Q: My wife and I plan to retire in three years. I'm considering shifting about 20 percent of our taxable investments from bonds into an annuity whose performance is tied to gains of the S&P 500 index. The principal is guaranteed from any losses, but the upside is capped at 12 percent per year. If the S&P has a 20 percent gain in a year, we get 12 percent. Conversely, if it has a 20 percent loss, our principal remains intact. This annuity doesn't work if you withdraw early, but if you can wait until year 10, there are no penalties. Is there anything wrong with this picture?
M.C., via e-mail
A: Because the equity-indexed annuity (EIA) you are considering is only 20 percent of your taxable investments, certified financial planner David Bohannon, of Louisville, Ky., believes the shift is appropriate. Since the EIA will replace a portion of your bond portfolio, the potential increase in asset value and protection from any loss is appropriate for your risk tolerance.
Mr. Bohannon recommends that you clarify that there are no fees involved. It is unusual for an EIA to have none. But if there are no fees, and you understand the limits on returns and the 10-year time requirement, he believes this is a workable alternative to your bond portfolio.
But Jeffrey Voudrie, a financial planner in Johnson City, Tenn., disagrees. "First recognize that you would be shifting 20 percent of your bonds into an equity- oriented investment," he says. "Are you comfortable increasing your equity portfolio?" And don't let the other bells and whistles of the EIA confuse you, he adds. Your return will still be based on the return of the stock market.
In addition, "you give up a lot of flexibility for the promise that your money won't go down," he says. You are required to leave the money in the EIA for at least 10 years or suffer substantial penalties. What if your situation changes?
Mr. Voudrie recommends keeping that portion of your money allocated to bonds - although it would be important to have it in short-term bonds right now because of rates going up. In another year or two, he says, it is likely that you would be able to invest this portion of your money in government or high-quality corporate bonds earning a stable 6 percent or more while retaining your flexibility and access to your money.
"Don't make the mistake of using a long-term investment like an EIA to solve a short-term problem like low interest rates," he warns.
Q: We are retired and thinking about moving to California to be closer to our daughter. The difference between what we would sell our house for in Washington and what a house in California would cost is about $120,000. I'm 68 and my gut tells me to not take any distribution from my retirement savings plan to make up this difference, but wait until I reach age 70-1/2. Is it more advantageous to tap into my retirement savings and pay cash for the house or take out a mortgage?
H.A., Gig Harbor, Wash.
A: You don't indicate how much money you have in your retirement account, says Roger Gorham, a certified financial planner in Hillsborough, N.J., but let's assume it holds $166,667.
If that's the case, you could withdraw all of that money, pay $46,667 in income taxes (at a 28 percent rate), and buy the house outright. But Mr. Gorham suggests you invest the entire retirement account into a GNMA fund or an intermediate-term Treasury fund, whose yield would match the interest rate you'd pay on a $120,000, 15-year mortgage. Gorham believes that the investment risk is mostly eliminated since the asset and the liability are nearly identical.
If you use the cash generated by the retirement account to pay the mortgage each month, you'll find that there should be enough money, says Gorham. Because the retirement account is larger than the mortgage debt, it provides enough cash to cover the mortgage and the income taxes on the withdrawal.