Protect Your Retirement: Insurance and Annuities

Zero is my heroBy Sunil PatelPublished February 20, 2012

Most financial advisors tend to emphasize growth and rate of return, but they seldom discuss the benefits of having a zero return in certain years. The policies involved in a zero-return plan fall between the realms of life insurance and financial planning, so many financial advisors aren’t familiar with these strategies. Moreover, certain kinds of plans were not available before 1995. Using the last ten years as an example, we can learn a lot about how zero can be your hero as well.

There are a lot of different options when it comes to pension plans: 401(k)s, SEPs and other market-linked investments are great for rich retirement income. The less-discussed downside of these plans, though, is that rather than tax-saving, these are tax-deferral programs. You struggle throughout your lifetime to put away money and make it grow, unaware that the IRS is your silent partner for all growth during your lifespan--even after death. Income and estate taxes become due on pension assets after the survivor’s death (Estate tax is applicable only to individuals beyond a certain level of wealth). And don’t forget that in a Qualified Pension Plan you have Required Minimum Distribution (RMD) at Age 70, which is mandatory. You cannot simply let your money grow and grow and not pay IRS until you die. This RMD is forced liquidation of your pension assets, so that the IRS has the benefit of annual income tax revenue from all your pension plan growth. Every dollar of pension income is taxed. There is no escape.

But as we have seen over the last ten years, market volatility has taken a toll on our investments. Looking at the S&P 500 since September of 1998, we can reference how making zero would put you farther ahead in the long run. If you had put $100,000 in an investment that followed the S&P 500 exactly on September 30, 1998, you would have been at $136,937 in 2000. Then the tech bubble burst, and by 2002 you would have been at $78,869, with an eventual steady increase to $145,542 in 2007. This seems great--but then the housing crisis hit and the markets fell again--by 2011, you would have $107,857.

Now, during the same time frame, we will take away some of the gains, but any time the market goes down, we get a zero return. From 1998 to 2000, you would have only made $125,080. This is not as much as the market, but when the downturn happened the next year and the market hit $78,869, your account would have stayed at $125,000, until it ended at a high of $156,857 in 2007. It would then stay flat in 2008 and 2009, finally increasing to its highest point in September 2011 at $171,388. If we have to give up some of the gains but take a zero in the down years, your overall growth will be greater. The power of indexed insurance products can be very effective for your portfolio. In the long run, losing money hurts us more than not making the highest returns possible.

Many people put money into 401(k)s, IRAs, SEPs, and other tax-deferral vehicles thinking that it is tax savings. Most people never realize that instead of a true tax savings, this is actually tax-deferral until retirement begins. They think that because they would not have any new earned income, they will be in a lower tax bracket at retirement. When they actually start drawing retirement income, however, they realize that their tax bracket is not lower. In most cases, where retirees were in high-income tax brackets to begin with, they end up in the same tax brackets--sometimes even in higher ones--because there were not many deductions left for them in terms of interest payments on home mortgages or other deductions. On the other hand, lots of after-tax money starts getting drained for personal health problems, such as alternative medicine costs, supplements, co-pay, deductibles etc. It is very frustrating for individuals who retire to realize so late that they will be losing 50% toward Federal and State income taxes. Many people have to scale down their lifestyle just because taxes wipe out almost half of their pension income. This leaves deep frustration in retirees. As the tax bracket is expected to increase in the future, retirement plans would be losing about 60% of income on taxes. Moreover, additional income and estate taxes after both spouses’ deaths could wipe off 75% or more from the pension plans of wealthy individuals.

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Protect Your Retirement: Insurance and Annuities

Zero is my heroBy Sunil PatelPublished February 20, 2012

It is extremely important for people in general to focus on developing personal tax-free retirement plans from very young ages. One should give priority to income-tax-free retirement planning instead of tax-deductible retirement planning. There are only three ways you can build tax-free retirement. (1) Municipal Bonds, which have a very low interest rate. (2) Roth IRA accounts, which have limitations. (3) Certain types of life insurance, which have substantial room to develop a sustainable tax-free retirement income. All other ways of growing money have Income Tax or Capital Gain Tax involved, which diminishes the power of compounding interest without taxes. Having the power of indexing in your portfolio, in addition to having accounts that can be accessed tax-free, will help you retire with confidence.

To read more from Sunil Patel, please visit his website at www.retiremillionaireriskfree.com

All numbers pulled from The “REAL BENEFITS” of indexed annuities with annual reset design by American Equity. Form 8109.

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