July 17, 2007

Synergy Financial Group

George Van Dyke
401 Washington Ave #703 How Much Annual Income Can Your Retirement
Towson, MD 21204
410-825-3200 Portfolio Provide?
410-530-2500 (cell)
[email protected]
www.synergyfinancialgrp.com Your retirement lifestyle will depend not only "safe" initial withdrawal rates in excess of 5%.
on your assets and investment choices, but All studies were based on historical data, how-
also on how quickly you draw down your re- ever, and past results do not predict future
The National Association of tirement portfolio. The annual percentage that performance.
Certified Valuation Analysts you take out of your portfolio, whether from
compiled a list of the ten most returns or the principal itself, is known as your Inflation is a major consideration
common errors found in valuation
reports: withdrawal rate. Figuring out an appropriate For many people, even a 5% withdrawal rate
1. Failure to define purpose and
initial withdrawal rate is a key issue in retire- seems low. To better understand why sug-
standard of value. ment planning and presents many challenges. gested initial withdrawal rates aren't higher,
2. Failure to discuss company
background, industry, market,
Why? Take out too much too soon, and you it's essential to understand how inflation can
competition and economic might run out of money in your later years. impact your retirement income.
environment.
3. Inadequate financial analysis.
Take out too little, and you might not enjoy
4. Mathematical errors. your retirement years as much as you could. A simple example illustrates the problem. If a
5. Use of formulas with no $1 million portfolio is invested in a money mar-
explanation. Conventional wisdom ket account yielding 5%, it provides $50,000
6. Failure to define earnings.
7. Inconsistent application of
A seminal study on withdrawal rates for tax- of annual income. But if annual inflation runs
discount or capitalization rates.
8. Leaps of faith regarding rates, deferred retirement accounts (William P. Ben- at a 3% rate, then more income--$51,500--
premia, discounts. gen, "Determining Withdrawal Rates Using would be needed the next year to preserve
9. Improper use of comparable
Historical Data," Journal of Financial Planning, purchasing power. Since the money market
companies.
10. Failure to disclose information October 1994), using balanced portfolios of provides only $50,000 of income, $1,500 must
sources.
large-cap equities and bonds, found that a also be withdrawn from the principal to meet
withdrawal rate of a bit over 4% would provide retirement expenses. That principal reduction,
inflation-adjusted income (over historical sce- in turn, reduces the portfolio's ability to pro-
narios) for at least 30 years. More recently, duce income the following year. In a straight
Bengen showed that it is possible to set a linear model, the principal reductions acceler-
higher initial withdrawal rate (closer to 5%) ate, ultimately resulting in a zero portfolio bal-
during early active retirement years if with- ance after 25 to 27 years, depending on the
drawals in later retirement years grow more timing of the withdrawals.
In this issue:
slowly than inflation. Calculating an appropriate withdrawal rate
How Much Annual Income
Can Your Retirement Portfolio Other recent studies have shown that broader Your withdrawal rate,
Provide? portfolio diversification and rebalancing strate- then, needs to take into
How Long Will You Live? And gies can also have a significant impact on account many factors,
Why Does It Matter? initial withdrawal rates. In an October 2004 including, but not lim-
study ("Decision Rules and Portfolio Manage- ited to, your asset allo-
Grandparents Help with
Ever-Rising College Costs ment for Retirees: Is the 'Safe' Initial With- cation and projected
drawal Rate Too Safe?," Journal of Financial rate of return, annual
Ask the Experts Planning), Jonathan Guyton found that includ- income targets (accounting for inflation as
ing additional asset classes, such as interna- desired), and investment horizon. Ultimately
tional stocks and real estate, helped increase there is no standard rule of thumb; every indi-
portfolio longevity. Another strategy that Guy- vidual has unique retirement goals, means,
ton used in modeling initial withdrawal rates and circumstances that come into play in plan-
was to freeze the withdrawal amount during ning, implementing, and adjusting a retirement
years of poor portfolio performance. Taken in income strategy.
concert, Guyton found it was possible to have
Page 2

How Long Will You Live? And Why Does It Matter?

Since the first baby boomers began reaching
Current Life Expectancy
retirement age, attention has been focused on
the growing number of older Americans. The SSA NCHS
news is both good--people can now expect to
Birth To age 77.2 To age 77.8
live many years in retirement--and bad--Social
Security and Medicare will be strained, and Age 65 To age 82.6 To age 83.7
people are saving less than they should.
A look at some statistics may convince you Sources: Social Security Administration,
Actuarial Study 120, Table 10; National
that the graying of America is more than just
Center for Health Statistics, Health 2006
media hype. Life expectancy is on a steady (based on 2004 data for total population)
upward trend, and planning for a long retire-
ment is more important than ever. many years you might spend in retirement, it
Life expectancy trends may be easier for you and your financial pro-
fessional to put together a realistic plan to
Gains in life expectancy over the last century help ensure that your retirement funds will last
have been dramatic. According to the National for a lifetime.
Center for Health Statistics (NCHS), from
According to the 1900 through 2004 (the most recent year for Here are some planning tips:
National Center for which statistics are available), life expectancy
• Prepare for several financial scenarios.
Health Statistics, at birth for the total population increased from
For example, how much money will you
approximately 45% 47 to 78. Much of the gain in life expectancy
need if you live to age 75? Age 85? Age
of women will live at birth came in the first half of the 20th cen-
95?
to at least age 85. tury, as public health projects and scientific
discoveries helped control many of the infec- • Recalculate your life expectancy
tious diseases and unsanitary conditions that periodically. Statistically, life expectancy
led to a high number of childhood deaths. changes over time.
• Consider your spouse's life expectancy
as well as your own when determining
Life Expectancy: 1900 to 2004
your retirement income needs. According
80 to NCHS statistics, women live 5 years
60 longer than men, on average, although
Age

40 the gap is slowly closing.

20
0 • Plan for the possibility of needing
1900 1920 1940 1960 1980 2004 long-term care. The longer you live, the
greater the chance that you'll need assis-
Year tance with day-to-day tasks or even ex-
pensive nursing home care that could
wipe out your retirement savings.
Life expectancy for individuals who reach age
65 has also been steadily increasing. Accord-
ing to the NCHS, life expectancy for older
individuals improved mainly in the latter half of
the 20th century, due largely to advances in
medicine, better access to health care, and
healthier lifestyles. Someone reaching age 65
in 1950 could expect to live approximately 14
years longer (until about age 79), while some-
one reaching age 65 in 2004 could expect to
live approximately 19 years longer (until about
age 84).
According to the NCHS, the
Reduce the odds of outliving your money average life expectancy for a boy
at birth is now age 75, while the
Using life expectancy tables or calculators to
average life expectancy for a girl
estimate how long you'll live can help you plan
at birth is now age 80.
for retirement. Once you understand how
 Page 3

Grandparents Help with Ever-Rising College Costs

As the cost of a college education continues were made in equal installments over a five-
to climb, many grandparents are stepping in year period and grandparents don't make any
to help. This trend is expected to accelerate additional gifts to their grandchild during this
as baby boomers, most of whom went to col- time.
lege, become grandparents and start gifting A 529 plan can be
what could be trillions of dollars over the next Significantly, this money is considered re-
moved from the grandparents' estate, even an excellent way
few decades. Helping to finance a grand- for grandparents to
child's college education can bring great per- though one grandparent can still retain control
over the funds if he or she is the 529 account contribute to a
sonal satisfaction and is a smart way for grandchild's college
grandparents to pass on wealth without hav- owner. But there are two things to keep in
mind here: (1) if a grandparent contributes education while
ing to pay gift and estate taxes. So what are simultaneously
the best ways to accomplish this? money, makes the special election, and then
dies during the five-year period, a portion of paring down their
Outright cash gifts the gift is recaptured into the estate for estate own estate.
tax purposes; and (2) funds in a grandparent-
A common way to help with college costs is to owned 529 plan can still be factored in when
make an outright gift of cash or securities. But determining Medicaid eligibility, unless these
this method has drawbacks. If you gift the funds are specifically exempted by state law.
money directly to your grandchild, he or she
might spend it on something other than col- Of course, grandparents can contribute
lege. Second, a gift of more than the annual smaller, regular amounts to their grandchild's
federal gift tax exclusion amount ($12,000 for 529 account instead. Contributions grow tax
individual gifts, $24,000 for joint gifts) might deferred, and withdrawals used for college
have gift tax and generation-skipping transfer expenses are completely tax free at the fed-
tax (GSTT) consequences (GSTT is the tax eral level (and often at the state level).
imposed on gifts made to someone who is
more than one generation below you). Another interesting feature of 529 plans is that
under current law, grandparent-owned 529
Another drawback to outright gifts is that the accounts are excluded by the federal govern-
gifts become assets of the student, and the ment's financial aid formula--only parent-
federal government treats student assets owned 529 plans count. So a grandparent-
more harshly than parent assets for financial owned 529 plan won't impact a grandchild's
aid purposes. Students must contribute 20% chances of qualifying for aid (however, there's
of their assets each year toward college costs, no guarantee this will be the rule in the future
compared to 5.6% for parent assets. because Congress periodically tinkers with the Did you know...
financial aid rules).
529 plans • Assets in 529
Note: Investors should consider the invest- plans are expected
A 529 plan can be an excellent way for grand- ment objectives, risks, charges, and expenses to grow to nearly
parents to contribute to a grandchild's college associated with 529 plans before investing. $200 billion by the
education while simultaneously paring down More information about specific 529 plans is end of 2008*
their own estate. There are two types of 529 available in each issuer's official statement,
plans: college savings plans, which are indi- which should be read carefully before • A survey of
vidual investment-type accounts whose funds investing. grandparents
can be used at any accredited college in the revealed that
United States or abroad, and prepaid tuition Pay the college directly over half were
plans, which allow prepayment of tuition at planning to
today's prices for the limited group of colleges Another excellent way for grandparents to
help their grandchildren with college costs is contribute to their
(typically in-state public colleges) that partici- grandchildren's
pate in the plan. Grandparents can open a to pay the college directly. Under federal law,
tuition payments made directly to a college education, with
529 account and name their grandchild as many expecting
beneficiary (only one person can be listed as aren't considered taxable gifts, no matter how
large the payment. But this is true only for to pay at least
account owner, though), or they can contrib- 25% of the cost*
ute to an already established 529 account. tuition--room and board, books, fees, and the
like don't qualify for this benefit. Aside from
A big advantage of 529 plans is that under the obvious tax advantage, paying tuition di- *Source: Financial
special rules, grandparents can make a joint rectly to the college ensures that your money Research
lump-sum gift of up to $120,000 ($60,000 for will be used for education. Plus, it removes Corporation
individual gifts) to a 529 account and com- the money from your estate.
pletely avoid federal gift tax, provided a spe-
cial election is made to treat the gift as if it For more information on any of these options,
talk to a qualified financial professional.
 Ask the Experts

What are convertible preferred shares of stock?

Convertible preferred Preferred shareholders must be paid divi-
shares of stock are one way dends before holders of common stock. Also,
to have some of the best of preferred shares are in line before common
what both stocks and bonds stock for a share of the proceeds if the com-
have to offer. Like bonds, pany goes bankrupt (though they are still sub-
they attract investors who want a steady in- ordinate to claims by bondholders).
come. However, this type of preferred stock
Synergy Financial Group also gives the holder the option of exchanging However, this greater security involves trade-
George Van Dyke some or all of those preferred shares for offs. Even if a company's earnings rise, pre-
401 Washington Ave #703
shares of common stock in order to participate ferred shareholders' dividends don't (though
Towson, MD 21204 holders of what's known as "participating pre-
410-825-3200 in a company's future growth.
ferred stock" may receive some benefits).
410-530-2500 (cell)
[email protected] Unlike dividends for common stock, dividends
www.synergyfinancialgrp.com for preferred shares are typically fixed, which Also, because their dividends are fixed, prices
can provide greater stability for someone who of preferred shares can be affected by
depends on that income. Those fixed divi- changes in interest rates. As with bonds, if
George Van Dyke is a Financial
Consultant with Synergy Financial dends also tend to keep the price of a com- interest rates drop, that fixed dividend be-
Group of Towson Maryland. Securities
pany's preferred shares more stable than that comes more valuable; if rates rise, the oppo-
offered through Linsco Private Ledger
(LPL) - Member NASD, SIPC. LPL of its common stock. site is true.
does not provide legal or tax advice.
The information contained in this Income investors often favor preferred stock Being able to exchange convertible preferred
report should be used for informational
over common stock because even though shares for common stock is one way to ad-
purposes only.
these shares generally carry no voting rights, dress those concerns. If you like the idea of
Synergy's mission is to build, preserve
they have a greater claim on a company's flexibility, convertible bonds offer a similar
and protect the capitol of our clients by
offering a comprehensive and earnings than its common stock does. feature.
professional level of advisory and
planning services as well as providing
exceptional customer service. Our
investment objective is to provide
serious investors with a very
acceptable after tax (where
applicable) total return over a long How do I compare convertible preferreds to common stock?
term horizon. In order to achieve our
client's goals, we recommend
investing in a diversified portfolio of When evaluating the price of convertible pre- converted at a lower price--say the common
high quality securities spread over ferred stock or deciding whether to convert it, stock is at $10 a share--you'd be trading your
multiple asset classes. We place
emphasis on creating tax efficient you need to consider its conversion ratio and $40 convertible for 3.5 common shares at $10
portfolios and managing risk. Through conversion premium. each--a total value of $35, not $40.
modern asset allocation techniques,
portfolios are assembled to match
each investor's individual investment A security's conversion agreement specifies Convertible shares typically trade higher than
goals and risk tolerance. We believe either the conversion ratio (how many shares the conversion price. That difference is known
that strict adherence to a disciplined of common stock your convertible equals) or as the conversion premium. In the above ex-
approach increases the likelihood of
generating consistent returns and the conversion price at which common shares ample, if common shares are $10, a 3.5 con-
limits the risk of significant loss. would be exchanged. A 3.5 conversion ratio version ratio means that the conversion pre-
means that each convertible share equals 3.5 mium is 14.3%. The $5 difference between
shares of common stock. the $40 convertible share and the $35 it would
be worth as 3.5 common shares represents a
The conversion ratio helps you gauge whether 14.3% premium above the common's price.
and when a conversion would make sense,
and whether the share price is appropriate. To The conversion premium can help you judge
calculate what the common stock should be how a convertible security may perform rela-
worth to justify switching (ignoring differences tive to common shares. The lower the pre-
in dividend yields and liquidation preference), mium, the more closely the convertible's fluc-
divide the price of each convertible share by tuations will track the common stock. A high
the conversion ratio. For example, if you paid conversion premium indicates the price of the
$40 each for preferred shares with a conver- convertible is based largely on its income
Copyright 2007 Forefield Inc. sion ratio of 3.5, the common stock price stream, which can help keep its price more
All Rights Reserved. would need to be at least $11.43 for a profit- stable than that of the common stock. A finan-
able conversion ($40/3.5 = $11.43). If you cial professional can help you evaluate con-
vertibles, and whether and when to convert.