How financially literate are you in matters of annuities, taxation, retirement planning, IRAs and home ownership? The following 10 questions are from the 38-item American College Retirement Income Quiz. Some of these questions are technically challenging even for financial professionals. See if you can beat the average score of 70 percent.
Answers are listed here.
1. Please choose the response below that best completes this statement: If you had a diversified portfolio of 50 percent stocks and 50 percent bonds that was worth $100,000 at retirement, based on historical returns in the U.S., the most you can afford to withdraw is ____ plus inflation each year to have an 85 percent chance that your assets will last for 30 years.
2. True or False: Taking a portion (20-40 percent) 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
3. A 65-year-old man in the U.S. has an average life expectancy of approximately an additional ___ years.
A. 5 years
B. 10 years
C. 15 years
D. 20 years
E. 30 years
4. Which of the following strategies is least likely to improve retirement security?
A. Saving an additional 3 percent 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.
5. Which one of the following statements 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. The policy will typically cost less than a term insurance policy.
D. You typically cannot borrow from the cash value.
Lifetime Income Payout Rate
6. 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 ...
A. 3-4 percent
B. 6-7 percent
C. 10-12 percent
D. 14-15 percent
7. 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.
E. All of the above.
8. In order to avoid a penalty tax, distributions from an IRA must begin for the year in which you attain age ...
B. 59 1/2
D. 70 1/2
9. 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 stable for 10 years.
D. Don’t know.
10. The salary required to afford PITI on the median-priced home in America is...
1. B – $4,000. This question reflects the well-publicized 4 percent safe withdrawal rule, based on research that looks back on investment returns in the 20th century.
2. A – True. Recent research has dispelled the long-held notion that exposure to equities should decrease throughout retirement. In fact, the research shows that the equity exposure should be lowest in the few years prior to and after retirement. As retirement progresses, a retiree can actually afford to increase exposure to equities.
3. C – 20 years. A man reaching 65 today can expect to live, on average, until 84.3, according to the Social Security Administration.
4. A – Saving 3 percent. 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.
5. A – 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.
6. B – 6-7 percent. If the safe withdrawal rate from a portfolio is 4 percent and the payout rate for an annuity for a 65-year-old male is 6-7 percent, the annuity begins to look attractive, considering it is low-risk and requires no ongoing consideration.
7. B – 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. The product offers 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 in case the policy underperforms. The guarantee is a specific payment based on contract terms. (This is why A is incorrect.)
8. D – 70 1/2. Minimum distributions must be made from an IRA for the year in which a participant attains age 70 1/2. However, the first distribution can actually be deferred to the following April 1. Failure to meet the required minimum distribution rules can result in a penalty of 50 percent of the amount that was supposed to be distributed.
9. A – If you have money in a traditional IRA, any withdrawals are going to be taxable. A useful tax rule-of-thumb suggests it is advantageous to take withdrawals from these plans at a lower-than-normal tax rate. If you don’t need withdrawals to live on, it might be better to convert it to a Roth IRA (and pay taxes at the lower rate), at which point future earnings become tax-free.
10. C – $48,604. The median-priced home in the U.S. requires an annual salary of $48,604 to support PITI based on an allocation of about 20 percent of salary. The figures vary geographically. In St. Louis, the median salary is $33,323. In New York City and San Francisco, corresponding salaries are $87,536 and $142,448, respectively, according to HSH.com and The Washington Post.