Mastering Money

A New Retirement Saving Vehicle?

I've always said it is far wiser to pay off your debt before you begin to invest, unless, of course, Hillary Clinton is your investment adviser and you can earn an after-tax return higher than the rate your credit cards are charging you.  It's that simple. 

Some credit cards are charging 29.9% interest.  Unless you can find an investment that yields an after-tax return above the rate your credit cards are charging, it is best to invest in yourself and pay off your debt before you invest for retirement.

That said, let's talk about 401(k) retirement plans.  Folks, gone are the days where retirement is funded by our employers.  It used to be we worked for a company for 700 years, then we retired, at which point we would receive a gold watch and a monthly stipend.  Today, it's different.  The burden of saving for retirement has been shifted from employers to employees.  The good news is that many employers will match what the employee puts in their 401(k) plan, at least up to a certain percent.  (Sometimes the employer will match 50% of what the employee contributes up to a certain amount or percentage of the employee's salary.)  That's free money!!!!  That's just like getting a raise.  Your employer is giving you money on top of your salary and you don't have to pay taxes on it until you withdraw it at retirement.

Again, the caveat is:  while it's beneficial to put money in your 401(k), and really good if it is indeed matched, if you are heavily in debt, you're simply digging your hole deeper.  Since this is pre-tax money, you are saving on your taxes; therefore, if your tax rate is greater than the interest on your debt, you'll come out ahead.  According to Hewitt Associates, a management consulting firm, about 30% of eligible employees don't participate in their 401(k)'s.

So what's new? Roth 401(k)'s!  Yes, that's right.  A Roth 401(k) is a 401(k) to which an employee can make contributions; however, these contributions are made after taxes, as opposed to a traditional 401(k) where the contributions are made before taxes.  What's the advantage?  You are betting that your tax rate will be higher in retirement than today, that's why you're paying the taxes on those dollars today, so you won't pay them when you withdraw the money at retirement.  Sound rather counter-intuitive?  Shouldn't my tax rate be lower in retirement, not higher?  Perhaps not:  as Pamela Yip of the Dallas Morning News states, "Most financial planners assume your tax rate will be lower in retirement because your income will be lower.  But given the federal government's ballooning Medicare and Social Security obligations, and the inexorable upward trend ever since income taxes were instituted, the higher-tax bet may not be a bad one."

By contributing to your employer's 401(k) and Roth 401(k), if they offer one (one poll taken by the Profit Sharing / 401(k) Council of America found that only 17% of their members were going to implement a Roth 401(k)), will give you choices later so you can withdrawal from the traditional or the Roth depending on your tax situation at retirement.

Something New to Affect Your Credit Score

Due to budget crunches, there are some major U.S. cities that are hiring private collection agencies to collect on small claims that are usually ignored by the population.  Since a delinquent account handled by a private collection agency can potentially land in a credit file, many people in large cities have recently discovered that unpaid fees such as parking tickets, dog-catcher fines and library fees are lowering their credit scores.  It is actually up to the city to decide whether the information will end up in a person's credit file.

If it sounds trivial, consider this:  hundreds of cities around the country are owed millions of dollars in unpaid fines.  Since 1997 Chicago began using a collection agency to track down unpaid parking fines.  The revenue from tickets has doubled from $68 million to $154 million.  In Florida, some cities have used private agencies to find swimmers who haven't paid "beach rescue" fees after they were rescued by lifeguards.  I'd be grateful if someone saved my life.

One private company, Unique Management Services, works exclusively with libraries around the country and handles collections for 750 libraries.  This is BIG business.  Unique says it has annual revenue in the millions of dollars, and its business is growing 15% per year.  Unique uses "soft" tactics.  They let library patrons know the library isn't mad at them and wants them to return the books they borrowed.  About half of their call-center employees are students at a local Baptist seminary.

Interestingly, some cities are using collection agencies to collect on fines that are over a decade old.  The Philadelphia Parking Authority had tried this, but had to cease due to numerous complaints by debtors and  media coverage. 

In order to be reported to a credit bureau, a bill has to be more that 30 days delinquent.  It doesn't matter the size of the fine, as even small fines in any activity in a credit file can do major damage to a credit score.  Maxine Sweet, vice president of public education at Experian, one of the three credit bureaus, says no matter the amount, even small unpaid fines in your credit file can have a seriously negative impact on your credit report, "on par with a tax lien or a bankruptcy."

FICO scores range from 300 to 850; anything above 700 will get you the best rate on a loan.  However, a municipal fine such as an unpaid parking ticket reported to a credit bureau can reduce your credit score by 100 points, making it hard for someone with previously good credit to receive the best rate on a loan.  Collections activity can stay on your credit report for seven years.

It is important to note that consumers should try to come to an arrangement to have the fines wiped off their credit reports before they pay them.  Consumers should call the government agency or the collection agency and ascertain that if they pay the fine, the collection activity will be removed from their report.

Go to creditboards.com to see sample letters to send collection agencies and other advice to help consumers get items removed from credit files.

Calculating Your Savings

Americans spent more than they earned in 2005, which is the first time that has happened since the Great Depression.  According to The Wall Street Journal, U. S. consumers will have spent $39 billion more than they earned in 2005, yes that is billion, with a "b." 

In order to calculate your own personal savings rate, let's start with disposable income, which is defined as income after taxes.  You can't dispose of your gross income because you owe taxes on it.  Therefore, disposable income is calculated as such (you may wish to use monthly figures since they are easier to obtain):

Gross Income:  Salary, interest, dividends, royalties, rental income and government benefits.

Less Taxes =

Disposable Income.

Now, subtract from Disposable Income all the money you spend in a month, if you used monthly figures to calculate your Disposable Income.  It may be easiest to go through your check book or your credit card statements to see how much you are spending.  You may find this to be very depressing.  Do not include any amounts you spent on investment, as that is considered savings.

Next, divide what is left from Disposable Income into Disposable Income and this is your personal savings rate.

For example, if your total Gross Income is $4,500, and you pay $1,200 in taxes, your Disposable Income is $3,300 ($4,500 less $1,200.)  If your had credit card charges of $1,500 and your bank outlays were $1,000, totaling $2,500, then your savings was $800 (Disposable Income of $3,300 less credit card charges of $1,500, less bank outlays of $1,000.)  Your savings rate would be the $800 divided by disposable income of $3,300, or 24%.  That would be far above average, as last year the average was -.4% of disposable income.

We're saving less because our home values are increasing.  This is very dangerous.  According to Dean Baker, co-director of the Center for Economic Policy Research, every dollar of extra housing wealth translates into a savings reduction of 5 cents.  Many homeowners have borrowed against this increase in home value due to low interest rates on home equity loans, and have spent the funds.  Mr. Baker stated that we saw the same thing in the late 1990's with the stock market bubble.  There was a huge run-up in stock prices, and Americans' saving rate decreased.

To create a spending plan, please check out my web site:  http://www.spendingsolutions.com.  This is a secure site that will allow you to keep track of your spending.  The only way to save is to keep track of what you spend!!!!

Let's get back to saving as we did in the 1970's:  5-10% of our Disposable Income.