Objective information about financial planning, investments, and retirement plans

7 Reasons to Avoid 401(k) Loans

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One of the features of many 401(k) plans is the ability for participants to take a loan against their balance.  There are rules governing what the loans can be used for, the number of loans that can be outstanding at one time, and the percentage of your account balance that can be borrowed.  Additionally there is a time limit by which these loans need to be repaid.

It is the decision of the organization sponsoring the plan whether or not to allow loans and also as to what they can be used for.  Typical reasons allowed are for college expenses for your children, medical expenses, the purchase of a home, or to prevent eviction from your home.

The flexibility offered by allowing loans is often touted as one of the good features of the 401(k).  However taking a loan from your 401(k) also carries some downsides.  Here are 7 reasons to avoid 401(k) loans.  

Leaving your job triggers repayment 

If you leave your job with an outstanding loan against your 401(k) account the balance can become due and payable immediately.  This applies whether you leave your job voluntarily or involuntarily via some sort of termination.  While your regularly scheduled repayments are deducted from your paycheck, you will need to come up with the funds to repay the loan upon leaving your job or it will become a taxable distribution.  Additionally if you are under 59 ½ a 10% penalty might also apply.

Opportunity costs in a rising market

While loan repayments do carry an interest component which you essentially pay to yourself, the interest rate might be much lower than what you might have earned on your investments in the plan during a rising stock market.  Obviously this will depend upon the market conditions and how you would have invested the money.  This can lead to a lower balance at retirement resulting in a lower standard of living or possibly necessitating that you work longer than you had planned.

There are fees involved 

There are often fees for loan origination, administration, and maintenance which you will be responsible for paying.

Interest is not tax deductible 

Even if the purpose of the loan is to purchase your principal residence interest on 401(k) loans is not tax-deductible.

No flexibility in the repayment terms 

The loan payments are taken from your paycheck which all things being equal will reduce the amount of money you bring home each pay period.  If you run into financial difficulty you cannot change the terms of the loan repayment.

You might be tempted to reduce your 401(k) deferrals 

The fact that you now have to repay the loan from your paycheck might cause you to reduce the amount you are saving for retirement via your salary deferral to the plan.

You will have less at retirement 

A loan against your 401(k) plan will result in lower nest egg at retirement.  Given the difficulty many in the United States already have in accumulating a sufficient amount for retirement this only adds to the problem.

You should especially avoid 401(k) loans if:

  • You are near retirement
  • You feel that your job security is in jeopardy
  • You are planning to leave your job in the near future
  • You are already behind in saving for retirement
  • You have other sources to obtain the money you need
  • You feel that repaying the loan will be financial hardship 

Look life happens and sometimes taking a loan from your 401(k) plan can’t be avoided.  The economy has been tough for many over the past few years.  However if at all possible avoid taking a 401(k) loan and rather let that money grow for your retirement.  Down the road you will be glad you did.

8 Year-End Financial Planning Tips for 2014

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When I thought about this post I looked back at a post written about a year ago cleverly titled 7 Year-End 2013 Financial Planning Tips.  The year-end 2014 version isn’t radically different but it’s also not the same either.

Here are 8 year-end financial planning tips for 2014 that you might consider:

Consider appreciated investments for charitable giving 

This was a good idea last year and in fact always has been.  Many organizations have the capability to accept shares of individual stocks, ETFs, mutual funds, closed-end funds and other investment vehicles.  The advantage to you as the donor is that you receive a charitable deduction equal to the fair market value of the security on the date of the completed transfer to the charity.  Additionally you will not owe any tax on the gains in the investment unlike if you were to sell it.

This does not work with investments showing a loss since purchase and of course is not applicable for investments held in tax-deferred accounts such as an IRA.  I suggest consulting with a financial or tax advisor here.

Match gains and losses in your portfolio 

With the stock market having another solid year, though not nearly as good as 2013 was, year-end represents a good time to go through the taxable portion of your investment portfolio to review your gains and losses.  This is a sub-set of the rebalancing process discussed below.

Note to the extent that recognized capital losses exceed your recognized gains you can deduct an extra $3,000.  Additional losses can be carried over.  This is another case where you will want to consult a tax or financial advisor as this can get a bit complex.

Rebalance your portfolio 

With several stock market indexes at or near record highs again you could find yourself with a higher allocation to stocks across your portfolio than your financial plan calls for.  This is exposing your portfolio to more risk than anticipated.  While many of the pundits are calling for continued stock market gains through 2015, they just could be wrong.

When rebalancing take a look at all investment accounts including your 401(k), any IRAs, taxable accounts, etc.  Look at all of your investments as a consolidated portfolio.  While you are at it this is a good time to check on any changes to the lineup in your company retirement plan.  Many companies use the fall open enrollment event to also roll out changes to the 401(k) plan.

Start a self-employed retirement plan 

There are a number of retirement plan options for the self-employed.  Some such as a Solo 401(k) and pension plan require that you have the plan established prior to the end of the year if you want to make a contribution for 2014.  You work too hard not fund a retirement for yourself.

Take your required minimum distributions

If you are one of the many people who need to take a required minimum distribution from a retirement plan account prior to the end of the year you really need to get on this now.  The penalties for failing to take the distribution are steep and you will still owe the applicable income taxes on the amount of the distribution.

Use caution when buying mutual funds in taxable accounts 

This is always good advice around this time of year, but is especially important this year with many funds making large distributions.  Many mutual funds declare distributions near year-end.  You want to be careful to wait until after the date of record to buy into a fund in your taxable account in order to avoid receiving a taxable distribution based on a few days of fund ownership.  The better path, if possible, is to wait to buy the fund after the distribution has been made.  This is not an issue in a tax-deferred account such as an IRA.

Have a family financial meeting 

With many families getting together for the holidays this is a great time to hold a family financial meeting.  It is especially important for adult children and their parents to be on the same page regarding issues such as the location of the parent’s important documents like their wills and what would happen in the event of a long-term care situationWhile life events will happen, preparation and communication among family members before such an event can make dealing with any situation a bit easier. 

Get a financial plan in place 

What better time of year to get your arms around your financial situation?  If you have a financial plan in place review it and perhaps meet with your advisor to make any needed revisions.  If you don’t have one then find a qualified fee-only financial advisor to help you.  Just like any journey, achieving your financial goals requires a roadmap.  Why start the journey without one?

If you are more of a do-it-yourselfer, check out an online service like Personal Capitalor purchase the latest version of Quicken.

These are just a few year-end financial planning tips.  Everyone’s situation is different and this could dictate other year-end financial priorities for you.

The end of the year is a busy time with the holidays, parties, family get-togethers, and the like.  Make sure that your finances are in shape for the end of the year and beyond.  

Family Financial Conversations

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Family financial conversations dealing with retirement, estate planning, elder care issues and other important financial matters between parents and adult children can be difficult at best.  A recent article by Fidelity highlighted some of the key issues involved.

According to Fidelity:

“In life and money, timing is often everything. And that’s particularly true when it comes to sensitive family discussions about retirement security, eldercare, and estate planning.

According to Fidelity’s latest Intra-Family Generational Finance study,1 three-fourths of parents and their adult children agree it’s important to have frank conversations on such topics, but almost two-thirds (64%) can’t agree on when. While parents would prefer to wait until after retirement, their children want the conversations to take place well before their parents retire or experience health issues.” 

“These discussions aren’t always easy, but there can be real emotional and financial consequences when they don’t happen or lack sufficient depth,” says John Sweeney, executive vice president of retirement and investing strategies at Fidelity. “It’s absolutely critical that families come together to sort through important matters related to such things as retirement preparedness, caregiving responsibilities, estate planning, and the tax implications of an inheritance.”

Suggestions for successful family financial conversations

 

How to have key family discussions

While these steps suggested in the Fidelity piece are no guarantee of a successful dialog, I think you will agree these steps offer a solid framework for these often difficult conversations.

PREP for family financial conversations

 The Fidelity piece offered this outline (their PREP plan) to break the ice and get these family meetings going: 

Make family meetings on retirement issues easier

While every family and every family’s situation is different, this is a good framework from which to start.

What’s at stake?

These conversations can be difficult because there is a lot at stake.

  • How will your parents provide for their retirement?
  • Where will the money come from in the event of a Long-Term Care situation?
  • Who will take over your parent’s financial affairs in the event they become unable to do so?
  • What are your parent’s wishes in terms of a myriad of issues including disposition of their assets upon their death, burial, staying in their home, etc.? 

Besides these issues a lack of communication and planning can be costly to the family in terms of taxes and other issues in terms of transferring your parent’s wealth to the next generation.  While this might sound like it only pertains to the very wealthy this is not the case.

At the end of the day what is really at stake is the opportunity for parents to communicate their financial wishes to their adult children and for the children to help their parents make these desires come true.

There is nothing easy about discussing these issues and having these family financial conversations.  But any difficulties that might exist will be dwarfed by the potential guilt and regret felt by both parents and children later on if this dialog does not occur.

Please check out our Book Store for books on financial planning, retirement, and related topics as well as any Amazon shopping needs you may have (or just click on the link below).  The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.  If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra. 

Dangerous Myths About Asset Protection

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This is post was written by Ike Devji, a Phoenix, AZ-based asset protection attorney and one of my oldest online friends.  I have spoken with Ike many times for advice on client asset protection issues and had the pleasure of meeting him in person a couple of years ago when he spoke to my financial advisor study group during a meeting we held in Phoenix.  Ike generally advises physicians and high income professionals, but these asset protection tips are relevant to all of us. 

I’ve spent the last eleven years of my practice helping successful Americans at all net worth levels protect and enjoy their hard earned wealth. A good part of that involves re-educating people about their money and their risks.  Below is a summary of the most common asset protection myths and mistakes top legal and financial planners want their clients to be concerned about.

Trumbull County Courthouse, Courthouse Square ...

I can do it later 

Asset Protection it best analogized to “net worth insurance” and like insurance you have the best, most effective and legally supportable options available to you when you implement the planning before a crisis exists. Transfer of assets into plans after you have specific exposures is costly, ineffective and some cases illegal (fraudulent conveyance). The best time to act is always now and every day that passes makes your planning stronger.

I’m not rich enough to worry about asset protection  

This is a sin I see committed on a weekly basis, often by professionals like lawyers, CPAs and financial advisors. These advisors often tell clients that they are not rich enough to do any planning and that that they should have a net worth north of five or even ten million dollars to consider it. Nothing could be further from the truth, especially if you are in the “Fall” of your earning career. Of course high net worth individuals must implement this kind of planning and always have, but all you have is important to you and there are precautions that can be taken at any net worth level. When should you start?

There are many simple ways to analyze this but here is an easy one, answer these questions: 

  • If you lost what you have today, or some significant portion of it, are you at an age, earning level and financial condition that will allow you to maintain your family’s goals and expenses?
  • Do you have assets that would be difficult or impossible to replace given your age, health and economic conditions?
  • Are you financially and legally prepared for a lawsuit that is either not covered by liability insurance or which often produces verdicts above the limit you are carrying?

No one can touch me because I have a “Trust”

Not a week passes when I don’t talk to someone who says, “I’ve got this covered, I think. I have my home, cars, and investments all titled in my Trust.” A little more probing on my part reveals what I expected, that the layperson I am speaking to feels that a transfer of these assets to a vehicle like an estate planning trust, commonly a Revocable Living Trust, is effective protection; it’s not. The first word in the trust is “revocable” and in most cases a judge will simply order you to revoke the trust and tender the assets for a judgment. I’m all in favor of estate planning, the huge new looming estate tax exposure is one of the issues on my client exposure checklist we address every day, but  that is death planning. What has been done about your life planning and the exposures you face every day practicing your profession, driving a car, having children (some driving your car), or having employees…?

I lease all my vehicles through my business and get an awesome tax deduction in addition to asset protection 

Similarly, we often see dangerous articles of personal property like your personal vehicles moved into this structure or others like an LLC or S-Corp that is your primary business, or equally dangerous, into an entity like an FLP that is holding safe and attractive assets like cash, stocks, bonds and other liquid assets. Think about it, if you lease or own your vehicle through your business, you have linked the most dangerous thing you likely do on a daily basis, drive a car, and linked it to either the source of your wealth, your business or in the case of your FLP, the place you keep your wealth. 

I don’t own anything – I gave it all to my wife and kids 

Transferring all of your assets to your spouse and/or children, especially after something has happened, will not protect your assets from a lawsuit. Even if it did protect you from your lawsuits, transferring your assets to your spouse and/or children opens up another Pandora’s Box. Keeping in mind that there are thousands of lawsuits filed daily due to employment grievances, “slip and fall” and auto accidents, consider this scenario:

Let’s suppose that you transfer all of your assets to your 18-year old son who causes an auto accident. Several other cars are involved in the accident and several injuries are incurred. Chances are high that the other parties will come looking for the driver with the deepest pockets. If your son “owns” your house and business, a sympathetic jury will undoubtedly take the possession away from your son in order to teach him a lesson for his reckless driving. The same holds true for spouses, parents and even friends. Also, gifting is limited to about $14K annually, per spouse, per donee. Gifts over that amount must be documented with a gift tax return. Failing to do so will result in you having to answer the question, “Are you lying now re: the date and validity of this transfer or did you cheat the IRS?” A bad place to be in a time of need.

I’m insured and have an umbrella

This is a reasonable and common question we get from clients and advisors alike. In the most egregious cases of arm-chair quarterback misinformation, we actually see uninformed advisors telling their clients that the only Asset Protection they need is a good umbrella policy – THIS IS FLAT OUT WRONG for the kind of successful people we protect. Why? Because they are successful, visible and typically have assets above and beyond just the insurance policy itself, they are good targets from a net-worth perspective.

Our position on Liability Insurance (as distinct from Life Insurance) is pretty simple: Buy as much liability insurance as you can afford, assume it won’t be adequate and have a plan B. Asset protection planning is about layers, redundancy and backstops.

What about my “umbrella” policy? – It is a great idea to have an umbrella policy, in fact, I insist on it for my clients as one of several layers.  You and your liability carrier have different ideas about what umbrella means. To you it means everything, to your carrier it means specific events in the base policy, covered to specific increased limits, and governed by a specific set of exclusions detailed in the fine print of your policy. Clearly two very different definitions. The lesson here is that there is no real way to insure yourself against a universe of possible exposures and have every single one covered to an unlimited dollar amount, nor is this reasonable to expect of your liability coverage.

Some real examples of the “impossible” that actually happened and resulted in large claims: 

  • Parents away for the weekend return to find that a teenager died at their home during a party their child had from the drugs he brought with him results in multi-million dollar wrongful death lawsuit;
  • Chiropractor adjusts a patient’s hip and the woman dies on table from cardiac arrest-he is sued for wrongful death;
  • Long time, most trusted employee of medical practice molests a minor female patient during treatment;
  • Employees of moving company get drunk and severely beat another employee and lock him in company truck in company yard over weekend;
  • LLC for real estate development is pierced and a passive member is held jointly and severally liable for the actions of the other members;
  • Dentist works on elderly patient who goes home and dies of unrelated heart attack hours later, dentist sued for wrongful death. 

SOLUTION – So how do we help make sure that the coverage is enough? Pretty simple – we buy all the insurance we can reasonably afford, make sure we have the appropriate riders and umbrellas in place then we present a hard, uncollectible target beyond the limits of the policy. Most, if not all, lawsuits are motivated by the potential financial gain to the plaintiff and their attorney. In most cases, plaintiffs and their attorneys don’t chase people beyond the limits of the policy if there is nothing else to take or if there is nothing that they can get their hands on with any reasonable certainty.

This article just scratches the surface of what you need to consider when evaluating your exposures, Asset Protection planning and the countless options available. I encourage you to act today, seek experienced counsel, and remember that information in forums like this is not specific to you, is written in the broadest terms and is never a substitute for consulting with an experienced professional.

Attorney Ike Devji has a decade of practice devoted exclusively to Asset Protection and Wealth Preservation planning. He works with a national client base including 1000’s of physicians and business owners often through their local attorney, CPA or financial advisor. Together, he and his associates protect billions of dollars in personal assets for these clients. Ike also regularly writes, teaches and speaks on these issues to executives, physicians and other professionals nationally. See his work in WORTH, Advisor Today, Physician’s Practice and at www.ProAssetProtection.Com.

As always, the information presented here is general and educational and can never replace the advice of experienced counsel specific to your assets or situation. 

Please check out our Book Store for books on financial planning, retirement, and related topics as well as any Amazon shopping needs you may have (or just click on the link below).  The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.  If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra. 

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Indexed Annuities – Pros and Cons

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A recent article by Investment News’ outstanding insurance and retirement products reporter Darla Marcado discussed the increased popularity of indexed annuity products (link may require free registration) among registered reps.  The zealousness with which these products are often sold sadly invokes images of the annual Canadian baby seal hunts in which the animals are often clubbed to death so as not to damage their valuable hides, with the remains then left to rot once the hides are removed.

Indexed Annuities – Pros and Cons

As with any financial product it is a good idea to look at the pros and cons of Indexed Annuities.

Indexed Annuities – Pros

For the life of me I cannot come up with a single reason why I would ever recommend an Indexed Annuity to anyone.  To be sure I wasn’t missing something I posed this question to my fee-only advisor study group recently and they agreed.

Indexed Annuities – Cons 

Unreasonably long surrender periodsI’ve reviewed a number of these contracts over the past couple of years and they all seem to have surrender periods of ten years or longer.  I can’t see giving your money to anyone who won’t let you have access to it for a decade.  You can of course annuitize and most contracts allow for the withdrawal of a portion (usually 10%) each year, but you’re prohibited from doing a 1035 exchange to another annuity contract if you find a better deal.

High fees and commissions.  These fees serve to reduce your returns and are often hard if not impossible to determine.  They can run in the 5% – 10% range and provide a great incentive for financial sales types to really push these products.  Make sure you demand that your rep disclose ALL commissions and fees that she might earn should you buy a contract.

They can be hard to understand.  With any financial product you should never even consider writing a check until you fully understand how it works and why it’s beneficial to you.  The premise is typically that you will participate in a portion of any gains on an underlying market benchmark such as the S&P 500 and that there is some minimum amount of return that you will make no matter how the index performs.  Make sure you understand the underlying formulas that determine your return and any factors that might cause a change in the formula.  Check out FINRA’s Investor Alert on Indexed Annuities as well.

Limited upside potential.  It is important for you to understand that this is not an equity investment.  Most contracts limit your participation in the underlying index.  For example in 2013 the S&P 500 gained over 32% so if your participation was limited to say 8% you would have missed out on a lot of the gain.

Confusing sales pitches. While technically not a feature of the product, it seems like the sales pitches for Indexed Annuities change to fit the times.  In the wake of the financial crises the fear mongering sales pitch was along the lines of avoiding the risk of the stock market while still participating in the upside.  These days it seems to be about the minimum returns as an alternative low-yielding CDs and other bank depository products.  Sorry there is no “wonder drug” financial product that I’m aware of.

Look this blog is not meant to provide readers with specific financial advice for their unique situation so please at the very least if someone is pitching you an Indexed Annuity (or any other financial product for that matter) ask them and yourself a few basic questions:

  • What’s in this for the financial sales person?  Is this recommendation based upon my best interests or based upon them earning a hefty commission?
  • Does this product make sense for me based upon my situation, my goals?
  • Do I understand how this product works including the upside potential and the downside risks?
  • What are the underlying expenses?  Is there a lower cost alternative that I’m not being made aware of?
  • Is this the best version of this type of product or just the version the sales person has available to sell to me? 

As with any financial product make sure you are buying an Indexed Annuity because it is right for you and not because you succumbed to a convincing sales pitch.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.

Please check out our Book Store for books on financial planning, retirement, and related topics as well as any Amazon shopping needs you may have (or just click on the link below).  The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.  If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra.

  

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Financial Advice and Mini Bottles of Liquor

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Regular readers here know that the inspiration for some of my blog posts comes from non-financial sources such as youth soccer fields and the Rolling Stones.  In that spirit the idea for this post popped into my head while waiting in line to pay for an item at a local gas station.

Financial Advice and Small Bottles of Liquor

I noticed the clerk behind the counter restocking the very prominent display case with mini bottles of liquor of the type you would buy on an airplane.  When I asked if they sell a lot of these she indicated that I would be surprised and I was.  This is the last place that I would think of buying mini bottles of liquor.  My hope is that the contents are not being consumed en route from the gas station.

I liken this to some of the places that people seek financial advice.  Are you getting financial advice from someone best positioned to advise you or simply from where it is convenient to obtain it?  Here are a few thoughts on some of the alternative sources available to you when seeking financial advice.

Insurance companies and agents

We have had our auto, homeowner’s, and person umbrella policies with an agent affiliated with a major insurance company for years.  Our agent is great and has provided outstanding service.  His company made a big push into providing personal financial planning largely to tap into their vast customer base to try to sell various financial products to these customers.  When I asked my agent if he was now going to become a financial planner he just kind of grumbled as he wanted no part of this.

My experience is that insurance companies are looking to sell annuities and other insurance-based products as their answer to your financial and retirement planning needs.  Many of these companies also offer their own proprietary families of mutual funds and other investment vehicles.  As with anything you need to understand the motivations and capabilities of the person trying to sell these products to you.  Is this agent qualified to provide you with unbiased financial advice or do all questions lead to a solution that involves the sale of a variable annuity or a related product?

Banks offering financial advice

Many banks offer investment and financial advice across a number of formats.  It’s not uncommon to have a registered rep at the branch selling various financial products.  The bank may even have their own line of mutual funds and their own brokerage operation.

Other banks have in-house or affiliated investment advisory operations which offer investment and perhaps wealth management services for a fee as opposed to the commission-based services mentioned above.

Again banks view this as a way to expand their service offerings and broaden their revenue streams by tapping into their depositor base.  As with any financial services provider you need to understand what your bank offers, how they offer it, any potential conflicts of interest, and most of all if this type of arrangement is right for you. 

CPAs offering financial advice

CPAs have rightly earned a reputation as a trusted advisor, especially for business owners.  The good ones offer a range of tax and financial advice that is invaluable.  Many CPAs have ventured into the business of offering investment and financial advice as well.  They realize that this is an excellent revenue stream, often a better one than they can generate via their core business.

As with other providers of financial advice you want to understand that if your CPA is qualified to provide financial planning and investment advice as this is a different knowledge base than his or her normal world.  A few other considerations:

  • Does the CPA have specific knowledge or training here?  A designation such as the CFP® or the PFS (the CPA equivalent) can be good evidence of training and commitment to this area.
  • What happens during tax season?  Are they available to answer your questions and monitor your situation?
  • Is the advice offered as an RIA (Registered Investment Advisor) or via a Broker-Dealer type arrangement?  In the latter case the CPA is likely engaging in advice via the sale of commissioned financial and insurance products.   

Financial Planners 

The term financial planner can be used by anyone so you will want to understand a few things about how any financial planner operates before determining if this is the right advisor for you.

  • What are the financial planner’s credentials and training?  Does he/she hold a CFP® or some similar designation?
  • How is the financial planner compensated?  Fee-only?  Commissions?  A combination of fees and commissions?  It is important for you to understand if there will be any conflicts of interest involved in the delivery of financial advice.
  • What type of financial advice does the financial planner offer?  Hourly as needed?  Comprehensive financial planning? Investment advice and wealth management?  More importantly is this the type of advice that you need?
  • Who are the financial planner’s typical clients?  If you are 60 and nearing retirement an advisor who specializes in clients in their 20s and 30s is probably not the right advisor for you.
  • Check out NAPFA’s guide to finding an advisor for some tips on choosing the right financial advisor for you.  

I’m often puzzled by the process used by many folks in choosing a financial advisor, but I guess it is no stranger than buying mini bottles of liquor at a gas station.  Choosing the right financial advisor can be very rewarding, choosing the wrong advisor can have a devastating impact on your financial life.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.

Please check out our Book Store for books on financial planning, retirement, and related topics as well as any Amazon shopping needs you may have (or just click on the link below).  The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.  If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra.

  

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7 Questions to Ask Before Buying a Variable Annuity

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Variable annuities are often touted as an ideal retirement investing vehicle, especially by financial advisors who sell them.  Variable annuities can be a useful vehicle for retirement accumulation.  However variable annuities (and other types of annuities) are quite often misunderstood by those who are the targets of these sales pitches.  Is a variable annuity right for you?  Here are 7 questions to ask before buying a variable annuity.

What does a variable annuity do for me that I can’t accomplish outside of a variable annuity? 

This is a great question and if you ask your annuity sales person you will get a variety of answers.  I’m certainly not anti-variable annuity, but they are not the wonder drug that many brokers and registered reps selling them would have us believe.  Make sure that you ask the next person who makes a variable annuity sales pitch this very question (and a few others) and listen to their explanation.  Maybe you will get a cogent, sensible answer maybe not.

Will I eventually annuitize the contract? 

One of the benefits of any form of an annuity is the ability to create a stream of income in retirement.  This is the reason for the mortality and expense charges in every contract, this is the insurance company’s compensation for your option to annuitize the contract in the future.  If this isn’t something that you are likely to do perhaps a variable annuity is not the answer for you.  At the very least find one with reasonable expenses.

Have I maximized my contributions to my 401(k), my IRAs, and other retirement plans? 

In my experience contributing to your 401(k) or similar workplace retirement plan and to your IRAs provide a better retirement savings vehicle than a variable annuity, if for no other reason than they usually have lower expenses and don’t have restrictions like surrender charges.  In fact I often put a variable annuity lower on the list than investing in a taxable account, though this will vary person by person based on each individual’s situation.

What are the expenses? 

As mentioned above many variable annuities are laden with onerous expenses that enrich the insurance company and perhaps the person who sold you the annuity, but likely not you.  There are many lower cost annuity products offered by the likes of Vanguard and others that may be worth checking out if a variable annuity is of interest.  A fee-only advisor will likely go in this direction, but an annuity sales person can’t as there is no compensation in it for them.

What are my investment options? 

Years ago there was an SNL skit that referenced something called “bef” which was almost like beef, but wasn’t.  This is similar to the variable annuity world where the investment options are called sub-accounts.  They look, feel, and smell like mutual funds but they aren’t mutual funds.  They might even have familiar mutual fund sounding names, but they are still different and generally pricier.  Understand the investments as this is the vehicle that will fuel your accumulation in the variable annuity.

Are there restrictions if I want to move my money? 

As they used to say on Rowan and Martin’s Laugh-In (NBC from 1968-1973) “… you bet your sweet Bippy…” there are restrictions on moving your money from a variable annuity in most cases.  While I can understand taxes and perhaps penalties for withdrawing prior to age 59 ½, the surrender charges on many variable annuities serve to hold your money captive for as many as 10 years even if you find a better deal down the road.  Make sure you understand any and all surrender charges and other penalties before buying into a variable annuity and better yet avoid financial products with these charges.

Who stands behind the product? 

Annuities are guaranteed by the “full faith” of the insurance company offering the product.  Be sure to investigate the financial strength of the issuer as they are the ones responsible for making any annuity payments you might opt for.  While annuity defaults are quite rare they do happen and if it does your recourse is likely with a regulator.

Variable annuities are a valid retirement planning tool.  Just make sure that you understand what you are buying, why you are buying it, and ALL of the underlying expenses involved.  Make sure that you buy the product for the right reasons and not because you succumbed to an aggressive sales pitch.

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