Answers on Retirement Planning

Readers recently submitted questions about financial planning for retirement to Doug Wheat, a certified financial planner with Family Wealth Management, based in western Massachusetts. Here is Part 1 of his responses; more will be posted on the Booming blog next Wednesday. (More than 100 questions were submitted, and regrettably not all can be answered on the blog.)

Q. My experience has been that retirement planners ask three questions, often somewhat obscurely: (1) How long do you expect to live? (2) How much income will you need to live comfortably in retirement? And (3) what do you expect the inflation rate to be? The math isn't very complicated -- if I were confident of my answers to those three questions, I could figure it out myself and wouldn't need a retirement planner. How about helping us figure out how to answer the three questions? -jrg, San Francisco.

A. By its nature retirement planning requires making plans without being able to know the future. You can, however, make reasonable assumptions and test them against historical data to determine the outcome with some confidence. The decisions you make in your preretirement and early retirement years set you on a path, but of course you will need to revisit your assumptions and adjust your path along the way. The Society of Actuaries estimates that for a married 65-year-old couple, there is a 45 percent chance of one person reaching age 90 and a 20 person chance of one person reaching age 95. So it is prudent to plan on living a long time.

The best way to determine the income you will need to live comfortably is to first determine how much you are spending on your fixed and discretionary expenses today. Second, determine which expenses will continue in retirement, which will disappear and which will be new. For instance, your property taxes will continue, but your mortgage may disappear and you may have new medical insurance and travel costs. And don't forget large periodic costs, like cars. No one knows what inflation will be. The Federal Reserve has a target annual inflation rate of 2 percent, but it is best to have inflation protection in some of your assets and income sources. Social Security is adjusted for inflation; some pensions and annuities are not.

Q. I have read that the rule of thumb is to withdraw 4 percent or 1/25 of your retirement funds each year. My guess is that this “rule” was developed when interest rates on “safe” investments (CDs, certain bonds, etc.) would support this level of withdrawal. However, with interest rates near zero (at least for now), it seems only equities have the chance to earn a sufficient return to support the 4 percent rule, but equities are risky for retirees. What is your advice on how to invest retirement funds, and is the 4 percent rule still applicable? -HonuCarl, Los Angeles.

A. The notion of a 4 percent safe withdrawal rate emanates from a 1998 academic study often referred to as the “Trinity Study.” In the study the authors from Trinity University provide historical evidence that if you begin withdrawing 4 percent of your accumulated savings your first year of retirement and increase that amount each year by the rate of inflation, you have little danger of running out of money over a 30-year period if it is invested in a balanced portfolio of stocks and bonds. For example, if you have $1 million at retirement, you can withdraw $40,000 the first year. Assuming the inflation rate is 3 percent, the second year of retirement you can withdraw $41,200. This strategy is appealing because it provides a steady cash flow while the value of your portfolio may be fluctuating. Updated studies through 2011 indicate that since 1926 there were no 30-year periods where you would have run out of money using this strategy (although if you retired in 1966 you w ould have come awfully close).

In a 2012 study, Wayne Pfau examined time periods of low dividend rates and high market valuations on withdrawal rates. He found that in those environments there may be reason for retirees to worry about the 4 percent rule of thumb.

In practice people may want to start with a 4 percent withdrawal rate and periodically adjust based on the current situation. A mix of stocks (equities) and bonds gives the best likelihood of success. If you are using a 4 percent withdrawal rate and the stock market booms, if you don't re-evaluate you will be living more frugally than you need to. The opposite is true as well.

It's also important to consider age. If you retire when you are in 50s, you will probably want to start with a lower withdrawal rate. If you are in your 80s, a higher withdrawal rate is certainly appropriate.

Q. I am very confused about what to do about long-term care insurance. Do you need to know where you will live when you retire, or are there policies that can be purchased in one state and used in another? Are there still such things as prepaid policies that you can pay off while you are still working? And are there any guarantees, or “insurance for the insurance”? That is, what if the company drops you, or the company goes under, or sells your policy to another company that goes under - do you lose everything you've already paid into it? And how much do they really cover? If you go into a nursing home, don't you end up spending down all of your assets and ending up on Medicaid anyway? I've heard rumors that they don't really cover all that much, once the time comes to actually collect. I understand that health care is a huge, huge cost when one is older, but are these plans really worth it? Are you really better off with one, given all the things that can go wrong? The l ast thing I want to do is to spend savings on insurance that won't actually do me any good in the end. - E., Long Island.

A. Deciding whether to purchase a long-term care policy is one of the most difficult decisions a preretiree needs to make. Like many insurance products, long-term care insurance is insuring against a risk that you hope you never need but that if you do need it, you want to be sure it is there.

Long-term care companies are bound by state regulators to pay for care covered in their contracts. Indeed, the insurance companies have paid so much in long-term care benefits that Unum Group, Guardian, MetLife, Allianz and Prudential are not writing new policies because they are not profitable. There are no guarantees for long-term care insurance companies, but they generally have the ability to request rate increases if their costs increase, allowing them to continue paying benefits (sometimes price increases are substantial). You should know, however, that at least one long-term care insurance company, Penn Treaty, is in bankruptcy, and it is likely the policy holders will receive little in the way of benefits. Make sure you check the credit rating of an insurance company before you buy a policy. You can move from state to state with your existing long-term care insurance.

Refinancing Spikes as Mortgage Rates Fall

By ANN CARRNS

Is it time to think about refinancing - or perhaps, re-refinancing?

Mortgage refinancing jumped to a three-year high, as interest rates on home loans dropped to new lows, according to a weekly industry survey from the Mortgage Bankers Association.

Mortgage applications overall increased 16.6 percent from one week earlier on a seasonally adjusted basis for the week that ended Sept. 28, according to the association's Market Composite Index, a measure of loan application volume. The survey covers more than three-fourths of all retail home mortgage applications in the United States, and has been conducted weekly since 1990.

The Refinance Index, meanwhile, increased 20 percent from the previous week. This was the highest refinance index recorded in the survey since April 2009.

“Refinance application volume jumped to the highest level in more than three years last week as each of the f ive mortgage rates in the M.B.A.'s dropped to new record lows in the survey,” Mike Fratantoni, the association's vice president of research and economics, said in a prepared statement.

He said the markets are continuing to adjust as the Federal Reserve's initiative to buy bonds known as mortgage-backed securities, dubbed “QE3,” pushes rates lower.

The refinance share of mortgage activity increased to 83 percent of total applications, from 81 percent the previous week.

The average interest rate for 30-year fixed-rate mortgages with “conforming” loan balances (meaning $417,500 or less) fell to 3.53 percent from 3.63 percent, while the average rate for 30-year fixed-rate jumbo loans (greater than $417,500) fell to 3.82 percent from 3.87 percent.

The average rate for 30-year fixed-rate mortgages backed by the Federal Housing Administration fell to 3.37 percent.

Those who can swing the monthly payments for a 15-year fixed rate mortgage saw the average rate decline to 2.90 percent.

Are low rates causing you to consider refinancing? Have you refinanced previously?

Birnbaum to Resign From MGM to Return to Production

By MICHAEL CIEPLY

LOS ANGELES - A long-standing Hollywood business partnership changed its terms on Wednesday, as Roger Birnbaum, who with Gary Barber had been a co-chairman and co-chief executive officer of Metro-Goldwyn-Mayer, announced plans to resign his posts and become an executive producer with exclusive ties to the studio.

Before joining MGM in 2010, as the company emerged from bankruptcy, Mr. Birnbaum and Mr. Barber had worked together for a dozen years, mostly through the film production and financing company, Spyglass Entertainment.

Mr. Barber will remain as the sole chairman and chief executive of MGM, according to a statement from the company. Mr. Birnbaum, meanwhile, expects to oversee the production of MGM's new version of “Robocop,” and will be involved with the studio's planned “Deathwish,” “War Games” and “Magnificent Seven” films.

The Boom (and Bust) That Your Mortgage Bonds Built

October 3, 2012, 10:45 am

By PADDY HIRSCH

Mortgage-backed securities are in the news again this week now that the Justice Department has sued a JPMorgan Chase unit accusing it of various improprieties during the housing boom and subsequent collapse.

In this excerpt from his new book, “Man vs. Markets,” Paddy Hirsch, senior producer for personal finance at American Public Media's business radio program production house, Marketplace, explains the history of asset-backed securities and how they ended up causing so much trouble.

Mr. Hirsch, perhaps best known for his series of whiteboard drawings and videos, leads the team of Marketplace staffers that co-produces two special newspaper sections and two hourlong radio shows each year with The New York Times.

In the 1980s, old-fashioned banks wanted big money. The kind of big money that the investment banks were making with all their fee­-based business. Commercial banks began asking themselves how they could get their hands on that fee money, without taking on risk. Interest income is great but it comes with an ever­-present risk that the borrower might default. The fee that a borrower pays on first signing for a loan, on the other hand, comes without any risk.

So one way lenders can make more money is to extend loans to borrowers, collect the fees, and then sell the loans to a third party, someone who's neither the borrower nor the lender. The risk of default is now assumed by the new owner of the loan, and the original lender simply pockets the fee and walks away.

The first mortgage­-backed security, which was assembled in this fashion from plain-old home mortgages, was created in 1970. It was called a pass-through, because the interest an d principal on all the loans in the pool were simply passed straight through to the bondholders (after the people running the trust were paid a fee, of course).

Securitization was a boon for homeowners, for the government, and for the banks who lent these mortgages. When investors asked for even more loans, with higher potential returns, Salomon Brothers and First Boston teamed up to give the idea a try. In 1983, they created a new securitization for Freddie Mac that offered a range of bonds based on a pool of private mortgages. Each class of bond had a different tenor and a different interest rate. Just like in a corporation, the safest, shortest-­duration investments were at the top and the riskiest and longest were at the bottom. It was a mortgage­-backed security with a twist, so it needed a new name. They called it a collateralized mortgage obligation.

It might help to think about a collateralized mortgage obligation as a pyramid of glasses, piled up in se veral tiers on a silver tray. Each tier represents a class of investor, the senior bondholders at the top, then the mid­level or mezzanine bondholders in the middle, and the junior bond­holders at the bottom. The tray is where the equity holders stand.

Now we pop the bottle of Champagne. The bottle is the bundle of mort­gages. At the end of the month, all the mortgage borrowers make their interest payments and the cash flows, like Champagne pouring out of the bottle. It flows out over the pyramid, filling the top tier of bondholders first, then the mezzanine tier, then the bottom and finally it fills the silver tray. And the same thing happens month after month after month.

If some of the mortgage borrowers get into trouble and fail to make their interest payments, or if they prepay or refinance their mortgages, less money will spout out of the mortgage pool and cascade over the pyramid. The top tier will likely still be filled, so those bondholders get paid, and maybe the mezzanine, too. But the chances of the bottom­-tier lenders and the equity investors being left dry become very real. That's why the junior bondholders get the biggest interest payments, while the payouts to the senior lenders are the smallest.

The collateralized mortgage obligation was a stroke of genius. It cre­ated a range of risk profiles and investment durations, and thereby appealed to many more investors. Now conservative banks could buy bonds that gave them a small, steady, and all­-but­-certain income, while speculators could gamble big with their bond investments, hoping for a fat payout each month.

And just like that, the genie was out of the bottle. Lenders realized that anything that generated cash flow or a steady stream of money each month could be securitized. Whether it was a mortgage, an aircraft lease, a student loan, or a book royalty payment, if it had cash flow, it was called an asset, which meant it could be turned into a so­-called asset-backed security, or A.B.S.

Now a single investor could put money into mortgages, credit cards, and car loans, rather than focusing on just one area. Investors liked the idea of being able to diversify this way, so they asked for more of these types of bonds.
That demand in turn fueled demand for more car loans, mortgages, and credit cards to put into the securitizations, which meant banks were pressured into going out and making more loans.

Suddenly it became a lot easier to get a loan. And that was great news for the economy. At the consumer level, it gave individuals access to money to buy goods and services in volumes that businesses had never seen before. That income allowed those businesses to grow, to hire more people, who in turn consumed more. At the corporate level, it gave companies access to the kind of money that gave them the freedom to do the kinds of things that companies could only have dreamed of in the past. Now they could expand into other parts of the globe, create new markets for their goods, even buy out their competitors.

In the late 1990s and early 2000s, the banks were happy, because they were making lots of fee money without taking much of a long­-term risk. American consumers and companies were happy because more money in the system and the banks' dwindling concern about credit quality (since it was bondholders who were now on the hook in the event of nonpayment) made it easier for them to borrow. But investors were happiest of all. Asset­-backed securities, whether they were based on mortgages, corporate bonds, or student loans, were enormously profitable. America was growing rapidly, unemployment was falling, and incomes were rising. Investors noticed that most people were making their interest payments, and the default rate of companies and individuals was way, way down. Many figured the riskiest bonds sold by an asset­-backed security were less risky than they seemed. So they demanded more.

And the lenders were happy to oblige. As the 1990s wore on, they doled out mortgages, car loans, and credit cards to people who would never have qualified for a loan twenty years before. Those borrowers of­ten paid painfully high interest rates on their loans, which reflected the possibility that they wouldn't be able to make their payments. But the investors who bought bonds backed by bundles of mortgages or car loans didn't mind: the more the borrowers had to pay, the higher the interest payments went on the bonds, and the more cash went into their pockets.

In the early 2000s, an unprecedented amount of debt was being lent to subprime borrowers, who opened credit card accounts, bought cars, boats, and, of course, houses. We now know that many lenders were giv­ing mortgages to people without asking for any collateral, or even proof of earnings. The lenders didn't care about the borrowers, because they could simply sell the mortgages on to a securitization trust. If the borrower defaulted, it was no longer the lender's problem.

The trusts didn't think it was their problem, either. The economy was booming, so that enough subprime borrowers were making their payments to funnel money to most of the investors who bought the bonds in these securitization vehicles. Most of the glasses in the pyramid were filling up, as it were. These bonds did so well that some enterprising financiers decided to take those bonds and securitize them, too! They called these new vehicles collateralized debt obligations, or C.D.O.'s, and they marketed them as completely safe.

But on Oct. 31, 2007, a stock analyst named Meredith Whitney shocked the banking world with a report that said Citigroup, one of the biggest banks in the nation, had too many bad home loans and was barely making enough money to operate.

The statement seemed absurd. Citi was the recipient of stamps of approval from analysts at all three ratings age ncies and the best investment banks. The bank insisted it had plenty of money and that Whitney was plain wrong.

But Whitney was right. She had ignored her peers, dug deep into Citi's balance sheet, and gone through its operations with a clear, hard eye. Other analysts rushed to do their own due diligence a little more diligently. Many downgraded Citi, and a week later, the bank's chief executive resigned.

Debt was the engine of the massive boom in the economy from 2002 onward, and the shadow banking system was the grimy stoker shoveling the fuel. Everyone benefited from debt: the people from all walks of life who could buy huge houses and max out their credit cards filling those houses up with flat­-screen TVs and leather recliners; the companies who could set up operations in far­-flung corners of the world one day and then gobble up a neighbor the next; the investors who rode the soaring stock market, and used asset­-backed securities to turn a billion dolla rs into a hundred billion on paper in less than a year; the politicians who could point to the buildings rising in their districts and the unemployment numbers falling all over the nation; the president who could boast about the country's stunning growth rate and announce the forces of terror had failed to suppress the American way of life.

Occasionally some egghead or analyst like Ms. Whitney would try to spoil the party by muttering darkly about the overextension of credit, or the lack of regulation in the banking sector, or the dangerous and poorly understood interconnected­-ness of the financial system. But most Americans had no idea what the eggheads were burbling about. And most of those who did understand the warnings dismissed them, saying they didn't acknowledge the benefits of a truly free and unregulated market.

Unfortunately, however, the eggheads were right. Debt, and consumer debt in particular, was the fuel that the stokers of the financial indust ry shoveled into the engine of the 1990â€"2007 economic boom. The trouble with fuel is that someone has to pay for it. A borrower can play the game of paying one loan off with another for so long, but one day the bill comes due and the debt must finally be paid. And in 2007, the bills started coming due, all over America.

Excerpted from “Man vs. Markets: Economics Explained (Plain and Simple),” published by Harper Business. Copyright © Paddy Hirsch, 2012. Reprinted with permission.

The Breakfast Meeting: Debate No. 1 Arrives, and NBC Likes Three New Shows

By BILL BRINK

The media world's focus is solidly locked on Denver as Wednesday's first presidential debate between President Obama and his Republican challenger, Mitt Romney, approaches. Jeff Zeleny provides a guide for viewers in The Times, and writes that there will be six segments of 15 minutes, “with ample opportunity for robust exchanges and a level of specificity that both sides have often sought to avoid.''

• Jim Rutenberg and Jeremy W. Peters report on the president's advantage in television ad spending, as out he outspends Mr. Romney in key battleground states, sometimes by a wide margin. The disparity, they write, has led to fears among Republicans that Mr. Romney's team has “simply been outmatched by Mr. Obama's in its approach to advertising and the way it goes about buying ad time on television.''
• The two candidates have been engaged in intense preparation for the debates, practicing against stand-in opponents as they try to hone their arguments, The Wall Street Journal reports. Mr. Romney has done full run-throughs against Senator Rob Portman of Ohio, in a setting meant to closely recreate the one for the debate Wednesday night. Mr. Obama has been sequestered at a resort outside Las Vegas and has practiced against Senator John Kerry of Massachusetts, standing in as Mr. Romney.

• In an interactive graphic, The Times allows readers to study the body language of the two candidates, broken down by an analyst with the New York University Movement Lab, with an eye toward how it might shape viewers' opinions during the debate.

• Peter Lattman reports in DealBook on an interesting phenomenon in election campaigns around the country. Candidates are demonizing Wall Street, relentlessly attacking their opponents for their “ties to banks and bailouts,'' even though many of the connections are tenuous at best.

 

The Drudge Report generated a wav e of interest promoting a video that Tucker Carlson discussed with Sean Hannity on Fox News, billing it as a racially charged speech by President Obama in 2007. Mr. Carlson acknowledged that he had reported on the video back in 2007, but he disagreed that it was an old story, the Web site Mediate reported. He said the media back then focused on Mr. Obama's prepared remarks, and not the ad-libs, which Mr. Carlson said contained divisive remarks.

NBC, which hasn't had much to celebrate lately in terms of prime-time television, moved quickly to reaffirm some early fall season success, Bill Carter writes for The Times. The network renewed three new shows for a full season of episodes: the drama “Revolution,” and two comedies, “Go On,” starring Matthew Perry, and “The New Normal,” about a gay couple and a surrogate mother. The three had done particularly well in terms of delayed viewing, with their ratings increasing significantly through DVR viewings after they were initially shown on television.

Wednesday Readiing: A Day Trip to Princeton for $66, Nap Included

By ANN CARRNS

A variety of consumer-focused articles appears daily in The New York Times and on our blogs. Each weekday morning, we gather them together here so you can quickly scan the news that could hit you in your wallet.