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Retiree Financial Advise
by Larry Klein
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Potential Danger for Retirees When Interest Rates Are Low
If you own bonds or bond funds, you know by now that the prices of fixed income securities move inversely with interest rates. Therefore, it seems that the best time to buy bonds or bond funds is when interest rates are high. Not only do you lock in a high rate, if interest rates subsequently decline, fixed income securities appreciate.
Correspondingly, the worst time to own or buy fixed income securities is when interest rates are low. You get a low rate locked in and if interest rates subsequently rise, you will suffer a decline in value. What solutions are there for fixed income investors?
If you buy individual bonds and hold them to maturity, then fluctuations in interest do not matter, as you will receive the face value of the bond at maturity. Fluctuations are a concern only if you sell bonds prior to maturity and must accept market value. Bond funds however do not have a maturity date so there is no date when you have assurance of recouping your original principal (it will be higher or lower than your original investment). Additionally, many bond fund investors do not realize that there is a trade off in bond funds. Funds that pay lower dividends have higher price stability and vice versa.
Therefore, you should check that your fund managers actively change the term of the bonds in the portfolio, if these price fluctuations are a concern to you. By switching to sorter term bonds during periods of low rates, subsequent fluctuation in the fund share value will be minimized. However, such a fund that acts to protect your principal will need to cut the fund dividend because short-term bonds pay less interest. Some investors flock to funds with the highest dividends (usually payable by investing in longer-term, higher interest bonds), and they soon learn that funds with long-term securities will fluctuate more in value.
Here's a recommendation. If you own the bond fund because you rely on the monthly dividend, then stay with long-term bond funds and ignore the fluctuations. If you reinvest the dividend and will not be holding the fund for a long a period of time, then get into a shorter-term fund.
Why Would a Retiree Own Life Insurance?
Traditionally, life insurance is purchased during your working years to replace your income for your family in case you died. But if you're retired, do you still need life insurance? Yes. There may be three reasons to own a policy:
1. Because many couples are dependent upon two social security checks or two pension checks, and when one spouse passes away, the other spouse finds that the income falls but many of the expenses and lifestyle requirements remain. The inexpensive way to protect against this is to own term life insurance.
Recently, I obtained a $100,000 policy for a 70-year-old male for a premium of $200 monthly. If he predeceases his wife (women statistically outlive men by 7 years), his wife will receive this $100,000. Invested for income at 8% (a hypothetical rate), this would produce $8,000 annually of income to offset the loss of his social security check. If used up over her lifetime, (assumed to be another 7 years), the principal plus interest would generate over $17,000 annually for the wife.
2. For estate planning reasons. Let's say you've developed your net worth by owning real property. One son takes an active interest and manages most of your property. The other son lives 2,000 miles away, travels around the globe as an archeologist and has no interest in the properties. Maybe you want to leave the properties to the son who cares for them but are concerned what to leave the other son. Easy answer, buy life insurance and name the archeologist as the beneficiary.
Or if your estate is over $1 million, the excess is subject to estate taxes at hefty rates. A simple, often inexpensive, way to pay the tax without taking money from the beneficiaries to do so is to have a life insurance policy to pay the tax.
3. To make the most of your IRA or retirement plan. Say you are age 70 and it's time to start taking mandatory distributions from your IRA. Let's assume the distributions are a hypothetical $15,000 annually. If you invested that at a hypothetical 8 percent (5.2 percent net after combined taxes of 35 percent), you would accumulate $190,439. Take that same amount and buy life insurance, and upon death your heirs get $1.25 million. You can do the same if you have a qualified retirement plan but the numbers are even better as you can purchase the policy inside the plan with pre-tax dollars.
There are some very powerful ways to use a policy you already own or use a new policy to achieve financial goals for your family. Check with your advisor about these options.
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