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The ability to sustain a steady income during retirement years has always been a primary concern for people in the United States. Recent studies have shown that 61% of U.S residents age 44 to 75 are more afraid of running out of savings/income than they are of death. In order to avoid exhausting a savings nest egg, guidelines have been developed. The most popular is the 4% income rule.

The 4% rule was developed in the early 1990’s by a certified financial planner named William Bengen. He set 4% as the amount of money a retiree can take out of their investments every year with a high probability that it will last for at least 30years. Since that time, financial advisors have been using it as the benchmark with clients.

A recent study from The Journal of Financial Planning has suggested that 4% is no longer a safe number. The study determined that 1.8 % is more appropriate to ensure income does not run out during retirement. The revised rate was based on many market factors. One marker was the historically high price to earnings ratio in the market which may lead to low future investor returns. The risk of poor market timing was also a factor. Taking income at the start of a bear market can have a drastic negative effect on account values and the ability to take future income.

Using a 1.8% model instead of a 4% model may be safe but it has obvious drawbacks. Consider that a person with a $500,000 investment account can only safely pull $9,000 a year from it versus the 4% model which allowed them to take $20,000 a year. If the 1.8% rule is going to be followed, there is an obvious need to increase the investment nest egg prior to retirement which may not be feasible for many people.

An alternative to this approach would be to use a guaranteed insurance contract (GIC) to create the needed income. The advantage of guaranteed contract is the ability to draw a much higher percentage of income on a guaranteed basis. The most competitive GIC’s will currently pay 5.5% to 6.0% income for life on a single life and 5% on a joint life basis. Most contracts do not require forfeiture of the lump sum invested. Some GIC contracts also offer a guaranteed roll up rate during the accumulation period. It is not uncommon for companies to offer a 7% or 8% compound accrual rate for up to 30 years. The guaranteed roll up allows for more precise planning of future asset needs.

While using a GIC can offer many advantages, caution most also be taken. There are hundreds of companies currently offering various bells and whistles on GIC contracts in order to gain market share. Some offer benefits or rates that look appealing but really have little benefit to the consumer. Others will promote incredibly high roll up on accumulation but will then lower the guaranteed income payout. The most important features should be compared prior to choosing a contract in order to obtain the best guarantees available.

Long Term Care Deposit Products vs. Traditional Long Term Care

Traditional LTC

Long Term Care insurance provides needed Protection against the costs of home health care, Skilled Nursing care and institutional care. While there are a number of reasons to purchase a Long Term Care Policy, one of the most important is to protect hard earned assets. If some form of care is needed, the LTC policy will help to cover the additional expense associates with that care and alleviate the need to spend assets in order to cover the cost.

While it is a needed benefit for many, LTC does have drawbacks. The first is the prohibitive cost of the policy. LTC premiums can represent a substantial investment over time and is increasingly expensive for those who purchase it later in life. A second drawback is the risk of carrying the policy for years to ultimately never use the benefits. There are some LTC plans that provide a return of premiums feature but they are restrictive and full of exceptions.

LTC deposit Strategy

An LTC deposit strategy will also protect assets against the cost of Long Term Care and offers major advantages over a traditional LTC policy. The deposit program uses a portion of the investable assets as leverage in the event future Long Term Health Care expenses are incurred.

The money is deposited in a non interest bearing account. In the event that Long Term Care is needed, the money is leveraged by a multiple to cover the cost of care. If Long Term Care is never needed, the account will pay out as a leveraged death benefit. Finally, if the money is needed for some other purpose, it can be withdrawn from the account any time without penalty.

We will use a 65 year old female as an example of how the strategy works

•65 Year old female has $100,000 in a CD or other investment. She has no long term care or has long term care and is paying a high premium for it.

•She can deposit $100,000 into the account which will leverage to provide $435,666 of long term care protection if it is needed. This leveraging starts from the first day the money goes into the account.

•In the event she passes on some day without the need for Long Term Care, the money would be paid as a non taxable death benefit of $233,128.00.

•The $100,000 could be returned to her at any time without penalty in the event her priorities or situation changed causing a need to utilize the money in a different capacity.

Traditional LTC

If she purchased a traditional Long Term Care policy, the annual premium would cost approximately $5,000 a year. She would need to earn 5% on her $100,000 in order to provide the premium payment. In today’s rate environment, it would not be possible to secure a fixed rate at 5%. She would also most likely give up flexibility with the lump sum in an attempt to generate the revenue to pay the LTC premium. Lastly, there would not be leverage provided in the event of early death and a portion of the non qualified account would most likely be taxable.

The final flaw with a traditional LTC policy is the money she may spend on premiums without ever needing long term care. If she lives to her actuarial life expectancy and then passes on without ever needing Long Term Care, she will be paying a large sum of money needlessly. Annual premium multiplied by the number of year s in her life expectancy ($5,000 x 21) would add up to $105,000.00 of premiums paid without any benefit.

In Conclusion

The deposit strategy cannot be utilized by everyone since there needs to be accumulated assets that can be dedicated to the account. For those that have the funds available, this strategy will result in premium savings and added flexibility over Traditional LTC plans.

Bank CD rates are averaging 1% to 1.8% on a 5 year fixed basis nationally. Rate offerings have not been this low in many decades. With the current inflation rate nearing 3%, a fixed CD at less than 2% will not even keep pace. Given this dynamic, it makes sense to look for alternatives.

Insurance companies offer interest rates for a fixed period of years similar to CD rates. Like a CD, once the fixed term expires, you are able to either roll over the account to another fixed period or take your money and go elsewhere with it. Historically, insurance companies have offered rates that are competitive with CD rates. Currently they are offering rates that are often 50% higher than the equivalent CD rate.

Insurance company offerings are not FDIC insured by they are backed by the Guarantee Association in each state. The amount covered by the Guarantee Association varies from $200,000 to $500,000 depending on the state the application is signed in. (For example: Connecticut is $500,000)

There are currently 2 insurance companies offering a 5 year fixed rate at 3.6%. Another is offering a rate of 3.15% and they offer it with a 100% return of premium feature that can be used at any time. Given the low nature of the rate environment, a return of premium feature may be useful. Both companies are A rated and owned by larger A rated parent companies.

The insurance company offerings provide a higher return on a fixed basis and should be considered as an alternative to CD’s due to their more competitive yields.

It is important for most retirees to create additional income streams in addition to social security in retirement. Many will rely on minimum distributions from qualified accounts (IRA’s, 401K rollovers, SEP plans, etc) and non qualified retirement plans to create additional income.

Retired couples will often only have one person receiving additional income. This strategy works well as long as the primary person drawing income is alive but an unplanned death can leave the surviving spouse short on income.

If the deceased spouse had substantial amounts of life insurance or other investments, the surviving spouse can use the proceeds to create their own income stream. Unfortunately, the odds are that the deceased spouse would not have an adequate amount of life insurance to allow for a new income stream to be created.
Using a joint income option is a great way to protect both members of the couple in the event the other passes away.

There are now a number of companies that provide very strong payout options. Most will offer guaranteed income numbers that will increase in the deferral phase prior to turning income on. The payment will not expire until the death of both members.

A number of companies offer joint payouts and the highest paying company changes often. The current leader in this type of contract is Security Benefit. They currently offer the highest single and joint payout in the field.

We will use a 61 year old male and his 61 year old wife as an example. Assume they have saved up $200,000 to supplement retirement. If they defer the money for 5 years, Security Benefit will pay them a Joint lifetime income of $16.186.00 a year guaranteed. This represents over an 8% joint payout percentage. If the defer for 7 years, the income would go up to $20,000 a year putting the payout at 10%.All payouts are projected on a guaranteed basis making it easy to plan for future income needs.

There is no doubt that a new company will counter with a higher payout at some point but for now, Security Benefit is the clear leader.

The average 5 year CD rate is 1.16% nationally and 1.34% in Connecticut. An A rate insurance carrier is currently offering a 6 year fixed rate at 3.15% for deposits under $100,000 and 3.25% for $100,000 and above. The plan comes with a 100% return of premium feature at any time, even if surrendered during the first year.

The company has stated that they will be offering this rate until March 15, 2012. The rate is subject to change after that date. 3.15% is certainly a strong rate compared to current CD offerings but it is bolstered even further by the return of premium feature.

It is always advisable to have reserve or emergency money to guard against financial crisis.   Those who are fortunate enough to have reserve money set aside usually keep it in a savings account or money market.   The idea is to keep the money in an easily accessible account and to limit any fluctuation in value.  In other words, it is not a good idea to have risk in an account that you may need to draw money out of for an emergency.

Money markets and savings accounts keep money liquid and safe from fluctuation but they do not provide much of a return either.   The average savings account yields less than half a percent of interest per year.  The cost of sacrificed return can add up over time.   For example, consider a 54 year old that keeps 50,000 in a savings account of some type of money market for 10 years.  Assuming they are getting a .25% return at the end of 10 years they will have $51,264.00 in their account.   The money certainly was accessible the entire time but the client only made $1,264.00 over the 10 year period.

As an alternative,  a return of premium fixed indexed annuity with an income rider could be considered.  The plan has 100% return of premium at any time. This provides quick (3 day turnaround) access to the initial investment at any time without any risk.  If $50,000 is put into the account, it can always be surrendered for a minimum of $50,000.  Accounts of this type will gain anywhere from 0% to 5% interest a year for an average of 2.5% to 3% which can offer greater growth potential than a savings account or money market. 

 The bigger benefit is the  account will also grow as a guaranteed income stream over time.  One of the more competitive companies currently offers a guaranteed growth of 10% simple interest per year.   If the same 54 year old put $50,000 into this account and did not ever need to access it, they would have a benefit base of $100,000 that they could draw 5.4% out of per year guaranteed.  This would generate $540 a month on a guaranteed basis for life.  They would not be forced to use this option but could do so if the need for extra income arose in the future.

Many return of premium annuities also offer a death benefit option  with the account.   If the account holder was to pass away at any time during the 10 year period, the account would pay out the income rider value as a death benefit. To stay with our example, if the 54 year old died in year 6, the account would pay out $80,000 as a death benefit to the current beneficiary.

A return of premium annuity offers a number of advantages over the traditional safe money strategies. The account holder can still maintain  liquidity while having the  additional earning potential and the ability to use the money for income purposes down the road.