Archive | Retirement Planning RSS feed for this section

How To Deal With The New Payroll Tax Hike

14 Jan

how to deal with the payroll tax hikeSo by now, most of you have probably already opened your first paycheck for the year and were unpleasantly surprised by the decreased amount of your take-home pay. In case you were living under a rock for the past few months, here is what caused the tax increase. Well, it is not really an increase. There was a temporary tax break (reducing the Social Security Tax rate from 6.2% to 4.2%) that all American workers got for the last couple of years. This temporary tax break was given to us in an effort to stimulate the economy by letting us have more disposable income and was set to expire at the end of 2012.  Congress decided to let the tax break expire and therefore allowing all Americans to effectively lose 2% of their income starting January 2013.  There is a lot of speculation on how this tax hike will affect the economy. Many economists predict that the decrease in money Americans have access to on a monthly basis will lead to economic stagnation; some even go as far as predicting another recession. However, regardless of the impact the tax increase will have on the economy, most of us are now mostly concerned with how to immediately deal with the decrease in income and how it will affect our own budget.

The reality is simple – 2% less income is a lot for most of us. If your annual salary is $50,000, then you are looking at bringing home $1,000 less this year. Here are some of my thoughts I would like to share with my blog readers and my past, current and prospective clients at The Baron Group:

  1. Reduce expenses. Of course the most obvious response to a reduction in income would be a reduction in expenses. Think carefully about your spending patterns and see if there is any discretionary spending you can easily reduce. Going out to eat, dry cleaning, daily lattes and buying lunch at work are some of the most obvious ones you can cut or reduce.
  2. Go generic. If your budget is already reduced to bare necessities, think if you can save money by buying generic brands as opposed to brand names. You don’t have to immediately look at your groceries list. Realistically, most of us prefer a certain brand of food/drink and even if we can easily see that the ingredients are exactly the same, switching to a generic brand doesn’t happen easily. Instead, consider other household items such as paper towels, cleaning supplies, diapers etc.
  3. Don’t reduce retirement savings. Reducing how much you contribute towards your retirement goals may seem like a good way to respond to the tax hike. This couldn’t be further from the truth. Remember with savings you have to always consider the effect of compound interest. Specifically, the amount you chose to not save today will be magnified because you will forgo the benefits of continuously accumulating interest on interest. So, before you decide to reduce your retirement savings contributions, explore every other strategy for cutting expenses. Ideally, you will avoid reducing your retirement savings altogether.
  4. Increase debt payments. You may think it is counterintuitive to increase payments when your income is reduced. Not when it comes to debt payments. As you are scrubbing your budget to see where you can find a few extra dollars to respond to the payroll tax hike, you may surprise yourself with reductions increasing 2%. If that is the case, and in an event of any room in the budget, I always recommend increasing debt payments. The sooner you are completely debt free, the closer you get to financial freedom and the realization of your financial goals. (Learn how to Eliminate Debt, including your mortgage in a fraction of the regular time)
  5. Deserve a higher raise. Usually 2% of annual income is what the average American receives as an annual raise.  However, since in 2013 this raise will be eaten by the payroll tax hike, maybe now is the best time to really excel and impress at work so you can make a case for an above average increase this year.

How about you? What will you do (have already done) to respond to the payroll tax hike? Please share in the comments section below.

 

13 Sure Ways to Be Broke But Cool… Forever

11 Jan

Broke But CoolYou know all those personal finance experts who always talk about saving, budgeting, living within your means and being financially independent? They often give advice that although has a desirable future outcome assumes that you save up for stuff, live within your means and are financially responsible. How boring! You only live once. Instead, read below how to be broke but cool.

  1. Keep up with the Joneses. Number one rule for being cool is making awesome impression. If your neighbors or friends get something new, you should definitely follow suit. Actually, think if you can get something bigger and better.
  2. Finance everything. You can’t afford it? No problem! That’s what credit is for! You are not buying a $30,000 car but committing to only $300 a month payment. For only 5 years. You can totally do this. Why wait to buy the stuff you really want when you can have it now. After all, you have a huge credit limit for a reason.
  3. Pay the minimum. When the credit card bills come in, don’t waste all your cash to repay them. There is this really cool concept of minimum payment. It is designed with your comfort in mind so you don’t have to use up all your cash and instead can spend it on some really nice stuff. Oh, and ignore that part about how it will take you 38 years to repay the balance if you only pay the minimum. That’s there just for informational purposes. No biggie.
  4. Stay in debt. There is no need to try and get out of debt when almost everyone in the US has debt.  You are in good company. And interest? Well, just focus on that daily interest percentage that your credit card company has listed for you on the statement. When you look at it that way, it doesn’t seem so bad.
  5. Buy the biggest house. Buying the biggest and most expensive house you can barely afford is a great way to be cool and broke.  Make sure you have the most lavish décor, high end everything and remodel as soon as possible. You can finance all of that. If you are lucky, your house may even go up in value so you can borrow against the equity and have some more spending money. Now how cool is that?
  6. Buy a new car. And do that often. There is nothing like that new car smell. A new car makes you feel and look great. Your car is one of the first things people notice about you so make sure it is fancy so you can make a good impression. Ignore them if people tell you that a car is one of the fastest depreciating assets. They must be jealous of your coolness!
  7. Don’t save. Why tie up your cash in a savings account when you could put it to better use? Financial advisors always talk about emergency fund. Do you really need that when you can use a credit card in case of an emergency?
  8. Don’t have insurance. Another favorite of financial advisors and all those personal finance folks. After paying for your big house, new car and cool new toys, life insurance just costs too much. Plus what are the chances you die anyways?
  9. Follow the latest trends. In fashion, cars, furniture, appliances and gadgets, the trends change all the time. And there is a good reason for it. After all, they are developed after countless hours of research by the consumer goods companies. So by all means, follow the trends! Even if that means renewing your wardrobe and cell phone every season, changing your car every two years and remodeling your kitchen every five years. Remember, that’s what credit is for and trendy is cool!
  10. Go on expensive vacations. You work so hard. You deserve it! And you have a huge credit limit on your new card. So why not treat yourself to that exotic vacation you have been thinking about. Make sure you choose the best. Go for luxury whenever you can. Think about the cool pictures you can show! You would really like that 5 star resort in the Caribbean.
  11. Don’t think about retirement. Retirement is for old people! You are way too young to think about that. You have plenty of time. You can think about that later. Plus towards the end of your career you will be making much more than today so it only makes sense to start then. Don’t get depressed thinking about getting old. Instead, enjoy your awesome life now.
  12. Wait to invest. Same logic as above applies here. Why waste precious dollars today for something that impacts your long-term future? Ok, maybe there is a merit to doing that but you can always start tomorrow. Or next year.
  13. Get regular “shopping therapy”. You didn’t know that “shopping therapy” is a scientific term? If you are sad, tired, or bored, go shopping. Coming home with something new will instantly cheer you up and make you feel better. Do it regularly and consistently for best results.

So, live by the above principles and you are guaranteed to look your best, make the best impression and always immediately get what you want. You will know that you have enjoyed life to the fullest and you are guaranteed to be the person everyone envies and wants to be like.

Who cares about not having savings, not being able to retire, living paycheck to paycheck and being broke when you are that cool!

The Parents Dilemma – Saving for College or Retirement

30 Jul

Should we save for college or should we save for retirement?

Whether your little ones are in diapers or about to head off to college, if you are a parent you have probably asked yourself this question over and over.

The hefty price tag of higher education seems to be increasing every year. According to the College Board, the average fees for four years at a private college is now more than $150,000 — including $38,589 for the 2012-13 school year. Even going to your state’s university, it costs close to half that total at an average of $17,131 a year. As a result most graduates have amassed significant amounts of student loan debt by the time they enter the workforce. You don’t want that for your children. You want to give them the best start in life, right?  After all, good parents are selfless and ready to sacrifice anything for the wellbeing of their babies.

Most experts agree than when it comes to deciding between saving for college or retirement, just wanting the best for our little ones should not be the deciding factor as emotional reasoning should not be applied to this all important decision. This is of course not to say that you should not save for college. It is essential to approach the college saving decision rationally, and carefully balance saving for college with working towards the remainder of your family’s financial goals such as being debt free and being 100% certain that you are going to be able to retire comfortably and when you want.

As parents we learn to juggle so much and here are a few considerations to keep in mind while balancing college and retirement savings.

When in doubt, choose retirement. Reasons are simple and not necessarily selfish. Unlike college education, loans, scholarships and financial aid are not available to finance retirement. As a parent, you might think your most important financial duty is to pay for your children’s education. You’d be wrong. Saving enough money for your own retirement is even more crucial.   Your Family Bank® is a concept that might allow you to a accomplish both. You can have a plan to safely and securely plan for college and have a tax-free source of retirement income simply by redirecting your current spending.  In addition, if you fail to save enough and are not able to retire comfortably, you may in your old age become a burden on those same children whom you tried to protect from being overwhelmed with debt.

Start early. Remember your best friends – time and compound interest. Give them a chance to do their magic by starting saving for college early. If you open a college fund when your child is born and invest $100 every month until it is time to pay tuition bills, assuming a 5% return on investment, in 18 years, the balance will be $35,000. While this may not be enough to cover all college expenses, it is at least something to get started.  It all depends on how much of the total higher education expenses you have decided you are going to cover.

Set expectations and communicate them with your children. This is a very personal decision and it depends on both your financial situation and your parental approach but however much you are going to contribute, make sure you set the expectations and communicate them to your children so they know what to expect. You may decide that you are going to pay for undergraduate degrees only and anything in addition (Master’s, MBA, Professional degree) your child will have to finance on their own. Perhaps you only cover tuition and encourage a part-time job or loans to finance the rest. Instill the right values in your children, encourage them to recognize the value of education and strive to be the best. There are plenty of merit based scholarships for students with good grades and high scores on standardized tests.

Get grandparents and relatives involved. Leverage the thoughtfulness and generosity of grandparents and relatives and suggest that instead of buying toys and cute new outfits for holidays and birthdays they contribute some or all of the money they ordinarily spend to the child’s college fund. Again, this is a personal decision and it depends on values and priorities but even if could get a few relatives on board, with time and compound interest on your side, you may be able to help cover a semester or two.

Consider the tax implications. Even if you end up financing some of the education expenses with loans, remember that there is a student loan tax deduction. You may deduct up to $2,500 per year in the interest paid on student loans if your modified adjusted gross income is less than $70,000 if you are single or less that $145,000 if you are married filing jointly. This deduction can be taken for the life of the loan.

Also, you may be able to take two federal tax credits – the American Opportunity Tax Credit and Lifetime Learning Credit – in the years you pay tuition.  Make sure you work with your tax professional to see if those apply to you.

Have a customized plan in place. College savings and retirement savings are not mutually exclusive and do not have to become the parental catch 22. Many factors play a role – when do you expect to retire, when are your children expected to head off to college, how many do you have, and are they likely to attend expensive private schools or the state college. With the average American paying $0.56-$0.64 of every dollar they earn on interest expense and taxes, it can be a challenge.  Your Family Bank® is one possibility that can allow you to plan for college and have a tax-free source of income during your retirement years.  Many times you can put this plan in place by spending no more than you are already spending now.  We do this by redirecting money normally lost to debt, interest and taxes back into your bank and ensure that your dollar gains a positive rate of return every day.  There are so many strategies to consider and the good news is that with the right financial plan in place it is possible to do both and strike a balance.

And at the end, you may be able to admire your Ivy League graduates without having to move in with them.

Taking the Mystery Out of Retirement Planning

13 Jul

Money.gov is a useful resource for personal finance. It is the U.S. government’s website dedicated to teaching all Americans the basics about financial education. Whether you are buying a home, balancing your checkbook, or investing in your 401(k), the resources on MyMoney.gov can help you maximize your financial decisions. Throughout the site, you will find important information from 20 Federal agencies and Bureaus designed to help you make smart financial choices.

 

One tool that I found particularly valuable is the Taking the Mystery Out of Retirement Planning tool. It doesn’t only discuss the issues most Americans are faced with when planning for retirement but it has some concrete, useful worksheets.

 

I hope you find it helpful!

The Fine Print on 401(k) Fees Just Got a Little Bigger

5 Jul

My last blog post 7 Threats To Your Retirement When All You Have Is a 401(k) Plan generated a lot of interest! It was my most visited blog post to date and for that I thank all of you who follow my blog. I sincerely hope you find it useful.

 

Still on the topic of 401(k) plans, you may or may not know that as of July 1, 2012  The Department of Labor, in an effort to improve transparency of 401(k) fees, has released a final rule which will:

 

help America’s workers manage and invest the money they contribute to their 401(k)-type pension plans. The rule will ensure: that workers in this type of plan are given, or have access to, the information they need to make informed decisions, including information about fees and expenses; the delivery of investment-related information in a format that enables workers to meaningfully compare the investment options under their pension plans; that plan fiduciaries use standard methodologies when calculating and disclosing expense and return information so as to achieve uniformity across the spectrum of investments that exist among and within plans, thus facilitating “apples-to-apples” comparisons among their plan’s investment options; and a new level of fee and expense transparency.”

 

(For more information, please refer to the Department of Labor website)

 

So when exactly and how will these fees be put under the spotlight?

 

First, there is the disclosure requirement from plan service providers (Principal, Fidelity, etc) to the fiduciary (your employer). They are required to disclose the fees they charge for investment management, administration, record keeping etc. The deadline for this disclosure is July 1st, 2012.

 

Then, the employer in turn, must inform (at least quarterly) its employees the fees they are paying for the above services. This is likely to be seen on statements as dollars charged per $1,000 invested. The deadline for this disclosure is August 30th or 60 days after the July 1st effective date.

 

What will that mean for all of us?

 

Will the increased visibility allow employees to really know how much of the fees charged are being passed down to them and potentially question some of them? Possibly.

 

However, what Mike Alfred, chief executive of 401(k) rating firm BrightScope considers the main advantage, as quoted by the Wall Street Journal is “We are already seeing fees coming down in preparation for fee disclosure. That will continue because the increased data will make the market more competitive”.

 

And more competition usually results in savings passed down to consumers.

 

So next time, you get your quarterly 401(k) statement, pay extra attention to the fine print, which just got a bit larger…

 

 

 

 

7 Threats To Your Retirement When All You Have Is a 401K Plan

22 Jun

Less than a week ago, US News posted an article in the Smarter Investor section titled 7 Threats To Your Retirement. While the article thoroughly discusses some of the threats to retirement, such as switching jobs, early retirement and lump sum distributions, which are indeed valid threats to the average American’s ability to retire comfortably, the author seems to focus more on the issues facing employees with defined benefit plans.

The reality is that a large percentage of Americans these days are not going to enjoy the security of pensions when they retire as less and less employers offer defined benefit plans (i.e. traditional pensions) and more and more employers offer defined contributions plans(i.e. 401Ks) with a tiny match, if any… Therefore to me, the real issue to discuss is

What are the 7 threats to your retirement when all you have is a 401K?

A little bit of history can help us understand the current reality…

In 1974 when The Employment Retirement Income Security Act gave formal approval to employee-funded savings plans via a pronouncement that became the Internal Revenue Service Sec. 401(k). By 1981, regulations had been issued and the 401(k) plan formalized.
Johnson Companies quickly introduced the first 401(k) plan. It was designed to give employees another way to save. Theoretically, it would provide a way for workers to supplement their pensions with additional, tax-deferred personal savings. These plans differed from their predecessors, where employees received a defined benefit, and came to be known as defined contribution plans, because the amount put into the plan is defined but the amount that comes out is variable.

As time has passed, companies have replaced their defined benefit plans with defined contribution plans. It saves money for the companies, as they are no longer responsible for providing income to retired employees. Today, most employees think of their defined contribution plans as “pension plans,” but real pension plans come with a guarantee. So what is the result of the DC plan experiment?

Defined contribution plans are often for most Americans the closest thing to a pension plan. One with a few pitfalls which pose a threat to retirement and make planning for it that much more important and also challenging.

  • 401K plan contribution is too voluntary – Every employee gets to choose how much, if at all, they are going to contribute to their 401K plan. Very often young employees find a myriad of what seems at the time legitimate excuses to postpone contributing to a 401K plan. It is not unusual for college graduates to be heavily burdened by student loan debts which they are repaying well into their 30s and therefore not contributing or contributing very little to their defined contribution plans.  The investors who fall in this category don’t start thinking about retirement planning into their 40s at which point they have lost the benefit of time and now have to contribute much more than if they had started contributing in their 30s.
  • Often employees use the loan option as an ATM – The loan options on most 401K plans allow for access to quick cash but unfortunately can put the accumulation of wealth in the nest egg at risk. As a matter of fact, close to 30% of people who have the option of a 401K loan have already taken advantage of it.  Without a doubt, having the ability to take a loan against the vested portion of the 401K can come in very handy in a situation of an emergency when savings only cannot cover the need. However, it is possible to ignore the disadvantages of borrowing from the retirement nest egg such as fees, possibility of hurting the credit score in the event of default and most importantly the opportunity cost of 401K loan. Or in other words, how much of a tax-deferred growth are you giving up by taking the money out of the fund.
  • When compared to traditional pension accounts, it is really a pay cut for workers – The logic here is quite simple, yet this is one of the most significant disadvantages of defined contribution pension plans. Compared to the few lucky ones who are still offered defined benefit plans by their employers, the majority of Americans who only rely on a 401K take in essence a pay cut in order to contribute to the plan. According to the Social Security Administration, the National Average Wage index for 2010 is $41,673. If one were to contribute the maximum 401K deferral amount per IRS regulations of $16,500, that represents a whopping 40% of income.
  • There are no guarantees – This is really a continuationof the previous point. Unfortunately, even saving a significant percentage of annual income, and thus forgoing the ability to spend it now, there is no guarantee that the securities or funds in the plan will not fall in value and therefore make it imperative for the employee to continue working. The worst is that this market risk does not end at retirement.
  • Fee Structures no matter what–  Another issue to consider is that al though the investor is exposed to market risk discussed above, the mutual fund provider, the custodian, the clearing firm, the transfer agency and a myriad of other functionaries get paid their fees even if the stock market falls.
  • Possibility of making bad decisions – Defined Contribution plan participants are responsible for choosing their own investments. While some might argue that this option empowers employees, the truth is that most investors are not that great at picking investments. This is not necessarily due to lack of knowledge. Same is true for professional fund managers. For example, The Vanguard S&P 500 which is the most famous index fun in the United States marketplace, failed to match the performance of the benchmark index as of December 31, 2011.
  • Timing is everything – Bottom line, the success of any 401K plan depends on timing more than anything. Financial markets do rise and fall and if one has the luck to be in the markets when they are rising, fortunate enough to make enough money to cover the numerous expenses associated with retirement and astute enough to pull all the money of the market before the next recession, then the 401K plan might indeed help to cover the cost of retirement.

So what is the conclusion?

 

While 401K plans are not all doom and gloom, it is imperative that they are a part of a well though out financial plan. Just like with any other investment decision, your individual overall investment goals need to be evaluated in order to determine the most effective investment strategy. Although certain general rules apply, there is never a “one size fits all” answer when it comes to investing. Your advisor will help you determine the most favorable strategy in your particular case.

Best of luck!!

Retirement age – the big unknown…

12 Jun

“When am I going to be able to retire?” is a question that is on the mind of many Americans, often keeping many of us up at night and giving many investors serious amounts of heartburn every time they look at the balance of  their 401K plans.

The current economic environment coupled with the uncertain future solvency of Social Security in the US, is causing more and more of us to question when are we going to be able to retire, if at all. The vision of leisurely afternoons on the golf course is beginning to look like a chimera…

The reality is not terribly encouraging. Just in the past decade we lived through the Great Recession, the global financial crisis, unemployment figures reaching double digits and we witnessed our houses lose value due to the burst of the real estate bubble. So what are we looking at – little, if any, equity in our homes; unpredictable value in our 401Ks and possibly some savings. The stock market is still below the levels reached in 2001 and we now have more than 11 years of inflation since then. In efforts to boost the economy, the Federal Reserve is keeping interest rates abnormally low and will not even begin raising them until 2014. In the equation of retirement, with variables such as housing and the volatile financial markets, the age of when most Americans will be able to retire is becoming the big unknown. With all of that in mind more and more of us are realizing the solution is only one – we will have to work longer. According to the latest Gallup poll, the average age at which Americans expect to retire has been progressively climbing up since the mid-1990s, and has now reached 67 years.

Still, younger workers seem to believe that things will eventually work out better than their older peers. In mid-April, Gallup conducted its annual Economy and Personal Finance survey, which concluded that people who are currently under the age of 40 expect to retire at age 65, compared to those who are over 40, still working and expect to retire not before 68. Why the difference? The younger population has the luxury of time. And although no one can predict the direction of the housing market or the global financial markets, those under 40 have at least 20 years to make changes in their lives; changes that are in their own control. Such changes could be efforts to increase the savings rate, pay off debt or rebalance their 401K portfolio. And most importantly just wait and hopefully weather the storm.

Those over 50, who don’t have time on their side can rely on different methods to achieve their retirement goals. Some of those include downsizing, taking advantage of products such as annuities that have contractual guarantees to pay income for life, or cash value life insurance and market linked CDs (which I recently discussed in details on this blog) or simply choosing a second career that they love. This will give a new flavor and better outlook on the possibility of having to work longer.

And finally, even if the retirement age gets pushed further out for most of us, statistically the odds are in our favor for enjoying some golden years since the average life expectancy in the US is now 78 years.

%d bloggers like this: