no exception. The weekly posts, together with the customized Glossary of Terms, which currently includes definitions of 99 terms to assist in the understanding of technical subject matter, has contributed to a growing body of knowledge in the relatively new retirement income planning profession.

Going back a year, the six August 16 through September 20, 2010 posts completed a 36-part series on Roth IRA conversions. This was a very timely topic with the January 1, 2010 availability of this strategy to all taxpayers regardless of income level, combined with the ability to defer 50% of the reporting of income from a 2010 Roth IRA conversion to 2011 and the other 50% to 2012.

The September 27, 2010 post, Plan for the Frays in Your Social Security Blanket, began a 25-part educational series about Social Security. The first two parts discussed some of the historical events in connection with changes to the Social Security system affecting benefit amounts and delay in the commencement of receipt of benefits. The October 11, 2010 post, Do Your Homework Before Flipping the Social Security Switch, began a five-part series regarding various considerations in connection with electing to begin receiving Social Security benefits before full retirement age (“FRA”).

The November 15, 2010 post, Wait Until 70 to Collect Social Security? examined the opposite end of the spectrum, i.e., delaying the start date of receipt of Social Security benefits. The follow-up three-part series, Pay-to-Play Social Security, presented the “do-over” strategy, a little-publicized strategy for increasing monthly benefits in exchange for repayment of cumulative retirement benefits received.

The “file and suspend” and “double dipping” strategies for potential maximization of Social Security benefits were addressed in the next two two-part posts from December 13, 2010 through January 3, 2011, Breadwinner Approaching Social Security Retirement Age? – File and Suspend and Working? Remember Your Social Security Spousal Benefit When Your Spouse Retires.

Income taxation and associated planning strategies was the subject of the subsequent respective two- and four-part January 10 through February 14, 2011 series, Say Goodbye to Up to 30% of Your Social Security Benefits and Increase Your After-Tax Social Security Benefits. The February 21, 2011 post, Remember Your Future Widow(er) in Your Social Security Plan made the point that the decision regarding the start date of Social Security Benefits, in addition to fixing the amount of your retirement benefit, may also establish the amount of your spouse’s monthly benefit.

Retirement Income Visions™ Social Security series culminated with the three-part February 28 through March 24, 2011 series, Your Social Security Retirement Asset. These three posts discussed the importance of Social Security as an asset, perhaps one’s most important asset, in addition to its inherent role as a monthly retirement income stream.

With the media’s emphasis in 2010 on the two-year deferral of inclusion of income from a 2010 Roth IRA conversion as the motivating factor for pursuing this planning technique, I felt that there wasn’t enough attention given to the potential long-term economic benefits available through use of this investment strategy. Roth IRA Conversions – Don’t Let the Tax Tail Wag the Dog began a six-part series on this important topic on March 21, 2011 that ran through April 25, 2011. The May 2 and May 9, 2011 Roth IRA Conversion Insights two-part series followed up the Roth IRA conversion economic benefit discussion.

The importance of nonretirement assets in connection with retirement income planning was discussed in the May 9, 2011 Roth IRA Conversions Insights post as well as the May 23 and May 30, 2011 respective posts, Nonretirement Investments – The Key to a Successful Retirement Income Plan and Nonretirement vs. Retirement Plan Investments – What is the Right Mix? This was followed up with two posts on June 6 and 13, 2011 regarding traditional retirement funding strategies, Sizeable Capital Loss Carryover? Rethink Your Retirement Plan Contributions and To IRA or Not to IRA?

The June 20 and June 27, 2011 posts, Do You Have a Retirement Income Portfolio? and Is Your Retirement Income Portfolio Tax-Efficient? addressed the need for every retirement income plan to include a plan for transitioning a portion, or in some cases, all, of one’s traditional investment portfolio into a tax-efficient retirement income portfolio. This was followed by the July 5, 2011 timely Yet Another “Don’t Try to Time the Market” Lesson post.

The July 11, 2011 Shelter a Portion of Your Portfolio From the Next Stock Market Freefall began a new timely and relevant ongoing series about indexed annuities. This post was published just ten days before the July 21st Dow Jones Industrial Average peak of 12,724.41 that was followed by the beginning of a steady stock market decline coinciding with the final days of U.S. debt limit negotiations and Standard & Poor’s unprecedented U.S. credit rating downgrade, culminating with a closing low of 10,719.94 this past Wednesday. As implied in the titles of the July 18 and July 25, 2011 posts, Looking for Upside Potential With Downside Protection – Take a Look at Indexed Annuities and Limit Your Losses to Zero, this relatively new investment strategy has the potential to be a key defensive component of a successful retirement income plan.

As I did a year ago, I would like to conclude this post by thanking all of my readers for taking the time to read Retirement Income Visions™. Once again, a special thanks to my clients and non-clients, alike, who continue to give me tremendous and much-appreciated feedback regarding various blog posts. Last, but not least, thank you to my incredible wife, Nira. In addition to continuing to support my weekly blog-writing activities, she also endured my year-long family tree project that I recently completed. Well, sort of. Is a family tree ever completed?

Social Security

Your Social Security Retirement Asset – Part 3 of 3

Part 1 of this post made the point that Social Security is a retirement asset, specifically, an annuity. Part 2 took this concept one step further and stated that, similar to a commercial annuity contract that has been annuitized, the value of the future payment stream can be calculated and included on every qualified Social Security recipientTM‘s personal financial statements. The question is, who is a qualified Social Security recipientTM?

There are two types of qualified Social Security recipientsTM when it comes to Social Security retirement benefits: (1) current recipients and (2) future recipients who are vested in their benefits.

Current Recipients

Although as stated in Part 2, the valuation of Social Security benefits as an asset isn’t straightforward, it’s easiest to do for current recipients. These individuals are currently receiving a defined monthly payment. What isn’t known and must be determined is (1) the number of payments that will be received going forward, i.e., life expectancy, (2) projected Social Security cost of living adjustments (“COLA’s”), and (3) an assumed interest rate. In the case of a married couple where one spouse currently receives or will receive 50% of the other spouse’s benefit, the 50% spouse’s life expectancy must also be determined.

Future Recipients Vested in Their Benefits

For those of you who participate, or who have participated, in defined benefit pension plans, you’re familiar with the concept of vesting. Simply stated, vesting as it pertains to pension plans, is the non-forfeitable right to receive a defined benefit based on one’s salary and the number of years of service performed by an employee. How do you vest, or qualify, for Social Security retirement benefits? Assuming that you were born after 1928, you need 40 quarters, or 10 years of work and associated payment of Social Security taxes.

Once you hit the 10-year mark, you become vested in Social Security. At this point, although it isn’t likely to be your actual starting benefit, an estimated retirement benefit can be calculated based on your earnings to date. Each year, the Social Security Administration mails statements to all American workers age 25 or older who aren’t yet receiving Social Security benefits approximately three months before their birthday. Each statement includes an estimated retirement benefit for three different retirement ages: (1) age 62, (2) full retirement age, or “FRA,” which varies from age 65 to 67 depending upon when you were born, and (3) age 70.

In addition to the age at which you start receiving benefits, your actual benefit payment will be based on the 35 years in which you earned the most. The closer you are to age 62, the more likely the benefit on your Social Security statement will approximate your actual starting benefit. Whether you’re 30 or 60 years old, assuming you’ve worked for 10 years and paid Social Security taxes, a defined benefit is determinable and readily available.

While your actual benefit is likely to be much greater than what is shown on your statement if you’re 30 years old assuming that you will continue to work for several years, in my opinion, this is the figure that should be used to calculate the current value of your Social Security benefits for inclusion as an asset on your personal financial statement. Future salary increases, although likely, should be ignored for purposes of this calculation. A basic principle that is used in the preparation of any financial statement, whether it be for business or personal purposes, is conservatism. Since there’s a possibility, although not likely, that even if you’re 30 years old, your current estimated Social Security benefit will be your actual starting benefit, this amount should be used since it’s known and non-forfeitable pending future potential changes to the Social Security system, itself.

The calculation of the value of Social Security benefits for a future recipient vested in his/her benefit is more complicated than for a current recipient. In addition to the three variables listed above for current recipients that must be determined to calculate the value of Social Security benefits, future recipients must also project their retirement age. This is used for to calculate two values: (1) the projected value of retirement benefits at retirement age and (2) the current value of #1.

Whether you’re a current or future recipient vested in your benefit, the calculation of the current value of your Social Security retirement benefits is referred to as determining its “present value.” Present value, as defined by Wikipedia, is the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money and other factors such as investment risk. While the calculation of present value of Social Security benefits is complicated, it can and should be done for every qualified Social Security recipientTM with the resulting value included as an asset on the individual’s personal financial statements.

Social Security

Do Your Homework Before Flipping the Social Security Switch – Part 5 of 5


What is the optimal age to begin collecting Social Security benefits? As stated in Part 1 of this series, lack of other sources of retirement income will generally dictate commencement of benefits sooner than later. There is one other situation where this is also true – health. Specifically, poor current health that is expected to result in less than normal life expectancy would be an important, if not the most important, factor in determining when to flip the Social Security switch. Like the other three factors discussed in the three previous blog posts, it should be considered individually and collectively when making this important decision.

One of the factors that was discussed in Part 4 – affect on amount of spouse’s Social Security benefit – needs to be examined closely if you’re married and health is a concern. As stated in Part 4, as a spouse, you can either claim a benefit based on your earnings record, or, alternatively, you can collect a spousal benefit equal to 50% of your spouse’s Social Security benefit. If your spouse’s current or projected benefit is expected to exceed 50% of your benefit, this won’t be an issue. If, on the other hand, the amount of your spouse’s benefit is dependent on the amount of your benefit, then additional analysis is warranted before commencement of your Social Security benefit.

Assuming that either you aren’t married or the amount of your Social Security benefit either won’t, or isn’t expected to, impact your spouse’s benefit, then mathematics will generally dictate your Social Security benefit start date. Let’s revisit an example from part 2 of this series to illustrate this. Let’s suppose you’re eligible to start receiving a monthly benefit of $2,000 beginning at full retirement age (“FRA”) 66, you’re in poor health, and you would like to begin collecting your benefit, which will be $1,500, at age 62.

Per Exhibit 1, assuming you start receiving your benefit at age 62, while your annual benefit of $18,000 will be $6,000 less than your annual benefit of $24,000 if you instead wait until age 66, your cumulative benefits will be greater until age 77 at which time cumulative benefits of $288,000 would be identical. In this example, if you’re 62 and you have a medical condition such that you don’t expect to live longer than 15 years, income tax considerations aside (See Part 3 of this series), it would generally behoove you to begin collecting your Social Security benefits at 62.

On the other hand, assuming your health issues aren’t as serious and there’s a chance that you will survive your life expectancy, commencement of benefits at FRA instead of age 62 should be considered. This may not be practical, however, if you need the funds to pay for uninsured health care needs.

Lack of other sources of income or poor current health that is expected to result in less than normal life expectancy are two reasons for beginning receipt of Social Security benefits at age 62 vs. waiting until FRA. As previously mentioned, even the latter reason needs to be further analyzed if you’re married and the amount of your spouse’s benefit is dependent on your benefit. Aside from these two situations, temptation, i.e., the ability to collect monthly benefits at age 62, shouldn’t be the reason for doing so. Instead, other factors, discussed in parts 2, 3, and 4 of this series, should be considered and analyzed before flipping the Social Security switch to determine what’s best for you.

Roth IRA

Roth IRA Conversion – Analysis Paralysis? – Part 2 of 2

Per Part 1 of this blog post last week, there are dozens of questions that need to be answered when deciding whether a Roth IRA conversion makes sense in your situation. Just looking at, let alone trying to answer, all of the questions is overwhelming and discourages many people from proceeding with one or more Roth IRA conversions.

This is without doubt an area that requires professional analysis and guidance. Even professional financial advisors, however, are often guilty of “analysis paralysis” when dealing with Roth IRA conversions. This term is defined by Wikipedia as:

“…over-analyzing (or over-thinking) a situation, so that a decision or action is never taken, in effect paralyzing the outcome. A decision can be treated as over-complicated, with too many detailed options, so that a choice is never made, rather than try something and change if a major problem arises. A person might be seeking the optimal or ‘perfect’ solution upfront, and fear making any decision which could lead to erroneous results, when on the way to a better solution.”

Roth IRA conversion analysis is a classic situation whereby one can spend an inordinate amount of time preparing dozens of multi-year “what if” projections, changing a single assumption in each scenario with each one being a potentially valid result. Is it necessary, forget about practical and cost-efficient, however, to go through such an arduous process in order to make a Roth IRA conversion recommendation and decision? I personally don’t think this is the best way to approach Roth IRA conversions.

While certain assumptions are important in Roth IRA conversion analysis, we need to recognize the fact that many of them are simply beyond our control. These include, but are not limited to, life expectancy, inflation rates, marginal income tax rates, and investment rates of return. While these assumptions need to be considered, they shouldn’t be over-analyzed since the possibilities are endless, inevitably resulting in analysis paralysis.

It’s also important to recognize that a Roth IRA conversion of any meaningful size is generally not a single event. It should instead be structured as a plan, or series of conversions, over several years in most situations. Besides reducing tax liability attributable to Roth IRA conversions, this approach also minimizes the possibility of unfavorable outcomes, in turn reducing the likelihood of analysis paralysis.

Perhaps the most important consideration in any Roth IRA conversion analysis is to not lose sight of the two main attractions of a Roth IRA that aren’t available to traditional IRA owners:

  1. Nontaxable distributions
  2. No required minimum distributions (“RMD’s”)

Analysis paralysis, combined with a natural and understandable reluctance to prepay income tax liability attributable to a Roth IRA conversion, can be a strong deterrent to implementing a prudent Roth IRA conversion plan, especially if one doesn’t understand, or loses sight of, the long-term potential benefits of the plan.


Clearing the Roth IRA Conversion Hurdles

Should you convert your traditional IRA’s to Roth IRA’s? This question is a hot topic this year with the repeal of the $100,000 modified adjusted gross income barrier for converting traditional IRA’s to Roth IRA’s. Last week’s blog post, Three Roth IRA Conversion “Show Stoppers” discussed three scenarios where the answer is a definitive “no.”

Assuming that none of the three “show stoppers” are applicable to your situation, you’re ready to lace up your running shoes and step onto the track. I liken the Roth IRA conversion decision-making process to the 100 meter (women) and 110 meter (men) high hurdles events in track and field.

Before discussing the various hurdles, once again it should be noted that a Roth IRA conversion doesn’t have to be an all-or-nothing event – you can do partial conversions over one or more years. The other important thing to keep in mind is that just because 2010 is the first year that you can convert your traditional IRA to a Roth IRA doesn’t mean that this is “the” year to do it. The hurdles discussed in this blog may be applicable to you this year, however, next year may be a totally different story.

Although the 100 meter, in the case of women, or the 110 meter, for men, high hurdles is a relatively short race, clearing ten hurdles 3.5 feet in height while running an all-out sprint is no easy feat. Likewise, there are three “high hurdle” situations when it comes to converting a traditional IRA to a Roth IRA as follows:

  1. Payment of Roth IRA conversion tax liability requiring liquidation of assets resulting in additional tax liability
  2. Withdrawals anticipated within five years of Roth IRA conversion
  3. Individuals with life expectancy of five years or less with no beneficiaries

Payment of Roth IRA Conversion Tax Liability Requiring Liquidation of Assets Resulting in Additional Tax Liability

One of the three “show stoppers” discussed in last week’s blog post was no source of funds for payment of Roth IRA conversion tax liability outside of retirement plans. If your nonretirement liquid assets, i.e., checking, savings, credit union, and money market funds are limited and you will need to sell securities to generate funds to pay the income tax liability attributable to a Roth IRA conversion, will you be creating additional income tax liability as a result of those sales?

If the result of your sale(s) will either be a capital loss or a capital gain that can be offset by either a capital loss carryover from the previous year or a capital loss generated earlier in the current year, then this isn’t problematic. If, on the other hand, your securities sales will result in a capital gain that cannot be offset by a capital loss, you will incur income tax liability in addition to the liability from doing a Roth IRA conversion. At a minimum, even if the securities that you sell were held for one or more years resulting in favorable long-term capital gains treatment, your tax liability from the capital gain will be at least 15% of the amount of your gain plus state tax liability. If significant, this additional tax liability on top of the tax liability attributable to the Roth IRA conversion could be a deal killer.

Withdrawals Anticipated Within Five Years of Roth IRA Conversion

Any distributions from Roth IRA conversions that aren’t attributable to non-deductible IRA contributions will be taxable as ordinary income if they’re taken within five years of January 1st of the year of the Roth IRA conversion.

If your situation is such that there’s a good chance that (a) you will need to take a withdrawal from your Roth IRA conversion within five years of January 1st of your Roth IRA conversion, (b) most of the distribution won’t be attributable to non-deductible IRA contributions, and (c) the income from your projected withdrawal isn’t projected to be sheltered by losses and/or itemized deductions or you aren’t otherwise projected to be in a lower tax bracket than in the year of conversion, a Roth IRA conversion probably doesn’t make sense. This is especially true if you will be less than 59-1/2 when you are projected to take your withdrawal since a 10% premature distribution penalty will be assessed in addition to the tax attributable to the income from your withdrawal.

Individuals With Life Expectancy of Five Years or Less With No Living Beneficiaries

Whenever analyzing the potential viability of a Roth IRA conversion, it’s important to keep in mind that, while the numbers may not favor a conversion if the analysis is based solely on the IRA owner’s life, this may not be the case when beneficiaries are considered, especially younger non-spousal beneficiaries, assuming that the Roth IRA isn’t projected to be depleted during the Roth IRA owner’s lifetime.

On the other hand, If you’re in a situation where either you’re very advanced in age or otherwise have a life expectancy of five years or less and you have no living beneficiaries who will inherit your IRA, the potential benefits to be achieved from a Roth IRA conversion probably won’t exceed the income tax liability attributable to the conversion in most cases.

So, you weren’t eliminated from the Roth IRA conversion game by any of the three “show stoppers” discussed in last week’s blog and you cleared all three “high hurdles” in this one. Are you a candidate for a Roth IRA conversion? Read next week’s blog post to learn the answer to this question.

Retirement Asset Planning Retirement Income Planning

The Sequence of Returns – The Roulette Wheel of Retirement

So here you are, crossing the threshold from earning a living to going into retirement. You worked hard for many years. You built a sizeable, diversified investment portfolio. You hedged your bet by purchasing life insurance and long-term care insurance. Your will and other estate planning documents have been updated to reflect your current goals and financial situation. Everything’s in place, or so you think.

Welcome to the roulette wheel of retirement, otherwise known as the “sequence of returns.” If you haven’t planned for this financial phenomenon, your retirement could be quite different than you envisioned. To illustrate this important concept, let’s take a look at three hypothetical scenarios. In each one we’ll use the following five assumptions:

1. Retirement age: 65
2. Portfolio value: $500,000
3. Annual withdrawals: $25,000, or 5% of the initial portfolio value,
increasing by 3% each year
4. Life expectancy: 25 years, or until age 90
5. Average rate of return: 7%

The last assumption is the most critical one and can wreak havoc on your portfolio if you only rely on a retirement asset planning strategy during your retirement years.

Let’s start with Scenario #1 – 7% Return Each Year. While this scenario never occurs in real life, it’s often used for illustration purposes. Once you review Scenario #1 – 7% Return Each Year, you will see that even after taking out withdrawals that begin at $25,000 and more than double to $52,000 at age 90, your portfolio value increases from $500,000 at age 65 to $576,000 at age 78 and then gradually declines in value to $462,000 at age 90. You’ve taken distributions totaling $964,000 and your portfolio has earned $926,000 over 25 years. Nice result!

Scenario #2 – Good Early Years assumes that you are fortunate enough to retire at the beginning of a bull market where your investment returns exceed your inflation-adjusted withdrawal rate of 5% for several years, you experience a couple of years of negative rates of return, and a bear market kicks in your final three years, resulting in negative rates of return each year. Per Scenario #2 – Good Early Years, although it doesn’t occur in a straight line, your portfolio increases from $500,000 at age 65 to a peak of almost $1.5 million at age 87, with a final value of $921,000, or double the value of Scenario #1, at age 90. Like Scenario #1, you’ve taken distributions totaling $964,000 and your portfolio has earned $1.385 million over 25 years. Life is great!

So far, so good. To illustrate Scenario #3 – Bad Early Years, let’s simply reverse the order of investment rates of return that we assumed in Scenario #2. As in Scenario #1 and Scenario #2, over 25 years, we’re going to end up with the same average rate of return of 7%, however, the first three years are going to be bumpy, to say the least. Unlike Scenario #2, where your portfolio value increases by $208,000 the first five years, going from $500,000 at age 65 to $708,000 at age 70, per Scenario #3 – Bad Early Years, it decreases by $224,000, going from $500,000 at age 65 to $276,000 at age 70, or a swing of $432,000 during the same period.

Your portfolio continues to decrease in value each year until it is depleted at age 81. Instead of taking distributions totaling $964,000 as you did in Scenarios #1 and #2, your total distributions over 25 years are only $541,000. Furthermore, instead of realizing portfolio income totaling $926,000 in Scenario #1 and $1.385 million in Scenario #2 over 25 years, your total portfolio income is a measly $41,000. Yikes!

In both Scenario #2 and Scenario #3, there are negative rates of return in only five, or 20%, of the total of 25 years of retirement. Two years of negative rates of return out of ten years, on the average, is fairly typical for long-term historical rates of return for a diversified equity-based portfolio. As you can see, in Scenario #3, it doesn’t matter that 80% of the returns were positive, nor is it relevant that there was an average rate of return of 7%. As a result of the portfolio being depleted at age 81, the hypothetical individual in this situation wasn’t able to experience the 11.4% average rate of return during the final nine years.

The most important factor in Scenario #3, and the #1 risk to any retirement asset plan, is the sequence of returns. While you have no control over this investment phenomenon, you don’t need to play roulette with your retirement assets.

Retirement Asset Planning Retirement Income Planning

Retirement Asset Planning – The Foundation

Last week, in Retirement Planning Risks, I discussed six risks associated with retirement planning in general. In order to understand and appreciate the value and importance of retirement income planning and its associated strategies, let’s take a closer look at retirement asset planning.

As was presented in The Retirement Planning Paradigm Shift – Part 2, the focus of retirement asset planning is on the accumulation and “spending down” of one’s assets. The accumulation phase is common to various financial planning areas, not just retirement, including house purchase planning and education planning, to name a couple. With most types of planning, you’re typically designing a plan for the purpose of accumulating funds for either (1) a single expenditure at some specified, or target, date, in the future, e.g., a down payment on a house, or (2) a series of expenditures for a limited and specified series of target dates, e.g., a four-year college education.

With all types of financial planning, there are two major stages:  (1) design, and (2) funding, or plan implementation. Similar to an architect, a financial planner, after consultation with his/her client(s), designs a financial blueprint, or plan, for achieving a particular goal, or series of goals. Assuming that the client approves the recommendations, the plan is generally funded with a single lump sum or a series of payments over a specified period of time, depending on the plan’s goals, the client’s current and projected resources, and various other factors.

With most types of financial planning, when you reach the plan’s target date, you immediately, or over a limited number of years, e.g., four in the case of college education, see the results of your plan. What distinguishes retirement asset planning from other types of planning and adds to the complexity of the plan design and funding strategy is the “spend-down” phase.

Unique to retirement asset planning, the timeframe of the “spend-down” phase is undefined. It can last for less than a year and, although it is unlikely, it can go on for as many as 60 years, depending upon when it starts and a host of many variables.

Unlike most types of financial planning where you get to see the results of your plan after reaching a specified target date, this is not the case with retirement asset planning. As a result of all of the risks discussed in last week’s post, there’s an inherent uncertainty associated with retirement asset planning. Even if you’ve done an excellent job of accumulating what appear to be sufficient assets for retirement, you generally won’t know if this is true for many years.

While retirement asset planning can provide a solid foundation for a successful retirement plan, unless it is accompanied by a customized retirement income plan at the appropriate stage in your life, there is a higher likelihood that your retirement income will fall short of your needs and that the plan, itself, may not succeed.

Financial Planning Retirement Asset Planning Retirement Income Planning

Is Your Retirement Plan At Risk?

Before I write about the specific risks associated with retirement asset planning and the strategies that retirement income planners use to address, and, in many cases, mitigate, these risks, let’s take a look at risks that are common to all retirement planning. While many of these are uncertain and/or uncontrollable, each of them needs to be addressed in a retirement plan.

The risks that will be discussed are as follows, with the first three common to all types of financial planning, and each one intended to be a brief introduction vs. a comprehensive discussion:

  1. Inflation
  2. Investment
  3. Income tax
  4. Longevity
  5. Health
  6. Social Security benefits reduction


Although it is unpredictable as to amount and fluctuation as it pertains to individual and overall variable expenses, a key risk that must be considered in the design and funding stages of all retirement plans is inflation. Unlike most types of financial planning where it is a factor only in the accumulation phase, inflation is equally, if not more important, during the withdrawal stage of retirement planning. The longer the time period, the more magnified are the differences between projected vs. actual inflation rates insofar as their potential influence on the ultimate success of a particular retirement plan.


Unless you are living solely off of Social Security or some other government benefit program, you are directly or indirectly exposed to investment risk. Even if you are receiving a fixed monthly benefit from a former employer, although it isn’t likely, your benefit could potentially be reduced depending upon the investment performance of your former employer’s retirement plan assets and underlying plan guarantees. Whenever possible, investment risk should be maintained at a level in your portfolio that is projected to sustain your assets over your lifetime while achieving your retirement planning goals, assuming that your goals are realistic.

Income Tax

Even if income tax rates don’t change significantly as has been the case in recent years, income tax can consume a sizeable portion of one’s income without proper planning. With the exception of seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) that have no personal income tax and two states (New Hampshire and Tennessee) that tax only interest and dividend income), the rest of us need to be concerned about, and plan for, state, as well as, federal income tax. In addition, if you have a sizeable income, it is likely that income tax legislation will be enacted that will adversely affect your retirement plan on at least one occasion during your retirement years.


Unlike other types of financial planning, the time period of retirement planning is uncertain. Although life expectancies are often used as a guide to project the duration of a retirement plan, no one knows how long someone will live. The risk associated with the possibility of outliving one’s assets is referred to as longevity risk. In addition, life expectancies, themselves, are changing from time to time. The August 19, 2009 edition of National Vital Statistic Reports announced a new high of nearly 78 years for Americans. Planning is further complicated for married individuals since you are planning for multiple lives.


An extremely important risk that is sometimes overlooked or not given enough consideration in the design of retirement plans is health. Under-, or uninsured, long-term care events as well as premature death in the case of a married couple, can deal a devastating blow to an otherwise well-designed retirement plan. It is not unusual for a prolonged long-term care situation, such as Alzheimer’s, if not properly planned for, to consume all of one’s retirement capital and other assets. Inadequate life insurance to cover the needs of a surviving spouse can result in dramatic lifestyle changes upon the first spouse’s death.

Social Security Benefits Reduction

Once considered to be unshakable, the security of the Social Security system, including the potential amount of one’s benefits, is questionable. In addition, it was announced in May that for the first time in more than three decades Social Security recipients will not receive a cost of living adjustment, or COLA, increase in their benefits next year. While beneficiaries have received an automatic increase every year since 1975, including an increase of 5.8% in 2009 and a 14.3% increase in 1980, this will not be the case in 2010.

Each of the foregoing six risks needs to be considered, and appropriate strategies developed, in the design and implementation of every retirement plan to improve the chances of success of the plan.