EIAs - Financial Advice Gone Bad

Q. My brother was talked into selling his old annuities, paying the penalty with the bonus this new company (####) was giving him and buying their equity indexed annuity. All this was done by his 'financial adviser'. Since then he has come to realize this was a big mistake after reading up on them. What would be his best course of action now? He is 55 yrs. old and has other investments.

A. It was good to hear from you and, unfortunately, your brother’s story is all too common. Legally, if your brother signed the paperwork which says he understood what he was doing then he essentially relieved the financial advisor of any liability!

How long ago did this happen? If it has been within 10-20 days then he may be able to get out of it. Let me know and I will explain. If it has been longer than that he is stuck.

The #### EIAs are some of the worst out there. Does he know that even though it is a 10 year contract, that if he wants the money in a lump sum he won't get the index gains? In fact, with this particular EIA, someone who put in $100,000 and took all the money out at the end of the 10 year period will only get $101,547 regardless of how well the market does!!!!

The only way to get the index gains in the #### products is if you annuitize. That means taking distributions over a multi-year period. So after 10 years, if he wants any index gains, he has to annuitize over an additional 10-year period!!

It is absolutely incredible. And it was all done so the advisor could make a 9-10% commission.

The first thing your brother needs to do is find another advisor! Then he needs to tell everyone and anyone what the advisor did to him. As for his money, he's probably stuck other than being able to withdraw 5% per year without the penalty. Even then, he will only be able to get 50% of his money over the 10 years.

Let me know if I can be of further help.

Q. From what my brother told me it is a 7 year contract (Master Dex10??). It has been longer than 20 days so that option is closed.

As to his advisor, he has already let her know what bad advice she has given him but I doubt she even understands that it is a bad deal. My thought was to take the 15% penalty for canceling, write it off on his taxes and then invest in good no-load funds. Would he be better off going this route and hopefully make up the loss and then some in the market. He has 10 yrs. to retirement.

Thank You

A. There are several issues involved. First, is it IRA money? If so, you can't deduct the loss.

Secondly, the 15% penalty probably does not include the loss of the bonus. So if he put in $100k and got a $6k bonus, he may only get back 85K. So not only will he be out the 15% penalty on this annuity but he will also be out the penalties he paid on the other annuities to get into this one!

There are ways to invest the money that would give him complete control and flexibility, allow him to participate in the growth of the market while significantly reducing the potential for loss all without commissions, surrender penalties, set-up fees or time commitments.

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Monthly Income From $170k in IRA

Q. If I have $170,000 to put in an IRA when I retire, could I get $1000 a month from that without too much trouble. I will have $1500 Social Security and I have the other in my Profit Sharing. I want to retire soon and just want to know without any fancy investing, could I get a monthly income of $1000.00

A. Thanks for asking. $12k a year on $170k is a little over 7% that you will need to earn each year. In today's environment, that can be difficult but it is possible. For instance, I have a client who came to me in 11/02 with $430k and was pulling out $36k a year (8%). He has pulled out almost $75k in the last 14-15 months and his account is worth about $485k.

If you are very conservative and don't want any fluctuation, then this will be just about impossible until rates get a couple percentage points higher.

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UTMAs and Beneficiaries

Q. My wife and I have IRAs and 401(k)s. We are each other's primary beneficiary. My 2 sons (both under 18) are the equal contingent beneficiaries. Let’s say my wife and I die at the same time (car crash), and my sons get everything. Since they are minors, how is the UTMA set up and how many will have to be set up, and by whom - the guardian, who picks the guardian if we didn't choose one. How do we choose one before we die? If the 401k requires a full payout in 5 years (no stretch?), what happens to the money, does it get distributed to the minor and taxed at his tax rate, or does it stay in the trust and taxed at trust rates? Does the trust have to dissolve at age 18 (or 21 in some states), and everything goes directly to the beneficiary.

For the IRA, it can be stretched even though it will be a UTMA? If yes, will the UTMA make it past 18?

Any help will be appreciated.


A. I'm not sure I'll be able to answer all of your Q's, but let's give it a try...

IRAs that your minor children would inherit probably would not be considered UTMA accounts. It is important that your children have a guardian and there is a Guardianship document you can use to name one with alternates before you die. Many people also name the guardian in their Will or Living Trust.

When a non-spouse beneficiary inherits an IRA, it is referred to as an Inherited IRA and the decedent's name must be in the title of the account.

For example: "John Doe IRA (deceased March 30, 2005) F/B/O John Doe II, Beneficiary"

If the child was a minor then I would think it would be: "John Doe IRA (deceased March 30, 2005) Maggie Smith, Custodian F/B/O John Doe II, Beneficiary"

You should verify this with a competent tax attorney, but the IRS does not state specific language for titling Inherited IRAs.

A 401(k) would be paid out to a custodial account for benefit of the child. It think it
would be taxed at the child's rate unless there is one parent still living. In that case the distributions would probably fall under the Kiddie Tax provisions. (If child over 14 then taxed at their bracket, prior to 14, $1600 taxed at child's rate, rest at parents).

Any custodial (UTMA,UGMA) account automatically gets controlled in it's entirety by the child when he or she turns 18. The only way to prevent this would be to have a trust set up fbo the child and make the trust the beneficiary of the IRA/401(k). In that case it would be taxed at trust rates and might not be eligible for stretching.

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Selling Land to Buy an Annuity?

Q. I have some neighbors that are elderly and getting ready to sell 110 acres of land. I know about the 1030 exchange for other land, but they want to invest in an annuity. Will they have to pay taxes on the profit from the land? Is there anything they can do to not pay taxes? Thanks

A. Good question. Yes, they will have to pay capital gains taxes on the sale of the land.

Moreover, you need to strongly caution them on buying an annuity. There are many charlatans scamming elderly seniors into selling property and putting the money into annuities that pay commissions of 10% to the agent while locking the money up for the investor.

If at all possible, find out what annuity is being recommended. As was stated in the Wall Street Journal this morning, there is ANY reason for someone 65 years or older to be in an annuity as an investment unless it is what is called an immediate annuity where you get automatic monthly payments like a pension.

That's not what this couple is being sold.

They need to be very, very, very skeptical. They are about to be taken.

I will help in any way I can.

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Planning For Retirement - Withdrawal Rates

Q. Jeff, I am thinking of early retirement and am concerned what would happen to my retirement money and 401k. I will be 55 and my wife is 53. My company pension is $315K and my 401k is at $70K. I have been going to Merrill Lynch for advice and would like your opinion. What could this amount draw for me and still grow without running out. I can be conservative and my wife will start teaching again as she had stopped to care for grandkids. She will work for 7 more years until she can qualify for her retirement at 60 years of age. Thanks Gerry

A. Let me congratulate you first for taking the time to get a second opinion, and second, for researching your financial options prior to making the decision to retire. When it comes to dealing with financial 'professional' it is good to have a healthy dose of skepticism!

Typically, you want to look at a withdrawal rate of between 4% and 5% per year. The idea is that the account will average more than that (maybe 6-7%) and since the principal increases over time, so will the amount you are taking out. In your case, that means withdrawals between $15k and $19k. If anyone is telling you that you can do more than that without tapping your principle watch out. It's easy to promise and hard to deliver, especially in today's environment.

That being said, I have a client that transferred $430k to me in 11/02 and has been taking out $36k per year. That's about an 8% withdrawal rate on his original investment. Even though he has now taken out close to $75k, his account is worth over $480k.

I have another client who moved over $100k around the same time and has had to take out $25k per year since then. Even after taking out around $45k, his account is still worth $75k.

These are exceptional results, and if I were you, I wouldn't want to base my retirement on achieving similar results. If you can't make it on 4-5% then you should consider reducing your living expenses or working longer. Your willingness to spend down principal could affect this calculation a little, but will increase your long-term risk.

Additionally, other factors to consider when making your decision to retire should be health insurance. If you wife has already obtained a position that will provide insurance then you are taken care of.

I hope this helps. I can provide specific recommendations should you decide to retire on how best to invest and manage the money. I can also provide specific comments on Merrill's recommendations.

You should keep in mind that when choosing a financial advisor, you are making one of the most important decisions of your financial life. Your selection can mean the difference between being forced to go back to work and living out the comfortable retirement you've always dreamed of. Understand that you won't know if you've made the right decision on who should be your advisor until AFTER you've been working with them for probably 6 months to a year.

With that in mind, make sure that you don't put your money in investments that have surrender penalties, time commitments or up-front commissions. These act like shackles that will keep you tied to that advisor or be forced to lose a lot of money when changing.

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Pressured to Buy EIA's - Another Sales Tactic

Q. I too have been approached about moving money from an IRA/401(K) toEquity Indexed Annuities. Your question/answer that I found in my search was very enlightening. I need to know how best to proceed rather than throwing hard earned money away. I hope you can provide insightful answers. The advisors are hard pressing for action, which I do not want to perform. What can I do?

A. Your situation is not unique in any way. Yes, I can help you explore your alternatives so that you will be able to make an informed decision without all the sales pressure. I manage money for a small number of clients nationwide. I don't need your account. That gives me the freedom to tell you the truth and to make recommendations that are in your best interests--regardless of whether they benefit me or not.

Here's how to deal with those pressuring you. Say NO. Let them know that you appreciate their time but explain that you are going to take your time making a decision and that if you decide that you want their EIA that you will contact them.

Ask them for a copy of the "Statement of Understanding". This is the disclosure document that is the closest thing to the actual contract you get to see prior to purchase. If you like, I can help you understand the ramifications of what the SOU says. You will find that it is significantly different that what is portrayed.

YOU DO NOT NEED TO MAKE A DECISION RIGHT AWAY. Their pressure is just a sales tactic. Your reservations are justified. They fact that they are applying the pressure should be your first red flag.

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Credit Union Selling Annuities

Q. My husband and I spoke with a financial advisor the other day (he is a salaried employee of our credit union so we are not "clients" of his) regarding two of our retirement accounts: his is a 401K with his previous employer and mine is a rollover IRA. I managed these accounts myself during the boom years, but feel "out of my league" in present market conditions.

The more volatile the market, the more conservative my impulses. I really want to protect these two nest eggs and grow them over time (they are currently worth about $230K total), while my husband starts fresh in his new401K plan. We also have about $50K in non-retirement CD's and cash savings.

The advisor mentioned a product called the US Allianz High Five variable annuity, which sounds like it might be a good choice for the two "nest egg"accounts. I've spent this evening reading mostly negative things about annuities, but we do seem to fall in to the "it might be right for you if..." category, mostly because retirement is still 20 years or so off.

Do you have any thoughts on this topic as it relates to us or this product in particular? My husband and I are 44 and 42 years old respectively, with two young children, ages 7 and 11. We live on one adequate but modest income.Saving is second nature--if only we had a similar talent for investing!

A. I appreciate you taking the time to do some research and to ask questions. That will help protect you greatly in the long run when it comes to investing!

First, don't be fooled by the fact that the person you spoke to is a salaried employee of the CU. Having worked in a bank environment, I am very familiar with what goes on there. CU and Banks make more money off of investments now than they do on any other banking product. They have intentionally moved to using salaried employees because they can give them the incentive to sell by just paying $50 or so each time they sell a product.

The CU is the one who will get the 5-7% commission on the Allianz annuity. There is absolutely no reason for your retirement money to be in an annuity (See my article on IRAs in VAs if you haven't already read it). Just because the person is salaried does not mean there isn't a conflict of interest.

Secondly, it is important for you to keep flexibility. By that I mean the ability to change your investments and advisors without facing any surrender penalties. There are ways to give yourself the conservative position without losing that flexibility.

For instance, I use a proprietary money management system for my clients that allows them to participate in the markets while significantly reducing their potential for loss (in many cases to less than 5%). It is designed for those who want to grow their money without losing their shirt. For my clients, there are NO commissions, surrender penalties, time commitments or set-up fees. They keep complete flexibility while having someone they trust who watches over their money on a daily basis and takes action when necessary to protect it.

It sounds like you could use something similar.

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Is a Health Savings Account a Good Idea?

Q. I read some of your investment advice regarding indexed annuities and I am so glad that I did not choose to invest in them.

I do want to ask your opinion regarding Health Savings Accounts. On April 1st, the company I work for is changing our current Blue Cross health insurance to Guardian Insurance set up as a HRA. I am single and currently have a $500 deductible. Under the HRA, the deductible will be $2,000.

Currently, the premium is split 50/50 between employer and employee. I pay $205.00 per month. Under the HRA it will still be split 50/50, but the employer is going to fund each employee's Personal Medical Fund up to $900. As I understand it, my responsibility will be $1,100 of deductible before any insurance coverage kicks in. We have not been given any rates for the HRA insurance, but I imagine it will lower than the monthly $205.00 amount.

I am trying to decide if this is a "good" thing to change to or if I should obtain an individual policy of my own. I contacted my insurance agent and was quoted a price of $213.20 per month for similar insurance ($500 deductible) that I currently have.

I assume a portion of the amounts I pay in to the "fund" would be tax deductible, but I am still not sure that a HRA is the right thing for me to do.

A. A lot will depend on your health status and how much you use your insurance. If you are healthy and don't take many medications then the HRA could benefit you because the amount the company contributes to your account is yours and can grow from year to year.

On the other hand, if your health means there is a good chance of using your coverage, then the HRA might be more expensive because the amount of deductible you will have to pay. Whether your monthly premium is lower than the $205 currently will also be a factor.

With private insurance, they most likely will not cover any existing conditions and it is very likely that you will see those premiums continue to rise. Of course, so will the HRA premiums but hopefully not as much.

It's a tough decision and there aren't any easy answers. The days of company paid health plans are quickly coming to an end and employees will have to bear much more of the cost. This may help the overall situation in the long run because people may not seek medical care as often if they have to cover a portion of the cost. When it's free, people use it when they don't really need to.

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Home Equity Line of Credit affecting Credit Score

Q. We bought a home in mid 2004 which is now worth $118,000 compared to $97,900 when we bought it. We financed through Countrywide and got a 7-1 ARM for 80% and a home equity line of credit (HELOC) to pay the other 15% and put 5% down. We have $18,000 in credit card debt, although we have not actively used credit cards for nearly two years.

We have perfect credit history, my wife and I, however this HELOC counts as revolving credit and has dropped my FICO to 630 from 690 when we bought the home. We would like to pay off our credit cards and or HELOC because then we would be on installment credit which would boost our FICOs back up. However, with a 630 even with a perfect payment history I don't see how we are going to get a decent rate from anyone.

I wonder if you have any thoughts. My wife and I make a combined income of about $80,000 per year, I am 31 and she is 25. She has a similar credit score but has some deferred student loans as she is getting her masters degree. Thanks.

A. You ask some great questions.

You didn't mention what rate your ARM, HELOC and credit cards are at. That can make a difference, but I imagine that it isn't worth refinancing your ARM.

And I agree that you will probably have a hard time finding a decent rate on a Home Equity Loan. I have been researching those because I am building out my basement and the rates aren't that encouraging. With your credit score you could be looking at rates of 7-8% or higher.

The other issue to keep in mind is that your credit card debt is unsecured. By transferring that debt to a home equity loan, you are then using your house as collateral. I wouldn't recommend this because it would also put you at close to 100% LTV. As interest rates go up, housing price increases will either moderate considerably and may even go down in some areas of the country.

I recommend using any income possible to work on paying down the credit cards. The FICO score won't really matter until you need further credit and in the meantime, paying down your existing debt will improve the score.

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Estates: Creditor's Claims on Beneficiary's Inheritance

Q. If I die with substantial bills, and I leave the bulk of my money to a beneficiary, will my beneficiary be required to pay my bills using the money he inherited?

A. This is a very interesting question, so I checked with an estate attorney to verify my answer. Creditor claims are typically filed against the estate. Assets on which your children are the beneficiary are not considered a part of the estate so the probably are not subject to the claims of creditors.

I say probably because a creditor can file a lawsuit and if a judge determines that you were trying to hide your assets or intentionally avoid paying the claims of creditors, then the judge can pull that money back into the estate (and away from your children).

Most bank, brokerage and life insurance accounts can be transferred to beneficiaries outside of probate. Real estate, vehicles and personal possessions such as jewelry are more difficult to transfer. They would have to be gifted to the children several years prior to your death and would have tax consequences.

Many people utilize revocable living trusts to handle the transfer of their assets without the estate going through probate. In this situation, it is the responsibility of the trustee to make sure that all the claims are paid prior to making distributions to the heirs. It is my understanding that the trustee will be personally liable in instances where the claims were intentionally not paid.

I am not a lawyer, but this is my general understanding. I would recommend that you check with an attorney to verify all of the facts relevent to your situation.

Thanks for the question. If I can be of further help just let me know.

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Can a 401k Be Rolled Over To a 'Stretch' IRA By My Beneficiary?

Q. Can a 401k be rolled over, by my beneficiary, to a 'stretch' IRA after my death? James

A. James, this is a great question.

Whether or not your beneficiary can rollover your 401(k) at your death (and subsequently stretch it) depends on who your beneficiary is and the terms associated with your company plan.

Let's assume for the sake of illustration that you have a spouse and 3 children.

If your spouse is beneficiary, she can roll the money from your 401(k) to her own IRA. Assuming that she has named the 3 children the beneficiary of her IRA, they would have the ability to stretch it at her death. Ideally, she would divide the money into 3 IRAs and name one child as the beneficiary for each one. That allows each child to stretch the IRA over their life expectancy. If the 3 children are the beneficiaries of 1 IRA then it would be stretched based on the oldest beneficiaries life expectancy.

On the other hand, if your children are the beneficiaries of your 401(k) plan they may or may not be able to stretch it. Let me explain. The tax laws allow for beneficiaries to stretch out distributions but most company retirement plans do not permit it. The reason is simple--the stretch can take place over decades. If the company allowed that then they would be responsible for all the administration necessary. There isn't any benefit to the company to do so while it exposes them to potential liability.

Instead, most company plans will cash out the beneficiaries at the death of the employee. At best, the beneficiaries may be able to stretch it out over 5 years.

Realize what this means. Let's say you have a $600,000 401(k). If your wife is the beneficiary, she can roll it to her own IRA and then when she dies, the children can stretch it. If a child is in their 50's, that means that taxes can continue to be deferred (except for the annual required distribution) for almost 30 years. If those children were the beneficiaries of the 401(k) and were cashed out at your death, they do not have the ability to roll that money to an IRA. They would have to pay taxes on all of that money in the year it was distributed. In our example, that would be $200,000 in ordinary income that year! That will bump the child's tax bracket and could result in 35% of it being lost in taxes right away. That's losing $70,000 right away not counting the literally hundreds of thousands they will lose by not being able to stretch those distributions.

Even if you have your wife as the primary beneficiary of your 401(k) and your children as the contingent beneficiaries, you are opening up the possibility of the children not being able to stretch distributions. If your wife passes away before you, or you both die in an accident, the 401(k) money would go to the children and most likely be distributed immediately.

There really aren't any benefits to keeping your retirement money in a 401(k) after your retire. All of this is easily avoided by you simply rolling that money to your own IRA. Your investment options will be much greater and so will your flexibility and control.

If I can be of help or if you would like to discuss ways in which the IRA can be invested just let me know.

[For more Free Financial Advice and information about 'stretch' IRA's read How To Stretch Your IRA - Tax Free and Q&A Stretching An IRA in our Article Repository at http://www.guardingyourwealth.com/]

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Investing for Retirement with a 401(k) and Variable Annuities

[This question originated from a reader who read the article "Don't Put Your IRA in a Variable Annuity”]

Q. Hi, Jeff:

I like all your articles about Index Annuities.

I am about 46 years old, my annual income is around
$75,000.00. I very concern my life after retirement.
As you said I want my money stable and growth.

The following are my investment combinations, would you
please give me your suggestions:

1. I have invested $4000.00 to Roth IRA for 2005.
2. Try to invest $14,000 to my 401K (My employer
doesn't match any)
3. The rest I want to invest to Preference Plus Select
Variable Annuity, this is a new product of Metlife for
retirememt plan. The selling point of PPS is the
guaranteed-minimum rate of reture is 6%. If money
market up, you can get more (no cap but have to pay
0.5% fee).

Should I invest more into 401K plan or to other
products, such as PPS as my employer doesn't match any
dollars to my 401k.

I am looking forward your advice.
Regards,
Helen

A. That is a great question.

First, you will always want to max out the contributions to your 401(k)
instead of investing it on your own because the 401(k) money is invested before Federal taxes are taken out. In other words, there is a big tax advantage to investing in a 401(k).

I don't believe that you should invest in the MetLife PPS VA. I assume this is after-tax money and one of the things you were looking for was the tax-deferral. I am not a big believer in annuities for tax-deferral for several reasons.

First, you are only pushing the taxes down the road to be paid when you withdraw the money or die. The earnings are then taxed at ordinary income tax rates. If this is done at your death it can quickly throw you into a high tax bracket and result in 30-40% being lost to taxes. On the other hand, the gains on an investment such as an ETF or mutual fund outside of the VA will be taxed at capital gains rates that top out at 15%. Based on your income, they may be taxed at an even lower rate.

Secondly, you will have to leave the money in the VA for 20+ years before you start seeing any benefits of tax-deferral.

Third, the 6% guarantee really doesn't give you anything and it will increase your costs significantly. The fees in a VA will already be approaching 2.5-3% or more between the M&E and the subaccount management fees. There hasn't been a single 10 year period that an investment in the S&P 500 hasn't made money since the early 80's. In other words, the chance of earning less than 6% in a low-cost S&P 500 index like SPY over a 10-20 year period is extremely low. So why pay for a benefit when there is only a very small chance it will pay off.

Hope this helps. Thanks for your question.

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