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Guru Q&A: Safety of an Annuity
FiLife User Question: Since there is no insurance for insurance companies comparable to the FDIC for banking instruments, how concerned should I be about the safety of an annuity I might purchase and the stability of particularly companies offering them? i.e - There was not much stated concern about Lehman Bros. until the bottom fell out. In particular, what about a company such as Allianz?
-devans
FiLife Guru Repsonse: First of all, it’s worth noting that there is some limited protection for annuities in the event that a company fails. All states have some form of State Guaranty Fund that provides coverage in some form - although the limits are higher in some states than others.
It’s certainly worthwhile to evaluate the safety of an insurance company before doing business with it. The major companies all have published financial ratings that should be reviewed, and particularly in difficult economic times like this, most people will prefer to stick with only the top rated companies.
Yes, there’s always a risk that there will be an unexpected financial problem, but it is worth noting that Lehman Brothers was an investment bank, which is an entirely different line of business, with extremely different risks, than an insurance company. And even for a company like Lehman Brothers, their problems weren’t entirely unanticipated - their stock price had already dropped by 75% in the 18 months leading up to their ultimate demise, giving some indication that the market believed there were at least significant and rising risks.
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Guru Q&A: When Should I Start a 401k Plan?
When should you start investing in a 401k? Here’s one young FiLifer who isn’t afraid to ask:
FiLife User Question: I am only 19 but I have never been told when I should start investing in a 401k. What is the average or best age to start a 401k?
-annadeel
FiLife Guru Response from Michael Kitces: he best age to start 401(k) savings is the earliest that you possibly can. I don’t have exact statistics for the average age that people start investing in 401(k) plans, but it’s certainly not 19 - which means you’re way ahead of the curve here! Good job!
When you decide to save into your 401(k) plan, you will need to make a selection from the available investment options. You should read some of the information that the company provides about them, to get a sense of how they invest.
If you’re completely new to investing, I would suggest that you also do a little additional reading to get yourself educated about it. Take a look at Investopedia.com, in particular the information on Investing 101, Index Investing, and Mutual Fund Basics. This will be a good start for you to get a handle on what’s going on.
Guru Q&A: How Much Should I Contribute to My 401k?
Despite today’s gains, lots of us are still nervous about investing our hard earned money in these rocky markets. But many experts advise people who are saving for a far-off retirement to get gutsy and get in the game. Our retirement guru Michael Kitces explains how to figure out how much you should invest in your 401k…
FiLife User Question: What’s the highest percentage you should have taken out of your check for your 401k?
-alpage21
FiLife Guru Response: On a dollar basis, the maximum contribution to a 401(k) plan is $15,500 for 2008 (increasing to $16,500 for 2009). These limits are increased to $20,500 for 2008 (increasing to $22,000 for 2009) for those who are over age 50 and eligible for catch-up contributions.
As long as your percentage contribution based on your salary doesn’t exceed these limits, you can generally contribute any percentage of your salary that you want. That being said, a few typical rules of thumb include:
Guru Q&A: How Many Life Insurance Policies Can You Have?
FiLife User Question: How many life insurance policies are you allowed to have? When I die can the government take this money if I owe taxes? A lot of insurance advertisements stipulate that you are just fine as long as your premiums are on time. What happens if you have some that are late? Can they deduct these from the amount your beneficiary will receive?
-RobinMolinari
FiLife Guru Response from Michael Kitces: There is generally no limit on the number of life insurance policies you can have (although a large volume just becomes difficult to manage!). However, there ARE some limits on the maximum AMOUNT of total coverage that you can have. There is no concrete amount for this - it varies depending on the person and the situation - but the basic idea is that the insurance company is willing to insure for the financial impact of your death, but not just to create an unreasonable windfall. For instance, a primary wage earner for a family might reasonably get $1M, $2M, or even $3M of coverage, but certainly getting $20 million of coverage would probably be unreasonable/unnecessary unless the family was incredibly affluent already. It is up to the insurance company to evaluate your “insurance capacity” or the total amount of coverage to put forward on your life.
Guru Q&A: How Do I Leave My IRA to Relatives?
FiLife User Question: I wish to leave my IRA to a number of relatives. I am aware of retitling and the FBO tag. What I would like to know is, can I do it a) before I die and b) since I have a trust doc should I do it through an amendment to the trust? Right now the trust stipulates that it shall be liquidated and then dispersed. I think that is the least attractive way to do this. What would you suggest?
-billspadaro
FiLife Guru Response: While you are still alive, all you can do with the IRA is name the beneficiaries of the account by filing a properly completed IRA Beneficiary Designation form with the IRA custodian. You cannot actually change the title to your IRA at this point (doing so would constitute a distribution of the IRA).
Thus, the question in essence becomes “What should the Beneficiary Designation” say? Should it name the relatives directly? Should it name a trust for their benefit? Or some other structure?
First of all, if it’s for minor children, it probably should NOT name the minor children directly. At the least, it should name a UTMA account and an associated custodian for the benefit of the minor children (your IRA custodian can provide more detail about how they require this to be worded for their systems).
Guru Q&A: Should I Convert My IRA to a Roth?
FiLife User Question: I have a good amount of Traditional IRA, with little bit in Roth IRA. With the dive in market, seems like it would be a great time to convert some money to Roth from traditional IRA. Make sense?
-lowkey
FiLife Guru Response: Certainly, with the market down the cost of completing a Roth conversion is reduced simply because the account value of the IRA is reduced.
In the end, though, it’s still only good to do a Roth conversion if the other factors for it are in your favor. Overwhelmingly, the top two factors (in order of importance) to having a beneficial Roth conversion are:
1) Tax rates. If your tax rate NOW (during conversion) will be lower than your tax rate in the future when you will ultimately be withdrawing the IRA funds, conversion is favored. Of course, this will be somewhat hypothetical (since we don’t KNOW what your future tax rate will be) so you’ll need to estimate as best you can based on your situation.
2) Outside money. If you have available funds outside of your retirement accounts to pay the tax on the conversion, it enhances the success of your Roth conversion.
With currently reduced account values, you’ll find that it’s a great time to convert, IF the above factors are in your favor. If they’re not, though, then a Roth conversion still won’t be a win for you.
I hope that helps a little!
-FiLife Guru Michael Kitces
Have a question? Ask it here.
Guru Q&A Deluxe: Switching from a 401k with a Loan to an IRA
FiLife User Question: I now have a 401K with Merrill Lynch but have a loan out on it - I’m thinking about switching to an IRA next year - how does that work?
-sunfl41287
FiLife Guru Response from Michael Kitces: Under the rules for 401(k) plans, if you end employment with the company or roll over the 401(k) funds, the amount of the loan will be treated as a distribution. This means you will have to pay income taxes, and potentially an early withdrawal penalty, on the amount of the loan.
Avoiding this undesirable result is fairly straightforward - you need to pay off the 401(k) loan before doing a rollover (or before ending employment). Of course, that can be difficult to do, depending on your other assets and income available to actually pay off the loan. But the bottom line is that to avoid adverse tax penalties, you’ll need to pay off the loan before doing any rollovers.
I hope that helps a little!
FiLife User Response from sunfl41287: Can I change what my 401k is allocated to. I’m not employed at that company any more and I’m in agressive model and scared that I’ll loose more of my money. I have one more year to pay off the loan. I’ll be 59 1/2 end of January if I turn my 401k loan over to IRA do I still get the penalty?
Diane
FiLife Guru Response from Dave Hanson: Yes, you should be able to change your allocation even though you are no longer employed there. You will want to consider carefully the suitably of your 401k allocation in the context of your larger financial picture: other investments and retirement income, social security, spousal income if applicable, et cetera. Our guru Michael, an acclaimed Certified Financial Planner, is well qualified to give general guidance on these issues here. For more in-depth guidance, You may also want to work with a recommended CFP in your area.
Once you turn 59 1/2, you will not incur early distribution penalties on a 401(k) distribution. Distributions will only be subject to tax liabilities.
-FiLife Gurus Michael Kitces and Dave Hanson
Guru Q&A: Should We Consider a Guaranteed Income Annuity?
FiLife User Question: My husband (59) and I (65) have been retired for two years. Our portfolio (no pension) has dropped dramatically with the recent market plunges (now @ $1.1M). Our expenses are relatively low, about $52K/yr. in today’s dollars. My Soc. Sec. is $1,500/mo. We are wondering if we should consider a guaranteed income annuity (with step-ups) for about half of our portfolio. These seem to be rather expensive, difficult to compare, and it’s hard to get objective info (all seems to be from salespeople), but lowered risk and guaranteed income are attractive features. I know there are many different types of annuity products on the market, but can someone tell me the primary “pros” and “cons” of this relatively new type of annuity for our situation? Many thanks!
-Callie
FiLife Guru Response: First of all, for better or for worse, you’ve hit the nail on the hard with many annuity retirement income guarantees - they are rather expensive, can be very difficult to compare, and it is definitely hard to get good info!
All that being said, I think you’re viewing the annuity in the correct light - that it IS about lowered risk and guaranteed income, and if that’s what helps you achieve your goals and sleep well at night, it may be a quite reasonable and modest cost to pay!
Overall, the primary benefit of using variable annuities with retirement income guarantees is to be able to stay invested in the markets while still having a minimum “floor” of retirement income. That is THE primary benefit, and for many is the sole purpose of purchasing such a contract.
The disadvantages are that there IS a significant cost (annuities with lots of guarantees aren’t cheap!), and that in many cases a reasonable, well-diversified portfolio will still accomplish the same goals without the costs (granted, not on a GUARANTEED basis, but success nonetheless based on all the retirement scenarios we can analyze throughout history).