Investing 
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The Basics of Annuities

One of the financial products that has been garnering a lot of interest lately is the annuity. Annuities can be very tempting because those providing them tout a “guaranteed income stream.” It is important to remember, though, that annuities can be very complex financial products, and that getting your money is not always straightforward.

For some people, annuities work well. They can be a way to ensure steady income, and they offer a degree of stability that many — especially retirees in an uncertain time — value. Before you decide on an annuity, it is best to consult with a financial professional, and also understand some of the tax implications that may come with an annuity. Study the ins and outs, and figure out if an annuity is right in your situation. The following is meant as a general overview of annuities:

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 Investing 
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Vanguard Offering Annuity Access Marketplace

Annuities often get a bad reputation because they can, at times, be very complicated and filled with fees. Like many financial products, they aren’t inherently bad for you but a few bad actors make the whole industry look a little shadier that it actually is. The most basic of annuities, known as immediate life annuities or income annuities, work like pensions, if you could buy into a pension. You pay an up front lump sum and receive regular payments for as long as you live. The bad part about annuities comes when you start getting more complicated, like variants of variable annuities, and throw in expensive fees.

I was a little surprised that Vanguard, my favorite mutual fund company, opened up Annuity Access, an annuity “marketplace.” They offer variable and fixed annuities with the promise that their fees will be as low as you expect from any Vanguard product. I haven’t done a lot of research into annuities but it seems as though Vanguard’s variable annuities are fairly cheap. There are no sales charges, no surrender charges, and their variable annuity’s annual costs are 75% less than the industry average, based on Morningstar’s July 2010 figures. Vanguard’s annual fees are 0.62% versus the average of 2.40%. (I only did a perfunctory look at the fees, if you’re planning on using this service I’d read into the fee schedule a little more just to be sure)
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 Investing 
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Comparing Fixed Annuities & Certificates of Deposit

Hand Painted Piggy BankWhen I first opened up my Vanguard account a few years ago, I requested all sorts of fancy investment brochures. I had just started Bargaineering and had a voracious appetite for financial information and fancy words like annuities, in all their flavors, really intrigued me because I had never heard of them. One of the books I requested was Vanguard’s booklet on annuities, an investment vehicle I would later learn is rife with ripoffs and unscrupulous characters.

I never read the booklet until my wife and I were cleaning out some documents and they remind me a lot of long term CDs, with a few wrinkles. If there’s anything I’ve learned in the last few years is that the financial community has a funny way of coming up with a million different ways to do the same thing, if only to be able to say they have a hot new investment option for you!

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 Personal Finance 
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How To Make Smart Tax-Advantaged Investment Decisions

You can avoid costly mistakes if you understand the difference between tax-advantaged investments and tax-advantaged accounts.

What are tax-advantaged investments? Investments that people make specifically because of the tax advantages they provide are referred to as tax-advantaged investments. In fact, if not for the tax advantages, most people would not buy those particular investments. Tax-free bonds, fixed and variable annuities are examples.

Mutual funds offer tax benefits but they are not generally considered tax-advantaged because people don’t buy them specifically for the tax benefits. Real estate also has tax advantages but is also not generally included in this category. What’s important to keep in mind is that these investments have tax advantages regardless of what account you hold them in.

What are tax-advantaged accounts? Retirement accounts are tax-advantaged. Examples are IRA’s, 401(k)s, SEP IRA’s, ROTH IRAs etc. What’s critical to understand is that you can buy any investment you like within these accounts and the returns are tax-advantaged. The tax benefits don’t depend on the investments you make within these accounts.

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 Retirement, Reviews 
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Review: Cash-Rich Retirement by Jim Schlagheck

Cash-Rich Retirement by Jim SchlagheckCash-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.


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