Archives for August 2013
As college tuition continues to skyrocket, it’s becoming more important than ever to know how the various savings plans work. The following is a link to a handy reference that outlines the latest rules on the most popular college savings programs (529 plans, Coverdell savings accounts, and the Education Savings Bond program) and how to use them to save money on your children’s education
In addition to details of each of the plans, the reference also contains information on Student loan availability and limits, Education tax credits, and Student loan interest and Tuition and fees deduction.
Whenever I have a discussion with someone about 529 plans and saving for their child’s college costs I am almost always asked the same couple of questions.
What if my child doesn’t go to college? You have a couple of options if your child does not go to college. Another family member can use the funds for education. That can include another child, yourself, or even nieces and nephews. There is no time limit to use the funds so you can keep the money in the 529 plan and use it to finance your grandchildren’s education. Having the money compound tax free for 30+ years can generate a substantial amount of money. If you decide to take the money out of the account and not use it for education you will have to pay tax and a 10% penalty on the earnings in the account.
What if my child receives a scholarship? You can withdraw money from a 529 up to the amount of the tax-free scholarship without paying the 10% penalty. You still have to pay income taxes on earnings, but contributions can always be withdrawn tax and penalty free. You still may be able to find some qualified expenses that you could use the 529 money for and avoid some of those taxes. In addition to tuition, you can use the money for tuition, room, board, books and mandatory fees there.
Should I prioritize saving for retirement or my child’s education? Retirement is probably many years away and we want to do everything for our children, but my advice is almost always to secure your retirement first. You can borrow to pay for college, but you cannot take out a loan to finance your retirement.
Recently the media and some prominent financial industry groups have made the shortcomings of 401k plans more prominent.
In April, PBS Frontline produced a special titled The Retirement Gamble, primarily focusing on 401k plans and their inadequate performance.
The special is a great watch, but if you don’t have the time to view it, two of the main points in the video are:
You do not receive a bill for the fees and expenses in your 401k plan, but rest assured they are being deducted and have an overall impact on how much money you wind up with when you retire. Some of the fees you are being charged include fund expenses, administration, and asset management expenses. A recent AARP study concluded that 70% of Americans did not even realize there were fees associated with their 401k.
One of the reasons that I recommend IRA’s over 401k plans is that most IRAs have no fees associated with them and you can add almost any type of investment in an IRA versus the 10-15 choices that you are usually limited to in a 401k plan.
If you are going to invest in a 401k plan ensure that you use a provider that agrees in writing to act in your company’s 401k plans best interest. The unfortunate reality is that firms in the brokerage, banking, and insurance industry have no legal fiduciary obligation to their clients that would require them to place the interests of those clients ahead of all others, including their own. Instead they operate on a much lower “Suitability” standard. Their representatives are commissioned salespeople who are incentivized to sell products, especially the ones that generate the highest earnings for themselves and their companies.
You may think that you do not have any input on the decision your company makes with its 401k plan, but you would be surprised if you and other employees bring your concerns to your HR and finance department of your company.
Frontline is not the only outlet talking about 401ks. Jim Cramer, the host of CNBC’s show Mad Money is not the biggest fan of 401k plans either. In a CNBC article, 401k Dirty Little Secrets, Cramer said “One of the basics of retirement planning – contributing to a tax deferred 401k plan – could come with a serious downside.” “As much as I like the tax-favored status of 401k plans, I need to tell you something heretical, something almost nobody else will come out and say: Most company 401k plans stink.” Many people think Cramer is a maniac for acting like he drinks a gallon of redbull right before he goes on the air on his show Mad Money, but he is spot on with his assessment of 401k plans.
Dan Solin of the Huffington Post recently wrote an article, 401k Participants Pay Dearly for the Crime of Underperformance on how 401k plans are usually loaded with actively managed funds which often underperform. It’s no coincidence that actively managed funds almost always come with higher fees.
Corporate America has shifted the burden retirement to individuals. Companies offering guaranteed pensions are on the decline and ensuring a secure and safe retirement is up to you. The wrong decisions or not making a decision can cost you hundreds of thousands of dollars over your career.
Before 2008, the federal government held less than $500 billion in cash, bonds, mortgages, and other instruments. Today, its portfolio has expanded to $1.1 trillion, financed mostly through borrowing.
Some of the debt was due to the financial crisis firefighting – but that debt has been sold off only to be replaced with a much bigger debt investment: student loans.
It is worth reminding ourselves that inflation is the major downside of holding cash. Even in the low-inflation environments in much of the developed world, returns on cash have not kept up with consumer price increases. So the value of cash diminishes in real or inflation-adjusted terms over time.
In the chart below the return on cash after inflation and taxes take their bite is a negative .8%. And that is taking into account a 3.5% historical annual return on cash. I don’t think there are too many savings, checking, money market, or mattresses that are paying a 3.5% return on your cash.
Among workers ages 40 and 50, nearly half fear the financial consequences of a critical illness- compared with just 29 percent who rate dying as their biggest concern, according to a new study.
That fear of a hit to the wallet being a bigger concern than dying is most pronounced among single workers, single women and single parents, according to the Sun Life Financail survey, “Well-Placed Fears: Workers’ Perceptions of a Critical Illness.”
For example, single women in that 40-50 age group are four times more concerned about the financial fallout of a critical illness than they are worried about being killed by it, the report found.
Earlier this month the city of Detroit filed for federal bankruptcy protection. Once, the city that defined industrial America, the Motor City’s bankruptcy is the sad culmination of six decades of decline. With industry and population fleeing and the tax base eviscerated, they have experienced a downward spiral exacerbated by years of corrupt and incompetent governance.
Detroit’s filing is the largest bankruptcy in history and stands out in size and scale, compared with other municipalities that have recently filed such as Vallejo and San Bernadino in California, or Jefferson County, Alabama.
What also distinguishes Detroit are competing obligations to bond holders and pensioners. Owners of the cities bonds are expected to battle with retirees and others for pieces of the city’s diminished wealth. Some may say that if you were holding municipal bonds from Detroit you are going to get what you deserve, but it may also set precedent for any other cities that declare bankruptcy in the future.
There are two types of municipal bonds: Revenue bonds and General Obligation bonds. The owners of revenue bonds are guaranteed repayment solely from revenues generated by a specified revenue-generating entity associated with the purpose of the bonds. Examples include water and sewer utilities, toll roads and bridges, power plans, airports and seaports. General Obligation bonds are secured by a state or local government’s pledge to use legally available resources, including tax revenues, to repay bond holders.
General Obligation bonds have always had precedence over other obligations, such as certificates of participation, leases, and pensions. The city of Detroit has proposed that all competing claims should be treated equally. A bankruptcy judge will rule if that will actually happen. The outcome of the bankruptcy process will dictate if the value of the full faith and credit pledge backing General Obligation bonds across the country will be diminished going forward. Recent history shows that we may be seeing a shift. In the case of General Motor’s bankruptcy, pension obligations were given precedence over bond holders claims.
The bankruptcy filing may also be a test case for how far a major US city can go in dealing with a chronic problem facing many local and state governments: unsustainable pension costs. Many city workers across the US have assumed that their pensions were untouchable, even in bankruptcy. Retirees in Central Falls, Rhode Island agreed to 50% cuts in pension benefits, in many cases, after the small city filed for bankruptcy in 2011. By contrast the city’s bondholders were paid in full.
Public pensions may lack the basic safety nets that private-sector benefits enjoy. Pensions granted by companies are typically backstopped by the Pension Benefit Guaranty Corp and regulated by federal law. Public pensions are not.
One lesson in all of this is to deal with the issues before the need to declare bankruptcy comes. Another take away from this is to review your municipal bond holdings. Muni’s are very popular, especially with retirees because the interest earned from them is tax exempt. Investors have been desperate for yield in recent years and within fixed income, they have gone longer in maturity and lower in quality.
Other links about the Detroit bankruptcy you might find interesting
Now that Detroit’s Gone Bust, these cities could be next
What Happens in a Municipal Bankruptcy
Detroit is Dead, Long Live Oakland County
Could a Detroit bankruptcy scenario happen here in NJ