MONEY Retirement

Here’s Why More Americans Are Retiring Earlier Than They Expected

More workers have retired early than late since the Great Recession, new Fed Data show. But it's not a happy story.

It seems counter intuitive: Of all Americans who retired since the Great Recession, more retired earlier than expected than later than expected, a new Fed report shows.

This finding appears to be at odds with everything we’ve heard about the growing need to delay retirement and — my all-time favorite oxymoron — work in retirement.

Yet the numbers don’t lie: 15% of those who have retired since 2008 did so earlier than planned; only 4% did so later than planned. This is according to the latest Fed data, which goes to September 2013.

The data clearly show what we all know: In order to make ends meet, workers intend to stay on the job longer, not shorter. Two in five workers 45 or older plan to delay retirement. Among pre-retirees 55 to 64 years old, only 18% expect to retire on time and stop working altogether. A quarter expects to work as long as they can and another quarter expects to work part-time or become self-employed in retirement.

Taken as a whole, this can only mean that we’ve seen a lot of forced retirements. In the lousy job market of the past few years, millions of older workers downsized out of employment couldn’t find suitable work. They retired rather than keep up the search or work for significantly less. That’s not good, and it helps explain other sobering statistics in the report.

Nearly 40% of households say they are just getting by or struggling to make ends meet, underscoring the uneven recovery. The rebound in stocks has mostly benefited the investing class. Home prices have improved, and that has helped a wider swath of the population—but not as much as you might expect. Of those who have owned their home for at least five years, about half say the value is lower than in 2008.

Meanwhile, many households are suffering from tight credit, student loans and poor retirement savings. Some of these pressures have eased in the past 12 months. The economy grew at a healthy 4% pace last quarter and mortgage lending has loosened up.

But a quarter of households have some form of student debt with an average balance of $27,840. One in five has fallen behind in payments on this debt. At the same time, 31% of workers say they have no retirement savings or pension, including 19% of those aged 55 to 64. Almost half of adults aren’t even thinking about planning for retirement. And yet, as the report shows, retirement may be coming sooner than they expect.

 

 

MONEY Health Care

Why the Good News for Retiree Health Care May Not Last

With overall health-care costs in check, Medicare didn't hike the premiums seniors pay again this year. But once economic growth picks up, rising prices could come back too.

Medicare turned 49 years old last week, and the program celebrated with some good financial news for seniors: Premiums will not rise in 2015 for the third consecutive year.

The question now: How long can the good news persist? Worries about Medicare’s long-range financial health persist, but for now persistent low healthcare cost inflation will translate into a monthly premium of $104.90 next year for Part B (outpatient services), according to the Medicare trustees. Meanwhile, the Centers for Medicare & Medicaid Services (CMS) says the average premium for a basic Part D prescription drug plan will rise by about $1, to $32 per month.

The Part B premium has been $104.90 since 2012—except for 2011, when it actually dropped by about $15, to $99.90. The moderation is good news for seniors, since premiums are deducted from Social Security checks. Beneficiaries will keep all of next year’s Social Security cost-of-living adjustment, which likely will be about 1.7%.

Meanwhile, the average Part D premium has been $30 or $31 since 2011. That’s because of a dramatic shift to cheap generic drugs, and innovation by plan providers competing for customers.

“Seniors can expect to see more of what they’ve been getting over the last few years, which is increasing effort by Part D insurers to offer very-low-premium plans,” says Matthew Eyles, executive vice president of Avalere Health, a consulting firm specializing in healthcare.

As in recent years, Eyles says, the best deals will be found in plans that require enrollment in preferred pharmacy networks. Those plans offer lower premiums and co-pays. “We’ll also see plans limiting or eliminating deductibles, and encouraging the use of generics by offering them free or at nominal prices,” says Eyles.

But the average figures mask a more complicated story. Part D enrollees will find significant regional variations in premiums around the country. CMS data shows average premiums will be as low as $21.19 in New Mexico, and $25.83 in Florida—but as high as $39.74 in Idaho and Utah.

Eyles says it is not entirely clear why premiums will vary so extensively, although the prices tend to track the overall cost of healthcare, and are related to the overall healthiness of seniors by state.

“The plan providers have to submit bids for regions that take into account differences in the enrolled populations, including prescribing and utilization patterns,” he says. “It could be that one state tends to have more people using statins, or a diabetes medication.”

Another complication in Part D is the “doughnut hole,” the gap in coverage for Part D enrollees with high drug costs. Higher-cost plans are available to provide gap coverage, but the hole’s size is being shrunk under a provision of the Affordable Care Act (ACA), and the gap is set to disappear in 2020.

The coverage gap begins after you and your drug plan have spent a certain amount for covered drugs. Next year the gap starts at $2,960 (up from $2,850 this year) and ends after you’ve spent $4,700 (up from $4,550 this year).

Seniors who enter the gap also get discounts on brand-name and generic drugs, and those breaks will be larger next year. Enrollees will pay 45% of the cost of brand-name drugs in 2015 (down from 47.5% this year) and 65% of the cost of generic drugs (down from 72% this year).

Can the recent good news on lower healthcare costs continue indefinitely? Medicare spending reflects our overall health economy, and the big picture is that the United States does not have effective controls on spending growth. Healthcare outlays have quadrupled since the 1950s as a percentage of gross domestic product, to 17.7% in 2011. What’s more, our spending is more than double any other major industrialized nation, according to the Organization for Economic Cooperation and Development.

Still, our per capita Medicare spending growth averaged 2% from 2009 to 2012, and it was nearly zero last year.

The Obama administration often points to the ACA, but outside experts are more skeptical. Research published this month by Health Affairs, a leading health policy and research and journal, credited 70% of the recent spending slowdown to the slack economy. Absent further changes in the structure of our healthcare system, the researchers expect higher healthcare inflation to resume as the economy improves.

“A significant amount of it is due to the economic slowdown,” says Eyles, “although we know that changes in the way providers deliver care, and how providers are being paid are also making a difference in the overall rate of growth.”

MONEY Savings

Here’s the Magic Amount You Need to Retire Happy

Numbers from American paper currency
George Adamson—Getty Images/The Bridgeman Art Library

A financial planner estimates how much money you need to save — and shares 5 keys to a successful retirement.

Most people would say money can buy you happiness in retirement, but financial planner Wes Moss wanted the details: Just how much money does it take to retire happily? And is there a point of diminishing happiness returns on the size of a nest egg?

Moss surveyed 1,350 retirees about net worth and income, assets and home equity. But he wasn’t hunting for the number of dollars it takes to live — rather, he wanted to understand how money correlates to retirees’ levels of happiness. To that end, he posed a series of detailed questions about their lives: where they shop, what kinds of cars they drive, how many vacations they take annually, their family lives and the activities they pursue. Then he associated their levels of reported happiness with their financial condition.

Here’s what he found: Most people can be happy in retirement with savings of about $500,000. A higher number can buy more happiness, but only to a point.

“There is a plateau-ing effect above that number, and the higher you get the rate of increase gets smaller,” Moss says. “I call it diminishing marginal happiness.”

Moss, managing partner and chief investment strategist at Capital Investment Advisors in Atlanta, explores the correlation of wealth and retirement happiness in his new book, You Can Retire Sooner Than You Think: The 5 Money Secrets of the Happiest Retirees. Moss is a registered investment adviser who previously worked for a big Wall Street firm.

His five secrets include a careful determination of what you actually want to spend money on in retirement and how you’ll save to meet your goals; paying off your mortgage early; developing diverse sources of income in retirement; and learning how to invest for income.

Here’s an edited transcript of five questions I asked Moss about his findings in a recent interview.

Q. Who are the happy retirees, and what makes them happy?

It’s not how much you save but how much you save in relation to what you need. When I worked on Wall Street, what we always were trying to breed is an expectation with clients that they need to spend more and more — you need an infinite amount because you will need to spend just as much or more in retirement. That’s what the mutual fund industry and Wall Street preach.

But we found that for most people, the amount of happiness correlates to median savings around $500,000. There are some increases above that number, but it’s a slower rate of incremental gains. So think of $500,000 as a financial bare minimum.

Q. Are the happy retirees making adjustments to their spending in order to be comfortable?

The survey data doesn’t tell me that, but my real-life experiences with clients suggest that people take a realistic look at how much income they’ll have — perhaps they have two or three thousand in Social Security income, and they can take another $3,000 monthly from their investments. They look at that and decide that they can live a good life on $6,000 a month.

Q. What makes retirees unhappy — and how can people avoid winding up there?

Many of the unhappy retirees are still paying mortgages, with no light at the end of the tunnel. Another thing I see a lot is people who don’t take care of big expenses before they retire – they wait to redo the kitchen until they retire because they think they’ll have time to deal with it then. But it’s much better to do these things while you’re working and still have cash flow.

Another mistake is people who don’t have enough core pursuits in retirement. They were too myopic and entrenched in making money and working before, and now they’re not as busy as they need to be. They are blindsided by free time.

Q. I’ve heard both sides of the mortgage-in-retirement argument — some argue it’s better to invest that money rather than use it to pay off a mortgage. Sounds like you’re a firm believer in getting rid of them.

If you have resources in a taxable account, I’d rather see a client use that to pay off the mortgage in one fell swoop — or, just accelerate your monthly payments by $200 to $400, which can shave a full decade off of a mortgage. I know people will argue that they can get a higher return putting that money in stocks, but I’ve seen a lot of periods in my career where all the market did was crash and then recover. Most Americans don’t get that average 9% stock market return over time, so a safer bet is to save that guaranteed 4% or 5% that a mortgage costs. Also, with older clients, what I see is an enormous level of contentment among people who have figured out how to get rid of their mortgages.

Q. Your book lays out a model for retiring early — or earlier than you think you could. That runs counter to much of the talk we hear today about longevity and the need for everyone to work longer. Why do you think people can retire earlier than planned — and how do you define the word “early”?

I define it as being in a position retire at 60 or 62. And there is a group of people where it’s obvious they have the financial means to retire — but the concept is foreign and they don’t have a handle on their finances. I’ve had many client meetings with couples where one spouse thinks they can retire, and the other doesn’t — but when you add up all their different accounts, you see that they have $750,000, along with pensions and Social Security. These are people who definitely could retire if they choose.

MONEY Careers

Wish Every Work Day Felt Like a Vacation? For This Guy it Is.

David Harris
"We offer a great product," says David Harris. "It was a matter of getting it in front of the right people.” Benjamin Rasmussen, wardrobe and grooming by Ashley Kelly

After toiling in the tech industry for over three decades, David Harris decided to buy an adventure travel company. Here's how he did it.

For 30 years, David Harris bounced around Silicon Valley, using his sales and marketing savvy to overhaul tech companies. But in 2011 he received a sizable payout from the sale of Tumbleweed Communications, where he had been vice president—and he was ready for a change. Though his work was highly compensated, it was also high pressure. “I wanted to continue to chal­lenge myself,” he says. “But I needed to get out of high tech for my mental health.”

Around the same time Timberline Adventure Tours, a Lafayette, Colo., company offering hiking and biking trips across the U.S. and Canada, went up for sale. Harris and his wife, Kisa, had gone on many vacations with Timberline and had even become friendly with the owners.

For Harris, it was the perfect opportunity. He was looking to do something he felt passionate about, and Timberline filled that bill. Plus, he felt the business had potential beyond its current revenue: “I knew Timberline offered a great product. It was a matter of getting it out to the right people.” While details of the purchase were still being ironed out, Harris moved with Kisa (then an aerobics instructor) and his three daughters to Louisville, Colo., where they lived off investments until he settled into his new role.

Immediately after taking over in January 2012, Harris began boost­ing Timberline’s digital presence—revamping the website and developing strategies for social media and email marketing. He used skills he’d honed in Silicon Valley, only now “product overhaul” meant testing trails and putting together a “fun puzzle of trip itineraries.”

Today Timberline offers 84 tours to about 600 clients annually. Revenues hit $1.2 million in 2013, up from $850,000 in 2011. While Harris isn’t making the big bucks he used to, he’s enjoying going to a job that doesn’t feel like work. “At the end of a trip, when clients are beaming and thanking you for making their vacation,” Harris says, “it’s just such a pleasure.”

BY THE NUMBERS

$500,000: What the company cost

Harris, who bought the business with cash from the sale of Tumbleweed, drew on his sales experience to create a valuation. The owners still cared about the company, and Harris says that made it somewhat harder to negotiate them down to the price he wanted to pay.

84%: how much less Harris earns than he used to

While his family can live off the $100,000 he and Kisa bring in (she’s the VP), they’re still adjusting to the seasonality of the business, which requires intensive budgeting. Harris credits Kisa, who is “as organized as the day is long.”

240: Target number of new clients to add in 2014

Harris is proud of Timber­line’s customer loyalty— 84% of travelers in 2012 were returning—but he’d like to grow the customer base so that 40% of clients are new. He plans to introduce more trip itineraries, and he’s working on building corporate partnerships, hoping that this will help raise revenues to $2 million by 2015.

MONEY Careers

What I Wish I’d Known About My First Paycheck When I Was 22

Tug of War
When you get your first job offer, you can dig in and ask for more (nicely). Paul Kelly—Getty Images/Flickr Select

Earning every penny you're worth when you join the workforce can pay off for the rest of your life. So don't hesitate to negotiate.

For many people, negotiating pay is not a welcome task. In fact, almost half of U.S. workers simply accept the first offer. And when you’ve just graduated from college and are interviewing for your first real job, your focus is probably on landing the job, not demanding top dollar.

I’m here to say that more often than not it’s worth asking for a little bit more. I’ve been there, and if I could sit down with my 22-year-old self, there are a few things I’d tell her about that first salary negotiation.

Employers Expect You to Negotiate

The greatest fear I’ve heard people express is that a job offer might be rescinded if they try to negotiate the pay. As long as you’re respectful and reasonable, that’s very unlikely.

The prospective employer has already expressed interest in hiring you. As in any negotiation, they expect you to do just that—negotiate. It’s okay to simply ask if the salary is negotiable or to suggest a number that is slightly higher than what’s proposed. Most employers will have a salary range in mind when they make you an offer, not a hard-and-fast number. If they are first to float a figure, they usually won’t start at the top of that range.

The best thing you can do for yourself is come to that discussion prepared so that you know what an appropriate counter-offer would be. Do your salary research ahead of time. You want to know the potential pay range based on the job title, city, company size, and industry, as well as what you bring to the table—your education and any relevant experience. Negotiating blindly is not a great plan. Proposing a salary number that’s too high or too low for the position just indicates that you haven’t done your homework.

Your Salary Will Level Out Around 40

Typically, your biggest opportunity for pay increases is in the first 20 years or so of your career, so keep negotiating well. When PayScale delved into the data, we found that pay essentially goes nowhere after age 40, once you account for inflation. Your early career is when you have the most opportunity to rise up in the ranks.

Once you’ve reached a certain level in your chosen career, meteoric growth just isn’t as possible as it was when you were starting out. Additionally, even if you continue to see pay increases in your later career, if your raises are not keeping pace with inflation, you may not be able to stretch your paycheck any further year after year. In fact, it could be shrinking.

Not Speaking Up Now Means Working Longer

I know retirement seems a long way off, but the earlier you start considering it, the happier you’ll be later in life. According to the 2013 Wells Fargo Retirement Study, 34% of the middle class expect to work until they are at least 80 years old because they will not have saved enough for retirement.

You don’t want to be one of those people, do you? You want to be in the group that planned early so you can retire in your sixties and travel the world.

Even a small difference in starting salary could mean some serious money over the course of a career, according to a recent study by researchers at George Mason University and Temple University. The study concluded that “a 25-year-old who negotiated a starting salary of $55,000 will earn $634,000 more than a non-negotiator who accepted an initial offer of $50,000” (assuming a 5% average annual pay increase over a 40-year career.)

Just remember to invest that extra $5,000 in a 401(k) plan or other retirement fund, especially if your employer offers a 401(k) match. Your 80-year-old self will thank you.

Lydia Frank is editorial director at PayScale.com, a site that provides on-demand compensation data and software to employees and employers.

MONEY Aging

As You Age, You Need to Protect Your Money — From Yourself

Piggy Bank Locked Up
Andy Roberts—Getty Images

A financial planner explains why he couldn't stop his client from making irrational decisions.

After three decades as a financial planner, I’m seeing more and more clients reach, not just retirement, but their final years. An issue that becomes especially important at this stage of life is how to help clients protect their financial resources from an unexpected threat — themselves.

One of my saddest professional experiences came several years ago when one of my long-time clients, a woman in her late 80s with no family and few close friends, abruptly fired me. Because Mary had no one else, I had helped her in many ways beyond the usual client/planner relationship and even reluctantly agreed to serve as her trustee and power of attorney in case she became incapacitated.

At what proved to be our final quarterly review meeting, Mary initially seemed confused. I was able to reassure her about the stability of her finances, and she seemed clearer by the time we finished. Three weeks later, I received a handwritten letter from her: “You have my finances in a mess. I can’t get to my money. You are fired.”

I was stunned. Yet ethically I was required to comply with her wishes by moving her holdings to another broker.

Several subsequent conversations demonstrated that Mary was suffering from periodic memory loss and delusion. Had she been disabled by a sudden accident or a stroke, I could have stepped in. Yet, because her decision to fire me was made at a time when she was arguably still competent, my hands were tied.

In theory, I could have gone to court with my power of attorney or in my position as trustee and petitioned to have Mary declared incompetent. But that posed a problem: Essentially, I would have been telling a judge, “Mary fired me as her adviser. I’d like to have her declared incompetent so I can re-hire myself as her adviser.” There was no way I was going to ask a judge to do that. I had a clear conflict of interest.

Since this experience, I have confirmed the wisdom, given the potential for conflict of interest, of never serving as a trustee or power of attorney for a client. With the help of suggestions from several other planners, I’ve also learned some strategies to help protect clients from themselves.

One tool is to ask clients to sign a statement authorizing a planner concerned about possible irrational behavior to contact someone, such as a family member or physician, designated by the client. While this would not prevent a client from firing an adviser, it would provide a method of discussing the issue and also involve another person in the decision.

Another possibility is to put clients’ assets into either an irrevocable living trust or a Domestic Asset Protection Trust (in states that allow them) and naming someone other than the client or the planner as trustee. While the client, as the beneficiary, would have the power to fire the trustee, concern about a trustee being fired irrationally could be mitigated to some degree by having a corporate trustee. In addition, with a DAPT, the beneficiary client would not have the power to amend the trust without the agreement of the trustee. This would give some protection against self-destructive choices by a client who was gradually losing competency. One disadvantage of this approach is cost, so it isn’t an option for everyone.

Perhaps the most important strategy is to work with clients to create a contingency plan in the event of mental decline. It could include arrangements to consult with family members or other professionals such as physicians, social workers, and counselors. For clients without close family members, the plan might authorize the financial adviser to call for an evaluation, by professionals chosen in advance by the client, if the client’s behavior appeared irrational. This team approach might alleviate clients’ fears about being judged incompetent by the person managing their assets.

The possibility of mental decline is something no one wants to consider. Yet it’s as essential a financial planning concern as making a will. Helping clients build financial resources for old age includes helping them create safety nets to protect those resources from themselves.

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Rick Kahler is president of Kahler Financial Group, a fee-only financial planning firm. His work and research regarding the integration of financial planning and psychology has been featured or cited in scores of broadcast media, periodicals and books. He is a co-author of four books on financial planning and therapy. He is a faculty member at Golden Gate University and the president of the Financial Therapy Association.

MONEY Planning

When Conventional Wisdom About Retirement is Good Enough

Retirement investing isn't an exact a science. Rather than worrying whether the rules need to be tweaked, just start saving.

What keeps you up at night?

As a money manager, I recently polled my clients on several questions, and that was one of them. Replies ranged from “my bladder” to worries about the Federal Reserve printing too much money.

The most common answer, though, was fear of outliving one’s savings.

For decades, people have confronted the issue of how much they need to retire. Today the topic hits with special force. People are living longer, and the financial crisis of 2007-2009 set millions of people back twenty squares on the economic game board of life.

Now, there’s much debate about whether traditional retirement planning advice needs to be tweaked.

The traditional advice on income, for instance, is that people in retirement need about 60% to 70% of their old annual income to keep roughly the same standard of living. Remember, when you retire, your taxes may be lower, your children may be grown, your commuting and clothing expenses may shrink, and you may move out of a big house into a smaller house or apartment.

If savings and investments were your sole source of income, you would need – again, by conventional wisdom – about 25 times that sum in hand when you start your retirement. That is based on the traditional assumption that you can safely withdraw 4% of your initial nest egg each year and still have it last at least 30 years, regardless of market conditions.

That means if you earned $100,000 a year at the peak of your career, you would need about $65,000 a year in retirement, and 25 times that amount is $1,625,000.

Of course, inflation may increase your costs as years pass. If inflation runs at a 3% clip, a loaf of bread that costs $2.50 today will cost $4.50 in 2034. At 5% inflation, the same loaf would cost you $6.62.

You can offset some of the effects of inflation by your savings and investments, post-retirement. My father retired at 77 but invested in the stock market, logging prices and trends on charts he kept by hand. When he died at 98, his net worth had increased 75% from the day he retired.

Social Security can help, too. Despite doomsayers’ screeds, I believe the Social Security system will be around in 30 years. But benefits may be a little less generous than they are today.

These days, I see a lot of articles by financial planners questioning the guideline that it’s prudent to withdraw 4% a year.

I’ve seen planners argue for anything from a 2.8% withdrawal rate to a 5% one.

Those arguing for a smaller withdrawal rate — which implies the need for a bigger nest egg — say it’s hard to earn 4% a year after taxes without wading into risky investments. Savings accounts are paying a paltry 1% to 2%, and that’s before taxes.

But I think that’s a short-term view. Savings rates probably won’t stay as paltry as they are – just as inflation didn’t stay sky-high, as it was in the early 1980s.

For the long run, I think the 4% rule provides a decent, if crude, approximation.

Let’s be realistic here. Accumulating a pre-retirement hoard of 25 times the expected annual need is an ambitious target to start with.

But it’s something to strive for.

MONEY Financial Planning

What My 3-Hour Lunch Says About Good Financial Advice

Women at a lunch meeting
Colorblind—Getty Images

Financial planning isn't about investing for retirement or saving for college; it's about turning your vision into reality.

It was Suzanne’s birthday. I really wanted her to have the next best thing to a day off. So I, the adviser, and Suzanne, my client, scheduled our meeting at Guglhupf, a lovely local restaurant.

In 2005, when I formed my company, I was sitting at one of Guglhupf’s upstairs tables when I came up with the tagline of my firm: “Driven by a Vision.” Now, years later, spending a sunny afternoon on Guglhuph’s patio with Suzanne, I had a powerful moment of living that ideal.

Suzanne is a visionary, an entrepreneur. She first came to me as a client because she wanted to be sure that the various ventures she had underway didn’t encumber too much of her wealth — that her assets wouldn’t all be at risk and that she would have enough set aside for her family’s future needs and her own retirement.

At its core, financial planning is helping people realize their vision. And for my entrepreneurial clients, I’m helping them navigate some very complicated waters at a time that’s emotionally charged due to hope, desire, exhaustion, and frankly, being stretched too thin.

These conversations can’t happen inside financial planning software, and they don’t happen on the pages of a financial plan. They aren’t about “Do I have enough money to fund my financial goals?” These conversations are about figuring out how to make those goals come to life.

And this is without my being a business consultant. I don’t know the trades of the businesses my clients start. What I do know is that there are risks associated with what they’re doing, and that likely their venture’s cash flow isn’t going to be as healthy as the projections project. I expect that there’ll be a need for another capital infusion. All of these things are going to impact their other financial planning goals: paying for their child’s education, for example, and being financially independent one day. They know all this too.

However, I believe that when a person has a strong vision for a world they want to impact — their community, their life’s energy making that impact — that inner urge trumps saving for retirement. It doesn’t trump it to the point of being reckless and blinded by today’s enthusiasm, but we recognize that they’re standing at the center point of the see saw, one foot on either arm, finding that balance between today and the long-term tomorrow.

I’ve never snuffed out their flame by saying, “You can’t do that.” I think that’s because I know what it’s like to be driven by a vision. It is my role to identify the risks I see, offer suggestions of how to look at it from another angle, ask them to name a Plan B, and beat the drum of the importance of managing cash flow. Then, I support them in their new venture, in whatever way reasonable.

At this meeting with Suzanne, there was an extra-special payoff. While I do try to stay out of the specifics of my clients’ businesses, over the course of our three-hour lunch we brainstormed about how she might finance one of her new ventures. I realized I knew some people who might be interested in funding it, and I promised to put Suzanne in contact with them. I later did, and they ended up providing money to Suzanne for this project.

So this meeting epitomized my work: My clients are driven by a vision, and I am driven to help them achieve that vision. And if we can enjoy a decadent dessert together, that’s even better.

MONEY financial advice

How Listening Better Will Make You Richer

140724_HO_Listening_1
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.

———-

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 Planning

The One Time Raiding Your Kid’s College Savings Makes Sense

Broken money jar
Normally, breaking into your college savings accounts is a no-no. Jeffrey Coolidge—Getty Images

It's never a great idea, but in an emergency tapping funds earmarked for education beats sabotaging your retirement plans.

Lauren Greutman felt sick.

She and her husband Mark were about $40,000 in debt, and were having trouble paying their monthly bills. As recent homebuyers, the Syracuse, N.Y. couple were already underwater on their mortgage and getting by on one income as Lauren focused on being a stay-at-home mom.

“We were in a really bad financial position, and just didn’t have the money to make ends meet,” remembers Greutman, now 33 and a mom of four.

There was one pot of money just sitting there: their son’s college savings, about $6,500 at the time. That is when they had to make a tough decision.

“We had to pull money out of the account,” she says. “We thought long and hard about it and felt almost dishonest. But it was either leave it in there, or pay the mortgage and be able to eat.”

It is a quandary faced by parents in dire financial straits: Should you treat your kids’ college savings—often housed in so-called 529 plans—as a sacred lockbox, or as a ready source of funds that may be tapped when necessary.

Precise figures are not available, since those making 529-plan withdrawals do not have to tell administrators whether or not the funds are being used for qualified higher education expenses, according to the College Savings Plans Network. That is a matter between the account owner and the Internal Revenue Service.

TIAA-CREF, which administrates many 529 plans for states, estimates that between 10% to 20% of plan withdrawals are non-qualified and not being used for their intended purpose of covering educational expenses.

It is never a first option to draw college money down early, of course. Private four-year colleges cost an average of $30,094 in tuition and fees for 2013/14, according to the College Board. Since that number will presumably rise much more by the time your toddler graduates from high school, parents need to be stocking those financial cupboards rather than emptying them out.

Joe Hurley, founder of Savingforcollege.com, has a message for stressed-out parents: Don’t beat yourselves up about it.

“The plans were designed to give account owners flexible access to their funds,” Hurley says. “I imagine parents would feel some guilt. But I don’t think they should. After all, it is their money.”

Why the Alternative Might Be Worse

Keep in mind that there are often significant financial penalties involved. With non-qualified distributions from a 529 plan, in most cases you are looking at a 10% penalty on the earnings. Withdrawn earnings will also be treated as income on your tax return, and if you took a state tax deduction on the original investment, withdrawn contributions often count as income as well.

Not ideal, of course. But if your other option for emergency funds is to raid your own retirement accounts, tapping college savings is a last-ditch avenue to consider. That’s not only because you do not want to blow up your own nest egg, but because it could make relative sense tax-wise. And as the saying goes, you can borrow money for college, but not for retirement.

“If you think about it, a parent who has a choice between tapping the 529 and tapping a retirement account might be better off tapping the 529,” says James Kinney, a planner with Financial Pathway Advisors in Bridgewater, N.J.

If the account is comprised of 30% earnings, then only 30% would be subject to tax and penalty, Kinney explains. And that compares favorably to a premature distribution from a 401(k) or IRA, where 100% of the distribution will be subject to taxes plus a penalty.

Lauren Greutman’s story has a happy ending. She and her husband made a pledge to restock their son’s college savings as soon as they were financially able. It is a pledge they kept: Now eight-years-old, their son has a healthy $12,000 growing in his account.

She even runs a site about budgeting and frugal living at iamthatlady.com. Still, the wrenching decision to tap college savings certainly was not easy—especially since other family members had contributed to that account.

“We tried to take emotion out of it, even though we felt so bad,” Greutman says. “Since we didn’t have money for groceries at that point, we knew our family would understand.”

Related: 4 Reasons You Shouldn’t Be Saving for College Just Yet

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