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Evaluating Savings and Investments

Senior Couple having Dinner

Tax Qualified Retirement Plans

As the years go by, more and more seniors will have substantial retirement assets that were a result of retirement plans sponsored by their employers while these people were working. In the past 30 years, these plans have become the standard method by which employer retirement funds are generated. These plans are generally what are known as "tax qualified" plans and include 401(k)'s, Tax-Sheltered Annuities, small employer arrangements and so on. The employee did not have to pay taxes on the amount of money that was contributed to the plan. On the other hand, those taxes must be paid when the money is taken out - including the earnings. In recent years, some tax qualified plans allow for contributions to be made after taxes so only earnings are taxed when the money is taken out. Depending on the tax bracket, taxes on withdrawals from these qualified plans could represent as much as 30% to 40% of the value of the assets. For those in a lower tax bracket, the tax is generally not this much.

The IRS requires that mandatory yearly minimum withdrawals must be made from all tax qualified savings plans when the owner of the plan turns age 70 ½. There are a few strategies discussed in other articles in this series to deal with these taxes if they cause a burden on the taxpayer.


Individual Retirement Accounts or IRAs were introduced with the Employee Retirement Income Security Act of 1974 (ERISA) and made popular with the Economic Recovery Tax Act of 1981. These are tax qualified plans for individuals and typically are not sponsored by employers. Contribution amounts are not taxable but all withdrawals from the account are taxable including earnings. Depending on the tax bracket, taxes on withdrawals from these qualified plans could represent as much as 30% to 40% of the value of the assets. For those in a lower tax bracket, the tax percentage is smaller.

We often find that seniors have rolled over money from employer-sponsored tax qualified plans into Individual Retirement Accounts to allow more control over the investment options in the IRA. The IRS requires that mandatory yearly minimum withdrawals must be made from all tax qualified savings plans - which includes IRAs - when the owner of the plan turns age 70 ½. There are a few strategies discussed in other articles in this series to deal with these taxes if they cause a burden on the taxpayer.

Fixed Interest Savings

Fixed interest savings represent accounts that have little investment risk pertaining to the earnings. These include bank or credit union savings, CDs, money market accounts and short-term bonds. Most of these accounts guarantee a certain rate of return and almost none of them ever result in a negative earnings rate. Seniors are attracted to these types of accounts due to the stability and the lack of risk. On the other hand, fixed interest savings typically do not allow for the savings to grow to keep up with inflation.

If one wants to hold onto savings for a long period of time without withdrawing that money, fixed interest savings are not a good way to provide any growth opportunity for that money. A more aggressive approach must be taken that involves some risk with some years of poor earnings and even possible losses. History has proven that over a long period of time, savings that involve some investment risk, grow much better than fixed interest savings and even though some years are down, over the long haul, most of these accounts have fared much better than fixed interest.

Deferred Annuities

An annuity is a guaranteed income stream over a certain period of time or over the lifetime of the person to whom the annuity belongs. A person receiving annuity payments is called the annuitant. Pension plans are annuities. In some respects, Social Security is an annuity because it is an implied guaranteed income stream and is based on the same actuarial assumptions that govern annuities. Annuities are typically sold by insurance companies where a lump sum of money is converted into a cash stream by the insurance company and the insurance company stands behind the guaranteed flow of income through a contract between the insurance company and the annuitant.

A deferred annuity is an insurance company product where money is accumulated over a period of time and then that accumulation account is converted into the annuity cash stream. For most deferred annuities, the conversion is intended at a future date when the annuitant is retired. A deferred annuity can be converted into an income stream at any time, but it must be converted on the age in the contract when annuitization must be done. Sometimes this annuitization age is pushed out to 85 or 90.

IRS rules allow that the earnings growth on money in a deferred annuity is not taxable until the annuity accumulation is surrendered or the account is annuitized. Some people see this as an advantage in their overall tax planning. For others, the deferral of taxes on the earnings may not be an advantage and in fact may be a disadvantage when money is taken out. This disadvantage is because first dollars taken out are considered earnings and taxes are due upfront. The principal amount - the contributions - which was taxed prior to the contribution must remain until all earnings have been removed and subsequently taxed.

Deferred annuities are often promoted as a way to receive fixed interest earnings that are a little above those of banks and credit unions, but are still considered to be safe from investment risk. Generally, the slightly higher rate of return is possible because it is based on the investments of the insurance companies. Insurance companies put most of their money into long-term bonds which typically produce a rate of return somewhat more than what banks and credit unions pay. There is a trade-off, however. During those times in the economy when short-term interest rates go to high levels, rates on deferred annuities are going to stay at a fairly level low rate because the underlying long-term bond interest rates are typically locked in during times of low interest. Early withdrawal penalties prevent the annuitant from removing the money and investing in the higher short-term rates.


Investments are financial vehicles that may incur the risk of loss in exchange for a higher rate of return. Investments include such things as stocks, long-term bonds, mutual funds, limited partnerships, commodities, hedge funds and hedging in general and several other uses of money. History has shown that investments generally produce a better return than fixed interest savings or deferred annuities and will typically outperform inflation. In other words, unlike fixed interest accounts and deferred annuities, investments should grow faster than the rate of inflation.

The trade-off with investments is twofold. First, unless they are held for long periods of time, investments can result in a loss of principal. Second, and more important for older seniors is if the account is being used to produce income, drawing off money when the account is down, could eat into principal and eventually eat up the account prematurely even though the long-term average earnings may have been higher than fixed rate.

For healthy seniors, investment advisors typically recommend having a certain percentage of retirement savings in investments. The strategy is to take money out of these investments when markets are doing well and transfer them to fixed interest accounts for the purpose of generating income. Direct withdrawals from investments for income purposes should be avoided.

Real Property Investments

Real property consists of raw land, commercial developments and rental properties. The principal residence of any investor is not considered an investment unless the owner is in the business of flipping personal residences. The personal residence can never be an investment, because it is impossible to get money out of a personal residence without having to borrow against it. People who claim that their personal residence will support them in retirement don't seem to understand that the home represents a place to live. If they sell the home, they must use money from the sale to buy another home or to pay for rental costs.

The great recession of 2007 has taught us that investment in real property can definitely result in significant losses. Generally, over a period of time, real property does produce a reasonable return. There is also a trade-off for this seemingly better rate of return. Investment returns in real estate are typically from rental income. Producing rental income requires property management either by the owner or by a professional property management company. Sometimes, the headache of managing property outweighs the potentially higher rate of return from investing in real property.

Another important disadvantage of investing in real estate is the threat of capital gains taxes when selling that property. To avoid capital gains taxes, many property investors continually rollover capital gains from previous properties into new property which only compounds the potential capital gains taxes when the property eventually has to be sold.