Please choose the response below that best completes this statement: If you had a well diversified portfolio of 50% stocks and 50% bonds that was worth $100,000 at retirement, based on historical returns in the United States the most you can afford to withdraw each year is about ____ plus inflation each year to have a 95% chance that your assets will last for 30 years.
E. Don't know
The correct answer is B. Only 38% of survey respondents answered this question correctly. This question reflects the 4% safe withdrawal rule that has been highly publicized and discussed in the press. The 4% rule is based on research that looks back at investment returns in the 20th century in the U.S. The research indicates that if you retire with $1,000,000, you could afford to take a withdrawal of $40,000 (4%) in the first year of retirement, increase it for inflation each year, and sustain that income stream for 30 years. The rule is good to know as it begins to help retirees understand how much can be safely withdrawn each year. It dispels the common misunderstanding that if the average return on the portfolio was 7%-8% then that amount can be withdrawn each year. Because of the ups and downs of the market, the sustainable withdrawal amount is much less than the average return on the portfolio. The rule also is a quick way to get a sense of just how much income can be provided by a lump sum amount. For example, $1,000,000 under this rule only generates $40,000 of inflation-adjusted income. The research is based on historical returns and many question whether it is sustainable going forward. It is also just one of many factors that should be considered in determining how much can be withdrawn in retirement.
Please choose the response below that best completes this statement: To maximize the safe withdrawal rate from a portfolio over a 30-year retirement period, it is best to hold ___ in equities throughout retirement.
E. Don’t know
The correct answer is actually B or C. 56% of survey respondents answered this question correctly. A is incorrect as having almost no allocation to equities (0-10%) will mean having to lower the withdrawal rate. D is incorrect because when the equity percentage is too high (90-100%), the volatility in the returns increases the chances of depleting the portfolio. Having approximately half (50-60%) allows for a higher sustainable withdrawal rate, with a reasonable chance of leaving a legacy to heirs. Lowering the equity portion (25-35%) still allows for a reasonable withdrawal rate, but this approach may feel more comfortable for the risk averse—but it does limit upside potential.
True or false: Taking a portion (20-40%) of a retirement portfolio and buying a life annuity can protect against the uncertainty of life expectancy, ensuring that a basic level of spending is available throughout retirement.
C. Don't know
The correct answer is A. Only 45% of survey respondents answered this question correctly. A life annuity pays the annuitant for as long as he or she lives. Taking a portion of a portfolio and purchasing an annuity ensures that even if the portfolio is depleted, the annuity will continue to pay out monthly benefits. Deferring Social Security benefits to 70 (which increases the annuity payments) and electing a life annuity option with a pension at work are other ways to increase guaranteed lifetime income.
A 25% negative single year return in a retirement portfolio would have the biggest impact on long-term retirement security if it occurs:
A. 15 years prior to retirement
B. At retirement
C. 15 years after retirement begins
D. The timing doesn’t matter
The correct answer is B. Only 34% of survey respondents answered this question correctly. The timing of good/bad investment returns does matter, and this is one of the uncertainties faced in retirement. This risk is referred to as sequence of returns risk. Significant negative returns occurring at or near retirement have a much bigger impact on whether portfolio withdrawals will be sustainable throughout retirement than if they occur well before or well after the retirement date. The primary strategy for addressing this risk is to reduce portfolio risk—especially during the 5-year period prior to and after retirement. Reducing risk can mean reducing the allocation to stocks and moving more toward bonds, or buying deferred income annuities that start at or after retirement begins.
Which of the following strategies is least likely to improve retirement security?
A. Saving an additional 3% of salary in the five years prior to retirement
B. Deferring Social Security benefits for two years longer than originally planned
C. Working for two years past the planned retirement date
D. Don't know
The correct answer is A. Only 33% of survey respondents answered this question correctly. This is an important one to understand. Working longer and deferring Social Security are the two best ways to improve financial security. Saving a little bit more in the years just prior to retirement will not have a big impact on retirement savings as the money does not have a lot of time to grow with investment earnings.
A 65-year-old man has an average life expectancy of approximately an additional:
A. 10 years
B. 15 years
C. 20 years
D. 25 years
The correct answer is C. Only 41% of survey respondents answered this question correctly. A man reaching age 65 today can expect to live, on average, until age 84.3 according to the Social Security Administration.
Which one of the following is true about cash value life insurance?
A. The cash value portion will accumulate tax deferred
B. The policy will expire after a specified period of time
C. You typically cannot borrow from the cash value
D. The policy will typically cost less than a term insurance policy
E. Don’t know
The correct answer is A. Only 38% of survey respondents answered this question correctly. Like annuities, earnings are not taxed inside a life insurance policy. The earnings are never taxed if the benefit is paid out as a death benefit and premiums can be withdrawn without income tax consequences during the insured’s lifetime. B is incorrect as cash value life insurance is intended to stay in force throughout life—although policies mature at a particular age (newer policies mature at 120). This is in contrast to term insurance that expires after a term of years. C is incorrect as cash value policies typically allow for loans as a way to access cash value if needed. D is incorrect as cash value life insurance will have higher premiums than term insurance because there is both a death benefit and a cash value which can be accessed during the insured’s lifetime.
True or false: The death benefit from a life insurance policy owned by an individual is income tax free.
The correct answer is A. 60% of survey respondents answered this question correctly. This is one of the primary tax benefits of a life insurance policy.
The lifetime income payout rate (the annual annuity payment as a percentage of the purchase price) for an immediate income annuity for a 65-year-old male today is roughly…
The correct answer is B. Only 17% of survey respondents answered this question correctly. This is a hard question, but if a retiree is considering purchasing a life annuity as part of a retirement plan, it is helpful to know how much it will cost. If the safe withdrawal rate from a portfolio is 4% and the payout rate for an annuity for a 65-year-old male is 6-7%, the annuity begins to look attractive considering it is low risk and requires no ongoing consideration while investing the portfolio is full of complexity.
An immediate income annuity that pays income of $1,000 a month is generally going to be more expensive…
A. The younger the owner is when the annuity begins
B. For a man rather than for a woman
C. If interest rates rise
D. For a single person than for a couple
The correct answer is A. Only 29% of survey respondents answered this question correctly. If you are in the market for a life annuity, it is good to know something about costs. Annuity payments that begin at a younger age cost more simply because of the longer expected payout period. For that reason, some consider adding additional annuity income at later ages (70 or older) to reduce the cost. This can be done by purchasing an immediate annuity when payments are going to begin or buying a deferred annuity that will begin payments at a later age. Annuities are less expensive for men than women, as women are expected to live longer. If interest rates increase and higher interest rates are used to price the annuity, the annuity will cost less. Life annuities cost more when benefits are paid over a couple’s joint life expectancy than over a single life expectancy because of the longer expected payout period.
A deferred variable annuity with guaranteed lifetime withdrawal benefits…
A. Pays guaranteed income that varies based on market performance
B. Can pay income even if the investment account goes to zero
C. Ensures that the investment account will not lose value
D. Only offers investment alternatives with fixed returns
The correct answer is B. Only 14% of survey respondents answered this question correctly. One of the most popular annuity options today when purchased at a younger age to accumulate assets for retirement is the deferred variable annuity with guaranteed lifetime withdrawal benefits. This is a complex product, and unfortunately some who own it do not fully understand its terms. The product combines the opportunity to benefit from the returns on the underlying investment choices, while the guarantee provides minimum income payments for a single or joint life (for a couple) in case the policy underperforms. The guarantee is a specific payment based on contract terms (this is why A is incorrect). B is correct as the guarantee ensures lifetime payments even when the investment account is depleted. C is incorrect as the investment account will vary depending upon investment performance. D is incorrect as investment alternatives will include both equities and fixed income investments.
Distributions from an IRA generally must be made every year once an individual has attained age…
The correct answer is D. 84% of survey respondents answered this question correctly. Minimum distributions must be made from an IRA for the year in which a participant attains age 70½. However, the first distribution can actually be deferred to the following April 1st. It is important to understand these rules as failure to meet the required minimum distribution rules can result in a penalty of 50% of the amount that was supposed to be distributed!
Which one of the following statements concerning the federal income tax treatment of distributions to a 65-year-old retiree is true?
A. Distributions from a Roth IRA are generally tax-free
B. Distributions from a traditional IRA are generally taxed as long-term capital gains
C. Distributions from a traditional IRA for the 65-year-old are generally subject to an additional 10% penalty tax
D. Don’t know
The correct answer is A. 64% of survey respondents answered this question correctly. All distributions from a Roth IRA for an individual who is at least age 59½ and has had the account for 5 years will be tax-free.
True or false: A retiree who is working part-time can generally continue to contribute to a Roth IRA.
The correct answer is A. 69% of survey respondents answered this question correctly. Many people work part-time or participate in some self-employed activity in retirement. Many do not realize that you can continue to contribute to a Roth IRA even after age 70½ as long as you have earnings from employment and do not exceed the earnings threshold. Taking full advantage of Roth IRAs even at an advanced age makes sense as it converts investments that would otherwise generate taxable income to tax-free income. Roth IRAs are not subject to the required minimum distribution requirements during the life of the participant meaning that the assets can continue to grow tax-free in the Roth IRA until distributions are needed.
Converting a portion of a traditional IRA into a Roth IRA is a good idea this year if…
A. You have a big tax deduction this year and your marginal tax rate is lower than normal
B. You have more taxable income than usual and your marginal tax rate is higher than normal
C. The value of the assets in your IRA have remained the same for 10 years
The correct answer is A. Only 34% of survey respondents answered this question correctly. If you have money in a traditional IRA, any withdrawals are going to be taxable. A useful tax rule-of-thumb is to take withdrawals from these plans at a lower-than-normal tax rate. If you do not need withdrawals to live on, convert it to a Roth IRA (and pay taxes at the low rate) and future earnings are now tax-free.
Suppose that the interest rate on your savings account was 2% per year and inflation was 4% per year. After one year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?
A. More than today
B. Exactly the same as today
C. Less than today
The correct answer is C. 88% of survey respondents answered this question correctly. This is one of the standard questions for testing financial literacy. It checks the basic understanding of inflation. If prices rise faster (4%) than earnings on investments (2%), the amount of goods that can be purchased in the future is less than today. When investing for a long time horizon (like retirement), investing too conservatively can mean that the portfolio value may not even keep up with inflation.
Of the following options, the best way to protect against inflation is to have a…
A. Diversified portfolio of stocks
B. Diversified portfolio of traditional bonds
C. Diversified portfolio of CDs (certificates of deposit)
The correct answer is A. 59% of survey respondents answered this question correctly. There is some disagreement about how well stock investments protect an investor from inflation. But as compared to traditional bonds and CDs there is little disagreement that stock investments are superior. Another option is Government bonds called Treasury Inflation-Protected Securities (TIPS).
Sarah is single, age 65, and takes a reverse mortgage with a lump sum payment. When does the loan have to be repaid?
A. When she permanently leaves the home
B. When she takes on any other loan
C. Whenever the mortgage company wants it back
D. When she attains age 75
The correct answer is A. 76% of survey respondents answered this question correctly. Reverse mortgages are being used in a number of ways in retirement planning, and it is important to have a basic understanding of how they work. The concept is that a loan is made (there are a number of payout options available) and it does not have to be repaid until the owner permanently leaves the home.
Continuing care retirement communities (CCRCs) are different than a 55-plus housing development in that CCRCs always offer…
A. A range of care from independent living to nursing care
B. The opportunity to participate in social events
C. The opportunity to have relatives move onto facility grounds
The correct answer is A. 65% of survey respondents answered this question correctly. Both adult active communities (55 plus) and CCRCs are living arrangements that appeal to some older adults. Both offer opportunities for social interaction and other services. CCRCs are unique in that they allow for an individual to age in place, as they offer a full range of care options from independent living to nursing care.
Traditional Medicare will cover which of the following medical expenses?
A. Physical exams
B. Hearing aids
C. Routine dental care
D. All of the above
The correct answer is A. 75% of survey respondents answered this question correctly. Traditional Medicare covers many medical services including physical exams. However, there are services that can be quite costly for seniors that are not covered including dental care and hearing aids. Planning for these expenses is an important part of planning. Beneficiaries have the option to elect out of traditional Medicare in favor of Medicare Advantage plans. These programs sometimes include additional services like dental coverage, but in exchange, the beneficiary will have a more limited network of health care providers.
True or false: Medicare supplement insurance policies are most commonly purchased to cover the deductibles and copays that are charged under Medicare Parts A and B.
The correct answer is A. 79% of survey respondents answered this question correctly. For those who are in Traditional Medicare, there will be annual deductibles for both Part A (hospital coverage) and Part B as well as certain copays. One way to limit unexpected out-of-pocket costs is to purchase a supplemental policy. The most extensive policies cover almost all deductibles and copays. Note however, that the supplemental policies will not pay for services that are not covered under Medicare, like dental coverage and hearing aids.
True or false: The total out of pocket medical costs for married couples in retirement is relatively consistent from retiree to retiree.
The correct answer is B. 74% of survey respondents answered this question correctly. Medical expenses are one of the big unknowns in planning for retirement needs, and costs can vary a tremendous amount. Having comprehensive insurance coverage through a Medicare Supplement policy is one way to make the total out-of-pocket costs more predictable.
What is the proportion of the population that is going to need assistance with activities of daily living (need long-term care) at some point?
The correct answer is D. Only 18% of survey respondents answered this question correctly. This fact points out that the majority of Americans will need long-term care at some point in their lives. The odds are so high—everyone needs to consider that this is an issue that is likely to affect them.
Nationally, who pays for the majority of long-term care expenses provided in nursing homes?
B. Private payment by individuals
D. Insurance purchased by individuals
The correct answer is A. Only 33% of survey respondents answered this question correctly. Many do not realize that the majority of institutional care is paid for by Medicaid. Medicaid only pays for care once an individual has essentially run out of assets, and care is limited to those institutions that take Medicaid and have beds available. This is a public policy concern as well, as the Medicaid system is really taxed by these costs—which are likely to continue to grow as baby boomers age.
Nationally, who provides the majority of long-term care services?
A. Family members
B. Nursing homes
C. Assisted living facilities
The correct answer is A. Only 30% of survey respondents answered this question correctly. Most long-term care services are provided outside of an institutional setting by family members. Family caregivers undergo a tremendous amount of stress as they manage caregiving responsibilities along with work and other family responsibilities.
Long-term care insurance is intended to cover…
A. Alzheimer’s care
B. Hospital expenses after surgery
C. Emergency room care
The correct answer is A. Only 42% of survey respondents answered this question correctly. Long-term care insurance is intended to provide a funding vehicle for custodial and semi-skilled nursing care, which is generally not covered by Medicare and other health insurance. Custodial care for someone with Alzheimer’s is one common example of when benefits would be paid out. Long-term care insurance reduces the burden on family members and helps make sure that the retiree is less likely to end up spending down all of their resources at the end of their life. It also, in most cases, gives the family more options for where and how care is provided.
True or false: Medicare typically pays for the costs of a nursing home for the first year.
The correct answer is B. 59% of survey respondents answered this question correctly. Many people are not aware that Medicare does not typically pay for costs of nursing care. There is an exception for those needing skilled nursing care after a 3-day (or longer) stay in a hospital. In this case, skilled nursing care may be provided for up to 100 days.
True or false: Buying a single company’s stock usually provides a safer return than a stock mutual fund.
The correct answer is B. 82% of survey respondents answered this question correctly. This is another question commonly used to test basic financial literacy. The concept of diversification is important, as certain risks can be minimized by holding a portfolio of stocks. Individual companies have many risks around product offerings, legal exposure, business cycles, and others that make holding one stock too risky. Financial advisors worry that people end up with too much invested in the company stock of their employer.
If 100% of a mutual fund’s assets are invested in long-term bonds and the investment climate changes so that interest rates rise significantly, then the value of the mutual fund shares…
A. Decrease significantly
B. Increase significantly
C. Will not change at all
D. May rise or fall depending upon the type of bond
The correct answer is A. Only 34% of survey respondents answered this question correctly. Investors often think of bonds as low-risk investments. They forget that the value of bonds varies depending upon the relationship between the interest rate paid by the bonds and the interest rates available in the market. When interest rates are rising, the market is offering higher interest rates on new bonds than the existing bond holdings, reducing the value of the existing bonds. In retirement income planning, sometimes individual bonds are purchased to provide income needs. If the interest and principal of the bond is going to be spent to meet income needs, the price variation of the bond is less important. In this case, what is more important is that bonds can provide specific income with certainty for a predictable cost.
Historically, which one of the following generates the highest returns over a long time period?
A. Dividend paying stock funds
B. Large company stock funds
C. Small company stock funds
D. High yield bond funds
The correct answer is C. Only 10% of survey respondents answered this question correctly. Small company stock funds carry more risk, which means that performance varies a lot from year to year. But on average, to compensate for that risk, returns are generally higher. From 1926 through 2012, small-cap stocks averaged an annual return of 12.28% compared to 10.08% for large cap, according to Morningstar Ibbotson data.
True or false: Exchange traded funds generally have higher expenses than actively managed mutual funds.
The correct answer is B. Only 29% of survey respondents answered this question correctly. One of the factors driving investors to exchange-traded funds is the lower costs. This is in part due to the fact that most are “indexed” versus actively managed funds. Indexed funds pick a portfolio based on external factors and do not require the managers to execute discretion in picking the right stocks—lowering management fees. Lower investment fees mean higher returns to the investor!
A PE ratio means…
A. Price to earnings
B. Profits to expense
C. Par value to earnings
D. Price to expense
The correct answer is A. 58% of survey respondents answered this question correctly. Price to earnings is one of those indicators that investors keep a close watch on as it is an indication of whether the stock is a good value.
Which of the following types of long-term bonds typically has the highest yield?
A. AAA rate corporate bonds
B. B-rated corporate bonds
C. Treasury bonds
The correct answer is B. Only 26% of survey respondents answered this question correctly. Bonds provide greater returns as the risk increases. Treasury bonds are backed by the Federal Government and AAA rated corporate bonds have been determined by the rating agencies to have a low probability of default by the corporate entity. As the ratings for corporate bonds get lower, the risk of default increases and the return to compensate investors for taking that risk increases.
A single person who is likely to live to age 90 is generally going to be better off claiming Social Security benefits at age…
The correct answer is C. 55% of survey respondents answered this question correctly. One factor in determining when to choose Social Security benefits is life expectancy because this affects total benefits provided under the system. Delaying to age 70 is a good idea if the higher benefit is paid for a long time, as in this case. This is tricky though, as most people do not know how long they will live. And for a married couple, the larger benefit is paid for the joint lifetime—so the couple’s joint life expectancy should be considered when thinking about this question. Another way to look at the claiming question is how can you improve your retirement security. Deferring Social Security can do this as deferring “buys” more lifetime income that will receive inflation protection.
Social Security workers’ monthly benefits are increased for each year that benefits are deferred from age 62 to age…
The correct answer is C. 59% of survey respondents answered this question correctly. Social Security worker’s benefits can be claimed as early as age 62, but benefits continue to increase for each year of deferral up to age 70. Benefits do not increase after that, so there is no incentive to defer worker’s benefits past age 70. Spousal benefits and widow(er) benefits do not benefit from increases past full retirement age, so there is no reason to defer these benefits past full retirement age (age 66 to age 67 depending upon date of birth).
Please choose the response below that best completes this statement: According to the Social Security Administration, around 2033 they will only have funds to pay for approximately ___ of promised benefits.
The correct answer is D. Only 27% of survey respondents answered this question correctly. If Congress does not act, the Social Security trust fund will be depleted after 2033, meaning the program will only be able to pay 77 cents of every dollar of benefits owed through additional tax revenue that it receives.
If a participant is given the choice of a lump sum or a life annuity from a company sponsored 401(k) retirement plan, the life annuity is likely to be the better choice if the participant is most concerned about…
A. Having enough money to meet basic expenses
B. Getting an increasing stream of income over retirement
C. Having flexibility to meet changing income needs
D. Leaving money to children
The correct answer is A. Only 43% of survey respondents answered this question correctly. Choosing the life annuity provides a specified benefit amount for life, essentially guaranteeing income to meet basic needs. On the flipside, it eliminates the possibility of growth in income, flexibility to change strategies, or leaving the asset to children. The annuity provides certainty and simplicity. Even though the lump sum may better meet these other goals, it presupposes that the retiree has the skill to make the right investment decisions and understands all the factors relevant in choosing how much can be withdrawn each year.
If a large public company sponsoring a 401(k) plan files for bankruptcy, employees are…
A. At no risk of losing their 401(k) benefits because the plan is outside the claims of creditors
B. At risk of losing their 401(k) benefits because trust assets will pay creditors first
C. Only at risk of losing their 401(k) benefits if the plan document says the creditors have the right to trust assets
D. Only at risk of losing their 401(k) benefits if a judge decides that the creditors should be paid first
The correct answer is A. Only 27% of survey respondents answered this question correctly. When building a retirement income plan, one step is evaluating sources of income and one question to ask is how secure each source of income is. Many do not realize that 401(k) benefits are held in an irrevocable trust and are outside the claims of the company’s creditors, meaning that the benefits are quite secure. What is uncertain in a 401(k) plan is that the benefit equals the current account balance and the underlying assets change value with market conditions.