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.