Tuesday, January 8, 2013

Prisoner of Wealth

Very rarely would someone ask: are you or have you ever been a POW (“Prisoner of War”).  If you were asked that question, you might ask what in the world they are talking about or jokingly respond that you are indeed a prisoner – a prisoner of work.  But certainly, no one would admit to or even consider being a “Prisoner of Wealth."

The primary step to financial freedom is to free yourself from all the things that make you a Prisoner of Wealth. What do I mean by Prisoner of Wealth? The story of the Monkey Trap is a great way to illustrate this theory.

In the jungles of Africa, trappers used to trap monkeys using a very peculiar strategy1. They would carve a hole in a tree just big enough so that the monkey could barely put their hand through the hole. Once their hand was through, they could expand it and grasp whatever enticing bait or treat was inside the hole. However, no matter how hard they tried, the monkey could not pull the bait out. What the trappers found was that, most times, the trapper could walk directly up to the monkey and catch it without needing to use a net or any other trap. The monkeys wouldn't run away because they would never want to pull their hand out and leave the bait. Thus, they were prisoners because of their unwillingness to let go of the bait (their possession).

This sets the stage for our theory on being a Prisoner of Wealth. Sometimes clutching our possessions and wealth so tightly can lead to our demise or downfall. Often in retirement planning, I see people who are obsessed with the fact that they must retain complete control over their assets and live only off the interest. Many times, these same people overlook great opportunities.

Let's consider this hypothetical example:

We’ll call this client Harold Truman (aka Harry Truman). Harry is a 70-year-old single male who has $100,000 in an IRA CD.  Currently, Harry is frustrated with the low interest rate on his CD, which is currently at 2% per year, or $2,000 per year of interest. 

Harry is further frustrated by the fact that he must take his Required Minimum Distribution2 (RMD) on the IRA at age 70.5. Harry is now going to be forced not only spend down interest, but also the principal of his IRA over his lifetime.

In this example, I would recommend one of three options:

1)   Harry selects a customized annuity insurance product within his IRA that pays him an income as long as he lives. He will receive an income of $500 a month, or $6,000 a year, which is the equivalent of 6%. He'll receive this income for as long as he lives and he can never outlive that income. If he dies any time before the 20th year, the income will continue to pay out to whomever he designates as his heir.

Note:  If Harry was married, depending on the age of his spouse, for slightly less, he could have this product continue to pay income for the rest of both of their lives.

2)   This option is identical to the first, except that Harry starts out at a much lower income of $306 a month, or $3,600 a year, which is the equivalent of 3.6%.  However, this income will continue to increase by 5% per year each year for the rest of his life.  If he dies any time before the 20th year, the income will continue to pay out to whomever he designates as his heir.

3)   If Harry is concerned that inflation and interest rates will soon increase, his third option is an identical product to the first and second, but would provide him with an income of $335 a month, or $4,020 a year, and includes a feature that increases with the cost of living, similar to Social Security.  If he dies any time before the 20th year, the income will continue to pay out to whomever he designates as his heir.

At this point, you may be asking, what are these products?  The product in Scenario #1 is called a “Life with 20-Year Period Certain.” The product in Scenario #2 is called a “Life with 20-Year Period Certain, 5% COLA (Cost of Living Allowance).” The product in Scenario #3 is a “Life with 20-Year Period Certain and a CPI-U Rider (Consumer Price Index – Urban).” These products are what we call a “custom pension.” A custom pension is based on your amount of money and current interest rates, but also factors in mortality credits (more on this will appear in an upcoming blog).

In Harry’s case, the bottom line is that he will be able to get a minimum of $3,600 a year for the rest of his life, no matter how long he lives. If he dies before every dollar had been paid back, he can guarantee it will be paid to his heirs for the remainder of the 20 years.   

Harry was quite pleased with this and it allowed him the flexibility he was looking for.  By carefully considering all of his options, he was able to meet his financial and retirement goals and avoid becoming a “Prisoner of Wealth.”

For more tips on how to avoid becoming a prisoner of wealth, check out our blog or contact us today.

"Monkey Trap: Staying Human (and rational) in Conflict" Conflict Communications; http://www.conflictcommunications.com/monkey-trap.htm

"Retirement Plans FAQs regarding Required Minimum Distributions” Internal Revenue Service; http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Required-Minimum-Distributions
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