Cash-Rich Retirement by Jim Schlagheck, seen on public television’s Retirement Revolution, seeks to turn the retirement advice community on its head by taking “the investing techniques of the mega-wealth” and bringing it to the masses. It’s quite a bold statement to make, since we all know the mega-rich are afforded a much different set of rules than the rest of us, so we’ll see if Mr. Schlagheck can deliver.

The dust jacket says that Schlagheck’s advice “breaks with conventional advice that tells the public to invest mightily in stocks, flip holdings, and seek capital gains.” I’m not sure that the conventional advice says you should be actively trading stocks, but then again personal finance bloggers live in a world where we are exposed to the sage advice of Buffett and Bogle, two accomplished investors who actively advocate index funds for the masses. However, even if you accept the belief that the conventional advice is flipping stocks, Schlagheck advocates investing for “prudent income… Build a ‘life-cycle’ annuity package for lifetime retirement income. Focus on dividend-, interest-, and rent-producing investments and insurance.” If your alarms went off when you red “life-cycle” annuity package, you weren’t alone - mine went crazy. Annuities are actually one of the “six straight-shooting, show-me-the-money steps” in the Cash-Rich Retirement plan. We can see what Schlagheck means when we get to them.

The six steps are:

• Change your “automatic pilot”
• Diversify your holdings in radically different ways
• Build out your investment plan with funds and objective research
• Get all the professional help you can
• Build income streams with a ladder of annuities
• Invest in long-term health care insurance

Setting the stage

The book begins by discussing retirement and how the rules of the game have changed. Schlagheck has a very straight forward and easy to understand writing style and the book is organized in a way that makes it very easy to follow. He makes excellent points about how the retirement is changing, given the changing demographics, solvency of Social Security, and a whole collection of other issues. It really does drive the point home that the old rules of retirement are changing (because they are!).

Let’s see these six steps…

Change your “automatic pilot”

Schlagheck’s term of “automatic pilot” refers to the fact that you concept of “saving for retirement” is investing for speculative gains. It means taking stocks in your Roth and going after high flyers, it means pushing your 401(k) contributions into microcaps or other more risky investments, and he argues that you need to rewire the way you think and act differently. Less like a slot-machine player and more like a saver and cautious investor. Mostly, he’s saying you need to take your retirement seriously right now. What does he recommend you do?

• Save at least 20% pre-tax income
• Hold savings in tax-sheltered accounts (401k, 403b, etc.)
• Automate saving (think, Automatic Millionaire)
• Don’t chase speculative gains

So far, nothing super incredible or only within the realm of the super-rich. It’s just straight up, smart personal finance advice that’s been repeated before, though it does have some eye-opening statistics not often included in other books.

Radically diversify your holdings

This chapter focuses on how your asset allocation is probably off, though it focuses on many of the simple mistakes people may make such as investing too much in company stock or being too risky in allotments. He advocates investing in things that provide cash flow. That includes dividend stocks, interest bearing accounts or investments, and “rent” producing REITS or rental properties. This is probably where the “Cash-Rich” in the title comes from. Another category he says you should increase in is international exposure, an idea that probably would’ve netted you quite a tidy sum had you implemented several years ago.

From here, this book has some nice ideas but nothing that’s radically new or unheard of. Since the annuity chapter sounded some alarms, let us skip to that chapter.

Build income with annuities

Annuities are like timeshares, they’re not inherently bad, they were just pitched by inherently bad people. The book makes an excellent case for annuities and one that I buy into, though, as they say, the devil is in the details. Annuities provide protection against longevity risk, which is the risk that you’ll outlive your retirement savings, by providing a guaranteed constant income stream and Schlagheck recommends using them after everything else (401k, Roth). I believe that to be prudent advice.

Schlagheck explains annuities, how they are structured, the four main types, the benefits, drawbacks, etc. If you want a primer on annuities, Schlagheck has a good one in his book. He warns about the costs of an annuity, which are 2.3% average, and says that there are many excellent ones at a fraction of the cost.

So what’s this life cycle strategy? The idea is that you want to ladder your annuities so that you get different amounts of income at different points of your retirement. His example has three annuities, each paying out for three different time periods. The first pays out income for 9 years from age 65 to 74, #2 pays out for 9 years from 75 to 84, and #3 pays out from 85 and onward. I’m afraid the details are outside my capability to detail with much clarity so you’ll have to check out the book if you want to know how their structured. He also provides a lot of explanation that I think is crucial for understanding how to ladder annuities, such as tax implications, purchase tactics, etc.

Overall Impressions

Overall, I felt Schlagheck did a good job explaining his cash-rich retirement plan, even though I skipped a few of them in this review, though nothing seemed exclusive to the mega-wealthy. Granted, the ability for most retirees to invest in rental properties is slim (but not unheard of) but investing in dividend stocks, buying annuities, and many of the other suggestions are not anything special. His explanation of annuities, for someone who knows little about them or the fact that laddering them would be a good technique, was comprehensive and easy to understand. If you have the basics of retirement down and are looking to learn more, I think getting this book, either at the bookstore or your local library, would be a great first step.

When I started working back in 2003, I was introduced to the beauty and power of 401(k)’s and how my employer would match fifty cents on the dollar to the first 6% of my salary I was willing to put towards my own future. I immediately saw it as a way to take advantage and get a 3% raise as well as put a large chunk of money away for the future. The 401(k) was my money time machine, allowing me to send some money to the future, money that could be fruitful and hopefully multiple if I made good sound decisions. The only question at that point was how much I should I put in my money time machine?

Many experts would argue that you should work backwards. Set your goals based on careful thought (”I want $10 million in my retirement fund when I’m 65) and then set your retirement contribution based on those goals, given dangerous assumptions like 10% annual growth. For some, that’s a great way to plan but that’s not something for me. There are simply too many variables for me to say that my target number is this, my growth rate is this, let’s start saving! Instead, I go the other direction, I plow as much as I reasonable can and see what happens! (did you expect something more structured? sorry!)

Setting Initial Contributions

When I started, I did was Paid Twice did, I put in as much as I would not miss. For me, that was the maximum contribution! (it’s crucial to do this when you’re still in the poor college kid mentality!) I went from earning a modest five or (really low) six figure income hawking items on eBay, selling freelance software I wrote, and other little online ventures to a legitimate job with a legitimate salary. My expenses had gone up for sure but I knew I had enough room to put ~20% of my salary (I would later reduce that to buy a new home) and I knew I wouldn’t miss it. This was exactly the same logic that led Paid Twice to set her contributions at 2% when she first started working.

Changing Your Contributions

As your life situation changes, your money needs also change and it’s important to identify those situations. I contributed the maximum amount for two years and then pulled the amount back to the minimum contribution for the maximum employer match. I did this so I could route the difference (minus taxes) to an account focused on saving for a house I wanted to buy within the next three years. It’s important that you make these adjustments so that you can foster sound decisions down the road. Had I kept contributions to the maximum, perhaps I would be tempted to raid my 401(k) funds, which is widely regarded as a bad idea.

You can also change your contributions based on your changing situation on the income side too. Many people increase their 401(k) contributions as they receive raises. If you get a 4% raise, maybe you increase your 401(k) contribution by another half or full percent (or more!). You don’t “feel” it because you still get an increase, though some would argue 4% is cost of living/inflation and not really a merit based increase (I would argue that, which means I’ve never received a “raise,” just COL adjustments!).

Is More Better?

In the very general, I believe so, but I’ve also said that you shouldn’t invest in the stock market (where most of 401(k) money goes!) and that everything should be in moderation. You can contribute too much and put yourself in a situation where you’ll need to take money out, sometimes at a 10% penalty; so please exercise moderation in this and all things.

Today is one of the two “Jump-Start Your Retirement Plan Days” that Kiplinger’s Personal Finance and the National Association of Personal Finance Advisors (NAPFA) has scheduled (the second is January 25th). So today and the 25th, you can get retirement planning advice from a fee-only advisor from the NAPFA absolutely free. It’s a great opportunity to ask a fee-only advisor some of your burning retirement questions and pay absolutely nothing for it (it’s like the Free Money Advice from a CFP that I suggested earlier, except this time there’s really no implied strings attached!).

Here’s a blurb from their press release (emphasis mine):

For the seventh time, NAPFA has joined with Kiplinger’s Personal Finance Magazine to offer “Kiplinger’s Jump-Start Your Retirement Plan Days” from 9:00 a.m. to 6:00 p.m. Eastern on Tuesday, January 15th, and Friday, January 28th. NAPFA members from across the U.S. will be standing by to answer your retirement questions. In 2006, more than 12,000 consumers received help during last year’s Jump-Start Days.

Just dial 1-888-919-2345 on these dates and a NAPFA member will respond to your questions. Or if you prefer, you may go to www.kiplinger.com/yourretirement/jumpstart/ to submit your questions.

There is no charge for this service—not even the phone call. To make the most of your financial checkup, please gather together any relevant documents that you need—such as mutual fund statements or your 401(k) choices before the call. If your questions are too complex to be answered on the spot, you may be directed to the NAPFA “Find an Advisor” search to locate a NAPFA-Registered Financial Advisor in your area.

Our retirement hotline is a public service that is offered to all, not just Kiplinger’s subscribers. “Volunteer advisers from across the country are prepared to help as many people as possible,” says NAPFA CEO Ellen Turf. “It is incredibly satisfying for them to have such a positive impact on so many lives.”

I personally have never used it but have heard plenty of good things about it. If you use them, please share your experiences below.

I don’t know whether there has suddenly been a push towards more reverse mortgages or if I’m just sensitive to those types of advertisements but there have been a lot more reverse mortgages advertisements lately (can anyone back me on that?). I saw an advertisement today by the Senior Lending Network Program in which Robert Wagner, looking distinguished and in front of an antique car; discusses how a reverse mortgage lets seniors enjoy retirement. In testimonials from actual customers, one woman says that a reverse mortgage gave her the confidence that she would be able to stay in her home - a statement that speaks volumes at how misunderstood reverse mortgages actually are. Before I did the research for this article, I had a very perfunctory understanding of reverse mortgages but knew enough to know that saying that the poor woman’s confidence was misplaced.

What is a reverse mortgage?

A reverse mortgage is exactly what it sounds like, it’s a special type of loan that lets the homeowner convert equity into cash. This differs from a home equity loan in that the borrower doesn’t pay back the loan unless they no longer live there as their primary residence. As long as you live in the home, you don’t have to begin repaying the loan.

The reverse mortgage you want to look for is one that is federally insured by the HUD, US. Department of Housing and Urban Development, and they mandate that only those that are 62+, own (or almost own) their home outright (i.e. no mortgage, or little remaining), and must live in their homes. With respect to ownership, the “almost own” part means that you can pay off the remainder of the mortgage balance with the funds from the reverse mortgage - that’s how close you need to be.

Are reverse mortgages a good deal?

Maybe. If you take out a home equity loan and cannot make the payments, the lender will seize the home. With a reverse mortgage, you don’t have to pay unless you leave your home. You can’t be eligible for a reverse mortgage unless you own your home outright. The reverse mortgage appears to be a safer bet if you’re looking to access cash but don’t want to risk losing your home but that comes at a cost.

First, the interest rates with reverse mortgages are generally not as good as home equity loans. While it’s something you’d expect when you compare the risk a lender is taking on a reverse mortgage, it’s not something that’s always clear when you’re reading the paperwork. Second, the fees involved with reverse mortgages may be pretty hefty as well. Again, the fees may not be spelled out very clearly as well (if you’ve ever seen any mortgage fee breakouts, it can get very confusing) so it pays to be diligent and seek out professional advice.

Heed AARP’s advice

Since this is a program designed for seniors (62+), what better place than AARP to go for advice? They have a whole section on reverse mortgages but the best page I found was a five questions article in which they basically tell you that these things are expensive and you really need to consider them one of many options, a very expensive option.

I don’t think I’m at all qualified to even given an opinion on them as they aren’t targeted towards me, but what I can tell is that the advertisements were very slick. They were definitely showing the finer things in life, how seniors can enjoy the consumerism of their active working income drawing days without the pressures of actually working 40+ hours a week, without at all discussing the two big sticking points about reverse mortgages - interest rate and fees. I think that if you know someone considering this that you should get some professional advice involved before serious mistakes are made.

(Photo by onlinehomes4u)

I just discovered this post, one that I had written on February 11th, 2005 (that’s right, that’s like forty years ago) but never published, deep in the “Drafts” collection. That’s right, it ranks as one of the first few posts I’d ever written but strangely enough it never made it out of Drafts. Much of the information is outdated (mostly the contribution limits and income phaseouts) however the reasoning is still good and I wanted to preserve it for posterity so I didn’t edit a single word. (It was hard not to edit it!)

If you haven’t heard about a Roth IRA, you’ve been missing out on one of the best tax-free growth vehicles you can possibly take part in. The government caps it, so you know it must be good. We will discuss the Roth and compare it to the other retirement juggernaut (if you don’t count what Social Security, Medicaid and Medicare are supposed to do) called a 401K.

Let’s get to a little history and the basics and then move into why the Roth is so awesome. In the Taxpayer Relief Act of 1997, the Roth IRA was created and taxpayers rejoiced.

The Basics:

Based on a max-contribution schedule (that increases each year and is detailed below) and your annual income, each individual is able to contribute the lesser of 100% of their annual compensation or $4,000 (for 2005). Individuals over 50+ can contribute a little more to “catch-up.” Distributions from the Roth IRA are tax free. The funds in your Roth IRA can be used to purchase almost anything from stocks to bonds to CDs, etc.

The Schedule:

For 49 and under - $3,000 for 2002-2004 (You can still contribute to a 2004 up until April 15th); $4,000 for 2005-2007; and $5,000 for 2008. You can deposit it all at once or bits at a time.
For 50 and over - #3,500 for 2002-2004; $4,500 for 2005; $5,000 for 2006-2007; $6,000 for 2008. So the “catch-up” is from $500 to $1000 a year.

Now comes the analysis…

Roth or 401K?

This is a question that has been hotly debated for quite some time. My personal opinion is that you should contribute to the minimum required to receive an employer match, then maximize your Roth IRA for the year, and then max out your 401K for the year. I have no children so 529 and similar plans were never a consideration in my decision. Another assumption I have made is that by the time of my retirement, I will have an annual income greater than the one I have no and so my tax bracket rate will be higher. (If I didn’t assume that, it’d be like aiming for mediocrity don’t you think?)

Breaking down the decision:

• Minimum Matching Contribution to 401K - This is a no brainer, if they are giving me free money then I will take it. I doubt much discussion is necessary on this one.
• Roth IRA Maximum - If my tax rate is higher later than it is now, I want to put in my money at the lower rate and allow it to grow and then later paid out at a tax rate of 0%. If my tax rate is lower in the future, then I would reverse the 401K and the Roth contribution limits. Since I don’t trade stocks in my 401K and I purchase funds, the Roth let’s me “gamble.”
• 401K Maximum - I don’t max out my 401K because at $14k this year, I can’t afford to not have the free cash flow. Putting a suitable amount in there is nice because it’s money you can’t mess up (only your company can mess it up) and hopefully it’ll be there later. Plus because it’s pre-tax, you’re feeling less of the tax implications now.

Other Considerations:

Another assumption not mentioned in my message is that I have no credit card debt. There is no point in putting anything (except perhaps the 401K match because most people get fifty cents to the dollar, or 50%) in a retirement account if you are carrying credit card debt. With APR’s in the double digits, you are killing yourself if you don’t pay that off as soon as financially possible. In order for that investment to make sense (because you are borrowing the money you aren’t paying back to the card), you need to get a rate of return great than inflation and the interest rate of the card. If you know of a safe investment generating more than double digit rates, please let me know.

What did you all think!?

I’ve always said that borrowing from your 401(k) is a bad idea. However, the other day I was talking with my friend Miller when I erroneously told him that one of the reasons I thought it was a bad idea was because you paid back the loan with post-tax money even though you borrowed pre-tax money. You don’t pay back with post-tax money, you pay your loan back through payroll deductions so it’s with pre-tax money. If I was wrong on that point, I had to do more research to see if my opinion of borrowing from 401K’s was even right in the first place.

It turns out, thanks to reader Tom who confirmed this, that you pay back the loan with post-tax dollars, so my original understanding was correct. I still think 401K loans are a bad idea and the fact that you pay back with post-tax funds make it even worse.

A few things to note, while the law allows your employer to offer the 401K loan, it doesn’t require your employer too. While it’s estimated that most employers do offer it, not every single one of them does so check first before you start making plans. If your employer does, then you’ll generally be allowed to borrow up to 50% of your vested account balance up to $50,000 as long as you haven’t taken a loan in the last twelve months. If you have taken one in the last twelve months, then your max is deducted by that loan amount - basically each 12 months you can borrow up to 50% or $50k, whichever is smaller. There are a few other rules specific to your employer like the minimum loan amount (this is just to reduce the headache of paperwork) and any associated fees.

Here are the advantages of borrowing from your 401(k):

• It’s generally really easy, no applications, no credit checks, none of the annoyances with typical loan application processes.
• Decent interest rate, generally a point or two above the Prime rate, and that interest is paid to your own account anyway.

What are the disadvantages?

• That interest rate is usually less than what the account could earn on its own with the money, plus you’re paying it anyway so it’s not coming from the market.
• The loan payment taken from your paycheck might tempt you to reduce your contribution resulting in less in savings.
• If you leave your employer, for any reason, you have to pay back the loan immediately (or within 60 days). If you can’t, it’s considered a withdrawal and you’ll owe taxes and a penalty on it.
• The terms of the loan are set in stone and there might be some fees involved. You generally pay back the loan over 5 years, it’s more if you use it to purchase a primary residence (10-15 years).

So, should you borrow from a 401k? That depends!

Are you employed? Does your employer offer a 401K (or 403B, or any number of similarly acronym’d up retirement plans)? Does your employer offer an employer match/contribution on dollars you contribute? If the answer is yes to all three, you better be contributing to your 401K. If your employer doesn’t offer a match, you should still be contributing to your own retirement though it’s not as pressing. It should take you less than ten minutes to sign up for your 401K unless your company is stuck in the stone ages. Give your HR a call or check out your company Intranet for a 401K enrollment form, fax/inter-office mail that baby over to HR/Benefits, and you should be all set. As for the what funds you should divvy up your hard earned money into, just wing it until the account is setup. You can figure all that stuff out later, time is of the essence!

For many recent hires, this is a non-issue because the Pension Protection Act of 2006 made employers auto-enroll their employees. So, for some, this tip took less than ten minutes! The next step is making sure you’re contributing enough. The law says that you’re auto-enrolled at 3% and then every year after that you’ll be bumped up 1% until you get to around 6% to 10%. Now, employers are not required to do this (they get out of some discrimination testing if they do), so there’s a chance your employer hasn’t done any of this (double check!). Also, this is what the employer must do, you can adjust it up or down or sideways as much as you want.

Let’s say your employer offers to match your contributions 50 cents to the dollar up to 3% of your salary. That means if you contribute 6% of your salary, they kick in 3%. Well, if you’re auto-enrolled at 3%, that means you’re leaving 1.5% of your salary on the table because you didn’t do anything. 1.5% doesn’t seem like much but:

1. It’s free.
2. In 40 years, with interest and years of 1.5% of your salary, that’s going to be a lot of money.
3. It’s free.

So, make sure you’re enrolled and make sure you’re contributing enough. If you saw a twenty on the sidewalk, you wouldn’t just walk by it would you?