May 31, 2012

To the Moon and Back, Twice

Want to hear something frightening? If someone were to stack the U.S. government’s debt in $1,000 bills, it would be almost 67 miles high. Want to hear something even more frightening? That was a fact during Ronald Reagan’s presidency in 1981! As of 2011, that stack would be more than 900 miles tall!

If that didn’t connect with you, I can also tell you that our national debt could buy 3,824,812,630 Super Bowl tickets, 58,000,000 homes at an average price of a little over $240,000, or all of the country’s 400 largest companies based on market capitalization. If I’m still not breaking through, I ask you to look at the moon tonight and try to fathom that our national debt in $1 bills could reach the moon and back, twice.

Now that I have your attention, I want to briefly discuss our national debt. Some economists, pundits, and politicians would have you believe that the U.S. could be imminently facing an economic Armageddon. Some would have you believe the national debt is not a big deal, and it could actually be a good thing. Well, which is it? 

Before we decide, let’s briefly consider federal government debt. In simple terms, a government deficit, or debt, arises when the government needs money to pay for a program or project that exceeds tax revenue. The government can address this deficit by increasing tax revenue, printing more money, or by issuing bonds. Increasing tax revenue requires politicians to increase taxes, and that is not always popular. Printing more money is an impractical, short-term fix because, though it allows the government to pay for the program or project, it will devalue the currency and cause inflation, as everyone suddenly has more money. The unpopularity and consequences of the previous options are why most federal governments in the world prefer to issue and sell bonds. By issuing bonds, the government is able to fund its programs and projects with money borrowed from bondholders in return for promising to pay the bondholders back in the future (with a little interest).

If you’ve had your television on in the past decade, you probably know that most nations have government debt. This is because during economic downturns tax revenue falls, and when there are natural disasters, wars, or new entitlement programs, government expenses rise. Theoretically, during times of economic prosperity and peace, there should be government surpluses, and over the long term, government budgets should stay in balance. As you probably know, that has not been the case for the U.S. and many other countries.

For those who firmly believe we should always have a balanced budget, I would ask you to consider why a person is willing to take out a student loan to go to college or why a company is willing to spend substantial amounts on research and development for a new product. Going into debt for the potential of higher earnings or for the potential development of a new or improved product that will yield huge profits is not such a bad idea. Similarly, when the government goes into debt for infrastructure, technology, education, and other programs that promise a better and brighter tomorrow, it is also not a bad idea. It’s those wars, social programs, and other controversial geo-political expenditures that only have an immediate impact with little or no future potential for cultural, social, or financial gain that get governments into fiscal trouble.

The real issue with our national debt is sustainability. Just like people will be financially okay as long as they can make interest payments on their loans and eventually pay down the principal as their earnings and income increase, a government will be okay as long as it can make interest payments on its debt and eventually pay down the principal as the country’s gross domestic product (GDP) grows. In short, our national debt is sustainable as long as GDP grows faster. If you look at the three charts below, you will see our national debt from 1792-2011, our GDP from 1792-2011, and our national debt as a percentage of GDP from 1792-2011. If you are like me, you will have two takeaways and one conclusion:

Takeaway #1: Our national debt has never been higher.

Takeaway #2: Our gross domestic product has never been higher.

Conclusion: Since our national debt is growing faster than our GDP, I would say our national debt is currently not sustainable. However, our country’s financial situation was more precarious right after World War II than it is right now.

How much debt is okay? I don’t know and neither do any of the economists, pundits, or politicians! All I do know is that our country is operating at an unsustainable rate of incurring debt. I believe it is okay to not have a strictly balanced budget as long as the extra spending is used for projects and programs that offer the potential for a future return that exceeds the current expense. I also believe that our policymakers should look to the 1950s as a guide, and they should cut our current spending and increase tax revenues until our GDP is once again growing faster than our national debt. At least then, our debt will become sustainable again. Then, going forward, our policymakers must create and stick to budgets that allow our country to start paying down our national debt principal so that our financial position can stabilize and improve. Similar to how people should never max out their credit if at all possible, our government needs to return to a financial position where it could comfortably sustain additional debt so our nation is ready when the next economic downturn, national security issue, or natural disaster arises.


May 22, 2012

How to Pay for College

You can pay for college in one of 5 ways:
  1. Be an unbelievable athlete and go to college on a scholarship.
  2. Be an unbelievable student and go to college on a scholarship.
  3. Be fortunate enough to live in a state that offers everyone a scholarship and be diligent enough to keep that scholarship.
  4. Be fortunate enough to have parents or family members who are willing to provide funds for your college expenses.
  5. Take out a student loan.
To be quite honest, alternative 1 and alternative 2 are not really options for very many people. Alternative 3 is awesome, but with rising education costs and shrinking state budgets, it is getting more and more academically difficult for students to keep state-sponsored scholarships. Alternative 4 is pretty sweet as well from a college student’s point of view, but it requires sacrifice and long-term savings on the part of the family members providing the patronage. Alternative 5 is in many cases necessary, but starting your adult life and working career with a large debt can be fairly daunting.

Not very many people end up being amazing athletes or Einsteins, but everyone can recognize how valuable not paying for college was, or would have been. That is why many families sacrifice and save for years so their children can go to college without having to face the difficulties generated by a large student loan. Here are a few suggestions for how you can save enough funds to help send someone you really care about to college, without having to sell a kidney:
  • Start saving sooner rather than later. If you can save just $100 per month from the time a child is born until they graduate high school and invest it in a prudently diversified portfolio averaging 8% a year, you could have around $48,000 in the child's college fund.
  • See if any grandparents, great aunts, great uncles, or any other friends or family members are willing or able to make a contribution for college. Funds can always be invested in custodial accounts, and as long as the gift is not more than the annual gift exclusion (currently $13,000 per person), there won’t be any gift tax consequences. You have to be careful, but don’t be afraid to ask others tactfully. A lot of people like seeing their assets help people during their lifetime as opposed to after they're gone.
  • See if your state offers a 529 plan. 529 plans are qualified tuition plans that are sponsored by states and designed to encourage saving for future college costs. There are two possible types of 529 plans: pre-paid tuition plans and college savings plans.
    • 529 pre-paid tuition plans allow you to purchase tuition credits at today’s rates that ensure tuition in the future. With education costs continuing to sky-rocket, it’s easy to see why this is a popular choice. Be careful though as many of these plans require the beneficiary to be a state resident, and you might not want to limit someone’s college choices to that extent.
    • 529 college savings plans allow you to invest funds for the purpose of paying someone else’s college expenses. The beauty of college savings plans is that, in most cases, any earnings are not subject to federal or state taxes. Be careful though as you could actually lose money depending on market fluctuations. 
  • When it comes time to actually pay college expenses, there are also some tax benefits out there if you pay qualified education expenses for yourself, your spouse, or a dependent. You should look at the Tuition and Fees Deduction, the Lifetime Learning Credit, and the Hope Credit (the Hope Credit is replaced by the American Opportunity Tax Credit until the end of 2012 unless it is extended).
Please remember that anything you save and are willing to give to people you care about for them to go to college is more than they should expect. Also, don’t forget that saving for your retirement and looking out for your own financial security is more important than providing for anyone to go to college. It’s very selfless and kind to help someone else pay for college, but our loved ones can always work through college, go to a less expensive school, or choose alternative 5.


May 15, 2012

Documents You Need to Have But Don't Want

Credit: David Castillo Dominici
As I was beginning this post, an Aflac commercial featuring Yogi Berra getting a haircut came to my mind. In the commercial, Yogi’s friend asks him what insurance he is chattering about. Yogi replies, “It’s the one you really need to have. If you don’t have it, that’s why you need it.” With apologies to the Aflac duck, this post is not about insurance, but it is about three documents you need to have.

  1. Financial Power of Attorney- Everyone should consider having this document in place so that a family member or a trusted friend can manage your financial affairs should something happen to you. Many people shrug this document off, but I ask you this: if you were to have an accident or become seriously ill, are you 100% confident that someone in your life would, or even could, pay all of your bills? What about all those account logins and passwords? Is your spouse even listed as someone the power company can speak to about your account? Without a Financial Power of Attorney, a family member would have to invest a lot of time and money to try to get authorization to handle your personal business if something were to happen to you. With a Financial Power of Attorney in place, even if you take a golf ball to the temple and are incapacitated, an agent you have designated will be able to handle your monthly bills or even more complicated financial affairs on your behalf, without any difficulty or delay.   
  2. Advanced Health Care Directive- Everyone should consider having this document in place so that a family member or a trusted friend can make health care decisions for you should you become incapacitated. This document varies from state to state, but it serves two purposes: (1) to give you a chance to outline how you want to be treated or to what extent you want your life prolonged should you become seriously injured or ill (like a living will) and (2) to allow you to designate someone or several people to have the authority to make health-related decisions for you that you are not in a position to make (like a health care proxy). If you remember the Terri Schiavo Case from several years ago, I don’t need to tell you why having an Advanced Health Care Directive is important. If you don’t want family members, friends, doctors, and courts fighting as they try to interpret your wishes, make sure you have this document.
  3. Last Will and Testament- In a perfect world, everyone over the age of 18 would have at least a simple will. You need a will to protect your family and protect your assets. The rules are different in every state, but having a will can minimize probate, reduce family conflict, and ensure that your earthly assets end up where you want them. Most importantly, if you have minor children, a will names a guardian that will take care of your most valuable assets.
Thinking about these documents is not fun. Preparing these documents takes time and will cost money, but they ensure that you are looked after. It will be hard enough on your friends and family when these documents have to be exercised, but at least everything will be in place. Having a Financial Power of Attorney, Advanced Health Care Directive, and a last will and testament will give you and the people you care for peace of mind.

Yogi was right about these documents, if you don’t have them, it’s why you need them!


May 08, 2012

Roth vs. Traditional

Credit: Ambro
In the red corner we have the challenger: a never-tax-deductible, special type of retirement plan whose earnings are tax-exempt. Weighing in as a heavyweight retirement planning tool at age 15 (created in 1997), formerly sponsored by the late Senator William Roth of Delaware, please welcome the Roth IRA.

In the blue corner we have the old champ: a possibly-tax-deductible, retirement plan whose contributions and earnings are tax-deferred. Weighing in as a heavyweight retirement planning tool at age 38 (created in 1974), made famous as part of the Employee Retirement Income Security Act (ERISA), please welcome the Traditional IRA.

I apologize if you don't care for my boxing commentary, but I wanted to be sure to make a point about how financially significant the choice between a Roth IRA and a Traditional IRA can be for an individual. There are other types of IRAs, but these two are by far the most common. I’ve briefly summarized the differences and glossed over the technicalities between a Roth IRA and a Traditional IRA and a Roth 401(k) and a Traditional 401(k) in previous blog posts, but the time has come for us to hammer this out. By the end of this post, it’s my goal that you will be able to make an informed decision about which type of IRA will better suit your personal preferences and cash flow needs, without wanting to throw in the towel. Here goes:

(Bell sounds)
  • Roth IRA starts the round by offering that you may contribute the smaller amount of $5,000 a year ($6,000 if you are 50 years of age or older by the end of 2012) or 100% of your 2012 taxable compensation (if your compensation is less than $5,000) to a Roth IRA.
  • Traditional IRA parrys with the exact same offering that you may also contribute the smaller amount of $5,000 a year ($6,000 if you are 50 years of age or older by the end of 2012) or 100% of your 2012 taxable compensation (if your compensation is less than $5,000).

  • Roth IRA submits that your contributions are not tax deductible, but counters that your contributions and any investment earnings will not be taxed when you withdraw your funds.
  • Traditional IRA lands a jab since your contributions may be deductible if your Modified Adjusted Gross Income is less than $58,000 if you file your taxes as an individual or less than $92,000 if you file as married filing jointly.
  • Traditional IRA was gloating a little when it was almost knocked down after having to acknowledge that whether you are eligible for a deduction or not, your contributions and any investment earnings will be taxed when you withdraw your funds.

  • Roth IRA continues the assault by pointing out that you never have to take mandatory distributions, and if you so choose, you will be able to make tax-free withdrawals after you turn 59 ½.
    •  I think it's important to add that you’re actually allowed to withdraw “contribution dollars” (what you have put in, not earnings) at any point after you have held the Roth IRA for at least five years.
  • Traditional IRA may be on the ropes here, because if you contribute to a Traditional IRA, you will have to start taking required minimum distributions by age 70 ½, but at least you will be able to make penalty-free withdrawals after you turn 59 ½. 
    • Just to be fair, I should also add that any withdrawals you make before 59 ½ (including “contribution dollars”) are subject to tax and a 10% penalty, unless a few, certain exceptions apply.

  • Just when you think Roth IRA has this fight won, you learn that you are not allowed to contribute to a Roth IRA if your Modified Adjusted Gross Income is greater than $125,000 if you file your taxes as an individual or greater than $183,000 if you file as married filing jointly.
  • Traditional IRA has landed quite a hook by proving that there is no income limit on being able to make a contribution.

  • As the fight draws to a close, Roth IRA gets in one last cross as it reminds us you can contribute at any age.
  • Traditional IRA heads to the corner knowing you are not allowed to contribute to a Traditional IRA after you reach the age of 70 ½.
(Bell sounds)

That's it! The fight is over.

I wish I could tell you the absolute winner, but unfortunately I can't always do that without knowing your particular financial situation. If you're still not sure who should have the lead on your scorecard, just remember: Roth contributions are not tax deductible, and the withdrawals are tax free; Traditional contributions could be tax deductible, and the withdrawals are taxable.

Before I sign off, let me briefly mention 401(k)s. You might recall from my previous post, “401-OK,” that some companies are allowing employees to choose between making Roth, or after-tax 401(k) contributions, and Traditional, or pre-tax 401(k) contributions. Well, the takeaways from above are about the same for 401(k)s. Just remember, Roth 401(k) contributions are made with after-tax money and the withdrawals are tax free; Traditional 401(k) contributions are made with pre-tax money, come with no possible deductions (unlike a Traditional IRA), and the withdrawals are taxable. You also might find this Charles Schwab 401(k) Calculator comparison useful in determining the best choice for your particular financial situation.

I know this was one of my more technical posts, and as always, I’m happy to help if you have questions. Try to look on the bright side; at least this Roth vs. Traditional bout was not Pay Per View.


May 01, 2012

How to Save for a Vacation

Credit: Africa
Vacation: “a respite or a time of respite from something,” “a scheduled period during which activity is suspended,” “a period of exemption from work granted to an employee,” or perhaps “a period spent away from home or business in travel or recreation.” Whichever definition is closest to your ideal vacation is up to you, but most days, I’d take any or all of the above. Financially planning for a vacation is crucial because it can allow you to take more exotic trips to new spots further away from home, and more importantly, it prevents you from being financially crippled the rest of the year as the result of a really lavish weekend. So without further ado, here are a few practical and even a few unusual ways to save for a vacation:

  • Try estimating your needed vacation savings with a spending plan. How much will those plane tickets, tee times, and spa treatments cost? If you know how much you need to save, you will be able to make the necessary financial sacrifices now to enjoy the vacation experiences later. By planning in advance, you have the joy of getting to look forward to your vacation and the satisfaction of knowing you will have the money.
  • One of my family members saves up for vacation by taking a little money out of each paycheck and putting it aside in a vacation fund. This has always been a successful strategy for him, and you can do the same thing by doing something as simple as sticking cash in a special envelope or doing something as complicated as setting up an automatic transfer to a dedicated vacation savings account. By saving a little each pay period, you are going to accumulate a lot of cash in the course of a year and will be able to take a pretty nice vacation with your savings.
  • Another effective technique from the other side of my family is to save your change. Now, saving your change for a few years is not going to get you to Hawaii, but it very well could pay for a night or two's stay or at least a few meals. $1.36 in change saved per day can equal $500 by the end of the year! In my opinion, helping pay for a memorable vacation is a better use of your change than gumball machines, arcade games, and lottery tickets.
  • If the chance for a trip with some friends or part of your family suddenly comes up and you only have a few weeks to prepare, don’t panic. Take the cost of the trip and divide it by the number of weeks until the trip. This is the weekly amount you need to save. This may require reducing the number of times you go out to eat, giving the house cleaner the week off, or even having a yard sale, but at least you have a plan to get yourself the vacation funds you need.
  • One suggestion I found amusing was to pretend gas is $5 per gallon. I know this sounds crazy, but what if every time you filled up, you saved the difference between what your gas bill would have been at $5 per gallon and what it is at the current price? Kind of a sick way to save as gasoline prices continue to rise and there continues to be unrest in the Middle East, but it could be effective.
  • You could always declare a “freezer/pantry week.” By that, I mean don’t go to the grocery store. Eat up that food that has fallen to the back of the freezer and the bottom of the pantry. Sure, you might end up having a frozen pizza with a side of Frosted Flakes, but what’s great is you can save the money for vacation that you would have otherwise spent on your weekly trip to the grocery store.
  • Finally, drink water. No sweet tea, no sodas, no coffee; just two hydrogens and an oxygen. This temporary lifestyle change could help fund your trip and improve your health.
Now you have several ways to save up for that next great escape, whether it is to Venice or SeaWorld. Remember, there really is no limit to where you can go as long as you plan ahead, save up for your vacation, and don’t exceed those vacation savings while you’re having one of those nice little drinks with an umbrella in it. Seriously, it must be 5 o'clock somewhere…