Financial Literacy

More companies are seeking to end their pension liabilities by extinguishing them with a buyout payment to those who were going to receive pension payments. Pension costs are rising which is spurring companies to get out of pensions. Two main costs are increasing: mandatory federal insurance on pensions and mandatory return assumptions are falling. When you receive a buyout offer from an employer, how do you decide what to do?

I recommend going through these five considerations for any buyout, each of which will tip toward or against accepting their offer.

1. Are they offering you a good deal?

For example, if they are offering you $40,000 for your $350 monthly pension, you must evaluate if their offer is an appropriately high enough to replace it with an annuity. You do this by contacting a few insurance agents and ask how much it would cost you to purchase an annuity of $X, starting in X years (when the pension payments would begin). You will receive price quotes from the insurance companies but these are most likely to be higher than your employer’s offer. But how much lower is your employer’s offer, is the discount 5% or less (Ok, not too bad) or is the discount greater than 10-15% (a financially bad deal). You could also ask the agents to arrive at a comparison by going the other way, starting with your employer’s offer and then determining what their annuity payment would be.

2. Is money in my hands a bad location for money?

Once you receive your payout, are you more likely to spend it all now or prudently buy an annuity that replaces it? If you might be tempted to spend it or invest it poorly, I recommend that you reject the buyout and keep the money out of your hands.

3. How financially stable is my employer?

Has your company been around for 125 years or just 3 years? If your employer is not financially stable and may likely run into financial trouble in the future, your pension plan may be taken over by the federal pension system. If this occurs, you will likely face a reduction in benefits, sometimes it is a very severe reduction in your pension payments. If your employer is not long lasting or stable up to this point, I’d be far more likely to take any buyout offer to maximize the pension benefit before it shrinks. (A relative had his pension taken over by the federal government – they cut the payments in half and delayed the retirement date that he could start receiving it by an extra 5 years).

4. Does your pension offer extra benefits?

For example, your employer’s pension may allow for early retirement or spousal benefits that make your employer’s pension far more valuable than a regular annuity. This makes a comparison more difficult but the more benefits your pension offers, the better it is to keep it.

5. Taxes and penalties

When you receive a lump sum, you must immediately place it into an IRS qualified retirement account, such as a Roth IRA. If you do not, you’ll face a 10% penalty and ordinary federal and state income taxes on the entire amount. Are you prepared to move this money to an appropriate location before you receive it or will the payout be vaporized by taxes and penalties?

In general, it is my opinion that your money in someone else’s hands is always a highly risky location and should be avoided. So I would be inclined to accept the buyout payment unless some of these five considerations excessively tilted more toward leaving the pension money with my employer.

A new art exhibit by photographer Brittany Powell is called, The Debt Project. It is a series of portraits along with the models’ stories of how they created their debt situation. Powell said she wanted to create a conversation about debt and stop the isolation people feel about it.

Any amount of debt can cause stress and some stories are disheartening to read – such as debts from medical bills and long-term unemployment. However, it is clear that most of the debts were created by various forms of financial illiteracy:

• Basic financial illiteracy – leading to large consumer debt and back taxes
• Student loan illiteracy – leading to an insurmountable amount of debt
• Business illiteracy – leading to a failed business with significant debt
• Homeownership illiteracy – leading to an unnecessary foreclosure and debt
• Car ownership illiteracy – leading to repossession and net worth destruction

If these people had been given an education on financial literacy, they could have been saved from heartache and difficulty. Several of the models recognized that they didn’t know anything about money and a few blamed society. But they all would have been financially better off than they are today with financial literacy.

Today, there is a perfect storm of demand for luxury cars:

• Interest rates are cheap
• Gasoline prices are low
• Luxury car manufacturers are offering lower-priced models

According to Edmunds.com, as a result of those factors, entry level luxury cars are 60% leased, up from only 43% being leased a few years ago. The arithmetic is that you can purchase a used average-price car for the same payment as a new entry-level luxury car, so more people are opting to lease the luxury car. Brands such as BMW, Audi, Mercedes, Lincoln, Lexus, and Acura.

The financial opportunity will arrive in a year or so when all of these extra leased luxury cars begin to exit their lease. Later in 2016 through 2018, there will likely be a glut of these used luxury cars that will be less than 3 years old with low miles. People that are financially savvy, seeing this coming, may be preparing to grab a deal. When the prices on these cars fall with the increased supply of off-leased vehicles, you will likely be able to buy one that you like at a dramatic discount from the original sale price.

Over the last 60 years, there has been a strong correlation between consumer sentiment and the unemployment rate. As can be seen in the chart, by a lag of 10 months, when consumer sentiment improves then the unemployment rate improves; and visa-versa.

The current consumer sentiment has run from 81.3 to 98.1, and if the correlation to the unemployment remains, then the U.S. can expect another 10 months of the unemployment rate improving.

What are some possible implications of a dropping unemployment rate?

1. It means that for the next 10-12 months, the stock market may continue to be steady-to-upward as the unemployment rate improves.

2. It also means the U.S. Federal Reserve will be more inclined to begin raising interest rates with such a low unemployment rate. So if you have any loans, now would be the time to re-finance them to lock in a low rate before interest rates rise.

3. If you are considering making a career move, the next 10-12 months may be a favorable window in which to make that move.

Whatever you are paying for health insurance from government exchanges this year, it will likely be higher next year. Prepare your budget for several out-of-pocket increases for 2016.

The health insurance rates on exchanges are set by the government. The rates for 2016 are being analyzed now and major insurers are requesting premium increases from 8% to 52% across the country. Insurers are experiencing actual costs far higher than expected and want these increases to begin to close their financial gap over the next few years.

(Unfortunately for taxpayers, any losses by the health insurance companies on exchanges is funded by taxpayers. For example, the largest insurer in Oregon experienced costs that were 61.5% higher than premiums that they charged, so federal or state taxpayers will be funding that loss).

There are a few other regulation price increases for 2016:

1. The maximum deductible amount for an individual increases from $6,600 to $6,850
2. The tax penalty for employers who do not offer health insurance increases to $2,160 per employee.
3. The tax penalty for families who do not have health insurance increases to $2,085.
4. A second tax penalty for employers: those that do offer health insurance that the government deems as unaffordable will increases to $3,240 per employee.

Obamacare subsidies are also being disputed in courts so there is not a definite financial number for residents of every state that expects to receive a subsidy for health care premiums.

The sooner you start budgeting for future expenses, the more stable your financial situation will become. Under the Affordable Care Act, mapping out your health costs and insurance is becoming a larger and more complex part of everyone’s expenses.

Colleges and universities use a federal formula for determining how much financial aid that students can receive for the upcoming college year. This formula is called the EFC, an acronym for Expected Family Contribution. The EFC is the baseline of financial support your family is expected to provide a college student. Above this baseline, colleges can provide financial assistance or grants to make a degree far more affordable.

However, college aid workers say that almost every reviewed EFC that parents fill out has errors. Meaning that families do not understand the rules well enough as they are filling out the forms. As a result, most families are unnecessarily hindering their eligibility to receive financial aid from the institution when they are applying for admission. For example, you are not required to list any qualified retirement accounts in your asset amount. If you do not know this, you will erroneously include it and receive far less in financial aid than you should be getting.

It important to understand all the rules of financial assistance – up front. For example, did you know that 529 accounts penalize you on getting financial assistance? It is very rare that money in a 529 account is a net benefit for college costs. Also, did you know that you can negotiate your financial aid package from a university or get a multi-student discount?

A degree is one of the largest expenses for any family and very few people take the time or work with an expert to minimize this cost. There is a maze of rules for qualifying and accessing financial aid for college, and if you are unaware of them, then will needlessly overpay for a degree.

There are financial planners that specialize in decreasing college costs with titles like College Aid Planning Specialist. I highly recommend finding one with a history of success and only charges a 1-time fee (normally under $200).