The U.S. Government realized many decades ago that too many Americans were not properly preparing for a financial future in retirement. Social Security was never intended to be the source of all retirement income. The traditional Pension Plan was neither universal nor financially secure due to underfunding. One of the surest signs that Washington, D.C. recognized impending problems was passage of the Employee Retirement Income Security Act of 1974 (ERISA). ERISA recognized and started correcting funding problems in the nation’s Pension Plans. That was followed in the early 1980s by a dramatic reform of Social Security.
In a Revenue Act passed in 1978, Section 401(k) was introduced into the U.S. Tax Code. Section 401(k) did not create a new type of Retirement Plan, but rather modified the already-existing Profit-Sharing Plan. Originally, Profit-Sharing Plans, which are defined contribution plans, only allowed employers to contribute a portion of profits into individual accounts for their employees. The addition of Section 401(k) allowed employees to defer part of their own salaries to that same account.
A steady transition to 401(k) Plans ensued nationwide, some by replacing traditional Pension Plans, and others by adopting the new employee salary deferral language into existing Profit-Sharing Plans. The rest, as they say, is history. 401(k) Plan growth has been rampant. In recent decades, many Americans have responsibly provided for themselves, and will not become a burden on society.
Guided by self-proclaimed Democratic Socialist, Bernie Sanders, Biden recently published the Biden-Sanders Unity Task Force Recommendations, which is a policy statement for the Democrat Party in the 2020 Presidential election. Biden’s retirement plan recommendations include (a) reducing pre-tax contributions to the lesser of $20,000 or 20% of pay, and/or (b) expanding the current Saver’s Credit to relatively lower earners ($19,500 for singles, and $39,999 for couples).
Overall, Biden’s Tax Plan, which allows smaller deductible retirement plan contributions as a main component, will further tax Americans between $3.5 Billion and $4 Billion over 10 years. Most of this new revenue will come from higher-earning Americans and Corporations. Taxing corporations and wealthy people does not create jobs, and in fact, has an opposite effect.
Lowering deductible contribution limits, or even decreasing tax savings from current limits, could never enhance the stated government role of helping Americans provide for their own futures. Biden claims that his proposal will reduce “income inequality” for Americans. We disagree.
Van Wie Financial is fee-only. For a reason.
The Monday Morning Quarterback: This type of investor is very good at pointing out how he should have been invested over the last year or quarter. He will look at returns for different asset classes or stocks over that time period, pick the best performing one, and then question why he wasn’t invested 100% in that. This type of investor will never be happy with their portfolio performance and will never be happy with a financial advisor.
The Nervous Nelly: This type of investor is always worried that the market is overvalued when it is doing well and will never bounce back when the market is doing poorly. There are no market conditions that look good to the Nervous Nelly, and any drop in the market, no matter how small, will warrant a call to their financial advisor. Sometimes, even a drop in the futures market, which they have decided to check at 5:00 AM, will warrant a call to their advisor. This type of investor is typically better off in an annuity or in bonds and CDs when yields are high enough to buy those products.
The Know It All: The know it all hires a financial advisor simply run ideas by the advisor that they are sure are correct. They do not want advice, and they certainly do not want you to manage their money, they just want you to bless their (usually poor) decisions that they have already made. The Know It All not only makes bad choices for themselves, but with the approval of an advisor they feel confident doing so. When it does not work out in their favor, lawsuits can result. Avoid the Know It All as a client at all costs.
The Return-Chaser: This type of investor always wants to re-balance their portfolio, but in reverse. They would gladly sell all asset classes that have underperformed over the quarter and buy everything that did well. Many individual investors fall in this category. In the short-term, this type of investor can perform very well. In the long-term, this type of investor will end up under-diversified and under-performing a balanced portfolio.
The Newsletter Subscriber: This type of investors pays money to follow a guru of some kind, or many gurus in some cases. Because they have shelled out $12.99 per month, they are obligated to follow all investment advice from said guru, no matter how sound the logic or reason is behind the advice. Meanwhile, their financial advisor, who they are paying more than $12.99 per month, takes a back seat to said newsletter.
The Unicorn: These are my favorite type of investors because they have never gotten a trade wrong, they have never made a mistake, and they were getting along just fine without you or anyone else helping them. They bought Amazon, Facebook, and Google at the IPO and never sold, and they shorted tech stocks in 2001. Their account has crushed the S&P every year for 30 years. And yet here they are sitting in your office, looking for a financial advisor. I wonder why.
Elections have financial consequences is a variation on a theme we have heard many times in recent political rhetoric. Presidential election cycles generally present clear choices, and 2020 is certainly no exception. As individuals, which side we support depends on our own economic circumstances and political persuasions. While sometimes the choices may seem a bit cloudy, this year the contrast is startlingly clear.
While Biden’s individual and corporate tax plan is out in some detail, Trump’s overall plan contains only generalities so far. Yet, a clear choice is presented, due to the fundamental approach taken by the two proposals. The former plan increases taxes on people and corporations, and the latter reduces taxes for nearly everyone. Take a preliminary look at the differences.
For decades, taxing corporations has been indoctrinated into Americans’ minds, and codified into the U.S. Tax Code. Some of us believe that no corporation ever pays taxes, because their customers actually pay the tax through increased costs of products and/or services. That said, the current political argument is about higher or lower corporate taxes. Will higher rates cause corporations to move more jobs overseas, or will higher rates generate more government revenue at home? Biden favors higher rates for corporations and for some people; Trump stands for lower tax rates for corporations and for most people.
Biden’s proposal calls for raising individual rates on everyone making over $400,000 annually, “coincidently” the salary of the President. Trump wants lower rates for middle class earners, and possibly for those in the higher brackets as well. Hidden in Biden’s Plan is a provision from the Tax Cuts and Jobs Act of 2017 (TCJA). Under TCJA, current individual rates expire after 2025, after which personal tax rates will rise. Trump would freeze today’s individual rates past 2025, just as the corporate tax rates were made permanent in TCJA.
Also included in the Biden Plan are increases in the Payroll Tax and Capital Gains Tax for high earners, a reduction of the tax benefit from itemizing deductions, and a large increase in Corporate Tax rates. “Take-home pay” is estimated to decline for all income levels.
Biden’s plan is estimated to cost taxpayers $3.4 Trillion (12 zeros) over 10 years. This money would have to come out of the pockets of Americans and corporations. It is estimated to lower the Gross Domestic Product (GDP) of the country 0.4% by 2030, which is too far in the future to be accurate. Strangely, it is estimated to increase the GDP by 0.8% in 2050. Forecasting over ridiculous time periods is absurd, and appears to be 100% political. Most of us would like to know what the economic impact of either proposal would be in the short run, more than anything that may happen in decades.
An old adage says that, “figures lie, and liars figure.” In Washington, D.C., economic impact plans utilize static “scoring” (cost estimating) to project the costs and benefits of economic proposals. Unfortunately, the real world reacts in a dynamic fashion, meaning that people react differently to changes in their financial environment. This renders static scoring essentially useless. We prefer to look at past results, which are as illuminating as they are routinely ignored by politicians.
President John F. Kennedy knew that cutting tax rates would increase tax revenue, because economic activity increases dynamically. When Congress went along with his proposed tax cuts, Kennedy reiterated that, “lowering taxes was the surest path to full employment and lower deficits.” Kennedy was correct, and it worked every time it was tried.
I am willing to re-test that theory in 2021.
Van Wie Financial is fee-only. For a reason.
Last week we discussed misconceptions regarding funding the Social Security System. This week we shift to Medicare, where even more financial misconceptions may be found. Being the political season, some Presidential hopefuls are consistently misleading potential voters by making impossible promises. Among the most egregious is, “free healthcare for all,” which is touted in various boastful campaign promises. Others specify, “Medicare for everyone,” without mentioning the individual and/or public costs involved.
In order to understand the financial irresponsibility of providing Medicare for all, we must understand what Medicare currently costs, both to the enrollee and to the government. Most current enrollees do not have a clear picture of what they are paying personally for basic Medicare coverage. Even fewer understand the total annual cost to government. Total Medicare costs were $750.2 Billion (9 zeros) in 2018 alone. Here is the breakdown of funding sources for Medicare:
- Payroll Taxes – 36% ($270.1 Billion, 9 zeros)
- Federal Government General Fund – 43% ($322.6 Billion, 9 zeros)
- Medicare Premiums – 15% ($112.5 Billion, 9 zeros)
- State and Local Government, plus Taxes on Medicare Benefits – 6% ($45 Billion, 9 zeros)
In that same year, 17.8% of Americans were enrolled in Medicare. Covering everyone would therefore cost about 5.6 times more, or $4.2 Trillion (12 zeros). Extending “free” Medicare coverage to people who have not yet qualified for enrollment would raise spending numbers beyond imagination. Medicare costs are estimated to increase at an annual rate of 7.4% for the next 10 years, assuming we continue to cover only qualified participants.
Every current Medicare enrollee pays monthly premiums, but most have never stopped to figure exactly how much they pay. This is largely because monthly premiums are blindly deducted from their Social Security benefit payments. Does this mean that everyone who is proposed to be added to Medicare prior to becoming age-qualified will get a bill for their monthly premiums? Recent political promises fail to mention this possibility, implying that “free Medicare for all” means the public would pay. Do you believe it?
As to benefits, consider the cost of actual healthcare services. Medicare doesn’t pay 100% of medical expenses. Every recipient has an annual out-of-pocket deductible and a co-pay (generally 20% after reaching the deductible) on service costs. Further, many services are not covered by Medicare, and others are covered at a low rate. Will “free Medicare” eliminate deductibles and co-pays? If so, how could we afford the costs?
In real life, nothing is free. Someone will have to pay, and you can rest assured that if you are reading this blog, that “someone” will likely include you. If it sounds too good to be true…….. (complete the sentence).
Van Wie Financial is fee-only. For a reason.
Ida May Fuller; a name that made history. The date was January 31, 1940, and the check in Fuller’s mailbox in Ludlow, Vermont was from the U.S. Social Security System. Ida May had recently retired as a legal secretary when she received the first ever Social Security benefit check in the amount of $22.54.
Fuller had worked for 3 years under the newly established Social Security System, and had paid in (through the Payroll Tax Deduction) a total of $24.75. Her first payment was the smallest check she would receive in 35 years of collecting benefits, having lived to age 100. She collected $22,886.92 tax-free during those 35 years. At the time, Social Security benefits were not taxed as income. That was a promise the U.S. Government made to us at the time; no taxes, ever. We now know what that promise was worth, as Social Security benefits are now taxed according to income, with higher income earners taxed on 85% of benefits received, at their marginal tax rate.
For decades, more people were working and paying into the Social Security Trust Fund than were collecting monthly benefits. Funding for the System was based on ever-increasing contributions from payroll deductions. Of course, it helped that life expectancy at the time was under 63, and the earliest benefits could be claimed was at age 62. The Social Security Trust Fund was flush with money, and growing monthly.
But that was then, and this is now. Life expectancy has grown steadily, with babies born today expected to live 78 years, on average. Coupled with a huge Baby Boomer generation retiring, with no concurrent increase in employment, the Trust Fund has been shrinking.
Recent proposals to make temporary cuts to Social Security Payroll Taxes made me uncomfortable, as any decrease in funding would bring the System closer to insolvency. Today’s Trump proposal calls for a 4-month Payroll Tax reduction of 6.2%. Obama implemented a similar reduction in 2011, and then extended it through 2012. Politicians loved the Obama Plan, and now detest the Trump Plan. They cite the reason (excuse) that it would cripple the ability of the Trust Fund to pay ongoing benefits. I initially agreed, until a little research changed my mind.
Most of us assume that Social Security is funded by only one source; the Payroll Deduction. That assumption is, however, incorrect. There are actually three funding sources. Payroll deductions are supplemented by the amount of income tax Americans pay on their Social Security benefits. Thirdly, when a “special situation” arises, Congress reimburses the Trust Fund from General Revenues.
These reimbursements have been used many times, including reimbursement of the Payroll Tax Holiday in 2011 and 2012. For some reason, politicians today can’t seem to remember that this process is simply “business as usual.” We suspect that the nearness of the next Presidential election plays a role in their collective amnesia.
Most Americans agree that the coronavirus pandemic required stimulative action by the government, and that has been done. Unfortunately, the stimulus expired, and there has been no replacement. Both sides are in “lockdown” mode, refusing to negotiate with each other. Losing are the remaining workers who were displaced by the nationwide economic shutdown last spring. Sadly, although they claim to be talking again this week, there is no end in sight.
Several days ago, the Trump Administration announced that the 2020 voluntary Plan would be implemented immediately. Yet, the whining continues, citing the “Big Lie” regarding insolvency of the Trust Fund. Now you know the truth, and you should be able to see through the smokescreen. What you will find is politics at its worst.
For the record, I understand that the “Trust Fund” has been spent and replaced by government “I.O.U.s,” but they are as good as the American Dollar is printable by the FED. It’s all we have for now.
Van Wie Financial is fee-only. For a reason.
Having studied Economics for over five decades, I have been perplexed by the return to favor of antiquated, disproven Keynesian economic theory. Sure, it has a shiny new name, Modern Monetary Theory (MMT). It also has articulate spokespeople and supporters galore in Washington, D.C., as well as in the nation’s institutes of higher learning.
In the early 20th Century, America was introduced to the teachings of British economist John Maynard Keynes. So popular were his theories that his followers became known as Keynesian economists. Essentially, Keynes surmised that national economies were controllable through government spending. During slow economic periods, increased government spending would increase activity, boosting the country out of recession. Today, we would call this “throwing money at the problem.” Keynesians claim that the resultant surge in the budgetary deficit wouldn’t matter.
The problem with Keynesian theories is that they so often fail in practice. So badly, in fact, that Keynes occasionally contradicted himself when attempting to apply his theories to various real-world economies.
Over time, Keynes’ theories lost their luster among many academics, including American born Milton Friedman. Friedman, whose policies and theories proved more workable and accurate, introduced his Monetarist economic theory. In my college years, Friedman was “the man,” and all others were left in the dust.
According to Friedman, inflation and employment are byproducts of the supply of money. In the U.S., the Federal Reserve (FED) controls the money supply. The FED came into being in 1913, when Friedman turned 1 year old, so he grew up studying the workings of the FED. Friedman soon realized the harmful power that was vested in the unelected FED Board members.
Competing economic theories are easily classified into 2 political arenas that we now dub conservative and liberal. That has not changed since Thomas Jefferson argued against a central bank, rivaled by his pro-central bank opposition, headed by Alexander Hamilton.
Welcome to 21st Century America.
Modern day Keynesians have created a hybrid economic model dubbed Modern Monetary Theory (MMT). MMT is dependent on government’s ability to completely control fiat currency, meaning currency unbacked by commodities, simply created out of thin air by the Central Bank as a legal tender to repay debt.
While proponents of MMT call it a hybrid, or heterodox macroeconomic theory, I see nothing more or less than a rerun of failed Keynesian economic dogma, with the shiny new moniker. No government can go broke, they claim, if it has complete control over its own “printing press,” whether physical or virtual. However, in my opinion, it can financially devastate its citizenry.
During 107 years of the (Keynesian) FED, the American Dollar has lost over 96% of its original value. Any private enterprise displaying that degree of incompetence would go bankrupt and be put out of business. After all, we can’t print our own money.
Governments can print money, but they can’t print wealth.
Van Wie Financial is fee-only. For a reason.
Do you receive one or more 1099-MISC forms instead of W-2s for the work you perform? 35% of Americans receive at least one 1099-MISC. Many receive both a W-2 and a 1099-MISC, having both a primary job and what has become known as a side hustle. Other names for 1099-MISC work include gig work, freelancing, consulting, temporary work, contracting, and good old-fashioned self-employment. If you don’t receive a 1099-MISC, you likely know people who do.
State governments, with a wink and a nod from the Feds, are attempting to curtail your side hustle. The 1099-MISC sub-economy is being threatened on a daily basis by greedy governments looking to find yet another revenue source. Worse, perhaps, is their false claim that, “It’s all about you.” Be wary of those words from politicians, as unintended consequences generally follow. In this case, they want 1099-MISC workers to be switched (they say “corrected”) to W-2 employee status, and they contend that it is all about the worker.
In 2019, the California legislature passed Assembly Bill 5 (AB5), affectionately known as the “gig-worker bill.” It is mislabeled, as it should be called the “anti-gig-worker bill.” California AB5 took effect in January 1, 2020, and has been extensively challenged by such companies as Uber and Lyft.
Unfortunately, on August 10, 2020, an unelected California judge ruled against Uber and Lyft, demanding that their drivers be reclassified as W-2 employees, effective Friday, August 21.
Unintended consequences were immediately realized in California, where Uber and Lyft threatened to suspend operations at midnight Thursday. Among those negatively impacted would be many 1099 freelancers, along with customers, employers, and various enterprises opposing AB5. The inconvenience and cost to so many Californians created substantial push-back.
Resistance organizers in California have managed to get Proposition 22 on a ballot. Prop 22 would exempt app-based, on-demand, ride and delivery services from AB5. If Prop 22 doesn’t pass, look for Lyft, Uber, DoorDash, and others to leave California. Meanwhile, another judge granted a stay before the implementation date, so that Prop 22 will hopefully negate the impact of AB5.
Washington, D.C. has unsurprisingly entered the fray with the so-called PRO Act, which would bring AB5 to the national level. PRO has already passed the House, and its future depends on election results in November. Americans need to understand the social costs of this concept, and prevent its passage. Otherwise, you will have to take your own car or public transportation.
Arguing for W-2 employee status, rather than 1099-MISC freelancer, is specious and detrimental to the gig model that contributes an annual $1 Trillion to the national economy. Will Californians and unelected judges allow the demise of a thriving industry that helps millions of Americans? Stay tuned.
Van Wie Financial is fee-only. For a reason.
Second chances, do-overs, re-dos, mulligans – all are great opportunities to correct prior actions that turned out worse than expected. Too bad they are so rare in real life. The Social Security System used to offer us several second chances, dubbing them “Buy-Backs.” To some extent, they still exist, but on a greatly reduced basis. The “good old days” ended in December of 2010, when Buy-Back opportunities were dramatically reduced.
We prefer the term “Pay-Back-and-Restart,” and the opportunity remaining today is best understood by examining the history of the process. Prior to 2010, a Social Security recipient who filed for benefits prior to age 70 could refund the total amount collected prior to the Pay-Back-and-Restart day, and receive the 8% annual (2/3 of 1% monthly) benefit increase credit that was forgone while collecting past benefits.
At any time, immediately or in the future, benefits could be restarted at the increased level. This was allowed as often as time permitted before reaching age 70. Some people exercised their Buy-Back rights annually until their benefits were maxed out due to age.
Under post-2010 rules, Pay-Back-and-Restart remains available, but only once per recipient. Any time within 12 months of the original benefit starting date, a 100% Pay-Back-and-Restart is available. Benefits can then begin any time the recipient wishes to do so, with the full 8% annual benefit increase, plus cost-of-living adjustments. This can be helpful when a recipient decides (after filing) to continue working, or to go back to work. This is a relatively common occurrence, as many people don’t adapt easily to retirement and their new, limited income stream.
Difficulty involved in performing a Buy-Back is commonplace, as 100% of benefit money previously received has to be paid back, and few people actually have that much spare cash. Taking out a loan for the Buy-Back requires accepting longevity risk. The recipient has to live long enough to repay the loan before any increased lifetime benefit is realized.
Suspension of benefits is not the same as Pay-Back-and-Restart, but remains available to most Social Security recipients. Under the rules for Suspensions, a person collecting benefits may shut off the benefit stream for a period of time before restarting (“Start, Stop, Start”). This option is available for recipients who have attained Full Retirement Age, or FRA. During the period of Suspension, the recipient receives a benefit level increase credit equal to 2/3 of 1% for every month in which benefits are not paid. This amounts to 8% annualized, and is available until age 70. For people who have sufficient income at FRA, Start, Stop, Start may enhance lifetime benefits received. Again, longevity is the key, and the risk is borne by the recipients and his or her family.
It is important to understand that after age 70 no further benefit increases are available, except for annual cost-of living (COLA) increases granted across-the-board.
Van Wie Financial is fee-only. For a reason.
For weeks now, we have been covering considerations when deciding how and when to claim benefits under Social Security (SS) and Medicare. Today we take a deeper dive into the Social Security claiming decision for couples. While their decisions are more complicated than singles’ choices, the objective remains the same; maximize lifetime benefits.
Last week we discussed the situation when a married couple are of similar age, and both are qualified to receive individual benefits from Social Security. The strategy is called “File and Suspend,” and is (was) very lucrative for people fitting the profile we described.
Here’s the rub. This option is available only to recipients whose higher-earning participant was born before 1954. For those who qualify, the secret is to file only a “Restricted Application for Spousal Benefits.”
Note that the remaining days of the “File and Suspend” option are numbered, as the youngest qualified recipients will turn 67 this year. In three years, these people, having been born in 1953, will all be 70, and there is no value to waiting past age 70.
Today we look at married spouses, both qualified for SS benefits, who can no longer “File and Suspend,” due to their ages. People born after 1953 are faced with a new set of rules, all of which took effect April 30, 2016. The new rules are not as beneficial to the recipients. Nonetheless, there remain options available to assist our goal of maximizing lifetime benefits from Social Security.
Some recipients file early in order to receive spousal or children’s benefits based off his or her account. Spousal and children’s benefits (called “dependent benefits”) are paid only when the primary recipient is collecting benefits. During this period, the primary claimant cannot suspend without losing dependent’s benefits. After exhausting dependent’s benefits, the primary claimant can again suspend and receive 8% annual benefit increases before restarting.
The largest determinant in the claiming process for most folks is the overall cash flow of the couple. For those who are OK with their current income, waiting to at least Full Retirement Age (FRA) for each of them is a compromise between longevity issues and the potential of a post-FRA benefit increase. However, each case must be taken separately to see what procedure maximizes income over the expected longevity of the couple. A knowledgeable financial advisor will guide you through the complexity, and assist your quest for maximum benefits.
Van Wie Financial is fee-only. For a reason.
In recent blogs, we have covered many considerations when deciding how and when to claim benefits under Social Security and Medicare. Today we are starting a look at married couples, whose decision making is more complex than is the same process for singles. Couples have an obligation to consider each other’s futures when planning benefits filing. More options are available, and errors can be costly. The objective, however, remains the same; maximize lifetime benefits.
In order to explain the possibilities, we have divided married couples into general categories for simplicity. Today we’ll cover one of the more common situations. Next week we’ll add even more complexity.
Case A: Married couples of similar ages, both qualified for Social security participation. This situation is relatively common these days, as the two-earner household has been ubiquitous for a few decades. A popular claiming strategy when their individual Social Security benefits are relatively equal is to merely have both spouses file for their own individual benefit at their own Full Retirement Age (FRA).
When a couple has more annual retirement income than they will need without receiving full benefits from each spouse, there are alternative claiming options that increase future benefits. A common method of claiming Social Security benefits in this situation is to have one spouse (often the oldest) file at FRA, and have the spouse, upon attaining his or her FRA, claim spousal benefits, which are half of the first claimant’s monthly benefit.
Filing only spousal benefits allows the younger spouse’s (as yet unclaimed) individual benefit to increase 8% annually until age 70. At that time, the second spouse files for his or her full benefit, now much larger than before. We will illustrate this strategy with a simple “Dick and Jane” example.
Dick is three months older than Jane, and they each have an FRA of 66 years old. At FRA, Dick’s monthly benefit would be $2,000, and Jane’s would be $1,800 at her own FRA. They have sufficient income to not require the entire $3,800 monthly, but wish to receive as much as possible while maximizing lifetime benefits.
At FRA, Dick files for monthly benefits and begins receiving $2,000 monthly. Three months later, Jane reaches her FRA, but files only for spousal benefits. Her benefit is exactly one-half of Dick’s, or $1,000 per month. During this period, Jane’s not-yet-claimed monthly benefit rises 8% per year, and there is no other impact on either spouse’s benefit.
Four years later (at age 70), Jane claims her own benefit, which is now about $2,376 per month, having increased 8% annually for 4 years. Dick continues to receive his $2,000 per month (we have ignored cost of living increases), and the couple’s total benefit is now $4,376 monthly. Jane did not give up four years of benefit, but rather took less than her FRA benefit during that period. This added substantially to the couple’s income for their later years, when the higher number will most likely be more beneficial.
This week’s example is common, but other situations abound, and will be covered in upcoming weeks.
Van Wie Financial is fee-only. For a reason.