MONEY Pensions

How To Be a Millionaire — and Not Even Know It

Book whose pages are hundred dollar bills
iStock

A financial adviser explains to two teachers why they don't need a lot of money in the bank to be rich.

Mr. and Mrs. Rodrigues, 65 and 66 years old, were in my office. Their plan was to retire later this year. But they were worried.

“Our friends are retiring with Social Security, lump sum rollovers, and large investment accounts,” said Mr. Rodrigues, a school teacher from the North Shore of Boston. “All my wife and I will get is a lousy pension.”

Mr. Rodrigues continued: “A teacher’s pay is mediocre compared to what our friends earn in the private sector. We know that when we start our career. But with retirement staring us in the face, and no more regular paycheck, I’m worried.”

Public school teachers are among the worst-paid professionals in America – if you look at their paycheck alone. But when it comes to retirement packages, they have some of the best financial security in the country.

For private sector employees, the responsibility of managing retirement income sits largely on their shoulders. Sure, Social Security will provide a portion of many people’s retirement income, but for most, it is up to the retiree to figure out how to pull money from IRAs, 401(k)s, investment accounts, and/or bank accounts to support their lifestyle each year. Throughout retirement, many worry about running out of money or the possibility of their investments’ losing value.

Teachers, on the other hand, have a much larger safety net.

Both of the Rodrigueses worked as high school teachers for more than 30 years. Each was due a life-only pension of $60,000 upon retirement. That totaled a guaranteed lifetime income of $10,000 per month, or $120,000 per year. When one of them dies, the decedent’s pension will end, but the survivor will continue receiving his or her own $60,000 income.

The Rodrigueses told me they needed about $85,000 a year.

Surely their pension would cover their income needs.* And since the two both teach and live in Massachusetts, their pension will be exempt from state tax.

As for their balance sheet, they had no mortgage, no credit card debts, and no car payments. They had a $350,000 home, $18,000 cash in the bank, and a $134,000 investment account.

But as far as the Rodrigueses were concerned, they hadn’t saved enough.

“All my friends boast about the size of the 401(k)s they rolled over to IRAs,” Mr. Rodrigues said. “Some of them say they have more than $1 million for retirement.”

It was time to show the couple that their retirement situation wasn’t so gloomy – especially considering what their private-sector friends would need in assets to create the same income stream.

“What if I told you that your financial situation is better than most Americans?” I asked.

They thought I was joking.

Their friends, I explained, would need about $1.7 million to match their $120,000 pension income for life.

To explain my case, I pulled out a report on annuities that addressed the question of how much money a person would need at age 65 to generate a certain number of dollars in annual income.

Here’s an abbreviated version of the answer:

Annual Pension Lump Sum Needed
$48,000 $700,539
$60,000 $876,886
$75,000 $1,100,736

If you work in the private sector, are you a little jealous? If you’re a teacher, do you feel a little richer?

The Rodrigues were shocked. Soon Mr. Rodrigues calmed down and Mrs. Rodrigues smiled. Their jealousy was replaced with a renewed appreciation for the decades of service they provided to the local community.

Whether your pension is $30,000, $60,000 or $90,000, consider the amount of money that’s needed to guarantee your income. It’s probably far more than you think. And it’s not impacted by the stock market, interest rates, and world economic issues.

With a guaranteed income and the likelihood of state tax exemption on their pension, Mr. and Mrs. Rodrigues felt like royalty. After all, they had just learned that they were millionaires.

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* The survivor’s $60,000 pension, of course, would be less than the $85,000 annual income the two of them say they’ll need. A few strategies to address this: (1) Expect a reduced spending need in a one-person household. (2) Draw income from the couple’s other assets. (3) Downsize and use the net proceeds from the house’s sale to supplement spending needs. (4) Select the survivor option for their pensions, rather than the life-only option. They would have a reduced monthly income check while they are both living, yet upon one of their deaths the survivor would receive a reduced survivor monthly pension benefit along with his or her own pension.
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Marc S. Freedman, CFP, is president and CEO of Freedman Financial in Peabody, Mass. He has been delivering financial planning advice to mass affluent Baby Boomers for more than two decades. He is the author of Retiring for the GENIUS, and he is host of “Dollars & Sense,” a weekly radio show on North Shore 104.9 in Beverly, Mass.

MONEY financial advice

How Listening Better Will Make You Richer

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Ruslan Dashinsky—iStock

A financial adviser explains that when you hear only what you want to hear, you can end up making some bad money choices.

Allison sat in my office, singing the praises of an annuity she had recently purchased. She was 64 years old, and she had come in for a free initial consultation after listening to my radio show.

“The investment guy at the bank,” she crowed, “told me this annuity would pay me a guaranteed income of 7% when I turn 70.”

I asked her to tell me more.

Allison had invested $300,000 as a rollover from her old 401(k) plan. She was told that at age 70, her annuity would be worth $450,000. Beginning at age 70, she could take $31,500 (7% of $450,000) and lock in that income stream forever.

“And when you die, what will be left to the kids?” I asked.

“The $300,000 plus all my earnings!” she said.

Suddenly my stomach began to sour.

Allison, I was sure, had heard only part of what the salesperson had told her.

I followed up with another question: “Besides the guaranteed $31,500 annual income, will you have access to any other money?”

“Oh yes,” she answered. “I can take up to 10% of the account value at any time without paying a surrender charge. In fact, next year I plan to take $30,000 so I can buy a new car!”

This story was getting worse, not better.

It was time to break the news to Allison.

I asked her to tell me the name of the product and the insurance company that issued it. Sure enough, I knew exactly the one she bought, since I had it available to my clients as well.

That’s when the conversation got a little tense.

I explained that if she withdrew any money from her annuity prior to beginning her guaranteed income payment, there was a strong likelihood she wouldn’t be able to collect $31,500 per year at age 70. Given the terms of the annuity, any such withdrawals now would reduce the guaranteed payment later.

She disagreed.

I explained that, with this and most other annuities, if she started the income stream as promised at $31,500, she would not likely have any money to pass on to the children.

She told me I was wrong — and defended the agent who sold her the annuity. She said that she bought a guaranteed death benefit rider so that she could protect her children upon her death.

I encouraged her to read the fine print. As expected, she reread the paragraph that stated that the “guaranteed death benefit” was equal to the initial investment plus earnings, less any withdrawals. When I told her that her death benefit in all likelihood would be worth nothing by age 80, she quickly said, “I need to call my agent back and check on this.”

I have conversations like this a lot, and not just with annuities. When it comes to investments, whether they’re annuities, commodity funds, or hot stocks, people often hear only what they want to hear. At various points in his sales pitch, the annuity salesman had probably said things like “guaranteed growth on the value of the contract,” “guaranteed income stream,” “can’t lose your money,” and “heirs get everything you put in.” What she had done was merge the different parts of the sales pitch together and ignore all the relevant conditions and exceptions.

When people hear about a product, there’s an emotional impact. “I want to buy that,” they think. They focus only on the benefits of the product; they assume the challenging parts of the product — the risks — won’t apply to them.

This story has a happy ending. Before Allison left my office, I asked when she received her annuity in the mail. “Three days ago,” she said.

I reminded her of the ten-day “free look” period that’s given to annuity buyers as a one-time “do-over” if they feel that the product they purchased isn’t right for them.

She called me back within two days. “The agent doesn’t like me very much,” she said. She had returned the annuity under the “free look” period and expected to get a full refund. The annuity salesman had just lost an $18,000 commission.

And I once again saw the wisdom of something I tell my clients every day: Prior to ever making a financial decision, it is absolutely critical you evaluate how this decision integrates into your overall financial life. That’s what’s important — not falling in love with a product.

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Marc S. Freedman, CFP, is president and CEO of Freedman Financial in Peabody, Mass. He has been delivering financial planning advice to mass affluent Baby Boomers for more than two decades. He is the author of Retiring for the GENIUS, and he is host of “Dollars & Sense,” a weekly radio show on North Shore 104.9 in Beverly, Mass.

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