Deposits at FDIC-insured institutions are now insured up to at least $250,000 per depositor through December 31, 2013. On January 1, 2014, the standard insurance amount will return to $100,000 per depositor for all account categories except for IRAs and other certain retirement accounts which will remain at $250,000 per depositor. (This supersedes the October 3, 2008 changes.)

May 20, 2009

NEW YORK — The option of a lump sum on retirement is likely to disappear for a lot more workers this fall.

Lump sums used to be a fairly common option for workers enrolled in pension plans. It is becoming more rare, however, as dramatic declines in stock values have sent pension assets plunging just as they have to meet more stringent funding requirements. (Pensions themselves, of course, are being offered to fewer workers.)

Some employees may slip through before Oct. 1, the deadline for businesses to update the funding status of their pensions. More companies are expected to be underfunded when the 2009 numbers are run.

The 100 largest pension plans ended 2008 with $217 billion in liabilities, compared to an $86 billion surplus at the end of 2007. The funding status dropped from about 106% at the end of 2007 to less than 80% at the end of 2008.

The Pension Protection Act begins to restrict lump sum payouts when a plan is less than 80% funded, says Judith F. Mazo, senior vice president, director of research at the Segal Co., a consulting firm. At that point, workers can only receive half of the amount in a lump sum and other half as an annuity. Plans that are less than 60% funded are forced to freeze and provide only an annuity.

The limits are designed to prevent participants from draining badly needed cash from the plans. They also give employers an incentive to keep funding at appropriate levels.

But as the markets have plummeted, credit has tightened, making it difficult for companies to add cash to underfunded plans.

While the majority of workers typically choose a lump sum rather than an annuity if the plan offers a choice, Rebecca Davis, staff attorney at the Pension Rights Center, says people need to carefully consider their choice. No one should make any decision before finding out exactly how much the lump sum would be, the center says.

Some people think they can manage the money better on their own, but as last year’s market losses illustrate, there’s no guarantee. A lump sum may be a lot of money, but a big advantage of an annuity is that it’s guaranteed for life, she says.

One disadvantage to an annuity is that many are not adjusted to reflect increases in the cost of living.

It also might be worth taking the lump sum if the Pension Benefit Guaranty Corp. (PBGC) has to take over the plan. About 84% of participants get their full benefits even if the PBGC steps in, but the limit is currently $54,000 a year.

By Jilian Mincer
A DOW JONES NEWSWIRES COLUMN

Americans say that despite daunting circumstances, they have developed a more practical attitude toward money and retirement since last year, according to a study by San Francisco-based Age Wave. And that’s good news for financial planners, says Ken Dychtwald, CEO of Age Wave, because Americans know they need planners’ help.

In a new study, Age Wave, a research firm, found that only 4% of respondents strongly agree that Americans behave in a financially responsible manner. An overwhelming 95% of respondents said financial management should be a standard part of high school curricula. Eighty-one percent said that to live within ones means was the most important financial advice that parents could pass on to their children. That figure jumped from 69% a year ago, when the survey was last conducted.

All of these responses underscore the need for guidance and education among financial services clients, and financial planners are positioned to provide those services, said industry professionals. “There has not been a moment in history when more people need to be coached, guided and educated about how to create a long-term plan,” Dychtwald said. “What you’ve got is a population of people who have been spooked. They don’t know who to trust, who’s lying, or what people’s intentions are.”

The study, called “Retirement at the Tipping Point: The Year that Changed Everything,” gathered opinions from more than 2,000 Americans from four generations. The study was conducted with Harris Interactive.

Nearly 60% of Americans lost money in mutual funds, 401(k) plans or the stock market. Respondents believe that it will take about seven years, on average, to recover losses. Among respondents 55 and older, 46% say that medical expenses not covered by insurance is a top financial worry for their retirement phase. Four out of ten respondents said they believe they will have to help support their parents, in-laws or siblings eventually. In light of their financial situations, respondents believe, they might need to postpone retirement by 4.2 years, on average.

Clients might find that they have other reasons for optimism, especially when it comes to the timeline for earning back financial losses. Financial markets typically recover very quickly from recessions, so the U.S. would have to be in a prolonged recession for recovery to take as long as seven years, said Russell Diachok, president and chief executive officer of Centennial, Colo.–based Geneos Wealth Management, Inc., an independent broker dealer. 

“Personally, I think it would be a shorter recovery time, more like three to five years,” Diachok said. Of course, he acknowledged, “that is a significant amount of time if you were planning to retire in two years.”

In the survey, some Americans did express optimistic attitudes about retirement, and even saw working during their retirement years in a positive way. Sixty percent of Americans say that they view retirement as “a new, exciting chapter in life.” That is an increase from the 52% who felt that last year, according to the study. Seventy percent say that working in retirement is a way to remain stimulated and pay bills.    

By Donna Mitchell

NEW YORK — Cracking into retirement savings early is the tax equivalent of standing on a street corner burning $10 bills.

Hard times have more people doing it anyway.

Early withdrawals from Individual Retirement Accounts and 401(k) plans trigger taxes and penalties that can really add up. There are exceptions, but only for some people who use the money to buy a first home, or pay for higher education or other items.

Many people have at least a vague understanding of all this, but that isn’t stopping them.

The number of companies reporting early withdrawals for hardship from 401(k) and 403(b) plans (the non-profit version of 401(k)s) rose from 15% in October 2008 to 44% last month, according to a recent Watson Wyatt study that polled executives at 141 U.S.-based companies using an online questionnaire.

Many more clients than usual asked about early withdrawals from retirement savings this tax season, according to Michael Eisenberg, a certified public accountant at Eisenberg Financial Advisers in Los Angeles, who is a member of the AICPA’s Financial Literacy Commission.

Eisenberg advises strongly against early withdrawals; none of his clients ended up taking money out, he says.

The federal tax penalty for taking money out of a 401(k) or IRA before age 59 1/2 is 10% of the amount of the distribution. That levy goes on top of any tax owed on the amount. State taxes and penalties may also apply, and they vary.

So, an early withdrawal of $1,000 from a 401(k) or IRA would generate tax on that amount, plus a federal penalty of $100, plus possible state taxes and penalties.

There are exceptions that allow penalty-free early withdrawals from retirement savings, though they differ depending on whether it’s an IRA or 401(k).

For IRAs, the taxpayer may be able to avoid a penalty (but not tax) if he or she uses the money for one of several reasons, including:

*To buy a home (if qualified as a first-time homebuyer under IRS rules).

*To pay for higher education for the immediate family.

*To pay for unreimbursed medical expenses over 7.5% of adjusted gross income.

*To pay for health insurance if the taxpayer has been unemployed for a certain period.

For 401(k)s, the taxpayer can make an early withdrawal without a penalty in several cases, including if he or she:

*Leaves the employer in the year he or she turns 55 or older.

*Uses the money to pay unreimbursed medical expenses over 7.5% of adjusted gross income.

Knowing the exceptions can save people from making common mistakes, according to Ed Slott, an IRA expert and author of numerous books including “Your Complete Retirement Planning Road Map.”

For example, the laid-off often use 401(k) money to foot the bill to go back to school; they assume wrongly that the education exception that applies for IRAs carries over to 401(k)s. The 10% penalty then applies;

“That’s a mistake a lot of people make, and actually go to court to argue a case they can’t possibly win,” says Slott.

Instead, the smart thing to do would have been to roll the money into an IRA and pay for education from there, he adds.

Rande Spiegelman, vice president of financial planning at the Schwab Center for Financial Research, says making an early withdrawal should be a last resort, “somewhere right before homelessneess and/or starvation.”

Early withdrawal deletes all potential for future tax-deferred compounding, to say nothing of the taxes and penalties that can wipe out more than half of the amount withdrawn.

“Better to borrow or beg (but not steal) before raiding your retirement,” says Spiegelman.

Eisenberg advises clients who are thinking about hitting up a 401(k) to consider a loan from the 401(k) instead. A caveat here is that if the employee leaves the company with the loan outstanding, it is considered income and tax will be due on it.

By Arden Dale
A DOW JONES NEWSWIRES COLUMN

After suffering deep losses in their retirement savings accounts, most Americans appear to be in a state of shock, unsure where to move next.

“People are shell-shocked, paralyzed and afraid to do anything,” said Christopher “Kip” Condron, chairman and CEO of AXA Equitable at a “thought leadership program” last week here. “Their retirement accounts have taken a terrible beating. There’s no question that virtually everyone is being affected in one way or another by one of the most severe recessions in generations.”

Mutual fund companies, insurance providers and banking advocates all want to help and are naturally pushing their own products, but battered and weary investors aren’t sure whom to trust.

About the only thing everyone can agree on is that Americans haven’t been saving enough.

“People start saving too late,” said Pamela Perun, policy director for the Initiative on Financial Security for the Aspen Institute. “We’ve been waiting until midlife to save. We need a saving system that covers people from birth to death.”

Employer-sponsored 401(k)s play a valuable role in getting people to put a little extra aside every month, she said, but the tax-deferred incentive is not enough to convince people to change from being spenders to being savers.

“It’s not just how much we save, but how and where we save,” Perun said. “The problem is bigger than just retirement. Saving needs to mean more than just saving on taxes.” Perun noted that 20% of Americans are not in the banking system at all, and the bottom 40% to 60% of Americans may or may not save, but they certainly do not invest.

For decades, there have been major imbalances between big savers and big spenders, particularly among nations, said Eric Chaney, chief economist at the AXA Group. The savings rate in the U.S. dropped from around 8%, where it hovered for decades, to practically zero in recent years as equities continually pumped up stock portfolios.

The extended bull market created the illusion that equity and real estate growth could take the place of saving for retirement, he said. With equities down 50% and the average defined contribution account balance down 27% in 2008, everyone has been reminded of the bitter truth: markets are volatile, and stocks don’t always go up. Financial advisers may be preaching that everything is on sale and now is a great time to load up on bargains-but most investors just aren’t buying it.

A February survey conducted by AXA Equitable found that 65% of Americans were worried about meeting everyday expenses should they lose their job, up from 54% in a similar study last year.

“Our research showed that paying bills was a middle-of-the-pack concern last April,” Condron said. “The fact that it is now a top priority underscores how the year-long market volatility has shaken Americans’ sense of security about their immediate financial future, most notably as a result of job instability.”

Securing guaranteed income for life remains the top priority for 69% of Americans, particularly among women, who tend to live longer. Approximately 75% of women surveyed said getting guaranteed income payments for life was a top priority, compared to 58% of men.

Annuities can provide that guaranteed income stream later in life, but many cash-strapped investors are hesitant to lock up money they need right now for an uncertain future.

AXA found that 61% of men said they planned to shift the asset mixture of their investments to react to the changing markets, whereas women were less likely to act, with only 51% saying they would make changes. Half the survey respondents said they had taken no action to change their financial situation.

“Women continue to show more concern than men as the period of economic instability lingers on,” said Barbara Goodstein, executive vice president and chief innovation officer at AXA Equitable. “What is troubling is that it appears that their sense of caution has morphed into an inability to take the prudent steps necessary to navigate through this crisis.”

“The fact that people are still concerned about the health of their retirement during the market volatility we are experiencing makes it clear that they still understand the importance of preparing for their financial future,” Condron said. “What is alarming, however, is that so many are still not taking the steps needed to achieve these goals.”

Beyond working longer and spending less, most Americans don’t seem to know how to recover their losses. The fastest way to recover their losses might be to take another risky gamble on equities, but most investors can’t afford to lose any more of the money they have left.

Approximately 40% of men and women within 10 years of retiring said they planned to delay retirement. Among the men surveyed, 40% said they would work an extra three years to retire at 64, while 39% of women said they would work an extra four years, retiring at 66.

Contrary to many reports, Social Security is not doomed, and experts say the program should have no trouble providing retirement benefits to future generations of Americans for the foreseeable future. It might not be much, but Social Security should provide most elderly Americans with enough money to survive. For those who can save a little more, it will provide a steady and reliable income supplement.

Unlike a personal retirement account that has a set period of wealth accumulation followed by an open-ended period of decumulation, the nation’s Social Security program is structured so that the income for the monthly payments to retirees are generated by current members of the workforce. Payments can keep up with inflation because the average income keeps rising.

Since the program began, there have always been more workers than retirees, providing the system with a net surplus, said Peter Brady, a senior economist at the Investment Company Institute. When the Baby Boomer generation begins retiring en masse, this situation will temporarily reverse, causing a deficit, he said.

“The demographic shock of Baby Boomers is a one-time event,” Brady said, but it won’t break Social Security because the income payments from active workers will keep coming in. The Congressional Budget Office estimates payroll taxes will cover at least 80% of benefits.

When the income/payment deficit happens, the government will have to either reduce payments or increase taxes. Others have suggested raising the minimum withdrawal age, but because of its inherently political nature, most experts don’t think older voters would approve of such hardships on themselves.

By John Morgan

Commenting on the House Savings Recovery Act introduced this week, Rep. Ed Royce (R-Calif.) said, “Along with our struggling economy, over the past 16 months, millions of Americans have seen their personal savings and retirement accounts hit hard. Americans should be given every opportunity to help rebuild their savings. “

Royce continued: “If our economy is going to experience long-term sustainable growth going forward, we have to encourage savings and investment. This is a step toward getting capital back into the financial system and putting our country on the path back to recovery.”

Among other things, the Savings Recovery Act would increase contribution and catch-up limits. It would also extend the tax credits that families get for contributing to a 529 plan.

The act would also double the Social Security earnings limit from $14,161 to $28,320, thereby allowing more Americans to increase their income without being hit by the Social Security earnings penalty.

Further, it would suspend the capital gains tax on newly acquired assets for the next two years, in order to provide tax relief to investors and seniors. It would suspend dividend income through 2011 and raise the amount of capital losses allowed against ordinary income to $10,000.

By Money Management Executive
April 24, 2009

A majority of non-retired Americans now doubt they will have enough money to live comfortably once they retire, representing an 18-point drop from just five years ago.

According to the Gallup’s annual Economy and Personal Finance survey, conducted April 6-9, 52% of non-retired Americans believe they will not have enough saved for a comfortable retirement. Only 41% of say that they will have enough money, compared to 59% who said they did in 2002.

This is the first time since Gallup has conducted the survey that the majority of those not retired say they will not have enough money to retire comfortably. The negativity is a reflection of non-retirees lost confidence that their 401(k) and other tax-exempt plans will be able to provide a comfortable retirement.

When Gallup conducted its first survey in 2001, nearly 6 out of 10 non-retirees said that their 401(k), IRAs and Keogh plans would be a significant source of income for them. In the latest poll, only 42% now believe this to be true—the lowest reading that Gallup has measured. Despite the drop in confidence, however, Americans still put their 401(k) and other retirement savings plans at the top of the list of what they believe will be their major source of retirement income.

Not surprisingly, the perceived reliance on a work-sponsored pension plan has also dropped to the lowest measure since Gallup started tracking the market. Just 24% of those surveyed believe this will be a major source of income, compared to 34% in 2001 and 31% two years ago.

Complicating matters, only 30% of Americans say they will be able rely on Social security for a substantial amount of income. According to Gallup, this pessimism I likely owed to all the talk about Social Security eventually going bankrupt.

Results of the survey were based on telephone interviews with 676 non-retirees.

By Editorial Staff, Financial Planning
April 20, 2009

 Evolution or Revolution?

The title of this Outlook, “The Future of Investing,” is a theme that will take the evolving years to resolve, let alone the next few days. Still, PIMCO is an organization that loves a challenge. All of us here today would agree that the answer to both questions will be highly dependent on the evolution of the global economy, and when it comes to those questions PIMCO has excelled because of its long-term secular outlook. It has paid dividends for our clients for over 30 years and it should do so now as well. The fact is, that the future of investing will depend on the long-term future of the global economy – its nominal growth rate and the distribution of that growth between public and private interests. And so we should start at the beginning, or perhaps at the top, of our top-down process – the future of the global economy.

 I. Future of the Global Economy

The future of the global economy will likely be dominated by delevering, deglobalization, and reregulating, yet if so, it is important to state at the outset that we do not envision a mean reversion, cyclically oriented future, but instead a new world where players assume different roles, and models relying on bell-shaped/thin-tailed outcomes based on historical data are less relevant. Historical models look backward while modern-day finance is being fast forwarded and reconstituted almost as we speak.

 1) Delevering – The prior half-century of leveraging and the development of the amorphous shadow banking system was growth positive. Major G-10 economies became dominated by asset prices and asset-backed lending most clearly evidenced in housing markets. Excess consumption was promoted, and investment based on that consumption followed in turn. Savings rates in many countries including Japan, the U.K., and the U.S. fell towards zero as the reliance on rainy day thrift faded. Deleveraging of business and household balance sheets now means those trends must reverse, and as they do, growth itself will slow, bolstered primarily by government spending as opposed to the animal spirits of the private sector.

 This topic is one which literally could take hours to discuss, and at PIMCO forums and Investment Committee meetings, it does. There are those of us here as well as highly respected economists outside of PIMCO who would suggest destruction as opposed to slow growth, and they may have a minority, but not insignificant, case. Much depends on the effectiveness of policy responses and the simplistic answer to a simplistic question. Can global financial markets and the global economy heal by pouring lighter fluid on an already raging fire? Can too much debt be cured by the issuance of even more debt? Must the debt supercycle come to an end by crashing and burning or does the world keep breathing with a whimper instead of a bang? We shall see, but there is a near certain probability that the financially based global economy of the past half-century will not return, nor will we experience the steroid driven growth excesses that it facilitated.

 2) Deglobalization – Lost in the wondrous descriptions of finance-dominated, Bretton Woods-initiated, global growth has been the adrenaline push provided by global trade and indeed portfolio diversification into a multitude of markets – developed or developing. Yet historians point out that globalization is not an irreversible phenomenon – witness the aftermath of WWI and nearly three decades of implosion. Now the beginning signs of trade barriers – “Buy American” and “British jobs for British workers” among them – as well as government support of locally domiciled corporations (banks and autos) suggest an inward orientation that is less growth positive. Additionally, “financial mercantilism” is an added threat – a phenomenon that speaks to growing pressure on banks to retreat from international business and concentrate on domestic markets.

 3) Reregulation – Academics, politicians, investors, central bankers and everyday citizens are questioning the economic philosophy that idolized free markets and their ability to self-regulate. The belief in uncapped and unregulated incentives producing unlimited upside but nearly always cushioned downside losses is fading. While Sarbanes-Oxley was a well publicized but relatively toothless response to the dot-com bust of nearly a decade past, today’s politicians have gained the upper hand, driven by a citizenry that has recognized the unbalanced, disproportionate distribution of incomes. The efficient market thesis, so prevalent in academic theory and market modeling is now in retreat, and perhaps rightly so. In its place, we will experience less efficient but hopefully less volatile economies and markets – monitored and controlled by government regulation. Executive compensation, of course, is just the poster child. Government ownership and control of vital financial and manufacturing institutions will politely be described as “industrial based” policy and “burden sharing,” but we should have no doubt that we will move significantly away from the free market model that has dominated capitalistic countries for the past 25 years.

 With the top-down framework for future global economic growth in place, let’s take a look at PIMCO’s outlook for the future of investing – evolution or revolution.

 II. The Future of Investing

Whether evolution or revolution it is important to recognize that the aftermath of an economic and investment bubble transitioning from levering to delevering, globalization to deglobalization and lax regulation to reregulation leads to an across-the-board rise in risk premiums, higher volatility and therefore lower asset prices for a majority of asset classes. The journey to a new stasis is a destructive one insofar as it affects previously assumed wealth. Rough estimates suggest that as much as 40% of global wealth has been destroyed since the beginning of this delevering process. In essence, asset prices, which are really only the discounted future value of wealth creation, go down – not only because that wealth creation slows down but because it becomes more uncertain. In such an environment, equity interests in the form of stocks, real estate or even high yield bonds become re-rated. Those who believe that capitalism is and will remain a going concern and that risk taking – over the long run – will be rewarded, must recognize that those rewards spring from beginning prices and valuations that correctly anticipate the global economy’s future growth path and volatility. In terms of that old maxim “buy low – sell high,” this means at the minimum that an investor during this period of re-rating must “buy low.”

 In turn, investor preferences towards risk taking, even when correctly calculated and modeled must be considered. Peter Bernstein has for several years counseled that policy portfolios structured for the long run and based on historical return statistics should be reconsidered. The standard pension or foundation approaches to policy portfolios are being challenged, he asserts, and PIMCO agrees. Stocks for the long run? Home prices that cannot go down? The inevitable levering of asset structures to double or quadruple returns relative to risk-free assets? These historical axioms must now be questioned. In fact, as of March 2009, the superiority of risk-asset returns are not what many assume them to be. For the past 10, 25, and 40 years, for example, total returns from bonds have exceeded those for common stocks.1 Home prices have declined a staggering 30% since their peak in late 2006, and have barely kept up with inflation for the last century according to Case-Shiller statistics. Commercial real estate when ultimately mark-to-market over the next several years will likely show similar results. In short, our stereotyped conceptions of what makes money are being challenged. As Bernstein says, there is no predestined rate of return. And a PIMCO corollary would counsel that future rates of return will be dependent on the beginning price and future growth rates and risk preferences that cannot necessarily be derived from historical models. Government policies will also play an important role, especially insofar as they impact long-standing property rights and capital structures. What I have previously described as a CQ – a common sense quotient – may take precedence over IQ and quantitative analysis in future years. How much of a benefit, for instance, did the renowned risk modeling of some of our major competitors produce over the past several years in terms of their bond funds and derivative-related products as compared to PIMCO’s? We invite comparison, not only of our own risk models, but our collective common sense quotient.

 What then does common sense tell us about future asset returns? Let’s revisit our previous conclusions on the developing environment for some clues. They include: delevering, deglobalization, reregulation leading to slow global growth, a heightened risk aversion, a distrust of conventional investment model portfolios, and a greater emphasis on surviving as opposed to thriving. If valid, then an investor or an investment committee would likely stress the bird in the hand – as opposed to the one in the bush; stable and secure income – as opposed to uncertain capital gains; a government-regulated utility model – as opposed to innovative yet risky venture capital investments. At current price levels, to cite one example, the current income from corporate bonds is higher and certainly more secure than the dividend income from stocks.2 A return to an era reminiscent of the first half of the 20th century is not unimaginable where stocks were viewed as subordinated income producers with yields exceeding their senior bond companions on the liability ladder.

 But let me not go too far in suggesting that asset classes near the perimeter of risk have no future. They do if only because they eventually will be priced right. In fact, PIMCO intends to participate in the management of many of them, and as argued previously should be well and healthily positioned to do so. Our recent launch of a global multi-asset fund featuring tail-risk protection is just one example. The potential participation in TALF and other government-sponsored levered structures is another. Still, the tide seems to be going out and as Buffet suggests, all swimmers are being exposed, swimming suits or bare-bottomed naked.

 There are a host of investment implications that one can subjectively conclude from this outgoing tide, although they have not been officially endorsed by our upcoming secular forum. It seems to me, though, that one has only to ask what investments were positively affected by the previous long-term cycle of levering, deregulation, and globalization in order to imagine which ones will do poorly as the trends reverse. A short list might read as follows:

 (1) The Dollar – As the center of structured finance and the shadow banking system, the dollar was bolstered as it sold paper to the rest of the world. To date, its recent strength seems counterintuitive. Weakness may more accurately describe its future.

 (2) Credit – Lax regulation and increasing leverage squeezed risk premiums and spreads to historically overvalued levels. We are now moving in full reverse.

 (3) Equity – In addition to the previous conclusions, it is evident in retrospect that narrow risk premiums in credit markets facilitated narrow equity premiums in stocks if only because they seemed cheap by comparison and allowed corporations to borrow cheaply and buy back their own stock.

 (4) Emerging Market Globalization and lax lending standards re-rated emerging and developing country financial markets to unrealistic levels. Eastern Europe is likely the first to fall.

 Many of these trends, of course, have now reversed course, direction, and magnitude, and there will come a point where those low and lower prices, as well as the potential for successful policy healing, will favor what is now in disfavor. For now, however, let it be simplistically said that the trend is your friend and that the ad hoc, disjointed and anemic policy responses of government appear to be too little, too late. Investors should therefore favor stable income as opposed to speculative growth or the subordinate liability structures of most private market balance sheets. Shake hands with the government is and has been our motto although the contractual certainty of a government handshake may now be questioned in an increasingly number of marginal areas.

 Another way to summarize our caution would be to quote a recent comment by Barton Biggs. “I am a child of the bull market,” he said which upon further elaboration meant that he bought on cyclical dips with the expectation of riding mean reversion to an upward sloping trend line of prosperity and ultimately higher peaks. In a sense, we are all children of the bull market, although some of us are more mature than others – a bull market of free-enterprise productivity and innovation, yes, but one fostered by a bull market in leverage, deregulation and globalization that proved unsustainable in its excesses. We now must view ourselves as chastened adults, forced into acknowledging a new reality that is dependent upon bear-market delevering and debt liquidation to deliver us to our new and ultimate restructured destination – wherever it lies. Thus, while historians might describe these years as an evolution, for those of us living it day-by-day it most assuredly has the feel of a revolution. Much like Irving Fisher’s “permanently higher plateau” of prosperity that was quickly turned on its head in 1929, those who would forecast a “permanently lower valley” of despair might similarly be off the mark. Yet there should be no doubt that the bull markets as we’ve known them are over and that the revolution is on. Investing is no longer child’s play.

Bill Gross, CIO PIMCO
 

NEW YORK — A big cash pillow is something investors, especially retirees, can sleep on these days — once they’ve filled it.

Experts recommend stashing away at least a year’s worth of expenses in easily accessible cash, along with several years worth of bonds prior to retirement. That allows investors to draw down those assets instead of selling equities if the market is down

“Although it’s not a guarantee, there’s a pretty good probability that five years from now stocks will be higher,” says John Smartt, a financial adviser in Knoxville, Tenn.

The question becomes: How does someone build up this cushion without looting their existing investments? The answer is to make savings a big priority over spending.

For those who already have six months of cash savings, as was recommended before the downturn, the change may not be as drastic as for those who have less.

How drastic? No new cars, no big-ticket purchases, even no vacations until enough cash has been shoveled away, especially in the current economy. All the money that is saved should go to cash savings.

“This should take precedent over other savings goals,” says Patrick Collins, a financial adviser in Towson, Md. He likens it to filling a glass of water: Only what flows over can go into other investments.

He says it’s not unusual for clients earning more than $500,000 a year not to have a cash cushion if they have other assets. They don’t think about the high cost of cracking the 401(k) early or selling real estate or stock in an emergency.

If one of his clients is close to retirement without cash reserves, Collins will gradually sell the client’s assets to rebalance the portfolio. For example, if the portfolio has 80% equities, he’ll sell off over several months some of the stock so that it has about 60% equities.

If investors are still working, they should increase their savings or temporarily suspend or lower 401(k) contributions to the level of the company match. (Getting the company match should remain a priority, since the returns are instant and substantial.)

This emergency cash should be in an easily accessible account, typically an FDIC-insured bank account or money market. Unless someone has lots of extra cash, it shouldn’t be put it into laddered CDs because the money needs to be readily available without penalties.

“Safety is much more important than returns on that pot of money,” says Collins.

In addition to the cash, advisers recommend that retirees have enough savings in a bond fund to cover several years of expenses. The fund should include Treasurys, corporate bonds and agency bonds. Again the goal isn’t a big return, it’s dependability.

Investors ideally should begin saving in a diversified bond fund 10 or 20 years prior to retirement.

The additional cash and bonds could grow either in or outside of a 401(k) or individual retirement account — as long as the investor won’t need the money before they’re 59 and a half or they’ll face penalties on withdrawals.

They’re not “ironclad,” warns Morningstar mutual fund analyst Michael Herbst. The investment-grade bond market suffered in late 2008 after the collapse of investment bank Lehman Brothers Holdings Inc. (LEHMQ).

But Herbst and others still recommend the Vanguard Short-Term Investment Grade (VFSTX) as a good option despite last year’s 4% loss.

“It’s solid,” Herbst says, “And the fees are extremely low at 21 basis points.”

By Jilian Mincer
A DOW JONES NEWSWIRES COLUMN

It sounds redundant: Put a tax-deferred investment, like a variable annuity, inside an already tax-deferred IRA or retirement account? But the wisdom of such a move is actually subject to much debate.

In fact, fifty five percent of all variable annuity assets are in IRA rollovers and qualified retirement accounts, such as 401(k) s, 403(b) s and Keogh accounts, according to the National Association of Variable Annuities (NAVA), Reston, Va.

Financial advisors often recommend that clients put annuities in qualified plans or IRAs primarily for their insurance benefits and income guarantees, according to a 2006 NAVA study. Seventy percent of the 1,000 advisors polled cited the variable annuity death benefit—a guarantee that when the policyholder dies, the beneficiary receives the greater of the market value or original principal–as one of three top reasons for advocating using variable annuities inside qualified plans or IRAs. Sixty-six percent named guaranteed lifetime income, and 61 percent listed living benefits.

The majority of respondents also reported that they favored variable annuities in IRA rollovers as a way to manage client investments in a large number of funds from a large number of mutual fund families.

Another top reason: The Guaranteed Lifetime Minimum Withdrawal Benefit. With this common feature, the annuitant is promised, at minimum, a return of all contributions—regardless of how the underlying investments perform. This guarantee can come in the form of regular withdrawals paid over a specific period. The most popular type promises withdrawal rates of at least 5 percent annually for life starting at age 65. Many insurers step up the withdrawal rate annually if the annuity is held for at least 10 years.

Questions
But is it appropriate to put an already tax-deferred retirement account inside another tax-deferred instrument? Many financial advisors believe it does not make sense. Investors, they say, can do a better job diversifying IRAs or 401(k)s to get high risk-adjusted rates of return, as well as income over the long-term. Their other big beef: The high cost of variable annuity insurance and fund management fees reduces the client’s return on tax-deferred investments.
Jeffrey D. Voudrie, financial planner and president of the Legacy Planning Group, Johnson City, Tenn., says one of the main arguments for using a variable annuity inside an IRA is flawed due to the high cost.

Most variable annuities sold through commission-based advisors have mortality and expense charges of 1.45 percent. This is an annual fee that is charged against the entire value of the account–not the original investment. On a $500,000 investment, that can amount to $7,250 the first year. If the value of an account doubles in 10 years, the cost would rise to $14,500 that year, he says.

There are also mutual fund management fees, ranging from 70 basis points to 1.5 percent. Plus optional living benefit riders cost more than 60 basis points annually. As a result, the average variable annuity charges range from 200 to 300 basis points annually.

“That’s $10,000-$15,000 each year on a $500,000 investment—and that expense increases as the value of the account increases,” Voudrie argues. “Do you really think it costs $10,000-$15,000 a year to cover the cost of the insurance associated with (for example, the death benefit)? Of course not.”

Fee-only financial planners, like Jane King, president of Fairfield Financial Services, Wellesley, Mass., prefer to invest IRA rollovers in no-load, low-cost mutual funds. King diversifies in growth and value stock funds, international funds, bonds and money funds for attractive risk-adjusted rates of return. Her retired clients use up their non-retirement savings assets first, leaving the retirement account to grow in value–even while taking the minimum required distributions. As a result, the tax-deferred IRA can be left to a child as an inherited IRA. The child can then take distributions based on his or her life expectancy.

A report by the New York law firm, Milberg LLP, says the insurance features of the variable annuity are not likely to justify sales of the product, because the insurance tends to be actuarially worth only a fraction of the higher fees. Those high fees, the report suggests, go toward profit and high sales commissions.

However, John Huggard, estate planning attorney and author of “The Truth About Variable Annuities–Debunking The Myths,” Parker-Thompson Publishing, disagrees.
The biggest flaw in the high-cost argument is the incorrect assumption that variable annuities are more expensive to own than other qualified investments, such as mutual funds, he contends.

For example, the average cost of owning a variable annuity in a qualified plan is about 2.9 percent. This includes fees paid to money managers, commissions, trading costs and insurance costs. But the average annual cost of owning an A-share mutual fund held in a qualified retirement account is about 3.23 percent.

“The average stock mutual fund held in a qualified retirement account is 33 basis points more expensive to own on an annual basis than a similar variable annuity held in a qualified retirement account,” says Huggard.
Huggard refutes those who argue that the practice of placing a variable annuity inside a qualified plan or rollover IRA results has no benefit because it duplicates the benefit of income tax deferral. “The duplication argument would have validity only where a variable annuity offered some income tax deferral as its sole benefit,” he said.
However, Huggard stresses that people put a variable annuity inside a tax-deferred IRA or 401 (k) to get insurance coverage. They are willing to pay the annual fees and charges to protect principal.
Those guarantees include:
· The guaranteed death benefit.
· Guaranteed minimum withdrawal benefits.
· Guaranteed minimum income benefits: With these, an annuitant can receive a guaranteed dollar amount in monthly income–regardless of how the contract’s investments perform.

Annuities in IRAs, he says, also can help transfer wealth to family members. For example, a variable annuity beneficiary can withdraw in installments over his or her life expectancy. The undistributed amount continues to grow tax-deferred.

In some states, a business owner’s Self-Employed Retirement Plan (SEP) may be subject to creditor claims. So, for example, a doctor concerned about lawsuits, could transfer the SEP to a variable annuity to obtain creditor protection.

In addition, Huggard notes, having a qualified plan in a variable annuity can reduce or eliminate the income tax burden facing beneficiaries who inherit qualified plans. An “earnings enhancement benefit (EEB)” rider, which is only available in variable annuities, can reduce or eliminate income taxes on inherited qualified plans, he says. Additional cash at the annuity owner’s death may help beneficiaries pay the income taxes on inherited money.

If you consider a variable annuity, always evaluate the financial strength of the insurance company and all the fees involved. This is particularly important today because A.M. Best, Standard & Poor’s, Fitch and Moody’s have downgraded the financial strength of many insurance companies due to the ongoing financial crisis.

By Alan Lavine