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The Looming Fiscal Cliff

Written By: Cathy DeWitt Dunn | President of Annuity Watch USA

The Looming Fiscal Cliff – What can you do to protect your retirement nest egg?

The financial world is buzzing about the looming “fiscal cliff.” The term, in-and-of-itself, strikes fear into the hearts of many Americans.

What is the “fiscal cliff” and what can you do to protect your retirement nest egg?

The “fiscal cliff” describes the precarious situation that the United States government will find itself in after December 31, 2012 – the day the terms of the Budget Control Act of 2011 are set to go into affect. Anticipated changes include the expiration of the Bush era tax rates followed by massive spending cuts, or sequester, on January 2, 2013.

Higher taxes may impact an already wobbly economic recovery. Thus, harder times may soon become a reality if nothing is done legislatively in the lame duck session of Congress. Capital gains tax rates will increase from 15 to 20 percent. Dividend tax rates, currently 15 percent, could more than double to a staggering 39.6 percent.

More repercussions from the fiscal cliff include the expiration of extended unemployment benefits for some 2 million Americans. In addition, Social Security payroll tax rates will increase. Regional Economic Models, Inc. (REMI) predicts that over 3 million more jobs will be lost due to sequestration cuts in the defense budget. To top it off, Morgan Stanley predicts a global recession in 2013.

Which brings us to what you can do to protect your assets. Everywhere you look…the news isn’t good. And, when there is so much instability – from higher taxes to higher unemployment – there is a greater than fifty-fifty chance that the stock market will reflect this instability.

If you are young and have the luxury of time, you may be able to afford to risk the ups and downs of the market. Systematically investing in the stock market (via your 401k for example) allows you to take advantage of dollar-cost averaging. According to Investopedia:

Dollar-cost averaging is the technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. More shares are purchased when prices are low, and fewer shares are bought when prices are high. The result is that the average cost per share of the security will become smaller and smaller, which lessens the risk of investing a large amount in a single investment at the wrong time.

If you are at or near retirement, however, and have money invested in the stock market, you can’t really afford a sharp market downturn. Now that you’re relying on taking money out of the market as opposed to investing money into the market, it is incredibly difficult (and may be nearly impossible) to recover from losing a portion of your principal due to a drastic market drop. In fact, many retirees are still trying to catch up from massive losses incurred in 2009 when billions of dollars in retirement savings were wiped out in a matter of days.

If you are looking at retirement – specifically putting a plan in place for guaranteed retirement income – it makes a whole lot of sense to move your money into safer havens.

So, what are your options?

Let’s start with gold. In times of panic many investors think, “I’m just going to go out and buy a bunch of gold.” However, from storage concerns to converting your gold into cash when you need it, it is not the most practical of solutions. For more on investing in gold

Next, let’s take a look at bonds. Bonds are traditional investments that, in the past, retirees have been able to depend on to generate a stable retirement income. In today’s world, however, historically low interest rates have created a “bond bubble” that could threaten to destroy retirees’ savings.

Since late 2008, when the federal government went on a $5 trillion dollar spending spree, the Federal Reserve has held short-term interest rates at near zero. The Fed has pumped more than $2 trillion into the economy by purchasing bonds.

According to the New York Posts Jonathan Trugman, “There’s a record $16.3 trillion of US debt and a good portion of that is sitting in baby boomers’ portfolios like a ticking time bomb ready to explode, and most investors know little about it.”

Mr. Trugman goes on to explain the basic math of bond investments:

“Bond prices (your principal) and interest rates (yield) move in opposite directions. When rates rise, bond prices fall. The inverse is, of course, true as well. When rates fall, the price (your principal) of the bond rises.”

But this makes current Fed policy very destructive.

“The problem today is that short-term Federal Reserve funds rates are pegged at zero percent. In addition, the Fed’s irresponsible bond-buying spree, dubbed QE, has driven even long-term rates insanely low, to 1.5 or 1.6 percent on the 10-year Treasury.

“Without rewriting arithmetic, rates have nowhere to go but up—and, eventually, up quite a bit. And the principal invested in bonds will fall substantially.”

This is potentially a very big hit.

“Rates would not have to go through the roof to take out billions in principal for investors, most of whom are in bonds because they are nearing retirement.”

“‘If the 10-year bond goes up 100 basis points, that could mean more than $35 billion is lost,’ says one bond trader.”

“One hundred basis points is just a 1 percent increase, which would put the 10-year at about 2.6 percent. The average rate of return over the last decade is roughly 4 percent, which, if we return to that yield, could put principal losses close to $500 billion, says a bond manager.”

If you can’t amass a pile of gold or rely on the previously fail-safe option of bonds, what in the world can you do to protect your nest egg to help secure your retirement future?

It may make a whole lot of sense to move a portion of your savings into an annuity or more specifically, a fixed index annuity. Similar to variable annuities, fixed index annuities provide the opportunity to participate in stock market gains. However, unlike a variable annuity, your principal is 100% protected against stock market losses.

Safe Money Talk Radio co-host, Matt Redding had this to say about the upcoming fiscal cliff and annuities.

“It was absolutely tragic watching what happened to people’s 401k retirement plans in 2009, but fortunately, many individuals have learned from that catastrophe and have moved some of their retirement savings into fixed index annuities (FIAs). The beauty of a FIA is that you may capitalize on market gains, but you are protected against market losses. Even if something similar to 2009 happens in the future, the issuing insurance company will guarantee your annuities against any loss. Our annuity clients have not lost a dime of principal –– or any gains their annuities have made –– despite the stock market rollercoaster of the past eleven years.”

Right now is the time to protect your hard earned retirement savings; December 31st is right around the corner. Before you make a financial decision including purchasing an annuity, I strongly recommend that you consult with a professional in retirement income planning or financial planning. The decisions you make in December may mean the difference between finding yourself at the bottom of the fiscal cliff or relaxing on your retirement oasis.

About the author

Cathy DeWitt Dunn is the President of Annuity Watch USA and co-host of the nationally syndicated Safe Money Talk Radio show, which airs each Sunday at 5AM. For over 15 years Cathy DeWitt Dunn has provided personal financial management to individuals and families who are looking for financial solutions that are not available in traditional brokerage houses. Each investment strategy or product she recommends is structured around protecting and growing retirement assets.

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