Financial Literacy

Part of financial planning is predicting the likelihood of future tax increases or decreases. This estimate is needed to make any decisions with tax implications – do them now or later depending on which way tax rates are headed.

A new report just released from the U.S Congressional Budget Office (CBO) offers clear guidance for U.S. taxpayers to use. The CBO summarized by saying that over the next 25 years, people at all income levels will be paying a larger share of their income in taxes; even if there are no tax increases!

Some specifics include:

• The mortgage-interest deduction will be cut in half
• More people will have to pay income tax on their social security income
• Obamacare taxes will increase and include more people than today

These increases will occur with no changes from the current rules. However, the CBO also points out that the national debt is skyrocketing from the deficits generated by: Social Security, Medicare, Medicaid, and Obamacare. The CBO claims these debts are NOT sustainable indefinitely, could possibly create a financial crisis, and so additional tax increases will be necessary in the future as well.

So for now, when you have a tax decision to make, such as triggering income or gains now vs. later, it is financially advantageous to do them now rather than a few years from now at higher tax rates.

One of the challenging financial dilemmas everyone faces is budgeting for retirement. This begins early in a career when retirement cannot be fathomed and ends when it is an imminent fact of life. For most people in their working career, retirement planning is little more than periodically adding some money to a tax-sheltered account.

As retirement approaches, we all have the face the reality of our past decisions and future financial needs. Whether you do your own financial planning or hire an expert, in my experience, the most commonly overlooked item in retirement planning is inflation.

This chart from the U.S. government tracks retail protein sources: beef, poultry, fish, pork, and eggs. From 1967 to 2014, the average annual increase is 4.01%, and it has been fairly steady with any drop proceeded by a new high within a couple years. The impact of this on your budgeting is this: you need to plan for a 4% increase in the price of these items during your retirement. Since the average retirement may last 20 years, as an example, if you spent $1,000 on these proteins in the first year, these would then potentially cost you $4,400 in the 20^th year. This reflects the impact of compounding inflation year after year.

This is just one food item that you’ll be budgeting for in your retirement. Yes, some expenses may decline or be eliminated, but many if not most will increase during your retirement. Budgeting is individual, and you can make a rough overall guess at an annual inflation increase; but it is best to examine each of your own expenses. If you don’t want to do that detailed work at least look at your 5 largest expenses to determine if they will likely be going up or down and a rough estimate of how they may change in your future. For example, where I live, property taxes just went up 11% this year and the city just approved an 8% increase in water rates. These increases don’t happen every year, but an increase of some type for these local expenses over any 5-year period is nearly guaranteed.

The important point to consider is to include several inflation rates and spending scenarios in your retirement planning. This will prevent or minimize foreseeable financial problems when you are retired and least able to maneuver for more income.

Country Financial, a financial planning service company released some results of their latest survey on middle-income families. They found that 50% of workers earning under $30,000 are saving nothing for retirement; 20% of those earning $30,000 – 50,000 save nothing; and 10% of those earning up to $100,000 save nothing. Among those middle-income workers that have a 401(k), almost one-third have no idea what investments their money is going in to.

Surveys like these highlight the need for financial awareness and financial literacy so that these workers and families will avoid predictable financial difficulties. One very useful tool for mapping out your financial life is the use of financial calculators. There are hundreds of them across the web that you can use. However, like everything, some are better than others. You need to understand which most closely matches your circumstances and which has assumptions that you can change to match your situation. Luckily, financial expert Todd Tresidder has narrowed down the calculator world into a helpful list on his website page here: http://financialmentor.com/calculator.

Tresidder has calculators for retirement, mortgages, credit card payoff, car loans, investing, savings, budgeting, and a couple dozen others that you may find very helpful. What does it tell you when experts spend a lot of time with financial calculators? That they are useful, if not critical, to mapping out your financial life and your financial future. How do you know where you stand if you do not plot out what you are currently doing so that you can make appropriate adjustments now, when it matters? Please bookmark that page, go through the list to find which ones may be helpful for you today.

Even though the stock market is at an all-time high and bonds are at a 30-year high, many pension plans are dramatically underfunded. So, what do you predict will happen to these pension plans if stocks and bonds inevitably experience a decline? That’s right, dangerously low shortfalls.

The average pension fund has only 77% of the assets they need to meet their legal liabilities. When pension plans become insolvent, they are taken over by the federal Pension Benefit Guaranty Corporation (PBGC), similar to FDIC insurance for bank accounts. Unfortunately, the PBGC is already running deficits and, by its own estimate, there is a 91% chance they’ll be insolvent by 2032.

The city of Detroit is cutting the pension benefits of city employees by 26% as part of its recent bankruptcy. There are public pension plans already reducing future cost-of-living adjustments that are necessary for pension recipients to keep up with inflation. These pension cuts can occur to anyone relying on a pension plan that is underfunded or in peril of becoming insolvent. The state of Alabama is predicting their pension fund will go broke and New Jersey just cut $2.5 billion to its pension payment to fill in the state budget deficit.

On a related topic, U.S. interest rates are still near record lows and yet, government deficits are still unusually high. If interest rates on government debts return back up to normal levels, then deficits will be markedly higher. This will also put pressure on reducing pension benefits for government employees; let alone social security.

In every financial area of your life there is one important lesson: you are on your own. You need to act as if you’ll get half your pension, half your social security, etc., and create your own retirement plan that is under your control. Anything money-related that you leave for others to manage creates an additional risk of not meeting your financial needs.