Retirement Income Plan

by Bruce Fenton

Coming up with a retirement plan to replace a weekly paycheck once retirement comes knocking is essential to making sure your money lasts as long as you do. The basics for designing this plan rest on the “three legged stool of retirement”…government pensions, personal savings and investments, and employer supplied retirement benefits.

An individual has little control over two of the three. But when it comes to managing the personal investments leg, a number of choices emerge.

Rules for investing retirement assets abound. A frequently quoted rule states that your portfolio should consist of bonds in proportion to your age minus 100. For example, a 60 year old would have his investment accounts invested in 60% bonds and 40% stocks.

The logic behind this rule is sound…as you age you need to reduce investment risk and increase certainty in your portfolio. Bonds held to maturity making predictable income payments are generally less risky than stocks held for price appreciation.

The problem with “rules of thumb” is that they do not account for individual preferences and situations. For example, individual risk tolerances might allow some seniors to maintain a riskier portfolio than a person half their age.

A retiree with a proportionately larger portion of their retirement income coming from government and company pensions (or other low or no risk income sources) may choose to be more aggressive in their investment strategy since the risk of investment loss is not as catastrophic to their plan.

Taxes play a part in determining an investment plan. For example, interest payments on corporate bonds are taxed as ordinary income while dividends and long-term capital gains are taxed at 15% (5% for taxpayers whose top marginal tax bracket is 15% or less).

Since all payments from a traditional IRA are taxable at ordinary income rates, a retiree with two portfolios…an IRA and a non-qualified investment account…would hold bonds paying interest in the IRA and dividend paying stocks or stocks held for appreciation in the non-qualified account.

This does not hold true for tax-free municipal bonds, which should always be held in the non-qualified account.

With the appreciation in real estate, many see their homes as a piece of the retirement income puzzle. I am commonly asked about the wisdom of paying off a home mortgage in lieu of holding the equivalent in an investment account.

A paid for home should be viewed as a bond in the portfolio. It provides a tax-free, risk free economic benefit…rent…to the owner. The cost to carry the mortgage is the after tax cost of the interest paid (equal to [1- your marginal tax rate x the mortgage interest rate]).

If a mortgage is carried, and the money to pay off the mortgage is invested, the investor should reasonably expect to earn the taxable interest on the mortgage plus 3% to 5% more to compensate for risk and taxes on investment returns.

Again, this decision to invest or pay off the mortgage should be based upon an individual’s risk tolerance, and investment time horizon (length of time before the investments have to be spent).

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Mortgages and Retirement

The decision whether to retire with or without a primary residence mortgage is a key planning issue for most retirees. This has become even more of an issue as housing values rise and mortgages grow bigger, often making the house the most valuable asset on the retiree’s balance sheet.

Prevailing logic holds that one should pay off the mortgage prior to retirement. Grounded by the experiences of the Great Depression when people did lose mortgaged homes, this wisdom runs contrary to our current tax code, potential returns from alternative investments and the need for liquidity.

Today’s tax code allows a tax deduction for mortgage interest paid on a principal or second home. To understand the true, after-tax cost of this benefit, subtract your marginal tax rate from 1 and multiply the result by the current interest rate charged for the mortgage. This is the after-tax cost of borrowing the money. For example, a borrower in a 28% tax bracket with an 8% mortgage is paying (1-.28) x 8% = 5.76% after-tax interest for that mortgage.

To put it another way, if the borrower were to pay off the mortgage, he would be investing in a tax-free, risk-free investment yielding 5.76%.

Paying interest for the sake of a tax deduction does not make sense. However, if the alternative is to keep the principal sum that would be used to pay the mortgage invested, earning an after-tax return greater than 5.76%, plus 3-6% margin for risk, then there is a valid reason for not paying the mortgage.

Finding the money to pay off the mortgage can be a tax issue as well. If the principal sum required must come from either selling investments which will generate a taxable gain, or withdrawing a lump sum from a retirement account—all of which will be taxed at ordinary income rates—it might be better to continue mortgage payments and avoid the higher tax bill. This spreads the taxes over a much longer period.

Conventional wisdom encourages those wishing to pay off their mortgage to do so by making additional monthly payments. However, if that same money were invested in an alternative investment, earning the equivalent after-tax return as the interest payment saved by paying off the mortgage early, the homeowner is faced with an interesting choice.

Which would he prefer, a paid for house at the end of the accelerated payment period or a continuing mortgage and a liquid investment amount equal to the interest he would have saved, had he paid off the mortgage early? When the tax consequences are factored into this equation, plus the investment return potential, paying off the mortgage early has little advantage other than peace of mind.

Finally, the need for liquidity in the retirement plan must be considered. A paid for home is an illiquid asset. It is easy to refinance when one is working and can show the ability to repay the loan from earnings. Lenders aren’t quite so anxious to lend money when there are no wage earnings.

Capital required for repairs, replacement of capital item such as appliances, automobiles, etc. and potential medical expenses are reasons enough to maintain liquidity. If all available capital is tied up in the house, a retiree is short on options when it comes time to pay such expenses.

A possible solution to this liquidity problem is to refinance just prior to retirement. If the existing mortgage has been paid down, the principal sum to be refinanced will be smaller, allowing for lower payments. Of course these payments will be stretched out over a longer term, implying that the house might never be entirely paid for, but by keeping liquidity intact, the retiree might have a sounder financial situation.

Moving Out

Property rich and portfolio poor is not a totally inaccurate way to describe the retirement plans of today’s baby boomers. The stock market bubble that burst several years ago, taking with it hopes of millionaire lifestyles in soon to be achieved retirement, has altered many retirement plans. But, thanks to changes in tax laws and our inherent wander lust, that is not all bad.

Billy Joel wrote a smash hit “Moving Out” in 1977 that is now a popular musical touring the country. The title could also be used to reflect the changes that have occurred in retirement planning as a result of stocks down, real estate up.

According to an article in Kiplinger’s, 60% of boomers ages 44 through 56 plan to move to a new home in retirement. That’s up from just 31% of pre-retirees they interviewed just 5 years ago.

Unlike their parents and grandparents, today’s boomers are not about to kick back in a rocking chair on the porch of the old family homestead where they were born, grew up, raised their family and now expect to pass on the family plot nearby. Boring!

Instead, they are carrying their active lifestyles and innate desires for the new and different into retirement, seeking out communities that offer opportunities to pursue other interests. And, it is beginning to sink in that they will be living almost as long in retirement as they spent working, so it is making sense to look for more suitable digs.

The tax laws that allow married couples to take $500,000 tax-free from a sale of a personal residence have made selling the family home and moving on particularly attractive. For many, they can sell their home, buy a smaller, more manageable retirement home in a more attractive retirement setting, and pocket the gain, tax-free.

Easy access to inexpensive air transportation, cell phones, the internet, instant message, and digital cameras have made it possible to be miles away from family and friends, yet remain closely in touch. And, as my wife has discovered, shopping on the Internet gives her 24-hour a day access to her favorite shopping haunts from the comfort of home. So why would one have to live anywhere near a big mall?

Financially, having a paid for home with some tax-free capital invested makes the diminished retirement savings plan a bit more tolerable. The difference between housing prices in “working areas” such as Silicon Valley in California and many other areas of California, or inside the Beltways of cities like Boston, Washington D.C., and retirement communities in the Sun Belt or areas like Bellingham, Washington, Ashland Ore, Park City, Utah or Naples, Fla., makes this work.

Certain retirement havens have tax laws particularly favorable to retirees. Six states, Alaska, Washington, Nevada, Florida, South Dakota, and Texas have no state income tax. New Hampshire and Tennessee tax only interest and dividends. But, as Kiplinger’s pointed out, income taxes should not be the sole reason for choosing a state.

Kiplinger’s published a Tax Survey of total taxes that a household might be expected to pay in locations around the country. Taking into account property taxes, sales taxes, gasoline taxes and other local taxes, they found that the lack of a state income tax does not guarantee tax-free living. They found the least expensive total tax bills in Cheyenne, WY. And the most expensive tax bills in Bridgeport, Conn. However, states like Colorado, despite a moderate income tax, were relatively inexpensive with lower property, sales and gasoline taxes.

The Internet has made shopping for a possible retirement location and home much easier. A quick search will yield a vast number of websites that can provide valuable insights into communities, retirement lifestyles, and real estate availability for those interested in “Moving Out”.

Other Benefits of Social Security

by Bruce Fenton

Lost amid the political rhetoric swirling around Social Security are many of the other benefits the system provides. For example, the right to choose when to start drawing benefits can be as important as the benefits themselves. Often overlooked are the benefits Social Security provides the families of retired workers, or the benefits that are available to families of deceased workers.
The right to choose a retirement date impacts the payments a worker receives. To test the value of this right, use the projected benefits for a worker age 62, who has earned the maximum amounts during his lifetime. To calculate this, use the Social Security Cost of Living Allowance (COLA) from the Social Security web site, www.ssa.gov, and a 3% discount factor.

Using the Social Security Quick Benefits Calculator for inflated dollars, our worker would receive $1,434 per month if retiring today, $2,163 a month if retiring at the normal retirement age of 66, and $3,314 a month if retiring at age 70.

To determine which is better financially, using the above assumptions, our worker is ahead using a Net Present Value calculation if he waits to draw benefits at full retirement age and lives to age 83. Benefits at age 66 are slightly better than waiting to age 70.

The longer the life expectancy of the worker, the more advantageous it is to wait to age 70. This advantage is even more pronounced if the worker’s spouse is considerably younger and expected to outlive the worker. In the latter case the surviving spouse’s lifetime income would be based on the worker’s higher payout.

Drawing benefits at age 62 are more advantageous if the worker’s life expectancy is shorter. Using my model, our worker is better off to draw at 62 if he/she dies by 69. For anything beyond that point, waiting to draw at full retirement or even delaying to age 70 is financially a better choice.

A worker would not opt for the early retirement if still working. Earnings above $12,000 in 2005 will reduce his benefit by $1 for every $2 he earns until normal retirement age. For the year of full retirement age, our worker would have $1 deducted for every $3 earned above $31,800 before the month he reaches full retirement age. The government does not count pensions, annuities, investment income and interest, veterans or other government or military retirement benefits as earnings.

If our worker became disabled today, he/she would draw $1,912 a month while his children would be entitled to $1,434 per month and his spouse caring for children under 16 would draw $1,434. The maximum spouse plus children could draw would be $3,347 a month.

If our worker married late in life and retires with minor children the system pays each of those children one half of his retirement benefit until they are 18, or 19 if still in a secondary school. His spouse will also receive a comparable benefit if at least one child is under 16. Again this family benefit is subject to a maximum of 1.5 times the worker’s retirement benefit.

Finally, Social Security provides a healthy life insurance benefit for families. The surviving spouse of a worker may begin drawing benefits based upon the worker’s earnings at age 60, albeit reduced. This same benefit is available to the divorced surviving spouse who was married ten years or more to the worker and who has not remarried.

Finally, for a family of a worker age 35 who dies today, and has earned the maximum Social Security wage ($90,000 in 2005) would receive a life insurance benefit of $1,470 per month per child under 18, and $1,470 a month for a spouse caring for a child under 16.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Distribution in Retirement

by Bruce Fenton

Changing from asset accumulation to asset distribution takes a major shift in thought and process for those moving from pre-retirement to the retirement stage of life. The steady, every-week paycheck is now replaced by pension, Social Security and more important, discretionary withdrawal decisions from retirement investment accounts.

The latter, if handled correctly, offers the promise of a relaxed, enjoyable retirement. To get there requires a certain amount of planning.

The first step in the process is to accurately formulate a budget to live by. The process of evaluating how you spend your money is as useful as the end result. Most go through their working years spending what they make without ever really analyzing where the money goes. When examined more closely, it becomes obvious that there are fixed costs … rent or mortgage, food, transportation, insurance, etc. … and variable or discretionary expenses … recreation, eating out, gifts, etc. … over which one can exercise considerable choice.

Many who go through this process are able to cut their spending by significant amounts without materially affecting their lifestyle simply because when there is a paycheck coming every week they are inclined to be more generous spenders.

Part of the budget for retirement has to include potential capital expenses such as major home repairs or an automobile purchase.

Once a prospective budget is put together, subtract fixed payments from Social Security and guaranteed pensions … the difference is the amount you will have to make up from retirement savings.

Retirement savings come in two tax flavors … qualified money, or money coming out of IRAs or defined contribution plan distributions … and non-qualified money coming from retail investment accounts, rental income, or work related. The former is generally taxed at ordinary income tax rates and the latter will be taxed as ordinary income, rental income, dividends or capital gains depending upon the source.

The object of the game is to maximize your after-tax wealth, which implies paying taxes on retirement income at the lowest possible rates.

If you have a choice it is generally better to spend money on which taxes have been paid first, and defer spending from qualified plan accounts as long as possible. Money left in a qualified account, which is allowed to grow and compound without paying taxes benefits from the fact that a larger principal amount is compounding.

For example if you withdrew $10,000 from an IRA, paid the taxes at 28%, and invested the money to grow at 8%, after 15 years you would have a hypothetical $16,678 after taxes. The same $10,000 left in a conventional IRA would accumulate a principal sum, inside the IRA, of $31,722. If the principal sum of either account were invested in taxable bonds paying 6% interest and then distributed as income, the taxable account would generate $1,000.68 and the IRA distribution would generate $1,903.32. Since both amounts are taxed at the same rates, the value of tax deferred compounding is clear.

In general, spend first from sums on which taxes have been paid … these might include inheritances, or tax free sales proceeds from a home sale. If in a higher tax bracket, invest for income in tax-free municipal bonds. For other taxable distributions look for qualified dividends and capital gains transactions, both taxed at a Federal maximum of 15%.

Hold risky assets that could potentially produce a capital loss inside a taxable investment account. The losses can be used to offset other capital gains. This is not the case inside an IRA.

In IRA and other qualified accounts, invest in bonds paying ordinary interest. As long as the interest income earned stays inside the qualified accounts, you will pay no taxes.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Flipping the Switch to Retirement

by Bruce Fenton

Flipping the switch from work to retirement mode is not quite like flipping a switch to light a room. It is not a black and white transition. And neither is handling your investment accounts during the change.

Ask anyone recently retired about the adjustment process … according to a poll done by American Demographics®, 41% of retired workers said they were having a difficult time adjusting to retirement … compared to 12% of the recently married having a difficult time adjusting to marriage!

I suspect that many of those disenchanted follow a similar pattern … hit the local coffee shop in the morning, hang out with the other retirees, drink too much coffee, listen to the same stories over and over … and, finally, one morning saying to themselves, “Is this all there is to life?”

Our way of thinking about retirement needs an overhaul. We are geared to think of retirement in terms of the way it was defined 100 years ago: Work to age 65 (never mind that life expectancies were 46). If lucky enough to live to retire, we wouldn’t have to worry about a long line at the coffee shop. We persist in asking our retirees to make what author Mitch Anthony (The New Retirementality) calls “age-justments” or simply turn off who they are and the activities that drive their pulse … simply because they reached age 62.

Retirement is really a three-phase process.

The first phase occurs between 50 and 61 when the kids leave and our focus becomes wealth accumulation. At this time we concentrate on building the nest egg, paying off education bills, and thinking about where and how we wish to live the last third of our life. Our investment focus is growth-oriented and the larger portion of our portfolio will be in equities.

The next phase extends from age 62 to 75. Real change begins, as we leave the work life behind, but not necessarily abandoned. At this point we begin to trade leisure time for human capital … the latter defined as the present value of future earnings.

This is probably the most misunderstood phase of retirement … because to retire does not simply mean quitting work. It is more about the choices we make for the use of our time.

A study done by the Gallup® organization found that 60% of retirees want to become entrepreneurs or to seek a new job to fulfill their dreams, 10% are seeking a new work-life balance, 15% hope to enjoy a traditional retirement and the remaining 15% do not want to retire. Clearly this phase is not about quitting work … more like having the freedom to do what we want, without having the economics of the endeavor as the chief motivating factor.

From an investment perspective, those who continue to work and earn, at whatever they choose to do, are continuing to build human capital and can afford to take more risk with their investments. Their portfolios should reflect a bias toward equity or growth investments, consistent with their willingness to accept investment risk. As their production of human capital tapers off, and the need to depend upon investments for support or other retirement goals increases, this more risky strategy should begin to give way to less risky investments.

The third and final phase of retirement begins about age 75. Now health concerns manifest themselves and we cut down on expensive travel and recreation that we pursued with such abandon 10 years before. The option of generating human capital has all but disappeared, and with it so should the risk in our portfolio. This does not mean that we throw out all stocks in favor of bonds … rather, that we begin to take a more cautious approach to investing with preservation of capital key.

Man’s life, as with all things in nature, has seasons. His investment strategy should reflect seasons as well.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

IRA Distribution - Section 72(t)

by Bruce Fenton

Traditional IRA distributions are taxable at ordinary income tax rates when distributed, either to the owner or beneficiaries. Setting up an IRA to pay out using the Substantially Equal Periodic Payment (SEPP) is an effective way to begin early withdrawals without unnecessary tax.

If IRA account assets are withdrawn prior to age 59 ½, not only will the owner pay ordinary income taxes on the withdrawal but also a 10% excise tax penalty. Section 72(t) of the Internal Revenue Code allows the plan owner to withdraw funds from a retirement account without the 10% penalty if the withdrawals are a series of substantially equal periodic payments.

Once the owner begins taking distributions as part of a SEPP, the payments must continue for the longer of five years or to age 59 ½. For example, a 53-year-old IRA owner must take distributions for five and a half years until age 59 ½, whereas a 56-year-old owner is only required to take distributions for five years to age 61.

The amount you can withdraw is a function of the account balance and one of three calculation rates allowed by the IRA. Each results in a different allowed withdrawal amount, making it possible to tailor the distribution to meet your specific need.

The amortization method is determined by using the life expectancy of the taxpayer and his or her beneficiary, and a chosen interest rate. This interest rate cannot exceed 120% of the federal mid-term rate, which for January 2005 was set at 4.53%.

The annuitization method is similar to the amortization method; however the amount is determined by using an annuity based on the taxpayer’s age, age of beneficiary and chosen interest rate.

The required minimum distribution (RMD) method calculates an annual payout by dividing the account balance for that year by the life expectancy factor of the taxpayer and beneficiary. Using this method, the amount to be paid will be recalculated each year.

To see how this works, let’s consider John Smith, age 53, wife age 52, who has a $250,000 IRA he wishes to tap for early retirement income. His IRA investment return is 6% annualized. He plans to continue the withdrawals for 8 years, and then tap other retirement accounts, leaving this IRA to accumulate. Using joint life expectancy and an interest rate of 4.53%, his withdrawal amounts would be as follows:

• Amortization Method: Annual payment of $13,908 and account balance at the end of 8 years of $260,809
• Annuitization Method: Annual payment of $14,942 and account balance at the end of 8 years of $250,573
• RMD Method: Annual payment beginning at $6,579 and a balance in 8 years of $315,441.

John’s choice of withdrawal calculation will be based upon his need for income and his plans for his IRA once his required payment to age 59 ½ has been met. He can change his distribution type one time without penalty from the Annuitized or Amortized methods to the Life Expectancy (RMD) method if he feels the fixed amount would prematurely deplete his account.

Other rules that must be followed to avoid the imposition of the 10% penalty tax include the prohibition of withdrawing additional sums, or making transfers from this account. The owner may transfer the full amount without penalty to another custodian or trustee as long as the payments continue. Finally, additional contributions may not be added to the account balance while part of a SEPP plan.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Social Security Dilemma

by Bruce Fenton

The “Yin and Yang” facing public policy makers was evident in a recent edition of USA Today® when the editors ran an article on the front page discussing how Social Security is being stretched by long retirements. In the next section, they presented the “yang” with a feature on how seniors live longer by taking care of their minds and bodies.

In a nutshell, the simple fix to the dilemma of potential future bankruptcy of the Social Security System is to not live as long. That’s not going to happen to our wave of self-actualizing Baby Boomers, each bound to hang on to eternal youth and outlive the actuarial tables!

According to the articles, people are collecting benefits an average of seven years longer than they did in 1960. President Bush is seeking to fill the gap created by larger outflows with his plan to allow workers to create private investment accounts from Social Security taxes to generate higher returns that will cover longer retirements.

When Social Security was established in 1935, the retirement age was set at 65…President Roosevelt’s mother raised no fool…the life expectancy was only 63 at the time! Today, the life expectancy for a male child is 77, and if he lives to 65 it is 83. In 1961 the Government lowered the early retirement age to 62. Today, the percentage of men still working at 63 has fallen from 78% in 1960 to 48%.

Longer retirements are stretching a Social Security System to pay more benefits than it was designed to handle. Earlier retirements hit the system with a double whammy, since a retired worker no longer contributes to the system, which essentially has become “pay as you go.”

Social Security administrators would like to see workers stay employed beyond age 62. For each additional year worked, worker retirement benefits go up about 7.5% annually. Today about 55% of workers start collecting benefits at 62, while less than one-fourth wait until 65 or later.

Federal Reserve Chairman Alan Greenspan has suggested raising the retirement age by one year. He projects that would equal a 7% benefit cut which would help eliminate about one-third of Social Security’s projected $3.7 trillion shortfall over the next 75 years.

We can help our struggling policy makers by staying healthy and working longer. And, as USA Today points out, there is plenty of evidence that we can thwart many debilitating effects of aging, both mentally as well as physically, by taking care of our mind and body.

Studies by the Albert Einstein College of Medicine and the Karolinska Institute in Stockholm, Sweden have found solid evidence that the most active seniors, mentally and physically, reduced their risk of developing dementia by 63% compared to the less active.

Their research indicates the activities that challenge the brain such as card playing, reading, even a good political debate with the spouse or friends now and then, help to stimulate brain cells. While such activity will not prevent Alzheimer’s, a disease partly caused by genetic factors, using the brain, especially in concert with a little physical activity such as a workout in the gym or walking, gives high-risk seniors a better chance of delaying the onset.

Like to dance? Researchers published an article in The New England Journal of Medicine in 2003 that showed ballroom dancing helped protect against Alzheimer’s, as did gardening, playing a musical instrument, and biking. Their findings suggested that physical activity might trigger the production of brain cells to replace those damaged by age.

“Use it or lose it” for our mind and body will help us live longer…and keep our public policy makers squirming over how to keep the checks coming.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Privatization of Social Security

by Bruce Fenton

High on President Bush’s list of priorities for his second term is the privatization of some portion of Social Security. The opinions on whether or not this is a good idea are even more varied and passionate than the various proposals about the issue. Some members of each side of the debate have emphasized black and white proposals. Like most complex issues, the truth lies more in a gray area.

Our Social Security System has roots back in the 1870s when public policy began to accept the fact that Americans were moving from the farm to the industrialized city. With this change came the realization that workers’ welfare should be protected. Both states and federal governments began to adopt laws such as a workers’ compensation to protect workers injured on the job.

Early in the 1900s retirement plans were beginning to sprout up for city and state employees. The Great Depression brought shrinking personal savings and lack of employment to the nation. Concerned that workers would be without resources at retirement, the Roosevelt Administration acted to put in place a retirement income supplement plan, followed in 1940 with a survivor assistance plan.

The result is now the largest public assistance program in the world, funded by a combination of worker and employer contributions. While we would like to believe that the money we contribute is set aside in individual accounts, nothing could be further from the truth, as the program has become a “pay as you go” plan.

Policy makers are struggling with the thought that as the work force declines…as it will because of the age wave of baby boomers retiring… there will be fewer workers working and contributing to the system.

Advocates for a form of privatization point to the fact that the current Social Security System does not provide enough incentive for people to save. Steven Landsbury in his book, The Armchair Economist, stated “most of economics can be summarized in four words: People respond to incentives.”

There is a fascinating article from the Cato Journal entitled "Empowering Workers: The Privatization of Social Security in Chile". Author Jose Pinera describes the successes Chile has had with privatization of their national retirement system.

In its first 15-years of operation, pensions in the new private system already are 50 to 100 percent higher than in the old “pay as you go” system. The resources of the private fund accounts are equivalent to almost 40% of GNP as of 1995. Because of the stimulus from additional savings and investment, the Chilean economy has grown at a rate of 6.5% annually as compared to 3%.

Under Chile’s Pension Savings Account (PSA) a worker’s pension level is determined by the amount of money he accumulates during his working years. Neither the worker nor his employer pays a tax into the system. Instead, the worker has a mandatory 10% withheld from his paycheck up to a pay base of $22,000. He may also save an addition tax-deductible amount of 10%.

The worker chooses a Pension Fund Administration company, similar to a mutual fund. Workers may change companies, which provide incentives for the private companies to achieve higher returns. The return within the account is tax-free, but when withdrawn the worker pays income tax on the amount.

For workers who have not contributed enough by retirement, the government has a standard for a minimal subsidy. At retirement the worker may chose to purchase an annuity from a private insurance company or take his money out over time with a series of withdrawals. Should he die before his funds are exhausted, the balance becomes part of his estate…a quite different plan from our Social Security System. A system like this one has clear benefits as well as disadvantages.

Personally I believe that some changes are needed with the current plan. The solution may not be as easy as privatization since this carries drawbacks with it as well. It will be interesting to observe how this unfolds. In any event, investors who keep abreast of this important issue and plan for any eventuality will be better off than those who do not.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Retirement as it Should Be

by Wendell Cayton

“When are you going to retire?” I recently asked a friend I have known since we were kids growing up in Yakima, Washington.

“Shoot, I’m never going to retire, I’m having too much fun,” responded Cliff Hollenbeck. “When I go, its going to be on a beach, with a camera in my hand, taking pictures of gorgeous models… and my last words will be, ‘Get the film.’” Cliff is a very successful, well-known, international travel photographer, author, moviemaker, and certainly capable of kicking back into retirement mode at any time.

In many respects, his attitude toward retirement is representative of the changing attitudes about retirement and how one should live the final third of a lifetime.

Life expectancies have made tremendous gains over the last century, more than any other time in history. In 1900, life expectancy was around 47. Today it is around 77, and for a male reaching age 65 it is closer to 80. Many of us will live more years past age 65 than we spent working!

And, as Cliff’s comments suggest, retirement today is not your father’s retirement! More and more retirees, having accumulated enough wealth to afford the lifestyle of their choice, are choosing to pursue active second careers. This has a very positive effect on the economy since these people are highly productive, and highly capable of continuing to contribute to our economic system.

I recently met a man who had retired from the software industry 4 years ago. He and his wife retired to Hawaii where they spent the last four years building a drop-dead, gorgeous home with all the toys and electronic gadgetry you can imagine. He was selling his home when we met, so I asked the obvious, “Why?” His response was simple. He and his wife built the house and then looked at each other and asked “What now?” So they have decided to buy a coffee farm and build a new house… a non-productive retiree returning to productivity.

Economist Harry Dent in his book, The Roaring 2000s Investor, redefines retirement as a “time of freedom when you can do what you really want, what is most meaningful to you, after you are freed of the obligations for career and child rearing… a time to pursue your highest lifestyle and goals.”

Dent goes even farther by suggesting that we consider moving into this phase in our life, which Maslov called “self-actualization,” earlier rather than later. He makes a point of noting that the most important dimension of a person’s financial plan should not be merely how to financially survive retirement, but how to create the lifestyle and life work that is most desirous, that most closely matches your dreams and aspirations, and most contributes to society.

I often find myself thinking that life is a little backwards—when we have the money to enjoy climbing mountains, traveling around the globe, or playing 36 holes of golf every day, we’ve run out of energy and physical capabilities to do so. When we have all the energy and physical resources to pursue those activities, we haven’t the money or the time.

“What would you do if you had ten years to live and $10 million in the bank?” asks Jim Collins, author of Built to Last. If you can answer this, you are beginning to get a vision of what life can be… a goal for your future we might say.

Retirement should be more than dying rich, never having enjoyed the freedom that wealth can bring. If that happens, chances are the kids will take your money and party… all in your honor!

Fixing Social Security

by Bruce Fenton

“Fixing Social Security” has become the mantra of choice for politicians on both sides of the isle in our nation’s capital. Some form of privatization may be the end result of the inevitable political babble and posturing as we approach another national election.

The original intent of Social Security was to provide government sponsored security for widows and orphans. Its secondary purpose was to provide a retirement supplement. Over the years, liberal politicians and economists have pushed Social Security as a national “savings” plan for retirement.

Nothing could be further from the truth. The Social Security system has become a pay-as-you-go entitlement program made possible by creative Washington bookkeeping. Theoretically, Social Security tax revenues go into a Trust Fund that is invested in U.S. Treasury securities.
The reality is that the tax revenue generated by Social Security goes into the Federal revenue stream where it is accounted for as income that is used to pay government operating expenses. Deposits to the Trust are paper entries.

The idea that the Trust will run out of money for retirement benefits has nothing to do with running out of money. It has everything to do with the fact that the work force will be shrinking, which will result in lower payroll tax revenues that pay current benefits, at a time when more people will be looking for their benefits.

Here is a radical idea for you to consider. Perhaps this dysfunctional, convoluted, last gasp of Socialized Government, is actually doing some good in its present form.

The operative word to describe this paradox might be “Incentive.” Steven Landsburg in his book, The Armchair Economist, stated “most of economics can be summarized in four words: ‘People respond to incentives.’”

Social Security has become nothing more than a big disincentive to save. Those depending entirely upon Social Security for their retirement will tell you that their incentive to save for retirement was diminished by their belief that they would be taken care of by Uncle Sam.
In 1986 and 1987, radical changes to the Federal tax code did away with a number of incentives for business-sponsored defined-benefit pension plans. These plans provided for a guaranteed retirement benefit for retired workers.

In place of those plans has come company sponsored retirement savings plans. These plans shift the responsibility for retirement savings from the government and company to the employee.

There is clear evidence that these changes have had a positive impact on both the economy and personal wealth. Edward Yardeni, chief economist for the Deutsche Morgan Grenfell bank cites statistics showing that from 1989 to 1995, the percentage of families holding retirement assets rose from 35.4% to 43.0%. The percentage of families with 401k plans increased from 19% to 27% during the same time period. Defined benefit plans, on the other hand, fell from 28% in 1989 to 19% in 1995.

The effect of this increased cash flow into self-directed retirement accounts has been nothing but positive. Since Americans now have more say in how their money is invested, they have opted for investments that offer higher returns—equities.

Yardeni points to the positive correlation of stock market returns with this increased savings activity. Since 1989 household investments in stocks and mutual funds have risen from 31.7% in 1989 to 41.4% in 1995. And, the stock market during this period has continued to show a strong, secular trend…upward and to the right!

Maybe, just maybe, our Federal lawmakers will take heed, and look to some form of privatization as the “fix.” The American worker has proven quite adept at responding to incentives to save and to self-direct their retirement accounts.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Scam Artists

by Bruce Fenton

The headlines of the Wall Street Journal® feature were eye-catching . . . “Confessions of a Scam Artist.” This August 9th piece by Glenn Ruffenach featured a lengthy prison interview with Eric Stein, a scam artist who bilked 1,800 investors out of $34 million.

Financial scams have a way of popping up when regulated markets for stocks and bonds offer investors little return or less hope. The granddaddy of scam artists, Charles Ponzi, realized this when he bilked investors out of $15 million in 1920 (that’s about $150 million in today’s dollars). At that time, the stock market was in a dive, and the country was going into a very sharp, but short depression.

Ponzi sold investors a “too good to be true” investment scheme. He made it work by using new money coming in to pay off earlier investors. Eventually investigators discovered the fraud, his house of cards collapsed and he went to prison. His technique of enticing new money into a fraud by paying off earlier investors bears his name, a “Ponzi,” and is at the heart of most modern day scams.

Eric Stein started out with a legitimate business proposition that needed money. He discovered that he could raise money by employing sophisticated telemarketers and promoters, and by packaging his idea into a glamorous, can’t-miss, proposition.

While his business faltered, his fund raising prospered. He paid original investors their promised returns from new money coming in. But, like Ponzi, he soon caught the eye of investigators and wound up in prison.

His promoters found the new money by targeting groups they considered the most vulnerable . . . people close to retirement or who had recently retired. These are folks who have been hammered by the stock market, perhaps never had a business opportunity when they were younger, and dreamed of an easy income source.

The French have a slang term for these targets . . . “mooches.” A mooch is someone with the right personality traits . . . they’ve got to have a deal. Typically, they’re in their 50s, or they’re entrepreneurs who have accumulated some wealth. Their names can be purchased from list companies.

List companies find mooches by soliciting information in shopping malls, for example, where one might be asked to fill out a simple questionnaire, or off the Internet where the unsuspecting are asked for information in return for free products or services. These names are sold for up to $100 a name to professional sales promoters.

Stein found that it was not necessarily the unsophisticated or economically uneducated that made easy targets. His favorite mooches were white-collar types with lots of cash . . . doctors and particularly dentists were at the top of his list. Small business owners who are risk takers also were easy marks.

As he told the WSJ, it’s all in the packaging. Make it easy to understand, make it glossy and professional, make it sound good, wrap it in phony testimonials, pay off the first ones in the door and soon their neighbors will follow with cash in hand.

Mr. Stein left the author with these tips. Never talk to a financial salesperson on the phone whom you don’t know personally. Don’t respond to unsolicited business promotions sent through the mail or by email. Never purchase unregistered securities. Never purchase any financial product that is described as “low risk, high yield,” or “safe” because a friend, relative, religious leader or fellow parishioner has recommended the opportunity to you. Finally, never answer any survey or enter a contest while shopping in a mall or while online.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Liquidity and your Retirement Plan

by Bruce Fenton

Liquidity, liquidity, liquidity is as important to retirement planning as location, location, location is to buying real estate. A retirement plan without adequate consideration for liquidity can become a scenario of frustrations and dashed dreams.

Liquidity in a retirement plan is the ability to write a large check to cover an unforeseen expense, without paying early withdrawal or surrender penalties, without having to sell an asset (real estate or stocks) in a down market and/or without having to liquidate an investment that is currently providing income.

Financial planning for retirement is a fairly simple process. Start with the fixed income sources such as pensions and social security. Subtract expected expenses, being careful to add inflation each year, from this income. If the number is negative, the retiree will either have to cut expenses or increase withdrawals from investments. Here is where it gets tricky.

Retirees with fewer resources needing investment income will generally elect to cut expenses in anticipation of trying to live off available income and/or a small investment portfolio. There is no margin for error in this planning. These retirees should be extremely careful that they do not “lock up” their available investment capital in non-liquid investments.

Here are several situations frequently seen in retirement planning:

• Investors chasing higher yields in order to squeeze out a little more income can find themselves paying a stiff price measured in lack of liquidity. This is especially true in the case of some limited partnerships and higher bonds with severe credit risk (costly to sell if forced to sell in a down bond market). Long term CDs that can carry substantial early withdrawal penalties are also costly to liquidate early.
  
• Annuities can present a difficult problem. Maximum income can be derived from a deferred annuity by annuitizing the contract. To do so, the owner enters into an irrevocable decision with an insurance company calling for the company to pay a stream of income for a period of years or for the lifetime of the annuitant. However, the owner gives up the right to withdraw additional cash to meet unexpected expenses.
  
• If the annuity is left in a deferred state, the owner can withdraw from the contract but may pay surrender charges or unexpected taxes.
  
• Retirees deriving income from rental real estate should be particularly careful in their planning. If the property has a mortgage their plan should provide for unforeseen expenses or vacancies that may reduce income flow required to cover the mortgage. If they are managing the property themselves, they need to consider how feasible it is to continue managing the property as they age or develop substantial travel interests.
  
• Even if the property does not have a mortgage, their plan should provide for a source of funds to take care of costly repairs, such as replacing the roof. This is not usually the case when one is working, since lenders are much more willing to lend to a working individual than to an individual with only portfolio or rental income.
  
• Finally, retirees should factor in the need to replace automobiles, household appliances and major household maintenance. As life expectancies increase the probability of wearing out durable household devices and automobiles increases.

Even if it means reducing some income, keep an eye on the need to maintain liquidity in your plan.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

IRA Management (Part 2)

by Bruce Fenton

Larger IRAs present major estate planning problems for the owner who wants to maximize the heirs’ legacy, not the federal tax system’s. Given the rate at which IRAs can grow over time, it will not be uncommon to see seven-figure IRAs as the major asset in many estates.

The federal tax system can extract a terrific bite out of such an IRA upon the death of an owner. For example, an IRA left by a decedent is subject first to the federal estate tax, which can be as high as 55% for larger estates. Then, the designated beneficiary, or the estate if no beneficiary is named, is taxed at ordinary income tax rates on every dollar withdrawn from the traditional IRA.

There are a number of planning steps that can be used to reduce some of the tax bite. Always name a beneficiary for each IRA. If the beneficiary is the spouse, two important benefits are realized.

First, a spouse who does not roll over the IRA and who is under age 59½ can draw from the IRA without the 10% penalty that otherwise applies, although income taxes must still be paid. Or the spouse can elect to roll over the IRA into his or her own name. Since this transfer qualifies for the unlimited marital estate tax deduction, there is no estate tax. Further, since the rollover is going directly into the spouse’s IRA, there will be no income tax paid until the money is distributed from the plan.

If the IRA is going to a non-spousal beneficiary, such as the decedent’s child, the beneficiary may elect to receive the IRA payments over his or her lifetime. This allows the IRA to possibly grow tax-deferred as a minimal amount is distributed each year. However, should the owner make the mistake of not naming a beneficiary, and if there is no spouse, the estate or heirs do not have the option of lifetime distributions.

Another solution is to spend the money while alive. It is counter-intuitive to think of spending dollars that represent taxable income if one has other less-taxed assets to spend first. However, keep in mind that by spending the IRA while alive, your estate will not be taxed twice at your death. Consider protecting other capital assets that will receive a step-up in basis at death. Even though these assets will be subject to estate taxation, they can be sold at the date of death and incur no income taxation. Such is not the case with an IRA.

Also consider giving your IRA to charity. If your estate plan calls for a sizable charitable bequest, make it out of an IRA. Your estate will receive a charitable deduction, reducing the value of the estate for death tax purposes. Since the charity does not pay income taxes, Uncle Sam misses out entirely.

Finally, when planning with a large IRA in your estate, by all means seek qualified tax advice. Laws are constantly changing, providing both opportunities for the informed and traps for the unwary.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

IRA Management (Part 1)

by Bruce Fenton

This isn’t your father’s retirement plan! No, tax law and company culture changes have shifted the responsibility for managing retirement accounts from the company’s shoulders to that of the employee. And judging by the size of the IRA accounts we see, the employees are doing a pretty good managing job!

It’s the very size of IRA accounts that raises planning problems, however. Where Dad’s IRA might have been for a few thousand, today it’s not uncommon for his children to have IRAs in six or seven figures.

The problems these larger IRAs pose are three-fold:

1. Managing the assets pre-retirement
2. Managing the assets after retirement, including dealing with complex required minimum distribution rules
3. Deciding what to do with an IRA for estate planning purposes.

This and my following column will speak to these issues.

Prior to retirement, the obvious objective is to manage the account to maximize growth and protect the principle. It is important not to trigger unintended taxation of the account. For example, it is not uncommon for an employee to change jobs every few years, each time leaving behind an orphan 401k plan. These orphaned plans should be consolidated into one IRA account through a trustee-to-custodian transfer.

Such a transfer will be considered a qualified rollover and not require mandatory withholding of 20% of the amount transferred—as would be the case if the employee withdrew the funds directly and then opened a new IRA account to accept the transfer.

Moreover, if an employee under age 55 attempts the do-it-yourself route and hangs on to the money more than 60 days, the rollover is disqualified and the owner will pay income taxes plus a 10% excise tax penalty for a premature withdrawal.

While you cannot borrow from an IRA as you can from many employer-sponsored retirement plans, you are allowed to roll the money over (take it out of the account and use it as you desire) for 60 days each year. Once per year per owner—but be sure it’s back not later than the 60th day!

By consolidating IRAs, the owner gains the advantage of ease of management. If set up in a brokerage account, then stocks, bonds, CDs, mutual funds, etc., may be combined in the IRA and the owner will see the entire account on one periodic statement.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Private Annuity in Retirement Planning

by Bruce Fenton

Retirement income planning has traditionally been built around the three-legged stool of Social Security, company pension, and private savings. Congress kicked out one of the legs, the company pension, with changes in the tax laws in the mid 1980s. By using a private annuity, retirees can replicate the company pension in their plan.

As life expectancies increase and returns from stock market investment come back to reality, running out of money in retirement is a real fear for retirees. The quandary for many people about to retire (or those recently retired) is whether to work a little longer now and delay drawing on retirement assets, or run the risk of not having enough in later years when working is no longer an option.

Part of the solution may lie in creating an annuity to take the place of the defunct company pension. An annuity is simply a steady stream of income provided on a regular basis for the lifetime of the beneficiary or for a set number of periods. An annuity can be guaranteed, as in a commercial fixed annuity purchased from an insurance company or non-guaranteed as in an insurance company variable annuity or an annuity derivative created from equity investments, bonds, rental real estate or similar income producing assets.

The income or cash flow statements of a household and business are very similar. Both identify income sources, as well as fixed and variable costs. In the case of the household, the fixed costs are those required to cover an acceptable minimum standard of living, such as shelter costs, utilities, food, clothing, insurance, and medical expenses. Variable expenses are the discretionary expenses that are nice to have, but not necessary for basic subsistence, such as travel, recreation, and hobbies.

When planning for retirement living, if fixed costs can be met by Social Security and other annuitized income sources, other private savings and investments can be earmarked for the discretionary portions of the budget. And, if the risk of the annuitized income sources can be lowered, the remaining portion of investments can be invested more aggressively to take advantage of the long-term, potentially greater, returns offered by the stock market (e.g., using an insurance company immediate annuity).

A few years ago when stock market investments were clipping along at 20% or more per year, the returns offered by an immediate annuity seemed paltry by comparison. A total return approach was feasible by selling off investment assets to provide income. In a down market, selling assets becomes an expensive proposition as more have to be sold for lower prices in order to meet income requirements. In this case, if high cash balances have been maintained, the annuity income stream can be generated by liquidating cash and holding the more risky portion of the portfolio in equities, allowing it to recover over time as the economy and the markets turn to the positive.

Although the insurance company guaranteed approach is appealing, there are both good and bad points to consider. In the latter case, the decision to enter into a contract with an insurance company is irrevocable. Second, since these annuity payments are fixed, it’s important to consider inflation. Fortunately, many companies are now offering riders with cost-of-living increases.

On the plus side, income can be guaranteed for life. When non-qualified funds are used to purchase the annuity, only a portion of the payments are taxed, providing significant tax advantages. Finally, the older the annuitant, the greater is the return/payout.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

SEP Plans

by Bruce Fenton

Congress made it easy for the self-employed and small business owners to save for retirement with the Simplified Employee Pension (SEP—pronounced “sep”) plan. A SEP allows an individual to put up to $40,000 a year, tax deductible, into his or her retirement account.

When an economy is going through a shakeout like ours has these past three years, large businesses lay off talented employees who in turn start their own small businesses. Once covered by corporate retirement plans, these ex-employees must now fend for themselves when it comes to retirement savings.

With a SEP plan, the employer or the self-employed individual contributes directly to the employee’s IRA account. Participants do not need a separate SEP account if they already have an established IRA.

Unlike the more common profit sharing or 401k plans, the SEP does not require complicated documentation, administration or annual tax reporting, relieving the employer of the expenses of a normal pension plan.

SEPs are available for the self-employed (including anyone with a part-time business), sole proprietorships, S and C corporations and partnerships.

An employer can contribute up to 25% of an employee’s annual compensation, not to exceed $40,000. In the case of self-employed individuals, compensation is considered to be income reported on schedule C of their tax returns. Direct employer contributions to a SEP are not subject to Social Security (FICA) or Federal Unemployment (FUTA) taxes.

An employer-sponsored SEP plan cannot discriminate between employees. Contribution percentages must be uniform in their relationship to the compensation of each employee. In cases where there is a large disparity in compensation, a SEP plan may be integrated with a Social Security wage base. This will allow workers who make more than the wage base to end up with a larger contribution.

Annual contributions by an employer are not mandatory and can be made when desired. All of the contributions go into the participant’s IRA, and the participant is immediately 100% vested in the contribution. This allows participants complete control over the investments, just as they would have in a regular participant IRA.

A SEP participant may purchase any investment allowed in an IRA. Unlike qualified pension plans that limit in-service withdrawals, a SEP allows the owners the right to withdraw the money immediately, subject to taxes and early withdrawal penalties. They may also convert the IRA into a Roth IRA, paying taxes for the amount converted.

Withdrawals from a SEP are taxed just like an IRA, with participants paying ordinary income taxes plus a 10% penalty if distributions are taken before age 59 ½. While loans are not permitted from a SEP, the account owner may make a qualified 60-day withdrawal and rollover once each year without incurring taxation or interest charges.

Employers wishing to set up a SEP for this year do not have to complete paperwork or make the contribution until they file their 2003 taxes (plus any extensions). Another important feature for employers contemplating establishment of a SEP is that employees do not have to be covered by the plan until they have worked three years. Employees covered by collective bargaining agreements and non-resident aliens are also exempt from coverage.

SEPs are an ideal pension savings plan for smaller businesses (generally with around 10 or fewer employees) because of the flexibility afforded the employer in timing and amounts of contribution, ease of use, reduced administration expenses and the fact that there is no limit to the number of employees that a SEP plan may cover.

Note: Please visit Atlantic Financial's website for more information on SEP Plans.

Bruce Fenton is a financial consultant, a writer, and the president and founder of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Social Security Benefits

by Bruce Fenton

In 1935, President Franklin Roosevelt signed the Social Security Act, which provided a nationwide retirement and social welfare program for the first time. Since then, Social Security has grown to become an essential part of modern life and has been modified to provide for widows, orphans, the disabled and divorced spouses.

Today, about 98% of all workers are in jobs covered by Social Security. One in six Americans receives a Social Security benefit, and nearly one in three beneficiaries is not a retiree. According to the Social Security website, www.ssa.gov , Social Security benefits comprise about 5% of the nation’s total economic output.

To be eligible for benefits, a worker needs to be employed and subject to Social Security taxes for 40 quarters. A fully insured status enables the worker to receive unrestricted retirement, disability and survivor payments. To be eligible in any quarter, a worker must earn at least $870.

Benefits payable are determined using a formula for the average indexed monthly earnings (AIME) that takes into account the worker’s top 35 earning years since 1950.
The retirement benefit amount may be equal to, less than, or greater than the AIME. If the worker chooses to retire early, say at 62, the earliest age for retirement, the amount is reduced by approximately .56% for each month before normal retirement age (generally 65). If the worker elects to delay receiving benefits beyond the normal retirement age, but prior to age 70, the benefits are increased by 8% a year up to 140% of the normal benefit.

A retired worker’s spouse may elect to receive the greater of one-half of the worker’s benefit or his or her own benefit. It does not matter if the primary worker is still working and has not begun to draw benefits—the spouse may draw at his or her eligible age.

A divorced spouse who has been married for ten years or more to an insured worker and who has not remarried may draw under the same rules as a married spouse. This does not impact the benefits available to the insured worker. As a matter of fact, the insured worker could have several divorced spouses drawing upon his or her benefit, and could also be currently married to a spouse drawing benefits.

The minor children and spouse caring for minor children of a retired worker may be eligible for benefits. For those of you who became parents when you were older, your children under the age of 18 (or 19 if not graduated from high school) will receive a check equal to one-half of your benefit. The same goes for your spouse if he or she is caring for a minor under age 16. The total payable to a family is limited by a family maximum benefit calculation.

Finally, if an insured worker passes on, his family is entitled to certain benefits. Children under age 18 (or 19 if not out of school) receive a benefit, as does a spouse caring for a minor child under age 16. The amount is subject to family maximums and is dependent upon the worker’s AIME. A surviving spouse may elect to draw a widow’s benefit at age sixty, whether or not he or she was married to the worker at his/her time of death.

The Social Security website contains a wealth of information on benefits and rules as well as a useful retirement planning calculator. The latter will help you estimate your benefit based upon different scenarios for retirement, earnings and family situation.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Investing in REITs

by Bruce Fenton

Today, many investors would gladly trade the uncertainty of the stock market for the certainty of collecting a rent check from commercial real estate. However, short of hitting the lottery, most would find it difficult to come up with the money to buy a piece of the skyline or their favorite shopping center. In 1960, Congress created the Real Estate Investment Trust (REIT), recognizing that by pooling the interests of the average investor the commercial real estate market could be stimulated.

A REIT is a company whose sole purpose is to own and/or operate income-producing real estate, such as apartments, shopping centers, offices and warehouses. Some REITs engage in financing real estate. What makes REITs unique is the requirement that they pay at least 90% of their annual income to their shareholders. This payout can also include non-taxed income representing cash flow from depreciation.

REITs were not a large factor in real estate investing for the first 30 years of their existence. Initially, tax laws made real estate an attractive tax shelter for investment capital using partnership arrangements. And REITS could only own property; they could not manage or operate property. Finding managers whose interests were aligned with the REIT was difficult.
The Tax Reform Act of 1986 materially altered the real estate investment picture. Out went the more abusive tax-shelter elements. REITs were granted the right to own and manage property. But it took the commercial property depression of the early 1990s brought about by overbuilding to encourage real estate companies to seek capital from the public investment markets and individual investors.

As an investment, REITs offer a number of attractions. Since they must pass essentially all of their operating income through to shareholders, there is reduced opportunity for management to turn the REIT into a private piggy bank.

And because public REIT shares trade on the stock exchange, investors have liquidity in their real estate investments. They may buy and sell a diversified portfolio of properties, as well as the management, on an instantaneous basis.

Finally, REITs offer the security of owning real estate with a long life and the potential to produce income. When compared to owning public company bonds or dividend-paying stocks, payment of rents to an investor take priority over payment of bond interest and stock dividends.

REITs are available in three forms:

1. Investors may buy the individual REIT public stock. The stock prices will fluctuate with the market, but they have the advantage of minute-by-minute valuation and immediate liquidity.
2. REIT mutual funds own portfolios of individual, public, REITs and other companies engaged in real estate activities. This provides the small investor with an opportunity to own a widely diversified portfolio of real estate related investments.
3. A number of sponsors sell private REITs. Like the public REIT, they pass through to investors at least 90% of their income. Unlike the public REITs, however, the price is stable, and since it is not quoted daily, it is an ideal way for nervous investors to participate. Liquidity is limited to cashing out at pre-determined times in the year when management values the holdings.

Investors seeking to outpace inflation should be encouraged by the fact that equity investments in real estate have historically outpaced inflation, according to U.S. Dept of Commerce Labor S