Your Questions Answered

Jonas Max Ferris
This week Jonas Max Ferris, co-founder of, answers YOUR money questions. Keep e-mailing us — we're making this a weekly feature. So, tap into the power of the #1 business team on cable at and be sure to tune in to "The Cost of Freedom," Saturday starting at 10am ET.

Are there reasons not to buy equity indexed annuities for retirement growth with low risk? The salespeople have plenty of reasons to buy them. — RCR

Here are some reasons:

Commissions: Annuities — which are insurance products — generally pay out fatter commissions to salespeople than even mutual funds with sales loads. This, and this alone, are why annuities remain big sellers year in and out. Of course, your returns will decline in direct proportion to these commissions.

Equity indexed annuities (EIAs) also have a much bigger built-in potential sales force as they are not regulated as highly as ordinary mutual funds and even variable annuities — they are not technically a stock market investment.

"Low risk" pitch is semi-bogus: Equity indexed annuities, or EIAs, are sold with the enticing pitch that they offer stock market upside (called the participation rate), but greatly limited downside. The bear market of 2000-2002 scared investors away from stock investing, and created the perfect environment for this marketing angle.

How does an insurance company offer such a great deal? By investing your money in a complex mix of bonds and derivatives. The guarantee you won’t lose money is often a white lie because the guarantee often only applies to about 90% of your investment, and if you need your money early you’ll pay surrender charges and tax penalties. Keep in mind that if you put your money in a broad stock index fund and don’t touch it for ten years you very likely won’t lose money either — it’s the short run that is uncertain, and EIAs only offer the illusion of loss-free returns in the short run factoring in these fees.

EIAs are probably better than just parking your money in a money market fund for years, and better than ordinary stock mutual funds in a down market, but over longer periods of time (over five years) you’d do better with a small allocation to a low-fee no-load stock index fund and a bond index fund.

The bond fund will beat the guaranteed rate on the EIA over time, and the stock index fund will likely beat the upside of the EIAs as you collect dividends on a stock index fund even if stocks go nowhere for years. You get nothing extra on an EIA unless the stock index climbs as the upside is set (through complex formulas that make EIAs tough to compare) to the index level NOT including dividends. Apparently salesmen have not told clients that a good chunk (up to 40%) of long-term stock market returns are from dividends, so this is a big chip left on the table.

Moderate your risk with a smaller allocation to stocks, not by using slick products. If you like annuities and want no risk, go with a fixed annuity — usually a better deal then higher fee variable annuities and EIAs. Whether you go with annuities or stock and bond index funds, check out Vanguard. They have both, and their phone reps offer a nice departure from high commission salesmen.

One more thing — your annuity “guarantee” is only as good as the company behind it. Some insurance companies may make promises their own trading department can’t deliver if the market goes haywire. Spread your risk around to several annuity providers.

Check out the SEC website for more information.

I am a 54-year-old male and would like to know how I can figure out how much money I need to retire right now and live the way I am living. Is there a formula that you suggest I use? — Mike

Short answer: 16 times your current salary. Here is the rough logic: You’ll need at least 65% of your current salary in yearly income to retire at about the same lifestyle you now have. The reason this number is less than your current salary is your tax rate will drop as investment income is taxed at a lower rate, (no payroll tax on investment income plus the Bush dividend and capital gains tax cut) and some of your costs of living now are directly related to working (living in a high-cost neighborhood near your job, commuting, lunches at restaurants, clothing, etc.)

On the other hand, you may find you spend more money not working as you have more time for going out, movies, travel, etc. What percentage of your current income you actually need depends on how your spending habits will change. If you live in New York City now it's safe to say you’d need maybe just 40% of your current salary if you moved to say, Kansas City. For someone already in a low tax, low cost of living area (or who wants to stay in a high cost area) the percentage needed could be 80% or more. Another big variable is if your home is or will be paid for soon — a big drag on your current salary.

Since you are only 54, you need your money to last decades. You will also need your yearly income from your money to grow to maintain your lifestyle because, thanks to inflation, your current salary in forty years will probably not pay for a used car.

The most you should bank on drawing down from your current portfolio each year and maintain some sort of growth is about 4% (this may change over time), assuming you own a mix of bonds and stocks. Excess portfolio returns above this 4% draw are to keep up with inflation. You can expect about 6-7% a year in total returns over time investing in stocks and bonds.

This means you will need a portfolio of roughly 16 times your current salary to make the transition safely (65% divided by 4% or .65/4= 16.25). If you earn $50,000 before tax you’ll need a portfolio of about $812,000 (no wonder retiring early is difficult). 4% of 812,000 each year is about $32,480 in income.

You can mess around with the numbers, but try not to rely on an overly optimistic expected return in your investments to bail you out from having a small portfolio. Note that if you will be collecting social security and/or a pension at some point you can be a little less conservative with your numbers.

Several websites have retirement financial tools where you can run some hypotheticals. Two good (and free) ones to check out are T. Rowe Price and Vanguard.

Why doesn't Congress enact the Fair Tax Act? It's the best solution by far to the abominable, messed-up income tax system (and IRS). — Cliff, WWII Vet (West Des Moines, Iowa)

The Fair Tax Act calls for a national sales tax to replace the insanely complex world of graduated (soak the rich) income taxes (with numerous deductions). There are several reasons Congress won’t enact such a plan, and other reasons why they shouldn’t, even if they wanted to.

The states that would benefit the most from such a move would be high income states like California and New York, states where the citizens pay the most income tax by far. Rich states tend to vote Democrat, so a move away from the progressive income tax — which largely benefits citizens in states with politicians who would probably not vote against progressive taxes — is unlikely. Poor red states don’t have the constituency to benefit from such a tax shift even if the politicians are for it.

Then there is the guaranteed bickering, because everybody in the world has a different opinion on what “fair” is. Some would say a fair system is one where just millionaires pay tax and the rate is 75%. At the other end of the spectrum some might say increasing tax rates as you get richer reduces incentives to work harder and make more money, so tax the poor at a higher rate than the rich to create more incentives to get rich.

Other problems with a move to sales taxes is such a system would not be nearly as simple as the architects envision. Think about it — income taxes could be simple: 20% tax across the board with no deductions. Income taxes are not simple because thousands of politicians along the way have tinkered with it for political benefits — to stimulate business, to help “the family,” to promote investing or home ownership, to ease the costs of healthcare, etc.

Do you really think these same politicians would not carve out thousands of deductions from the national sales tax? Somebody would want healthcare to be sales tax free, then home buying, cars for work, food, etc. Before you know it the sales tax would be 65%, and only some people would be paying it. Everybody else would be buried in paperwork trying to dodge it just like income taxes.

There would also be a huge black market for untaxed goods. Some would leave the country to buy lower-tax goods (they already do it for drugs, legal and illegal versions), and Internet merchants would set up shop in Mexico. Would the U.S. government have to go through every international shipment and value it for taxes?

As a World War II vet living in Iowa you may want to just bite your tongue about radical tax reform. Because of the current progressive tax system most retirees are paying very little tax compared to what they would pay with a national sales tax — a shift that is supposed to be tax revenue neutral. Why would you want a tax code that taxes you in Iowa more and someone like me in New York City less? Doesn’t self-interest trump fairness? Congressmen seem to think so…

I have my retirement invested in a Smith Barney program call TRAC. Their fees are based on the amount I have invested. Have you heard of this program, and what do you think of it? — Patricia Merrifield

I have not heard about a program with that name, but it sounds like a Wrap account. In order to move away from the older model of charging commissions to buy stocks, bonds, and mutual funds, brokers have moved more towards a financial advisor style relationship (although technically they are still stockbrokers— salespeople) of ongoing fees regardless of how much (or little) you trade.

While in theory this can be good, as in the past accounts were churned just to generate commissions for the broker, they tend to be expensive for lower net worth investors — even more than paying ordinary full-service commissions to buy stocks assuming you don’t trade very frequently.

Some brokers charge as much as 3% a year to manage money this way. An exorbitant sum for asset allocation considering likely future stock and bond returns. If you like your broker in this plan, are getting good ongoing advice, and the fees are more reasonable, this program can be good. If you’re just paying 2-3% a year and are getting the silent treatment (common for low net worth clients) and some generic portfolio everyone else gets (likely) consider buying some low fee funds yourself or finding a lower fee advisor. Several companies (including mine and Vanguard) charge less than 1% a year to manage portfolios.

What's the outlook for oil prices this fall? — Tim

While any short-term prediction on a commodity is an educated guess at best (unless you are an OPEC member…or perhaps an Exxon executive), my outlook is for a barrel of oil to fall to $40 or lower by the end of this year. Why? A good $10 per barrel of the current price is from speculators bidding up prices, not from real global supply and demand issues. Another $10 is because global economic growth rose faster than production capacity in recent years, a situation that should come back into balance eventually, as it often does.

Jonas Max Ferris is a regular contributor on "Cashin' In" (Saturdays at 11:30am ET and Mondays at 5:30am ET) and is co-founder of .