Category: Personal Finance

Car buying tips

As I said yesterday – I am in the market to buy a car, and there are several lessons I learned in this process, which I thought I’d share with you in this post about car buying tips

There are a couple of things you should know before you start reading these tips. First is that we are in the market for a used car, and secondly – we don’t have a particular make or brand in mind. We just wanted to check out the options available and then take a decision.

Car buying tips
Car buying Tips

With that in mind, here are some car buying tips you could use.

1. Cars.com is a good resource for checking out car listings online: I have found cars.com to be the best place as far as initial screening is concerned. It is always handy to have an online resource to browse through car listings before you head out to the dealer and in my experience – cars.com is the best place to do that. You can search by make, model, year, location and price – and that gives you a good idea of the nearby options in your price range. It is a good idea to get a sense of the local tax rate and also add about $300 – $400 dealer documentation fee to the price because that is what you will have to pay in addition to the sticker price.

2. Check out the KBB value: I check the KBB value of a car after finding something I like. This usually helps in getting a perspective on how much the dealer is asking for with respect to the fair value, and is a natural next step for me. The thing to keep in mind about KBB values is that there are two types of values – Individual and Retail. Individual prices are lower than retail prices, and based on who you are buying the car from – you should look at individual or dealer KBB values. Another thing to keep in mind is that KBB values for retail cars assume excellent condition. So, if the car you check out is not in great shape – it should be priced lower than the excellent condition price.

Continue reading “Car buying tips”

No related posts.

Retirement saving options for early retirement

You did your math.  You know how much you need to save for retirement.  Now what?  Do you just keep all your savings in a box under your mattress?  What about in the freezer?  A savings account at the bank?  None of these let your money work for you while you save it.  Let’s go over a few popular retirement saving options.  After we do, we’ll talk about how early withdrawal affects your savings.  Tax deferred savings options include:

  • 401(s)s at work
  • Annuities
  • IRAs

401(k)s are employer provided retirement savings plans.

  • The employee decides how much to contribute a month.
  • The employee gets to choose what to invest in from a list of mutual funds.
  • Contributions are put into the account before they are taxed.  Building interest is not taxed.  All withdrawals are taxed.  If the person lowers their tax bracket at retirement, the savings here can be great.
  • Company matching provides financial benefits to employees.  The maximum amount a company can pay is six percent the employee’s annual salary.
  • The maximum amount a person can contribute to their 401(k) is $16,500.  If an employee is over 50 ½, they can contribute an additional $5,500 annually.

Annuities are insurance contracts people buy from insurance companies.  By agreeing to pay a set amount of money up front, the owner receives money back after a set time.

  • Annuities are not normally good retirement investments unless a person has maxed out other options and wants to save more money tax deferred.
  • Annuities have many more up front fees than 401(k)s.  To take your money out before a minimum period (usually from three to five years), you must forfeit a surrender fee.  This fee is typically between 5% and 7%.  In addition, you must pay the 10% early withdrawal penalty to the IRS.
  • Payments are taxed first.  Contributions are not made pre-tax.  Earnings are tax deferred but are taxed as ordinary income when distributed.  This is a higher rate than the capital gains rate used for 401(k)s.

IRAs are self-directed retirement savings accounts.  There are eleven types.  Some are done through work.  The two most common ones are the traditional IRA and the Roth IRA.

  • With the traditional IRA, the amount contributed is tax exempt but everything is taxed when distributed.
  • With the Roth IRA, money is contributed after a person has paid his or her taxes on it.  Then, when the money is distributed, it is tax-free.  This makes sense if you think you will be in a higher tax bracket when you retire than the bracket you’re in now.  Oh, we can all hope, can’t we?
  • As long as you are younger than 70 ½ and you are earning money, you can start an IRA.
  • You can contribute $5,000 a year to your IRA.  If you are over 50 years old, you can contribute another $1,000 a year.  You can have both types of IRAs open (traditional and Roth).  Your total contribution in one year is still $5,000 or $6,000 (for those over 50).

If you are deciding to retire early, you might worry about what the IRS thinks.  After all, they don’t think you should retire before you turn 59 ½.  If you do, you would have to pay an early distribution penalty.  This is a 10% fee paid to the IRS on withdrawn money.  The penalty is supposed to help people keep their retirement money in their retirement savings accounts until they need them.

Here is the lowdown on that early distribution fee.

  • Not all early withdrawals face an early distribution penalty.  A person can convince the IRS they need to make a hardship withdrawal.  In this case, he or she will not pay the 10% early withdrawal fee.  The IRS usually accepts the following reasons for approved early withdrawal of retirement savings:  medical and funeral expenses, college tuition, to purchase, repair, or keep from losing his or her main home.
  • Tax law under 72(t)(2)(A)(IV) lets people start early withdrawal of their retirement savings without being penalized with that 10% fee.  This is the golden key for anybody contemplating early retirement.
  • As long you take out equal periodic withdrawals made during the rest of your life, you do not pay the early withdrawal fee.
  • Figuring out the right amount to take out is complicated.  The IRS accepts three ways to figure out how much you should start taking out.  These methods are the life expectancy method, the amortization method, and the annuity method.

A lot of paperwork is involved as well.  You have to use the same method to withdraw the money for five years or until you reach 59 ½, (whichever one happens last).

No related posts.

Using annuities for retirement

An annuity is a contract between insurance companies and people arranging for retirement.  The insurance company agrees to pay you money in the future for the money you give them now.  In theory, an annuity would make sense because:

  • Annuities offer guaranteed income in the future (although surprisingly, the definition of guaranteed is malleable here).
  • Annuities are tax deferred retirement investments.  You pay taxes first for money you put into an annuity.  The capital gains grow tax-free until you start withdrawing them.  When you receive your annuity benefits, you will pay taxes on capital gains as well.

So far, annuities sound good.  The following problems, however, exist with annuities:

  • Annuities lock up money for a minimum period (usually five years).  If you want your money, you will need to pay surrender fees.  Surrender fees are stiff.  They range anywhere from 5% to 7%.  This is in addition to the federal 10% early withdrawal tax.  This tax occurs when money is taken of retirement funds before the owner is 59 ½ years old.
  • Annuities often offer lower returns than other retirement options.
  • Contributions are not pre-tax as they are for 401ks.  The earnings are, however, tax deferred.
  • The IRS taxes capital gains earned in an annuity as ordinary income.  Ordinary income taxation rates are higher capital gains rates.
  • Annuities usually have many more fees than other retirement options.
  • Annuities are not the best for estate planning.  If you die before using your annuity, beneficiaries must pay taxes on the capital gains.  Not so with mutual funds.

Why consider an annuity at all?  Annuities make sense in the following situations:

  • You have maxed out 401k and IRA annual contributions.  You still want to invest money into tax deferred investment options.
  • Annuities do not have a contribution limit.
  • You want to diversity your retirement plan.  Insurance sounds wonderful to pessimists.

When shopping for annuities, one size does not fit all.  Types of annuities include:

  • Fixed annuity meaning the interest rate for the invested money is fixed.  It does not change.  The money is usually invested in low-risk fixed income products like bonds.
  • Variable annuity meaning the interest rate for the invested money is variable.  This type of annuity can produce a higher or lower payout.  The payout depends on how well the investments do.  Variable annuities usually still have guaranteed minimum returns.
  • The equity-indexed annuity is an option that has been around for about ten years.  This annuity acts a variable annuity with a safety net when the market gets bad.

Payout schedule options include immediate payments and deferred payments.  Payments can last for the owner’s lifetime or for a set term.  Other options when purchasing annuities include:

  • Cost of living protection
  • Premium protection
  • Joint and survivor benefits

Annuities are only as good as the insurance company backing them.  Shop around before picking one.  Do not buy in a rash moment.  Make sure you know whom you are dealing with.

Federal law allows for tax-free exchanges between annuities.  This can happen if you decide you invested your money in a poor annuity.  You would like to move your money to a different annuity.  Normally, if you take money out of an annuity before retirement, you face the 10% early distribution penalty tax.  However, if you move the money into another annuity, US tax code 1035 allows for tax-free exchanges.

No related posts.

5 factors to think about before you start investing

I got a few interesting questions in comments and emails while I was away, and now that I am back, I will try and address at least some of them.

One of the more interesting emails I got was to do a write-up about investments for beginners. As I thought about this question — my mind kept wandering to a situation where someone had just started earning, and although I realize a write-up about investment for beginners doesn’t necessarily imply that the person just started to earn, — in this post — I am penning down some thoughts on how people who just got a job and started earning should approach investments.

Before I begin, I should warn you that post this is solely based on my personal experience, and the lessons I learned from my mistakes and is not expert advice.

1. Pay down your education loan: Before you think about investments or building assets, – you need to think about your liabilities and how you will deal with them. I had a student loan when I graduated, and I paid as much as I could every month to get rid of the loan as quickly as possible. I think this worked out really well for me; not only financially but in terms of discipline as well. I got into the habit of putting aside some money every month, and when the loan eventually got over, – I found that it was easy enough to put aside the same money as savings. The discipline helped me build savings once I got out of the debt.

2. Don’t get into credit card debt: The only thing greater than paying down existing debt is to not get into a new one, and especially credit card debt. That to me, is the worst kind of debt. It is almost always spent on stuff you could live without, and the high interest rate means it adds up pretty quickly. I actually got into quite a bit of credit card debt early on. I got lulled into thinking that I can manage a certain number on my credit card bill, and that number just kept increasing every month. Finally the outstanding balance became quite big, and I realized my folly. I paid off the debt in a few months, and have learned my lesson since then.

If you are paying an insane amount of interest for the new jeans you just bought, – there won’t be much left for you to invest. Stay away from it.

3. Risk: One of my finance professors used to say that she had students come to her all the time and talk about returns, but no one spoke about risk. I think this is very important. Thinking about risk, when you first start out to invest is very important. Different people have different tolerance for risk, and different products offer different risk levels. A fixed deposit is usually much safer than an investment in an equity fund. How much money can you lose without losing your sleep? This is an important question, and you should keep asking this to yourself.

4. Invest in tax saving instruments: I bought my first stock in my first year of college, and it was only natural that I continued investing in stocks when I started earning. I think that was a mistake. Early on, I should have invested in mutual funds that are eligible for tax savings instead of buying stocks. After some point in time, – you will reach the upper limit and not be able to save any more tax, but until then invest in stuff that reduces your taxable income and tax liability.

5. Stay away from short term trading: If you are not a professional trader, – stay away from short term trading in the stock market. You will only lose money. If you must trade, then do so with small sums of money that you are comfortable losing.

As you can see only one out of these 5 factors really talk about investing your money. To me, when you start thinking about investing, that’s how it should be, investing is just not buying a certain stock or making a fixed deposit, – a lot of factors influence how you invest and it’s important to think about the big picture and take a holistic view of things before you start thinking about specific investment options.

These are my top picks for factors that will influence investing early on, do you have any to add?

Photo credit: Wonder Webby

No related posts.

Factors influencing your emergency fund decision

Last week I read an interesting post about emergency funds over at Dough Roller, in which DR states that he has never kept cash stashed away for emergencies and doesn’t plan to do it either.

Here is what he had to say:

Confession time. I’ve never kept 3 to 6 months worth of cash sitting in a bank account and don’t plan to. In an emergency, I can tap investment accounts, a home equity line of credit, or yes, even the dreaded credit card. The question for today is whether it’s a smart money move to rely on credit cards as your financial backstop.

An emergency fund is a sum of money that’s easily accessible, covers 3 – 6 months of your expenses, and is only used in emergencies. Money in your savings account qualifies, but money tied up in stock doesn’t.

Some people don’t like keeping cash in savings accounts for emergencies because of the pathetic returns. Their argument is that the same money will earn higher returns elsewhere, and if there is an emergency, — you can always tap into your stocks, home equity line of credit, credit cards etc.

I used to be part of this camp, but my perspective has changed over the years. Primarily because, when things start to go wrong, everything goes wrong at the same time, and all hell breaks loose.

During the recession — people lost their jobs, the stock market crashed, home prices went down, and quite a few saw their credit card limits slashed too. Even if the limit wasn’t slashed, it must really hurt to pay interest in an emergency. This, in a nutshell is my reason for having a cash emergency fund. To protect yourself from times when all hell breaks loose.

Now let’s take a look at the factors that determine how likely a person is to have an emergency fund.

1. Total savings: This is an important factor when it comes to an emergency fund. If your total savings cover just 12 months of expenses, then it is highly unlikely that you will be comfortable with keeping half of that in a savings account that doesn’t pay much. On the other hand, if your savings are somewhere to the tune of 3o or 40 months expenses, then you won’t mind keeping some cash idle.

2. Job security: If you have a reasonably secure job, like someone in the government sector, then your propensity to think about emergencies will be slightly lower than someone who is used to seeing layoffs around him. As a result, your inclination to keep money idle will be lesser.

3. Fixed expenses: If you have to make a number of fixed payments every month like car loan payment, home loan payment, credit card bills, school fee etc. — then getting into financial trouble is a lot easier than if you didn’t have so many liabilities. Higher liabilities should generally mean that a person protects themselves from emergencies by having some liquid assets.

4. Dual income: A family where both the husband and wife work would feel a lot more financially secure than a family where there is only one earner. I think single income families should be keener on an emergency fund as compared to a dual income family.

5. Personal experience: I see families where someone or the other is always sick, and such families are more likely to appreciate the need for having some cash at hand. Then there are people who lost a job, have their car damaged every month, or have some sort of financial demand on them every other month. Such people are more likely to appreciate an emergency fund, than someone who hasn’t been through many financial hardships in the past.

Personally, number 1 influenced my emergency fund decision the most. As soon as I built size-able savings, I stashed away a certain sum and forgot about it. I have a bright sunny outlook on life, but I have seen several stock market crashes, and layoffs to not worry about a rainy day.

I would hate to make distress sales in the stock market, and a credit card is a tool of convenience for me, and I’d hate for it to become my lifeline.

Think about these factors and how they apply to you, maybe you need to build an emergency fund, but haven’t thought about it.

It is a question of sound finances, but also of mental peace.

Photo Credit: Gilbert R

No related posts.

401(k) and your retirement

The 401(k) is a retirement savings plan that happens through the employer.  Here are some major points about the 401(k) plan:

  • Contributions made to the account are pre-tax.  Depending on a person’s tax bracket, this can mean substantial savings when investing money for retirement.
  • The employer automatically takes out the money from the employee’s paycheck.  An employee can typically start and stop investing into a 401(k) on a monthly basis.
  • The employer picks a financial investment company to manage the 401(k) for them.  Money is invested in mutual funds of stocks and bonds.  Investment choices may be limited but are self directed.
  • 401(k)s are not guaranteed savings plans.
  • Earnings grow tax-free.
  • Withdrawals are subject to taxation.  Early withdrawal is subject to an additional fee.

Company matching is an employee benefit where the company agrees to match a percentage of the employee’s contributions.  Here are some points about company matching:

  • Company matching is usually limited to a set percentage.  Typically, it is worded like “the company will match 50% up to the first six percent” of what you contribute.  Employers cannot contribute more than six percent of your salary to a 401(k).
  • You can only keep company matched savings if you are properly vested with the company.  This means you have to stay with the company for a set number of years.  If you leave before that time is up, the amount of company matching you get to keep in your 401(k) may be limited by your vesting.
  • Vesting normally takes three to five years.  Graded vesting means your vesting is increased each year.  You are vested 20% after one year, 40% after two years, etc.  Cliff vesting means you are not vested at all until after the vesting schedule.  For example, with a three-year vestment period, you are 0% vested after one year and two years.  After three years, you are 100% vested.

Maximum amounts limit how much a person can contribute to a 401(k) account.  Here are details regarding contribution limits:

  • Starting in 2009, the maximum annual contribution made to a 401(k) account is $16,500.
  • This amount increases after age 50 ½ to $22,000.
  • The contribution limit includes the total contribution between employee and company.
  • Highly compensated employees face further restrictions over what they or their employer can contribute to his or her 401(k) account.

Variations of 401ks include:

  • 403(b) is for the non-profit sector.  Hospitals, churches, charities, and college employees use a 403(b) instead of the 401(k) savings plan
  • Starting in 2006, employees can opt for the Roth 401(k) if the employer avails this option.  In this case, money is contributed after being taxed but it is distributed tax-free.
  • The Solo 401 (k) plan is just like the 401(k) plan but for self-employed people who do not have employees except for spouses.

The following points specify 401(k) withdrawal:

  • If you take your money out before you turn 59 ½, you must pay the IRS a tax penalty of 10% of the total money withdrawn.
  • You can roll over the money from a 401(k) into an IRA without tax penalty.
  • You can take money out if you show justifiable hardships.  Reasons the IRS will accept for a hardship withdrawal include:
  1. funeral expenses
  2. medical expenses
  3. college tuition
  4. mortgage or rental payments
  5. to purchase or repair your main home
  • Tax law under 72(t)(2)(A)(iv) is a little known rule that lets you start your withdrawals earlier than when you turn 59 ½ without suffering an early withdrawal tax penalty.

No related posts.

How to retire early when you didn’t plan ahead

You’ve always wanted to retire early but you just don’t see how you can do it.  Somehow, the years have slipped by and now you are looking at your golden years coming around the corner.  But what if you wanted to retire now?  Could you do it without having planned for it all those years ago?

Work out how much you need to retire now.  Use “Planning Now to Retire Early” to work out how much you need to retire right now.  The next step we need to do is figure out what the difference is between where you want to be and where you are right now.  What does your current savings look like?  If it doesn’t reach the mark, consider the following ideas to try to breach the difference:

  • Use your current equity to retire early.  Downsize your home, sell a vacation home, or get a reverse equity on your house mortgage.  Instead of selling your vacation home, you could rent it out year round for extra income.
  • Move in with your grown children.  Many more retirees are moving in with their families anyways; now they finally have the time to spend time with their families.  Your children might let you live rent free because you raised them like that or maybe you can stay in exchange for watching the kids after they get home from school.  Consider becoming a boomerang senior so you can use your property as a rental for an income stream.
  • Sell whatever you have in your house that you don’t need, want, or care about.  Nothing is too insignificant.  One man’s trash is another man’s treasure.  Those collections, jewelry, anything that you have at home that you care less about than an early retirement.  Have yard sales, sell them at consignment stores, or auction them on eBay.  If you would rather retire than be surrounded by stuff, then take that cue to start selling all your stuff.
  • Think about moving if the cost of living is too much where you live.  Every year magazines come out with the best places to retire.  While medical and community services as well as the crime rate all factor into these lists, one of the biggest contributing factors is the cost of living.  AACRA publishes cost of living indexes for major cities in the US.  Leaving crazy places like New York City and San Francisco out of the equation, you could still easily cut your costs down 20% by moving.  For example, using 2005 statistics, living in Charlotte, NC is 10% cheaper than living in Albuquerque, NM and 25% cheaper than living in Philadelphia, PA.  Think outside the box.  What about becoming an expatriate?
  • Consider Semi-Retirement.  Work PT.  Still consider yourself retired but working enough hours might help you with health insurance coverage.
  • Slash your annual budget requirements.  If the gym membership and a new car is all that stands between yourself and an early retirement, consider what really matters to you.  Do you want that country club membership or the chance to play more golf at a public golf course?
  • Take money out of retirement accounts earlier.  Look into Substantially Equal Periodic Payments as a way to do this without penalty.

No related posts.

Planning now to retire early

Sure you want to retire.  In fact, you would like to retire early.  Who wouldn’t want to have time to enjoy all those things in life you never had time to enjoy when working.  But the reality is that many people are not adequately preparing for a comfortable retirement, much less an early one.

Reaching an early retirement successfully can be done but it takes planning and working.  You need to first come up with a viable plan and then second, use discipline to work that plan, every day, until you reach your retirement.

According to a retirement survey published by the EBRI (the Employee Benefit Research Institute™) in 2007, only 43% of the people surveyed have ever tried to work out how much money they would need to retire.  Why such a small percentage?  How can anybody guarantee success if he or she isn’t even working off a game plan?  Planning is confusing when you don’t know what to do and scary because you’re not sure you’ll like the results.

But here’s the cold fact: You definitely won’t be able to retire like you want to if you don’t do something about it now.  An early retirement will definitely not happen on its own.  Follow these steps to figure out how much you need to start saving now in order to retire when you want.

  • First, determine how much money you need a year to retire.  To figure this out, you can use a percentage of your current income.
    • How much is your annual income now?
    • Take your annual income and multiply it by 70%.  Retirement planning experts recommend using 70% of current income.  They reason your mortgage should be paid off and you won’t be worried about paying tuition in your retirement.
    • While using your annual income to determine your retirement needs, check that you are not currently building up debt.  That would suggest that you are not living within your current income.
  • Multiply your annual retirement income requirements by how long you plan to be retired. You can determine this by deciding how soon you want to retire and statistics on average life expectancies.
    • Write down how old you will be when you plan to retire.
    • Research life expectancies for where you live.
    • Subtract how old you will be when you retire from how long on average you can hope to live to.  The US Social Security Administration reported that for people reaching 65 in 1990, they could expect to live 15.3 (men) and 19.6 (women) years longer.
    • Multiply the number of years you will be in retirement by what your annual spending requirements will be in your retirement.
  • We’re almost done.  You’ve got a good idea of how much you would need to save in order to retire but that number is in today’s money.  We need to take inflation into effect.
    • Pick an inflation rate you are comfortable with.  You could use the current inflation rate or take an average over a period of years.  If you are pessimistic or wish to be more conservative with your planning, use a higher rate.
    • We’ll need to work in the impact that inflation will have each year that you will be retired.  Use a hand or online calculator to make calculating the accrual of inflation over your retirement period.
  • Now you have a number to work with.  Working backwards, figure out how much you need to save each year.
    • How far away is early retirement for you?  This will tell you how many years do you have to save.
    • Determine how much money you can make each year with your savings by investing it.
    • Remember to offset the amount you make in interest by the amount you will lose through inflation.  You could go with 5% for example (8% interest in savings minus 3% inflation).  Use a calculator to make calculating the accrual easier.
    • Now you know how much you need to set aside each month in order to retire like you want to, when you want to.
  • Is this number seems impossible, consider if any of the following initiatives could help:
    • Reduce your annual cash requirements for when you retire by working out a careful budget.
    • Investigate a better return on your savings.
    • Cut your current spending so you can save more.
    • Earn more now.
    • Determine if you are taking advantage of company matching for retirement plans.

No related posts.

Retirement Withdrawal Management

Retirement finance has an accumulation stage and a decumulation stage. Accumulation gestates, hatches, and cooks your retirement nest egg; decumulation allows you to eat it. Accumulation commands the lion’s share of attention in popular finance, but decumulation, or distribution, is equally important. Understanding how to disburse wealth is just as important as understanding how to build it.

The Basic Problem

On retirement day, you possess a store of wealth built up throughout your working life. Stretched out before you is the rest of your life, of uncertain duration. You want to withdraw a sufficient quantity of wealth to finance a comfortable lifestyle, but not so much that you run out of money before you run out of life.

In order to make your problem manageable, you will probably choose to withdraw and consume a specified fraction of your wealth. If your chosen fraction doesn’t work well – either because you don’t have enough money to live on or because you are using up your wealth too rapidly – you may either choose a bigger fraction or a smaller one. You won’t, or shouldn’t, simply withdraw a random amount whenever the spirit moves you. That would leave you with almost no control over how fast your money is used up.

Your basic problem is choosing that fractional withdrawal, which is called the withdrawal rate and is expressed as a percentage. The optimal rate depends on subjective factors – your tastes and preferences, your need for security, and your tolerance for risk – as well as objective ones. Copious research has been devoted to identifying it. The most widely-cited studies focus on the question of how much can be safely withdrawn, and over what time period, without depleting the principal.

The Right Withdrawal Rate

Financial advisors can and should tailor their estimation of the right withdrawal rate to the particular circumstances, needs, and proclivities of each client. When asked to suggest a “rate of thumb,” however, they usually fall back on a conservative standard – a rate that will not deplete principal over a long retirement – or an even-more-conservative standard – a rate that will keep principal from declining.

The most widely-cited studies of this issue were conducted around the turn of the twenty-first century. They suggested that a withdrawal rate of 4-6% would probably not deplete principal, although the risk of doing so seemed to rise steeply once the rate reached 5%. (Another factor affecting the withdrawal rate is the rate of return earned in retirement, which depends on the allocation of retirement assets. The larger the equity allocation, the higher is the permissible withdrawal rate.) Today, 10 years later, financial advisors have lowered their sights markedly, picking 3-3.5% as the rate of thumb. What accounts for this change?

Over that 10-year interval, stocks have turned in their worst performance ever, with a negative rate of return. That has reduced the historical rate of return to equity, which in turn has driven down the highest permissible rates. The recent financial crisis has almost certainly exerted a downward psychological pull, leading planners to pull in their horns in case the recession stretches out over the next decade.

Other Important Parameters

Other parameters also affect the right withdrawal rate. Life expectancy at age 65 has increased dramatically over the last half of the twentieth century. All other things equal, a longer withdrawal period lowers the withdrawal rate consistent with non-depletion of principal.

Interest rates are a key determinant of the right withdrawal rate. Higher interest rates produce lower bond prices, reducing the value of a bond portfolio. This is a difficult parameter to gauge, however, since the higher rate will also increase the interest yield on both fixed-income and liquid assets.

Expenses in retirement can vary widely for different households. In particular, debt can eat up income otherwise available for consumption. The more debt (or other expenses), the lower is the permissible withdrawal rate.

How Do Annuities Fit Into This Picture?

After reading the foregoing, how much would you pay to simply forget about all potential complications and settle for a guaranteed income for life? That is the concept underlying most annuities. Its attractions obviously depend on the size of the guaranteed payment, as well as the solidity of its guarantee. Since the rate of return on an annuity varies directly with the length of the annuitant’s life, the trend toward increased life expectancy certainly favors the annuity.

Perhaps the biggest plus for annuities – especially equity indexed annuities – is the elimination of the need to guess about future stock prices, interest rates, and longevity. The world’s greatest experts cannot forecast these parameters with much precision. It is very likely that, in hindsight, there will be a particular allocation of stocks, bonds, and real assets that will outperform the annuity. The problem is that we cannot know this allocation in advance, so we cannot guarantee that it will find its way into our portfolio.

If we compare the annuity payout with an optimal withdrawal rate and asset allocation chosen after the fact, the annuity will likely come out second best. That is hardly a decisive argument against annuities, however, since there is no particular reason to believe that the choices we actually make will be the optimal ones. Annuities give us a reasonable outcome, guaranteed, compared to the prospect, but not the promise, of a better outcome if we make the right choices.

Annuities: The Dark Horse Choice

It is ironic that, given all the lip service paid to the concept of security, the only asset able to provide lifetime security of income is not even-better understood and utilized. The reasons for the dark-horse status of annuities are many and complex, but the fact remains that a life annuity is probably the best, most secure way to provide guaranteed income for life. The quickest way to realize this is to sit down and try to compute the right withdrawal rate on your retirement savings. Afterward, check out the best deal on a life annuity. Ask yourself if the incremental gain in income is worth sacrificing the security of the life annuity.

No related posts.

Quick post on debit card usage

After spending what seemed like an eternity in airplanes, and getting a taste of the Delhi fog, I am finally home for my vacation, and having a great time here.

I thought I’d write about a couple of things in a quick post, as I found a free hour or so today.

First the fog: I can’t describe how much fog there was last week. You had to see it to believe it. Our flight managed to land somehow, but the pilots weren’t able to see very much so they didn’t taxi the airport to get to the gates. Instead, buses came to the plane and whisked away the passengers, and that took forever. I am just glad we were able to land and that didn’t get delayed, well not by much anyway.

Next; some fun I am having with my debit card: This time I have to do a fair bit of shopping, and since all my Indian credit cards have expired, I am heavily dependent on my debit card.

It has become harder to use debit cards because of some new RBI regulations to prevent fraud, and I am facing a bit of trouble in using my debit card for slightly bigger amounts.

I thought I’d do a post on what I have learned over the past few days.

1. Maximum limit of Rs.25,000 per day: I was told that there is a maximum limit of Rs25,000 per day on transactions on your debit card. You can’t make a transaction of more than Rs.25,000 for a day on a debit card. I know this is only partially true because my ICICI debit card was only allowed Rs. 25,000 for a transaction, whereas my uncle used his SBI debit card, and the transaction went through for Rs. 50,000. So, there is definitely a limit, and for a lot of people it is going to be Rs.25000, I am just not sure whether it is Rs.25,000 for everyone.

2. Maximum withdrawal limit of Rs.10,000 per swipe on the ATM: There seems to be some rule that says you can’t withdraw more than Rs.10,000 by swiping your card once at the ATM. The maximum limit is Rs.25,000 in a day, and if you want to withdraw that much, — you have to make three transactions at the ATM. Again, at least a couple of friends told me that the limit is Rs.15,000, but I saw Rs. 10,000 when I went to my ICICI bank ATM.

Now, the fun part is that you can transact thrice and withdraw 25k, but they won’t let you do that at one go.  There must be some good in this, but I can’t think how this helps anyone right now.

3. The two limits above don’t come in each other’s way: You can withdraw 25,000 from the ATM and make a transaction worth that much in the same day. It seems that you can first withdraw 25k, and then go to the store and swipe for another 25k. That works just fine.

If you are planning to buy stuff worth more than Rs. 25,000 with your debit card, then you might face some of these troubles too. The best way to overcome this is to use a credit card on which the only limit is your own spending limit.

Since I don’t have that luxury right now, I am forced to withdraw cash and use the debit card, use a combination of debit and credit cards for the bigger purchases, and in one instance, I was able to pay by check also.

I don’t have any other ideas to deal with this situation, and welcome your suggestions on this. These rules caught a lot of my family by surprise too so I thought that even a post that details the issues without the solutions might be of assistance to a few.

No related posts.