Marketplace

Monitoring Financial Institutions

Question: In tough times like these, how do I monitor the health of my insurance company and bank? Sure the bank is FDIC insured but getting money back from the government can't be easy or efficient, how do I protect myself? Thanks in advance, Tim

Answer: This is a timely question. Federal Reserve Board chairman Ben Bernanke recently testified before Congress that he expects some small banks to fail. A number of insurance companies have also reported losses from subprime mortgage investments.

As you mention, the key with banks is to make sure it is backstopped by the Federal Deposit Insurance Corporation. The FDIC website has a clear explanation of the insurance basics. The basic insurance amount is $100,000 per depositor per insured bank. However, certain retirement accounts like IRAs, are insured up to $250,000 per depositor per insured bank. Now, there are a variety of ways to increase that insurance limit depending on the type of account. But most people are well below that $100,000 and, if that's the case, the FDIC is good sleep insurance. By the way, the FDIC has a sound reputation for restoring access to your money after a bank failure. This is from their website:

It is the FDIC's goal to make deposit insurance payments within one business day of the failure of the insured institution. Typically, a bank that has failed will be closed on a Friday. The FDIC will then work the weekend to complete deposit insurance determinations for most deposits and be prepared on Monday to either transfer the insured portion of a deposit to another FDIC insured institution or provide deposit insurance payment checks.

Insurance companies are regulated by the states, and the track record of state regulation is uneven (to put it charitably). Even the information for concerned consumers isn't easy to find. For instance, if you head to the FDIC website you can get most if not all of your questions answered. Now try and do the same information at the National Association of Insurance Commissioners website, the umbrella organization for state insurance commissioners.

Anyway, property and casualty, life and health insurers are backed by various state "guaranty funds". Here is the money quote from the National Organization of Life & Health Insurance Guaranty Associations:

Insurance companies that experience severe financial difficulties are taken over by the insurance department of the state in which they are based. You should be notified by the insurance department if this occurs. Even if the company is placed under the control of the insurance department, claims will continue to be honored as long as premiums are paid or cash value exists. The claims will be covered by state guaranty associations, which will either pay them directly or transfer the policies to a financially stable insurance company.

When it comes to insurance companies you'll want an extra layer of financial comfort. I prefer blue chip companies with high credit ratings from Moodys and Standard & Poor's.

03/03/08 by Chris Farrell

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A, B, C, Shares, And So On

Question: I have some investment and savings questions. I'm 24 with about 12,000 in CDs and no debt. I recently went to a financial planner from Primerica Financial Services. They are suggesting for me to open up a Roth IRA with one of their Mutual Funds...to be determined. Because I am going to have these funds for the long haul should I buy A or B shares? They have suggested B. Are there calculators available see what the difference will be for the different shares because of the different fees? What should I look for in a mutual fund company? There seems to be so many. Over the long haul, what % gain can I predict?...Thanks Much, Ray

Answer: It's great that you want to open up a retirement savings plan. But I wouldn't buy shares labeled A, B, C, D, and so on. Instead, why not open up a Roth-IRA with a no-load mutual fund company?

Here's what I mean. The fees you pay to own mutual fund shares matter a lot. There are all kinds of fees, but essentially you can divide the mutual fund universe into two basic types: "load funds" and "no-load funds." Load funds charge a levy when you buy or sell. They also assess a fee for ongoing expenses, the costs associated with running a fund.

The load is the commission paid to the broker who advised you to get into a particular fund. Typically, the load is paid when you buy the fund (those are so-called A shares), but some mutual fund companies impose the fee when you sell (B shares). The other letters represent combinations of the two.

A no-load fund doesn't impose a fee on either end. It does charge a fee to meet ongoing expenses. But it's realistic to expect to pay a fee -- you're not going to get something for nothing. The important thing to remember is to evaluate exactly what those fees are in total and how much will they cut into your return on investment.

So, if I invest $1,000 in an equity mutual fund with a 5% load, $50 goes to the mutual fund company (or broker) and $950 goes into my investment. Now, let's say I invest the same $1,000 in a no-load fund. No one steered me toward this fund. I did my own research, spent my own time. The payoff is that the full $1,000 goes into my mutual fund investment. But in both cases -- load fund and no load fund -- I'll pay an operating fee. And that fee can range significantly, from around 0.10% to well over 2%. .

The Securities and Exchange Commission offers a Mutual Fund Cost Calculator at its website. It makes it easy for investors to compare the costs of owning different mutual funds over time. The Cost Calculator takes the mystery and math out of the cost equation, revealing how costs add up over time. And to get you started on investing and personal finance, I'd recommend taking a look at Burton Malkiel's The Random Walk Guide to Investing: Ten Rules for Financial Success. It's short, and full of good advice.

03/04/08 by Chris Farrell

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A 401(k) "Margin Call"

Question: My former employer has gone into receivership and I was informed that they will be terminating their 401k program. I would have rolled my 401k over into an IRA a year ago had it not been for a personal loan I took out against it. The outstanding balance is about $9,000.00, or about 35% of the value of the account. (A side note, last year, the loan was, in fact, outperforming most of the other elements of the plan!)

According to the letter I received from the financial services group involved, my options are:
1) Pay off the loan, which is possible, if I tap my home equity, and roll the whole thing into an IRA. or ...
2) Deduct the outstanding balance from the 401k, roll over the un-leveraged balance into an IRA, and pay taxes on the loan amount.

I do have an open line of credit with my bank against my house, with a zero balance, that I could use to avoid the tax consequences.

What would you do? It kind of feels like a margin call, and right now, I could ring my former employer's neck.

Thanks!

Answer: I don't blame you for being upset. You did get the equivalent of a "margin call." You borrowed money to invest, and now the bill is coming due quickly. By the way, I have to say that I am not a fan of borrowing money to invest. I think leveraging up a portfolio like that is too risky for most people. What's more, although I hear the "mantra" that when you borrow from your 401(k) you're borrowing from yourself, I don't find the idea persuasive. It's still an expensive loan.

That said, what do I think is your best option? I would choose to pay off the loan by borrowing on the home equity line of credit--with this critical caveat: That you can repay the loan quickly. If the answer to that is "yes," it'll allow you to roll the whole amount in your 401(k) into an IRA and avoid an income tax hit, as well as the 10% penalty to Uncle Sam.

03/05/08 by Chris Farrell

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Too much Debt

Question: I'm 54, earn about $80,000/yr and plan to work for 10 more years. I have $100,000 invested with Edward Jones in growth funds and would like to use some of that to reduce my $140,000 home equity loan. I have another $500,000 in 401k & IRA savings. And I don't have any other debt -- no car loans or mortgage.

Currently I am in a loan plan with my bank where I only pay interest on the debt. That plan continues for 4 more years. The interest rate is ~6.7% or $850/month. I have not paid anything on the principal in the last year.

I know I earn a comfortable salary, but after enormous increases in property taxes and some unexpected house maintenance spending, it seems I live from pay check to pay check...even though I'm a pretty frugal person.

I contribute the maximum amount to my 401k--$17,000/yr. My friends say I put too much money into my retirement, but I plan on doing some spendy playing when I retire: ski, travel, hike the Sierra Mountains and Wine country etc.

How should I manage by debt and savings? I'd appreciate your advice. Sincerely, Mary

Answer: Mary, many people are in similar financial circumstances. Like you, they're carrying too much debt, but hardly living the champagne lifestyle. I wish there was a magic-wand-suggestion for eliminating debt. But there isn't. But there are trade'offs to consider. Here are some thoughts and suggestions.

You need a budget, but that's not the same thing as bookkeeping. Budgeting is really all about bringing goals, expectations, and money into accord. Ask yourself, where do you want to be a year from now, 5 years from now, 10 years from now? Then map out a way that will get you there. The real trick here--I can't emphasize this enough--is that you don't want to go through all this work to get rid of debt only to start building it up again.

Once you've gone through that process, and only then would I tap into your savings to pay down a chunk of your home equity loan. You can get rid of the rest of it over time with a budget. So, play with the numbers, and see how much you want to take out of savings (and pay capital gains tax on) and how long it would take you to get rid of the debt.

One other reaction: I'm with your friends. It's terrific that you're aggressively saving for retirement and that you have all these plans for what you want to do in your Golden Years. My fear is that you're denying yourself too much today to pay for your dreams tomorrow. Ease up a bit to shore up your finances now--and for tomorrow.

03/06/08 by Chris Farrell

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The Falling Dollar

Question: The dollar continues to hit new lows almost every day. What is the retired investor to do to protect his/her portfolio from the effects of the falling dollar? Ken

Answer: Well, the dollar reached another new low against the Euro today. For U.S. individual investors, the main impact of the falling value of the dollar in the international currency markets comes through the inflation rate. A falling dollar tends to make imports more expensive which, in turn, leads to heightened inflation expectations.

For example, import prices have risen 13.7% since January, 2007, representing the largest year-over-year increase since the index was first published in September 1982. The rise in import prices may be one reason the producer price index over the past 12 months has risen at a 7.4% rate and the consumer price index over the same period is up by 4.3%. (In the past three months the CPI has been running at a 6.8% pace.) You're right to be concerned since inflation depreciates the value of savings.

To protect your portfolio from rising prices means making sure you have a foundation of securities that won't lose their value during inflationary times. That can mean a heavy dollop of "cash"--Wall Street jargon for short-term Treasury bills, money market mutual funds, and other creditworthy short-term fixed income securities. It also suggests owning Treasury inflation-protected securities (better known as Tips), I-bonds (the inflation protected savings bond), and blue chip stocks paying a good dividend. Gold and other commodities are classic hedges against inflation, although commodities are volatile and they've already had enormous upwards movement in recent years.

By the way, taking inflation into account is critical for any retiree managing a portfolio. Even in an environment where the dollar is strong, inflation is still the big risk that most retirees face. I wouldn't do anything dramatic during these turbulent times, but I would evaluate my portfolio to see how protected it is against inflation and, if additional moves are called for, make those investment shifts opportunistically.

03/07/08 by Chris Farrell

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A Cautious Investor

Question: I'm 44, working at a university. My position is not secure nor stable. I have $40,000 in CD. How do I make my money grow? I would like to have a short term investment. Where should I put my money? I hate to think about retirement... saw many people try to save money for their retirement but it turns out they die before they can use their money. Sorry if my idea is strange. Thanks. Lekas

Answer: Your idea isn't strange. You've focused on a risk all of us take when we set aside money for the long-haul. However, your question also highlights how limited your choices are when you want to stick to short-term investments. There is a trade-off between risk and return. And by limiting the risk you're willing to take in the market, you're also limiting your potential return.

That said, the way for your money to grow is to add to savings. You can then preserve the value of your savings by investing in certificates of deposit (as you're doing), Treasury bills, money market mutual funds, and the like. And, of course, this money is available to you if you lose your job.

Still, how about putting a small slice of money into your university's retirement savings plan? Most universities offer their employees a good pension plan made up of low cost mutual funds.

03/10/08 by Chris Farrell

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529 Plans

Question: How does a 529 plan affect a person in terms of financial aid eligibility? Samir.

Answer: The terrific thing about 529 savings plans is how many pitfalls it sidesteps. Your money compounds tax free. And when the money is withdrawn to pay for qualified college expenses, it's free of Uncle Sam's grasp. Most colleges and universities count it as a parental asset in the financial aid formula (meaning parents are expected to fork over 5.6% of their assets, which is much lower than the 20% figure applied to student money.) However, private colleges and universities are free to make their own rules and percentages. The bottom line: It pays to save for college, and a 529 plan is one of the best options available. .

03/11/08 by Chris Farrell

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Market Turmoil and a Retirement Portfolio

Question: My husband and I both put the maximum into our 401ks, which we now see dwindling (9% loss this year already). Money is tight; our daughter is making the decision about what college to attend; and we do not have a lot in savings ($200k in our 401ks; $50k in stocks). Should we continue to put the max into our 401ks or decrease the contribution during this economic downturn? We both turn 50 this year. Thank you so much for your help. Kary.

Answer: With the drop in the market, I'm getting many variations of your question. The feeling about retreating from the market is understandable. But here's my cautionary note: You're both still young. Taking into account your average life expectancy, you're still investing for another 30-plus years. That's why the main lesson I would take from this volatility and turmoil in the market is to review your portfolio. Are you comfortable with how much you have in stocks, bonds, and other securities? Do you need to get more conservative?

That said, you have a big expense coming up: Your daughter's college education. It's a big deal, and if you want to slightly cut your contributions to your retirement savings in order to help pay for college expenses, that's fine (with me, that is).

Nevertheless, I do believe you should take care of your retirement needs first and your daughter's college expenses second. She can always borrow. The reason for establishing this priority is that you and your husband are nearing the end of your earnings years to save for retirement, and she has a lifetime ahead of her.

03/12/08 by Chris Farrell

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Market Turmoil

Question: I have some money in 401K but it's all vanishing because of the stock market drop. Is it a good idea to ride it out,or transfer the money out of stocks (investment optons) and put it in a safe stable fund? Frank, Satellite Beach, FL

Answer: A bear is mauling the stock market, and the worst may be yet to come. The S&P 500 is down some 17% from its October high, still in so-called correction territory but not all that distant from the 20% decline that traditionally defines a bear market. The desire to get away from the carnage is understandable. (My answer to your question assumes that you're still in the "accumulation" stage of life, working and adding to your retirement portfolio.)

Still, for many investors the first rule of managing money in a downturn seems to be "do no harm." When people try to time the market, the result is usually disastrous. The average saver who sits tight with their retirement money during a bear market typically does much better than the person that gets in and out of the market.

That said, my mantra is to take advantage of this time by figuring out whether you're comfortable with your portfolio. Are you too much in stocks? Bonds? International? How do you wish your portfolio was constructed? Once you've figured that out, then I would create that portfolio over time.

03/14/08 by Chris Farrell

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Flight to Safety

Question: My wife and I are very cautious with our money--we have only one loan (our mortgage), we pay off credit cards every month, and we have more than 6 months of living expenses saved... BUT it's in a financial firm's money market account. We also have IRAs and "deferred compensation" saved in mutual funds.

The recent near collapse of Bear Stearns echoed the bank runs of '29 and the collapse of markets. It's an uneasy time--world markets seem unstable, inflation in energy and food costs etc... Should we be worried about having money saved in non-FDIC backed instruments? Worried in Ann Arbor. Jim

Answer: It is an uneasy time, especially with the Bear Stearns meltdown and takeover. But you are in a good financial situation to ride out the storm.

The answer to your question involves shades of risk. Let's look at your money market mutual fund. Every once in awhile, during tumultuous financial periods like now, the mutual fund industry is roiled by fear that a fund will "break a buck." The promise of a money market mutual fund is that if you put a dollar into it, you will at minimum get a buck back at withdrawal. As far as I am aware, no major money market mutual fund has fallen so much that withdrawals have been worth less than a buck. However, I am aware that in some cases where the parent company has injected cash into the money market mutual fund to preserve its value.

What to do about this? I always recommend a two-fold strategy. First, investors should put their money market money into a brand-name financial institution with the resources to support a money market mutual fund if it becomes necessary. Second, I would put my money into the most conservative money market option offered by the financial institution. The fund's assets should be primarily in very high quality short-term securities, such as U.S. government short-term debt and U.S. government agency debt.

If you believe that even after these two safety screens, a money market mutual fund is too risky, I would put my money in one of two places (or both): Keep it at a bank in FDIC insured accounts, such as certificates of deposit, a savings account or a bank money market deposit account. Or buy default-free U.S. Treasury bills directly from the government. It's easy to do. Check it out at www.treasurydirect.gov.

03/17/08 by Chris Farrell

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Online Banking

Question: As much as anything is "safe" these days, is it safe to open online savings/CD accounts with such companies as "ING Direct"? Sarah, Lakeville, CT

Answer: Yes. For safety and soundness, the key is to make sure that any online bank is backed by the FDIC, and ING is insured by the FDIC.

03/18/08 by Chris Farrell

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Cash is King

Question: I'm 35 and already maxing out my 401K and IRA options. My only debt is my mortgage. Half my paycheck automatically goes to a money market for savings. But I don't feel that's the wisest investment. Should I pay off my mortgage early? Or should I invest in variable annuity, mutual funds, stocks, etc.? Bernie, Clarks Summit, PA

Answer: This is a huge, open ended question and I can't focus on all the options open to you. Still, I wanted to deal with your question to make a simple point: Cash is king during an economic downturn. You've been making a wise investment. You'll have ample opportunities to put at least some of that cash to work buying good assets at bargain prices over the next year or so. I would use this time to research your financial opportunities.

For all of us, the trick during a recession is finding the right personal finance balance between safety and speculation. For households without much in the way of a money cushion the focus is on shoring up the household balance sheet. For savers like you with good credit the mantra is mantra is investigate, research, and preparation, all with an eye toward buying assets for pennies on the dollar. Good luck.

03/19/08 by Chris Farrell

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Bank Stocks

Question: Chris, could you elaborate on your comment made on 3/14 about the undesirability of buying bank stocks. Do you mean all bank stocks? We're several years away from retirement and are in the process of building an income-producing portfolio of stocks to supplement our pensions and other retirement savings. We carefully choose two bank stocks (USB and BAC) to be part of that portfolio because of their dividend payouts and perceived soundness. If banks such as these are not worth investing in, doesn't this signal that the whole system is in far bigger trouble than most investment experts are letting on? I realize the laws involving tax treatment of dividends may change in the future, and there is always a risk with any investment. But might the current situation be an opportunity to purchase bank stocks with good fundamentals at a reasonable price? Jeanne, Lauderdale, MN

Answer: I like what you are doing with dividend paying stocks. Period.

What concerns me is the advice peddled by some on Wall Street that individual investors should plunge into bank stocks because they've been beaten down so much. Yes, bank stocks are down a lot. But that doesn't mean they won't go lower.

For instance, Laurence Kotlikoff, economist at Boston University and head of the financial planning firm ESPlanner, is one of the smartest people I know. He recently took a flyer on beleaguered Citigroup. After all, last year it was trading at $60 a share. He recently bought some shares when it fell to $30 following a string of massive write-offs. It's now at $20. Of course, he can afford the bet, and there's nothing wrong with taking a flyer on a hunch with a small amount of money. But for most people, I'm skeptical that it's good advice. It's better for Wall Street's wallet rather than their customer's return.

What you're doing is part of a long-term, income producing retirement plan. Bravo.

03/20/08 by Chris Farrell

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Interest-Only Mortgages--No

Question: My husband and I recently attended a workshop on optimizing real estate assets. The program presented information on how to create a debt and cash flow management strategy, optimizing real estate assets to build wealth. In other words, they recommend taking the asset of your home, and have that money work for you to build income. One of their recommendations is to obtain an interest-only loan, which will allow you to take greater tax benefits and spread your mortgage over the longest term so that you can invest money that you would put towards a shorter term (15 yr vs 30 yr.) What do you think of this idea? Thanks, Susan, Boulder, CO

Answer: No. No. No. It's by following financial advice like this that a number of homeowners have fallen into dire financial straits. Interest-only mortgages are highly risky. Stripping out the equity in your home to invest in other (risky) assets is very hazardous to your wealth.

03/21/08 by Chris Farrell

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Las Vegas? Hmmm

Question: I am lucky enough to receive some extra money from my parents for loans they took out in my name to help pay for my college education. I have about $30k in students loans (master's and bachelor's degree). About a third of that is what I am receiving from my parents.

My question is what should I do with it? I have almost no credit card debt, installment payments on a car loan and student loans but I am able to make those easily. However, I have very little liquid savings. Is this money something I should actually use to pay for my student loan debt? I would like to buy a house someday should I save it for that? Should I invest it in retirement? Or is something just to hold on to? The other option is always just have a very fun weekend in Vegas!

Any advice you would have on what to do with extra money in this economy/housing market would be greatly appreciated. Thanks! Chris, Madison WI

Answer: Las Vegas, huh? Well, let's put that option to one side. Now, all your thoughts about what to do with the money are good. You really can't go wrong.

But if I were you I would get rid of your small credit card debt, and then I would invest the rest of the money in a conservative money market mutual fund with a brand-name financial institution. For one thing, it's always a good idea to build up a reservoir of emergency savings, and the extra money from your parents lets you do that in one fell swoop. For another, investment bargains open up during tumultuous times like this, and you'll have a pool of cash to tap if an opportunity comes your way. These days, Cash is king.

03/24/08 by Chris Farrell

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Boosting Credit Score

Question: I am looking for a way to boost my credit score. My fiancé and I plan on buying a house in about a year. My credit score is considered poor or medium-high risk. I had tried to get a credit card a few months ago and I was turned down.

My bills are all current and I've paid off any old debt I had accrued. But I do not have any credit cards right now- only a car loan and a student loan. Would you recommend getting a credit card and staying current and keeping a low balance for better credit? If so, is there a certain type of credit card that's more "forgiving" of a lower credit score? If not, are there any other ways? Could I pay one of those people who "repair" credit? I would really appreciate any advice. Thank you very much. Michelle, San Diego CA

Answer: Time is on your side. You've paid off your old debts, and you're current on your car loan and student loan. The longer you make your loan payments on time the better your credit score will become.

That said, it can make sense for you to get a credit card, assuming you use it and pay off the bill in full at the end of the billing period. (Technically, it doesn't matter if you carry a balance so long as you pay the bill on time. Your credit score will improve whether or not you're carrying a balance. I just don't want you to take on any credit card debt.)

One common maneuver for getting a credit card is to apply for a retailer's card. Retail credit cards aren't that attractive since they usually come with high rates. But if you use it and build a good credit history with it you can always get rid of it later on and apply for a better card. (And this time you'll qualify.) Another option is a "secured" credit card. With secured plastic, you open up a savings account with a bank that issues you a card that looks like any other credit card. Your credit is equal to or somewhat less than the amount you deposit. Eventually, after showing a pattern of paying off your bills on time, you can usually switch to a traditional "unsecured" credit card.

03/25/08 by Chris Farrell

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A European Adventure

Question: I am to take a trip to Europe this summer with two friends of mine before our senior year of high school. I have about all the money I need now to pay for the trip. But, my mom thinks I should start converting some of my money into Euros as the dollar continues to fall. Should I convert some (or all ) of my money into Euros now to save myself from the falling dollar? If not, how much extra should I set aside to protect myself if the dollar does go lower? Thanks. Andy, Minneapolis MN

PS: I have the plane ticket already so rising oil prices shouldn't hurt me in that regard.

Answer: I'm jealous. A trip to Europe at your age is an adventure. Okay, it's an adventure at any age.

I find it fascinating that travel from the U.S to Europe remains strong despite the low value of the dollar and the high value of the Euro. What I've been told by industry insiders is that one tactic people are using to keep costs in line is to prepay as much of their big ticket expenses as possible, such as travel and hotels. Another expense you might want to prepay is Eurail pass early (assuming your going to be traveling around Europe by rail and not just stay in one place).

I think your Mom is right to suggest converting some of your money into Euros. She might even consider buying you an insurance policy against the dollar going even lower by putting some of your trip money into a short-term certificate of deposit denominated in Euros. For instance, Everbank offers CDs in Euros.

03/26/08 by Chris Farrell

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Co-signing a Loan

Question: I have a very good credit rating and am considering co-signing on a loan for a family member who has a very poor credit rating. Will her poor credit rating affect my credit rating in any way, if I co-sign the loan? Thank you, Bette, Richfield, MN

Answer: Her poor credit rating won't immediately affect you on co-signing--assuming that she then pays her bills on time. But if she defaults you're on the hook to make good on the debt. The lender will go after you for the money she owes. Your good credit rating could be ruined. It's understandable that you want to help out a family member, but co-signing a loan is very risky.

03/27/08 by Chris Farrell

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The Whole Portfolio

Question: My wife and I each have retirement (401K, Roth IRA) and non-retirement (joint brokerage, ESPP, REIT) investment accounts. I also have a beneficiary IRA setup from an inherited qualified annuity. My question is whether we should consider each account independently in terms of balancing the investments, or view the combined accounts as one big portfolio? For example, an aggressive overall retirement portfolio balanced by a conservative non-retirement portfolio? Or an aggressive 401K with a conservative Roth. We are in our mid-40's and plan to retire in about twelve years. As we near retirement, we would re- balance things for a more conservative overall portfolio. Thanks, and we love your show! Pete, Golden Valley MN

Answer: This is an important question. A very common mistake in allocating your investment money is not looking at your portfolio as a whole. The reason is just what you suggest: You may be more aggressive than you realize or more conservative than you want.

Here's a hypothetical portfolio that makes the pojnt. Lets say a family has saved $100,000 in a 529 college savings plan and their child is off to college in just a few years. The asset allocation is 20% equity and 80% fixed income. The wife has another $100,000 in her retirement account, split into 75% equities and 25% bonds. The asset allocation in each account sounds about right on its own. But taken all together, the overall asset mix is 52% fixed income and 48% equity. Is that the right mix for the household? It's probably too conservative.

So, yes, every once in awhile strip away all the product names (401K, IRA, 529, and the like) and see what is the overall asset allocation for the household. It's a good discpline.

03/28/08 by Chris Farrell

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An IRA and a Variable Annuity

Question: I'm 61 and will work until 65 or 66, unless my employer decides otherwise. My financial advisor is recommending that I put my IRA into a variable annuity for about 4 years, as I can get a guaranteed 5% return if the Market goes down and a better return if it goes up. The fees of the annuity plus the 1.3% fee the advisor is charging now would raise the annual management fee to 2.8%. I ran the numbers and his suggestion makes seems to make sense if the Market does go down for the next 2 years or more and I start taking money out at retirement.

The IRA is about 37% of my current retirement savings, I'm putting 19% of my income into my 401K at work, and pension and social security are expected to replace ~34% of my current income (no adjustments for inflation) if I stay employed until 66. Does a variable annuity make sense for me? Gary, Omaha, NE

Answer: I can't stand this tactic. The fundamental reason I dislike it is that an IRA is a tax sheltered account. A variable annuity is also a tax sheltered account. Therefore, you're wasting valuable tax shelter with this maneuver--and taking on huge fees at the same time.

The Financial Industry Regulatory Authority (FINRA), is the largest non-governmental regulator for all securities firms in the U.S., overseeing more than 5,000 brokerage firms, about 172,000 branch offices and more than 676,000 registered securities representatives. It periodically issues "Investor Alerts" and one was on variable annuities. In its typically cautious language, here's what FINRA has to say about the recommendation to mix together a variable annuity and an IRA:

"Investing in a variable annuity within a tax-deferred account, such as an individual retirement account (IRA) may not be a good idea. Since IRAs are already tax-advantaged, a variable annuity will provide no additional tax savings. It will, however, increase the expense of the IRA, while generating fees and commissions for the broker or salesperson."

You can read the whole investor alert at www.finra.org/InvestorInformation/InvestorAlerts. It's called "Variable Annuities: Beyond the Hard Sell." The bottom line: Don't do it.

03/31/08 by Chris Farrell

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