Faith Based Investing

From my article at MoneySmartRadio.com

Matthew Sapaula  is a great radio host in the Chicago area.  He’s one of those positive, uplifting, wise, and helpful kind of guys we should all surround ourselves with.  He recently featured a conversation we had about annuities at his site.  Check it out!  

What mistakes do investors often make when they look at annuities?

Most of the money gurus attack annuities.  For the most part the criticisms are justified. After all, when you look at the fee structure, commission incentives for agents, the often lengthy surrender charges, inflexibility, and the many stories about seniors getting taken advantage of because of improper annuity sales, it’s easy to see why they get such a bad rap.

 There are two main types of annuities: fixed and variable. In a fixed annuity, your money grows at a fixed rate usually determined by current interest rates. Another variation of the fixed annuity is an indexed annuity which ties your interest to an index like the S&P500 or Dow Jones.  You usually have a cap (maximum you can earn) and a floor (lowest return you could achieve). A variable annuity, on the other hand, allows investors to participate in mutual fund-like subaccounts. The assets in a subaccount may be allocated across a mix of stocks, bonds and money market funds. 

Let’s look at six of the biggest mistakes investors make when they choose an annuity.

Mistake 1: Underestimating variable annuity fees

In addition to high commissions, variable annuities have high costs compared to many other investments. These expenses essentially guarantee you won‘t achieve a reasonable long-term rate of return. It‘s like you have a ball and chain!

Here’s a typical expense structure:  

Mortality and Expense Charge 1.50% 

Sub Account Management Fees 1.00% 

Unreported trading costs 0.78% 

Annual Administrative Expenses 0.15% 

TOTAL EXPENSES 3.43%  

Mistake #2: Tying money up for years 

Many annuities (fixed and variable) have surrender periods ranging from 3 years to 15 years or longer.  The typical surrender period is seven years! This means your money is tied up! If you want to sell your annuity, you will pay dearly. For example look at a typical surrender schedule on a 7 year annuity: 

Surrender Schedule 

Year 1: 8%  

Year 2: 7%  

Year 3: 6%  

Year 4: 5%  

Year 5: 4%  

Year 6: 3%  

Year 7: 2% 

This means on a $100,000 investment you may have to pay $2,000 to $8,000 or more to sell your annuity. Talk about inflexible! Yes, most annuities do allow you to withdraw up to 10% per year without penalties, however, you can never completely cash out until the surrender period expires. In the investment world seven years is a long time and things change rapidly. Being stuck in an expensive annuity is not a place you want to remain in limbo. 

Mistake # 3: Not reading the fine print 

For most investors, annuities are quite complex investments. Between knowing what a subaccount is, how living and/or death benefits work, surrender schedules and fees, withdrawal options, living benefits, how cap rates work, on and on. Fixed and variable annuities are often so complex that even the advisors who sell them truly don‘t fully understand what they‘re selling. The prospectus that comes with an annuity is often filled with legal jargon galore! 

Mistake # 4: Underestimating inflation.  

Many investors choose fixed annuities instead of the variable option. In a fixed annuity, your money grows at a fixed rate. At first that kind of financial predictability sounds wonderful, but there are two problems that come with it. One, your rate of return might be meager compared to what you could earn in the stock market. Two, inflation is going to make that fixed return worth less and less with the passing years, unless you pay (possibly through the teeth) to have the rate of return adjusted. 

Mistake # 5: Relying on a variable income guarantee 

Many variable annuities let you benefit from stock market gains while shielding you against stock market losses. In the past, many have offered the annuity holder at least a minimum rate of return (a GMIB, or Guaranteed Minimum Income Benefit). Many have also offered guarantees that the annuity value will not dip below the value of the initial principal (a GMAB, or Guaranteed Minimum Accumulation Benefit). Be very careful that you understand how these benefits work and what strings are attached.  These benefits often come with a high price tag and require that you follow a ton of rules to take advantage of the benefits. 

Mistake # 6:  Thinking an index annuity will perform better than the market 

Equity Indexed annuities are not necessarily all they’re cracked up to be. They are a class of fixed annuity that is linked to the performance of a stock market index, commonly the S&P 500. An EIA has a guaranteed minimum rate of return (guaranteed by the insurance company, not the FDIC), and it gives you a chance to capture some of the stock market gains. That’s the upside. (On the whole, EIAs are not designed to beat the stock market; they are basically designed to perform a little bit better than the fixed markets.) Many investors assume they get all of the good side of the markets with none of the bad.  Often I have found that the average return and investor gets with an indexed annuity is more in line with the bond market than the stock market because of the annual caps set by the insurance company issuing the annuity.  For example, the cap may be set at 8 percent and that is the maximum you can earn that year.  The market may be up 20, but you will only earn a maximum of 8.  This cap limits your long-term rate of return.As you can see, annuities are quite complex and often confusing.  They offer many benefits but you need to fully understand what you’re getting and know the benefits along with the limitations.  Before investing in annuity always get a second opinion and read the fine print carefully.  As with any investment, buyers beware!

Mistake # 1: choosing a salesperson instead of an independent professional with a fiduciary responsibility.

According to Registered Representative Magazine, salespeople in the financial services industry earn on average $175,000 to $200,000 per year. It’s not uncommon for financial advisors to earn millions annually.

Though many advisors may claim to have your best interest at heart, you actually fall to the third slot on the totem pole of many advisors:

1. Your advisor’s interests
2. His or her firm’s interests
3. Your interests

The Securities and Exchange Commission (SEC) and the National Association of Securities Dealers (NASD) govern brokers and investment advisors.  However, the odds of an advisor facing daily conflicts of interest are as common you spotting a Toyota while running an errand.

Conflicts are so widespread and entrenched on Wall Street that all attempts at reform have failed. The backroom deals, commission incentives, payments for shelf space, etc are happening as you read this.  Advisors are often “glorified salespeople” who have one goal: make as much money as possible.  Most have no fiduciary responsibility so the prudent rule says they can invest in anything as long as it does not harm you.   So the advisor is free to sell you a variable annuity with a 10 percent commission.  Your cost? Five percent annually in fees and by the way you can’t sell it for at least ten years or you’ll pay huge penalties.

So in essence, they are not bound to act solely in your best interest.  With commissions on the line, many sales people will act in their own self-interest, justifying the product with the highest commissions. With two identical product choices (one paying a 7% commission, the other 4%, which do you think the advisor would choose?)

From a legal standpoint, an advisor is only required to avoid selling you an “unsuitable” investment product. This meets a very minimum standard.  There is no requirement to act in

your best interests or as a fiduciary on your behalf. Additionally, they don’t even have to disclose any conflicts of interest that may exist.  Talk about a bum deal for you!

Mistake # 2:  Listening to the media

Money magazine, Fortune, USA Today, CNBC’s Jim Cramer, Forbes, you name it; they are all there to entertain! Let me repeat this they are all there to entertain. This means sell you something! If you don’t tune in, buy from their advertisers, and continue to frequent them regularly, they go out of business. Bold headlines, irrational advice, entertaining news, sensationalized stories…it must capture your attention.

How poor is the advice from the media? In 2000, Case Western Reserve University conducted a study showing that investors who follow media recommendations lose 3.8% of their money in the following six months after the recommendation. So why do so many people blindly follow the media’s investment advice? Predictions made about sports, weather, and Wall Street make good conversation pieces, but poor investment strategies! Instead of listening to unqualified professions, listen to people like Dan Celia, who have been advising clients using biblical principles for over 30 years!

Mistake # 3:  Listening to friends and family talk about “what’s hot”

Since 1990, we’ve seen investing fads come and go. In the 1990s it was technology stocks, followed by real estate, and then it became oil and gold, then emerging market countries like Brazil, Russia, India, and China. Today many flock to any form of green or environmental investing. Investment fads are only in vogue until everybody knows about them. Once they become cocktail party conversation, financial magazine material, or an internet sensation, the fad is as good as dead on arrival.

I remember late in 1999 when I received a call from one of my beloved clients Molly. Molly was in her mid-80s and a very conservative investor. She was wondering if she should sell many of her dividend stock investments and put them into an Internet mutual fund. I asked Molly about her nearly 30% return from the prior year. Was she not happy? She said she had a friend (and everyone has one of these friends) who made over 100% the prior year in an Internet fund. After explaining the risks, and discussing her personal situation, I talked Molly out of investing in the Internet fund. Not that I had a crystal ball or anything, Molly had no place being in the internet.

Normally a fixed income and dividend stock owner, this would have taken her risk level from a 4 all the way to a 10. Molly took my advice and we all know how the Internet story unfolded. I don’t always claim to get it right when it comes to trends or predicting short-term movements in the stock market, but what I can spot are troubled signs that a strategy is headed for disaster. Human nature drives people to invest in fads only after prices have already risen. This means those late to the game are the most apt to get hurt. We only hear about a trend after people have already been successful making it less and less likely that you can follow their success. Instead, you need to figure out how to buy low and sell high. Here’s a hint: investing in fads is not the way.

So what should you do?

How about getting an independent, unbiased review of your portfolio situation?  We can take a look and analyze both the moral and financial implications of where you’re investing. How should you be investing the money God has entrusted to you?  Let’s look at your strategies and see if they make financial sense.

Give us a call today at 877-832-3847 or email me at jay@valuesfirstadvisors.com.  I will be more than happy to take a personal look at your accounts and give you my best advice.

Miracle on the Hudson

Captain Chesley “Sully” Sullenberger avoided catastrophe by safely landing a US Airways plane on the Hudson River.  On January 15, 2009, Sullenberger was the pilot in command with an extensive flight and military experience, the kind of guy you want in the control pit with the slightest hint of danger.

According to reports:

“Shortly after taking off, Sullenberger reported to air traffic control that the plane had hit a large flock of birds, disabling both engines.  Several passengers saw the left engine on fire. Sullenberger discussed with air traffic control the possibilities of either returning to LaGuardia airport or attempting to land at the Teterboro Airport in New Jersey. However, Sullenberger quickly decided that neither was feasible, and determined that ditching in the Hudson River was the only option for everyone’s survival.  Sullenberger told the passengers to “brace for impact”, then piloted the plane to a smooth ditching in the river at about 3:31 P.M.”

The Miracle?

Every passenger survived!  To land the way Sullenberger did in such a small space with no casualties was beyond a miracle.  With God’s protection and Sullenberger’s expert skills, this flight is remembered for what was saved not what was lost…

There are some things best left to a professional

I can think of a short list of professionals I would want by my side in a jam:

• Doctor for my health issues/problems
• Attorney for my legal issues/problems
• CPA for my tax issues/problems
• CFP for my financial issues/problems

People often refer to the professionals when it comes to legal and health issues, but when finances enter the picture, all too often people tackle their 401ks, IRAs, and investments alone without consulting a professional.  I’d like to say these do-it-themselves-ers often land safely, but unfortunately miracles are few and far between…

This  only confirms to me that sometimes having a professional makes all the difference in the world!

Could filling out one form put more money in your mailbox?  

 A couple of years ago, Boston University economics professor Laurence Kotlikoff publicized a mindblowing discovery: retirees could dramatically increase their Social Security checks by reapplying for Social Security benefits.

It was entirely legal; it was an opportunity that had lay unnoticed for years. It was soon discussed on National Public Radio and PBS, and in USA Today and a number of in financial magazines. Let’s discuss it here.

Hit “restart” and reset your RIB. Everyone eventually applies for Social Security, but few people reapply – and that’s the key to this strategy, which can potentially bring retired couples $1,000 or more in additional RIB (retirement income benefits). Kotlikoff calls it “restarting the Social Security clock”. If you are in good health and have retired within the last few years, it is a move worth considering.

You can start collecting Social Security benefits when you’re first eligible, and then restart your payments at a higher rate later. You simply file Form SSA-521 (www.ssa.gov/online/ssa-521.pdf) to request a withdrawal of your Social Security application. After the SSA processes that form, you reapply for Social Security – and since you are older now than when you first applied, this time you will receive much higher payments.

So if you think you applied for Social Security too soon, this presents you with a remedy, as Kotlikoff noted while presenting a hypothetical example to the Los Angeles Times in 2009.

Take the case of a 70-year-old husband and wife, he noted. In 2009, they each would have received $13,250 in benefits if they had started taking Social Security at age 62. But if they had waited to apply for Social Security until 70, they each would get $20,692 annually. Instead of $26,500 in combined monthly benefits, they could get $41,384 – 36% more.

That’s a pretty good case for hitting restart.

What’s the catch? If you want to restart your Social Security benefits at a later age, you have to repay the Social Security benefits you have already received. But you don’t have to pay interest on that money.1 Basically, you’re repaying an interest-free loan from Uncle Sam.

Now if enough people do this, there is the risk that the federal government may say, “Wait a minute – look at all these people exploiting this opportunity.” But very few retirees do.

If you do reapply, there’s nothing fishy about it. Visit your local Social Security office (make an appointment by calling 1-800-772-1213). Bring Form SSA-521 with you, or ask for it and fill it out while you are there. Don’t be surprised if the person on the other side of the desk doesn’t know what you’re talking about when you mention reapplying for benefits. So bring a copy of the formal SSA explanation (www.ssa.gov/OP_Home/handbook/handbook.15/handbook-1515.html) with you.

Once you repay your benefits, you can restart them whenever you want. If you fill out Form SSA-521 and hand over a check repaying the money you’ve received, you can reapply for benefits right then and there – the request is routinely approved. 

For the record, Form SSA-521 only allows you to check one of two boxes for why you want to reapply for benefits. The first is “I intend to continue working” and the other is “Other (please explain fully)”.Mickie Douglas, a spokeswoman with the Social Security Administration, told Financial Advisor Magazine that it is entirely legitimate to write down that you are reapplying because it is “financially better for you”.What risks do I run by doing this? The big risk is that you could die soon after you repay your benefits – you could be out, say, $50,000 or $60,000 without living long enough to enjoy much of the additional income. But survivor benefits would be larger for your spouse, of course. Speaking of spouses, widows and widowers cannot employ this strategy to reapply for a deceased spouse’s benefits.

Is this a good move for you? It might be. In case you are wondering, Kotlikoff is no hack – he holds a Harvard Ph.D. in economics and is a former member of the President’s Council of Economic Advisors. He knows his stuff, and so should you. If you have the money to repay a lump sum equivalent to the benefits you have received, this may be a great move – but talk with your financial or tax advisor to see how this decision affects your overall financial strategy.

From my post at ChristianPF.com

Are Annuities Right for You?

How many times have you gone to meet with a financial advisor and they offer you an annuity? How many times have you heard about how awful annuities are? The truth is annuities very rarely make good investment vehicles.

In light of the recent market volatility, variable annuities are being reintroduced to a broader audience. Pre-retirees and retirees are giving annuities a second look because of the tax-deferred features and income guarantees. Is an annuity right for you? Let’s take a look at a few of the basics:

What is an annuity?

An annuity is a contract between you and a life insurance company that promises you lifelong income in exchange for a lump sum payment or series of payments to the insurer. The income arrives in periodic payments, either at once (an immediate annuity) or in the future (a deferred annuity, which also offers you tax-deferred growth of the assets inside it).

A look at the Pros and Cons of Annuities

As an independent financial advisor who gets paid a fee only rather than commission, I am always looking at the pros and cons of various investments. Let’s take that same approach with an annuity. There generally are two types of annuities – fixed or variable annuities. Fixed are tied to interest rates or indexed annuities tied to various indexes and variable are tied to the investment performance of the mutual funds within the policy. Let us look at the good, bad, and ugly features of the most popular type of annuities- variable.

The Good

Annuity ownership does come with some attractive benefits such as:

1. Flexibility and investment choices – Variable annuities have sub-accounts with various mutual funds to select from. This makes it easy to change investment direction or your allocations with little or no costs.

2. Tax deferral for your investment gains – Just like your 401k or IRA, your contributions and earnings can grow tax-deferred until you withdraw funds. If this is in a non-qualified account (non IRA or retirement), you do not have to make mandatory withdrawals at age 70 ½.

3. Income for life – I will concede that no other investment allows for the creation of income for life. Once you select monthly payments (or annuitize) your annuity contract, the insurance company will guarantee you (and your spouse, should you desire) the income payment for the rest of your life. This is like creating your very own pension!

4. Asset protection – In certain states, annuities are a shelter from creditors. If you work in a field prone to lawsuits or even if you are in a car accident, protecting your assets is important. Annuities typically provide this type of protection.

5. Potential protection from market losses. Many variable annuities let you benefit from stock market gains while shielding you against stock market losses. In the past, many have offered the annuity holder at least a minimum rate of return (a GMIB, or Guaranteed Minimum Income Benefit). Many have also offered guarantees that the annuity value will not dip below the value of the initial principal (a GMAB, or Guaranteed Minimum Accumulation Benefit). However keep in mind these guarantees are expensive and come with many strings attached. So buyers beware.

The Bad

1. Irreversible consequences. The idea of income for life sounds enticing but here are a few cavots. For example, once you annuitize (create income for life or a period of time), it often becomes irreversible. You often give up the ability to get your lump sum back or even pass it to “other beneficiaries”. So say you put $250,000 into an annuity at age 60 and accept the insurance company’s offer to pay you a monthly income for the rest of your life. It could take 20 to 25 for you to break even on that investment.

2. Locked up until 59 ½. Another downside is that once you put funds into an annuity contract you cannot touch those funds until you reach age 59.5. Otherwise you have to pay a 10% penalty for early withdrawals.

3. Poor tax planning. A withdrawal from an annuity is treated as ordinary income rather than qualifying for the often more favorable long-term capital gains treatment. When you do start to take funds from the contract, the portion of your payments that are considered investment gains are taxed at your ordinary income tax rate instead of the long-term capital rates. This rate could be higher than the current capital gains rate.

4. Insurance company financial health. You can’t judge a book by its cover, but you can judge an insurance company by its Comdex ranking. This is a useful place to start. As the name implies, the Comdex is a composite index: an average percentile ranking of credit ratings provided for life and health insurance companies by firms such as Moody’s Investors Service, A.M. Best Company and Standard & Poor’s Corporation.

The Comdex ranks insurers using a weighted average on a scale of 1 to 100, 100 being best. If an insurer has a Comdex rating of 85, for example, that means the Comdex has ranked its strength and solvency as superior to 85% of the insurance companies in the index. If you want to see the actual ranking/opinion of Moody’s or Best or another credit firm rather than an average, visit www.iii.org/individuals/life/buying/strength – this is the website of the Insurance Information Institute, a longstanding information source for media and the public about the insurance industry. Or find your state insurance department via www.naic.org.

5. Inability to screen for your moral and social preferences. Most annuities have no choice for morally or socially conscious investors. Your investments may be supporting companies involved in abortion, pornography, embryonic stem cell research, gambling, tobacco, alcohol, or other issues important to you.

The Ugly

1. Surrender charges – If it’s not bad enough that your funds are tied up until age 59 ½, you also have to be careful because most insurance companies also charge a surrender fee (usually on a five to seven year scale). These fees often start at around 8% in the first year down to 0% in year seven. So, a $100,000 investment could cost you $8,000 (8%) in surrender fees if you take your money out in the first year. It will usually go down 1% per year until reaching 0% at the end of the surrender period.

2. Up-front commissions. Annuities are still primarily a commission-based product. They can pay commissions of 5% or more to the agent who sells them to you. That’s $5,000 or more in commissions for each $100,000! Don’t be afraid to ask about the commission he or she collects by selling you the annuity before you invest. Not that it always influences a recommendation, but you have to be careful as some agents are glorified salespeople looking for their next commission check.

3. Annual fees, administrative charges, mortality expenses, and other charges – With so many layers of fees, how will you make money? I have seen investors who have been in annuities for 10 years or more make very little money because of these high fees. It will affect your investment performance. These charges are often buried into the cost of your annuity. Reading a prospectus is often eye-opening!

As you can see, everything is not what it appears with an annuity. You need to read all of the fine print before investing a dime.

Five questions I would ask before investing include:

1. Where is your money going and what values are you supporting?
2. How much risk are you taking?
3. Is your money liquid and easily accessible?
4. What rate of return should you expect in this low rate environment?
5. How do you protect yourself from taxes and inflation?

If the investment you are considering doesn’t answer these five questions in a way that you feel satisfied, go with your gut instinct, and look elsewhere. Annuities are certainly not a fit for everyone!

RULES change for IN-SERVICE 401(k) rOLLOVERS 

401(k)-to-Roth rollovers are now possible before age 59½.

A new possibility. Sometimes employees want to pull money out of a 401(k) before they retire. It isn’t always because of an emergency. Some workers want to make an in-service non-hardship withdrawal just to roll their 401(k) assets into an IRA. Why? They see lower account fees and greater investment choices ahead.

As a result of the Tax Increase Prevention Reconciliation Act (TIPRA), tax laws now permit in-service non-hardship withdrawals from 401(k), 403(b) and 457 plans to traditional IRAs and Roth IRAs before age 59½. Of course, the employee must be eligible to take a distribution from the plan, and the funds have to be eligible for a direct IRA rollover.

This option may be very interesting to highly compensated employees who want the tax benefits of a Roth IRA. The income limits that prevented them from having a Roth IRA have been repealed, and they may have sizable 401(k) account balances.

Does the plan allow the withdrawal? Good question. If a company’s 401(k) plan has been customized, it may allow an in-service withdrawal for an IRA rollover. If the plan is pretty boilerplate, it may not.

The five-year/two-year rule also has to be satisfied. IRS Revenue Ruling 68-24 says that for an in-service withdrawal from a qualified retirement plan to take place, an employee has to have been a plan participant for five years or the funds have to have been in the plan for two years.

401(k) plan administrators may need to amend their documents. Does the Summary Plan Description (SPD) on your company’s 401(k) plan allow non-hardship withdrawals? If it doesn’t, it may need to be customized to do so. This year, plan administrators nationwide are fielding employee questions about rollovers to Roth IRAs.

401(k) plan participants need to make sure the plan permits this. An employee should request a copy of the SPD. If you ask and no one seems to know where it is, then call the toll-free number on your monthly 401(k) statement and ask a live person if in-service, non-hardship withdrawal distributions are an option. In some 401(k)s, an in-service non-hardship withdrawal will prevent you from further participation; be sure to check on that.

If this is permissible and you want to make the move, you better make an IRA rollover with the assets withdrawn. If you don’t, that distribution out of your qualified retirement plan will be slapped with a 20% federal withholding tax and federal and state income taxes. Oh yes, you will also incur the 10% early withdrawal penalty if you are younger than age 59½. Additionally, if you have taken a loan from your 401(k), any in-service withdrawal might cause it to be characterized as a taxable distribution in the eyes of the IRS.

Obviously, this IRA rollover possibility is not a big hit with the national and regional retirement plan providers, who would like to see you keep participating in their 401(k) programs rather than partly or fully bail out. But many employees would like a broader and more diverse range of investment options – and some would like the chance to direct their money into vehicles designed to produce future income streams.

Don’t forget to talk to the professionals. Retirement plan administrators and participants should talk to the financial consultant that has helped them with their 401(k) program before making a move. This article is simply an overview, and there will be different details to attend to with each employee. So be sure to touch base with the financial professional you trust.

Other articles to consider:

5 Reasons Your 401k is a Bad Investment

401k Fees: See what you’re really paying