Monday, December 15, 2014

The end of a tradition? Traditional pensions plans on their way out

In the summer of 2012, General Motors offered many of its employees the opportunity to receive a lump sum payment in lieu of a monthly pension check. After crunching the numbers for a retiree client and highlighting both the pros and cons of taking the lump sum, my client chose to continue with the traditional pension format.

In fact, more than half of those who were offered the choice in 2012 selected to remain with the pension format. Clearly then, this particular retiree’s decision was not unusual. It was actually the majority decision.

My intent is not to say that my client’s decision was right or wrong. What has remained in my thoughts, though, was his reasoning for turning down the lump sum and continuing with the monthly pension.

His rationale for staying with a pension was simply that he is a traditionalist. Now, there’s certainly nothing wrong with being a traditionalist.

But, as with so many things in our world these days, traditions are changing. Traditional pension plans that pay a lifetime of income along with a survivor’s benefit are disappearing fast.

There are a number of reasons why. One, of course, is that retirees are living so much longer than was the norm just a few decades ago. Another is the scary reality that many pension plans, public and private alike, are underfunded.

Unfortunately, word of the many pension crises our nation is facing rarely makes it into the headlines. But it’s a fact that there are a great number of public pension plans that are fast approaching crisis level. They just don’t have enough funds in their coffers to fulfil their pension obligations.

We all followed the city of Detroit’s bankruptcy proceedings. One of the key issues that needed to be resolved before bankruptcy was approved was how to settle the pension situation with retired city employees.

From coast to coast, there are state and municipal pensions that are terribly underfunded. In New York City alone there are more police officers collecting pensions than there are active police officers on the street.

In corporate America, 41 million employees and retirees have the comfort of knowing their pension is protected by the Pension Benefit Guaranty Corporation (PBGC). There are currently 10 million Americans whose pensions have already failed and their pensions are now handled by the PBGC.

That being said, what concerns me is that the PBGC itself is underfunded. It has a deficit of $62 billion. Signed into law by President Ford, the PBGC has run a shortfall for the past 12 consecutive years.

I believe that the traditional pension is on its way out. Not only is the writing on the wall, I think you could say that the wall is collapsing. I don’t see how public and corporate pension plans can meet their pension obligations.

Traditions do change. It used to be that department stores were closed on Thanksgiving Day and all the College Bowl games were played on New Years Day.

What I’m saying is don’t stay with your pension just because it’s “traditional.” If you have a lump sum offer, review it and analyze it. The world of a gold watch at retirement and a traditional pension is near extinction. The only constant in our ever-changing world is change.

Monday, December 8, 2014

Shadow banking steps out of the shadows

In a recent article I mentioned that former Federal Reserve Chairman Ben Bernanke initially had difficulty refinancing his mortgage. When I decided to downsize from my house to a condo, I opted to have a modest mortgage for tax planning purposes.

But after seeing the never-ending list of documentation that the bank required, I decided to forgo the tax benefits provided by a mortgage.

Since the meltdown of 2008, the banking industry lending standards have been significantly tightened. And there’s a long laundry list of new regulations including those in the Dodd-Frank bill.

You would think with interest rates at record low levels that businesses and households would be flooding the banks with loan applications. But, many have scars from the financial meltdown in the form of less than a stellar credit rating. Or perhaps they depleted their savings account in order to survive the downturn.

Because of such previous setbacks and the need for loans, a low credit rating is forcing many to seek alternatives to traditional banking for business and personal loans.

These banking alternatives are commonly referred to as shadow banking, which is becoming a booming enterprise and emerging from the shadows as real competition for traditional banks.

Many used to think of shadow banking as pawnshop loans and establishments that offered cash advances on paychecks. But today it’s much more.

It’s estimated that the non-traditional banking environment in this country has grown to more than $3 trillion. Small wonder. Because unlike the traditional banking system which is regulated and monitored by a plethora of regulators, the shadow banking industry is under the radar of watchdogs.

Some would argue that lack of regulation is a godsend. But others might fear that it could be the next big problem because nobody is paying attention.

I tend to be more of a traditionalist and favor traditional regulated banking. But I can certainly sympathize and understand those that turn to the shadow banks for help.

Shadow banking is serving a segment of the population that needs capital but doesn’t meet the strict guidelines that the banking industry follows.

Shadow banks can have significant differences and are all over the board. A typical transaction for a $1,000 loan, for example, might have a loan processing fee and an interest rate at around 6 percent.

Yes, their rates and fees are likely to be higher than a traditional bank, but if you had some financial problems in your recent past, this just might be the only way you can obtain a loan.

Recently, the well-known PayPal announced it would be entering this shadow banking space. The non-banking industry is not only looking for borrowers, they’re also seeking investors that have the money that is needed to make these loans.

I would be very careful from this end as well. I see a definite potential for investors to take it on the chin. Again, it’s the lack of regulation that concerns me.

As shadow banking moves from the shadows and closer to Main Street, I suspect we’ll hear from legislators after problems arise. Don’t get me wrong; traditional banks don’t serve the needs of everyone. But when you step into a game that lacks rules, don’t be surprised when you encounter a lot of problems.

Monday, December 1, 2014

Living long and prospering takes meaningful effort

The onset of cold weather and the earlier arrival of darkness have changed my life. Not in a major way. It’s just that I tend to spend a lot more time in my house compared to the summer months.

Personally, I can only read or watch television for so long before I start to climb the walls. One day I actually went to the gym before and after my day at the office.

I certainly don’t pretend to be the Energizer Bunny, but I just can’t see how people can sit for hours at a time, regardless of the season. I probably drive my wife a bit crazy, but the reality is that we’re all wired a little differently.

We all have our own unique quirks, idiosyncracies and fears during life’s journey, but no matter how different each of us may be, all of us want good health.

I think it would be fair to say that, along with good health, most of us would also like to have wealth. But the odds of having both just because you want them are not very favorable. In fact, it’s very unlikely to have both without meaningful effort. Work is definitely required to achieve both health and financial goals.

Just as with financial planning, there are steps you can take to improve your chances of achieving good health. A better diet and exercise are two obvious examples. But again, just as it is in the investment world, you may be able to statistically improve your chances, but there are simply no assurances you will achieve your goals.

Various studies are pointing out that the journey of life is getting longer and longer. Longevity and financial planning have always been connected, but now they are becoming deeply intertwined.

Take a married couple aged 65, for example. How much longer are they expected to live? Obviously, there are a number of factors involved, but according to statistics, there’s a 52 percent chance that one of the spouses will live to see 90.

Better diets and exercise help contribute to longevity, but along with longer life expectancies, comes another important consideration. You’re going to need more money to maintain your lifestyle.

I talk to my clients about this all the time. When I point out that they could easily spend over $250,000 in today’s dollars on out of pocket health care expenses they seem surprised.

But it could get even worse. The more I read the more it seems likely that dollar figure is going to rise. In fact, it could easily exceed $300,000 in the near future. That’s just one reason why it’s extremely important to save and invest for retirement.

When people are in good health, they should also discuss their money concerns with their financial adviser. The financial services industry has evolved far beyond the traditional long-term care policies.

There are now life policies that pay out the death benefit while the insured is living if care is needed. There are also some annuities that have special provisions and language for those in need of special care.

As I stated, health and wealth are more intertwined that ever. You might not need wealth to have health, but with sufficient wealth you can enjoy and celebrate your good health.

Tuesday, November 25, 2014

Know when to take your lumps when retiring

Once I push myself away from the Thanksgiving dinner table, it seems to me that the remaining portion of the calendar year moves at lightning speed.

There’s an abundance of year-end items that need to be taken care of in just a few short weeks. If you’re in your late 50s or early 60s and employed by a large company, let me add one more item to your list.

If your company has a frozen pension, ask your HR department for a handful of retirement projections covering a variety of retirement dates over the next few years. You might be surprised at what you discover.

To set the stage, interest rates are extremely low. Bank deposits earn next to nothing and mortgage rates are about as low as I can ever recall. The surprise is how these low rates can impact your frozen pension account.

Pension fund managers need to be somewhat cautious in the manner they invest pension funds. Hence, much of the money is in relatively safe, low-interest bearing funds to meet their pension obligations. In this low interest rate environment, that translates into a larger lump sum compared to just a few years ago.

Consequently, if your company offers the choice of a lump sum buyout in lieu of a monthly pension check, you just might be sitting on a once-in-a-lifetime opportunity and not even realize it.

I recently encouraged a client in his late 50s to ask his employer’s HR department for year-end retirement projections for 2014, 2016 and 2018.

Since the pension is frozen, retiring now and taking the traditional pension wouldn’t be much different than if he continued working until 2018.

However, the lump sum offers provided by the HR department were quite interesting. If he took the lump sum now or in 2016 or 2018 the amount would be virtually the same. In other words, he could retire now and receive a lump sum of $500,000 or wait a few years and collect the same $500,000.

Mathematically and historically speaking, there is every reason to believe that a $500,000 lump sum today would be worth more than the same $500,000 lump sum a few years from now.

In my client’s situation, other than any new 401(k) deposits and company match, there’s no compelling reason for him to stay with his current employer. In fact, you could even argue that, since his benefits are frozen and not growing, by staying on the job he is effectively taking a reduction in pay.

In this low-interest environment, where my client’s speciality is in high demand, and because he is somewhat disenchanted at his current place of employment, he should consider taking the lump sum and retiring now. Then, if he wanted, he could seek new employment with comparable benefits somewhere else.

By investing wisely, his lump sum could actually grow over the next few years, and at actual retirement some years later, he could have a considerably larger nest egg than if he stayed on course.

I believe many of my readers may be sitting on a similar opportunity and not even be aware of it. Take the time to request your retirement projections. If the lump is a viable option, discuss it with your financial adviser, along with ideas for investment.

Monday, November 17, 2014

Are you prepared to ride the DJIA seesaw?

The often-mentioned Dow Jones Industrial Average (DJIA) is simply a basket of 30 domestic stocks that provide a barometer for the performance of the U.S. stock market. There are other measures, but the Dow is the one most frequently referenced.

In October, it appreciated a very respectable 2 percent. On the surface, you would likely say it was a decent month. On the other hand, it could have been a poster child for the phrase “investors need an iron stomach.” In other words, it was a really wild ride.

The stock market was open for trading on 23 days last month. As measured by the DJIA, the action was pretty evenly split. That is to say there were 12 days in which the market lost ground and 11 positive days that it gained.

Recently, the Dow has been hovering around the 17,000 mark, swinging above and below it with apparent ease. Historically, 17,000 is where no DJIA has ever gone before.

Generally, when the market is down 200 points in a day, you would consider it a really bad day. Conversely, when the market is up by more than 200 points in a day, you’d call it a really good day.

During the month of October, there were swings exceeding 200 points up or down on 19 of the 23 trading days. Clearly, it was not a time for the faint of heart.

Since we’re an automotive town, let me illustrate with an automotive analogy. If October were a stretch of road with the speed limit of 50 mph, we were either chugging along at 25 mph or flying at 70 mph.

Although we never actually traveled at 50 mph, we arrived at the end of the ride as if we had traveled all the way just a hair above the posted speed limit. On the surface it may have appeared to be an uneventful ride, but moment-by-moment it was wild and crazy.

Quite often, it’s best to simply tune out many of the world’s worrisome current events. Looking back at October, the Ebola virus was the dominant news story. But there was also ISIS and the bombings in Syria, tensions in Hong Kong, and tragedy with our neighbors in Canada.

Not to downplay any of these events, but history books are full of conflicts, crises and catastrophes that could be used to rationalize why you should avoid being an investor. And while history is no assurance of what lies ahead, time and time again the investment world seems to reward those investors who have an iron stomach and stay the course.

October was an absolutely perfect example. If you had let your emotions take hold, you would have missed out on a fairly respectable month. If you had watched the news on an hour-by-hour basis, you might have thought the world was ending.

There is a lesser-known index called the VIX, which measures volatility. It has often been referred to as the fear index. In non-technical terms, it was all over the charts in October, further confirming what a wild ride October was for investors.

I don’t recall ever experiencing a month quite like this past October. But it certainly reminded me why it’s so important to keep your emotions out of your investments.

Monday, November 10, 2014

Who wants you to be a millionaire? No one

Thank goodness the mid-term elections are over and done with. I anticipate we’ll begin hearing about the upcoming 2016 election within the next few weeks and I, for one, can hardly wait.

I intentionally try to avoid being political in this column, but there’s something that really bothered me throughout the recent pre-election campaign. The television ads. Specifically, it was how they seemed to vilify anyone who had money.

The ads would have you believe that everyone who is considered wealthy is selfish and doesn’t care about the schools or the environment. As a financial adviser I’m taken aback by this growing perception of people who are financially well off think it’s unfair to routinely criticize someone just because they have money. There seems to be some sort of automatic assumption that they came into their money dishonestly or illegally.

But it’s just as likely that they attained their financial status because they worked hard during their careers. And they probably put their families first and were active in their communities.

Generally speaking, most people accumulated their wealth because they were dedicated savers who stayed committed to their financial goals throughout their careers.

Simple mathematics shows that it’s possible. For example, let’s say you were to save $1,000 per month in a tax-deferred account at five percent interest. If you did so every year throughout a 35-year work career, you’d have in excess of $1,000,000.

This is obviously a hypothetical example, but it illustrates that, although it may be difficult for many, it can be done. That being said, if you’re just in the early stages of your career and don’t have $1,000 a month, you should still get into the habit of saving whatever you can.

This is especially important if your employer’s retirement plan provides a match to your contribution. Then, as you age and hopefully have more disposable income, Uncle Sam will provide more incentives to save even more.

The maximum annual contribution into a 401(k) this year is $17,500. If you happen to be over age 50, you can actually contribute an additional $5,500. That’s $23,000. Next year, both numbers increase. The maximum 401(k) deposit is $18,000 with an additional $6,000 for those over 50. That’s $24,000. If you’re in a financial position to take advantage of these provisions, I strongly encourage you to do so.

One out of twelve households in the U.S. has a net worth in excess of $1,000,000, excluding the value of the principal residence. That translates into more than 9.5 million households. Of that 9.5 million, fewer than twenty percent inherited their wealth. In other words, wealth for the vast majority was earned, saved and invested. Which is to say, they made it happen.

There’s no question that a million dollars is a lot of money. But even if you were to have that much, there’s still no assurance you won’t encounter financial issues during retirement.

Keep in mind that, in retirement, health related issues could easily carve out a huge slice of a million dollars. And interest rates can have an adverse impact on a retirement nest egg if they continue to stay at today’s extremely low rates.

When all is said and done, attaining a million dollars is a goal that should be encouraged, not vilified.

Monday, November 3, 2014

When the elections are over, will anything change?

Election day is finally on our doorstep. I sincerely hope, as you enter the voting booth, that you don’t make your election choices based on the 30-second commercials that have taken over the airwaves.

They are misleading at best. And while I hesitate to say that some of them are intentionally so, I can say with certainty that some of them are contradictory.

That being said, I know how difficult it is to get your arms around certain complex issues when things are going at full speed in your personal life. In many instances, even if you know your stance on specific issues that are near and dear to your heart, it’s difficult to determine exactly where political candidates stand. After all the annoying and half-truth commercials, at the end of election day, some of you will be thrilled with the results and others will be disappointed. I kiddingly state that I’ve been voting for so long, I can remember elections where the final results didn’t require the intervention of attorneys to determine a legitimate outcome.

In the financial world, I’ve always cautioned investors not to become overly euphoric when their investments were making rapid gains. Conversely, I’ve urged them not to become too distraught when their bottom line took a downward turn.

In other words, it’s a good idea to stay calm and collected regardless of the direction of your fortunes.

And that’s exactly how I feel about election results. I don’t believe any one loss or victory by a particular candidate will suddenly alter the long-term financial planning objective of any household.

When the election dust settles and reality sets in, everyone is still going to be paying taxes. Young families will still need to save and invest for college and retirement. Empty nesters will still need to plan for a rapidly approaching retirement. And those already retired will continue to fret over the increasing costs of living.

Regardless of who wins or what propositions are passed, post-election is the time to make year-end financial adjustments.

For example, if you have a high-deductible health insurance program, you should consider making a contribution into a Health Savings Account. If you participate in either a 401(k) or 403(b) account, you should at the very minimum make certain you’re contributing enough to receive any employer match.

If you received a pay increase during the year, you should consider increasing the amount of your contribution for the balance of the year. Keep in mind that there are special provisions to encourage contributions for those over the age of fifty. If you’re over fifty, you should definitely take advantage of those provisions.

If there’s no company program, you can still take the initiative to open an Individual Retirement Account. Because they can be somewhat confusing, in that there are both tax deductible and non-deductible programs, I suggest you consult your attorney or financial planner.

In the short term, investors need to move quickly to put any finishing touches on year-end strategies. Long term, no matter who is elected, it’s not the responsibility of Lansing or Washington, D.C. to make or break your financial goals.

In spite of all the political promises, your financial success or ultimate failure is not decided in the ballot box. It’s up to you.