Thursday, August 27, 2015

Think Twice Before Giving Up Part of Your Pension

For most workers, pensions are a thing of the past. The days when a company would provide you with a lifelong retirement income based on your years of service is rapidly becoming a relic of the 20th century.

However, there are still millions of workers nationwide who retire with a “guaranteed” monthly income, especially among government employees and many union members. (The pension “guarantee” is not as reliable as it once was as some state governments in recent years cut retirees’ pensions to help balance budgets.)

For those who do include a pension as part of their retirement income portfolio, an important decision must be made: whether or not to forfeit part of your pension earnings for the remainder of your life in order to leave money to your beneficiary or spouse after your demise.

It’s a decision that comes with some risk. If you reduce your pension payments for the purpose of providing an income for your beneficiary (or multiple beneficiaries) you accept the risk that they may predecease you. In the event that happens, you will have given up part of your pension for naught.

Once you make this decision it is permanent and cannot be changed.

Before you make a decision that could potentially leave a lot of money on the table, you might want to give some thought to other creative solutions that could achieve the desired results without as much risk.

For example, if you are relatively or very healthy, you might consider purchasing a life insurance policy instead of forfeiting part of your pension. A life insurance policy can be designed with flexibility, to either provide beneficiaries with an ongoing income after your death or a bulk death benefit payout.

In nearly all cases, the premium amount you will pay for a life insurance policy is less that the amount you would sacrifice from your pension every month.

One recent example comes to mind. A 62-year-old client of mine was considering giving up more than $300 per month from her pension in order to provide her beneficiaries with 50 percent of the pension. Instead, together we found a life insurance policy that will provide for her beneficiaries at her desired level for one-third the amount she would have paid—approximately $100 a month.

In addition, the life insurance payout will be tax-free and will not be subject to probate court process. And she can change her beneficiaries at any time.

Best of all, she gets to keep her entire pension, but with the knowledge that her beneficiaries will receive a tax-free income after she is gone.

Thursday, August 20, 2015

Less Cherry-picking, More Information

Many people do not realize how much of an impact on our lives that daily spending habits have. How we spend our money on a day-in-day-out basis affects our psychology and mental health, adding or alleviating stress and worry, peace of mind and general enjoyment of life.

And yet, given this sizable impact that daily spending has on our lives, it’s amazing how many people tool along spending money without a single thought about budgeting.

I know, budget is a scary word for some people, boring to others, and has arduous connotations for many. But a simple household budget does not have to be a complicated process and could pay off in significant ways. After all, a budget is nothing more than a chart of data that can guide and inform spending habits.

The number one error many people make when formulating a spending plan is cherry-picking certain expenses to cut, as if this one or that one is causing the budget shortfalls. Not enough money at the end of the month? Cancel the sports package from the cable television bill. Unable to pay all your bills? Eliminate luxuries like dining out or shopping for clothes.

A solid spending plan is more complex. The first step in gaining control of your finances should be gathering information, not cherry-picking expenses you can cut.

Such cherry-picking is the first line of thinking for many families and individuals, and it’s a mistake. It’s likely not the sports package that got you into financial trouble and cutting it will probably not solve the problem sufficiently. But for some folks, a good financial plan is like a diet or a fitness plan—no pain, no gain. I’ve seen too many clients try this approach, and they may be able to hold the spending line for a while but only end up bingeing on a large expense eventually, taking on more debt.

As a financial coach, I've been helping people build successful budgets for more than 25 years. It all boils down to three basic steps: 
  1. Track exactly what you're spending for at least 30 days, preferably 60 days. Collect receipts for every penny you spend, even if it’s for a candy bar. Once you have that information, chart it out in categories like food, utilities, entertainment, etc., and compare it with your total sources of income.
  2. Think about creative ways to increase your income—start a part-time business, perhaps, do some consulting, buy and sell items, or request a raise.
  3. Look for ways to trim the budget. Now, armed with a full picture of your spending, it may be time to find sources for savings. Some examples: use coupons for retail purchases, eliminate your landline, carpool or bike to work, review your insurance policies, install solar panels, cut back on soda and drink more water. Ideally, find ways to cut costs while improving your health or standard of living; these types of win-win changes in your budget are usually the most successful and likely to endure. 

Importantly, once you've gathered your data and designed a budget, don't regard it as a structured box you must live in no matter what. A budget is a work-in-progress, always subject to revision. Allow flexibility and wiggle-room. Treat yourself now and then (just make sure it’s only an occasional treat!), even if it doesn’t always fit perfectly within your budget.

How we spend our money has enormous long-term effects and makes a substantial difference in how much debt we carry for how long, the growth of our savings and investment accounts, and our ability to plan for the future.

I hear comments almost every day from clients caught up in constant financial shortfall. “I make enough money,” they might say, “but I don’t know where it goes.” Or “I don’t do anything expensive, I don’t go out, I don’t spend money foolishly, I should have enough.”

That is the logical result of living without a household operating budget. Shadow expenses—catching a movie, perhaps, or a quick dash into the market on the way home for bread and milk, a stop by the hardware store for a new door fixture—are not considered. By the end of the pay cycle, before another payday has arrived, you find yourself running short but don’t understand why.

Discipline is not about feeling guilty over our spending habits and punishing ourselves by removing things we enjoy. Rather, discipline is about taking the time to get a clear picture of what you spend, what you make, and how best to make them coincide comfortably over time.

Money should be enjoyed. The best way to enjoy spending money without causing undue stress is to create a solid, realistic spending plan, full of information, not cherry-picking.

Thursday, August 13, 2015

Should You Make Bi-Weekly Mortgage Payments?

There is one simple and effective way, in theory, to save a lot of money over time on your mortgage: make bi-weekly payments.

Paying your mortgage bi-weekly—that is, making 26 half-payments a year (52 weeks divided by 2) instead of 12 full monthly payments—is like making an extra payment on the principal balance every year.

Over time, that additional payment on principal can add up to substantial savings on interest.

Consider: for a 30-year fixed-rate loan at 4.5 percent interest, you could cut the payoff date down to 25 ½ years and save more than $13,000 in interest for every $100,000 of principal by making regular bi-weekly payments from the beginning of the loan.

Bi-weekly mortgage payments can yield so much savings that there are numerous third-party companies that provide a service of processing regular bi-weekly mortgage payments for homeowners.

Be very wary, however, in signing up for this type of service. It’s possible and may be most beneficial to simply handle the bi-weekly payments yourself, directly to your mortgage-holder.

If you opt to do it yourself, be sure to contact your bank first to find out if they accept bi-weekly payments. Many do not, and if they don’t your bi-weekly half-payments may result in a steep late fee. Banks that do not offer a bi-weekly payment plan will likely hold the first half-payment until the second half-payment is received, then apply the two payments to principal and interest as they would with a single full payment, yielding no advantage.

If you decide to make bi-weekly mortgage payments yourself, be absolutely certain to note that the extra amount resulting from your bi-weekly payments is to be applied to the principal, by either including a note stating that request or using a payment coupon from the bank and writing in the additional principal payment amount on the designated line.

If your bank does not accept bi-weekly payments, you could still jump ahead on the payoff schedule by making a lump sum extra payment periodically (perhaps quarterly or bi-annually), when finances are available. Again, be sure to clearly state that these payments are to be applied to principal.

If you consider working with a bill-paying company to administer your bi-weekly payments, do a thorough examination into the company, the contract, fine print and fee structure.

Most of these companies will charge small monthly fees for providing the payment service and it may not be worth it. Others might charge a hefty up-front fee to sign up for the service.

One such company recently came to my notice. This company charges $181 to enroll their clients in the bi-weekly payment plan, plus $3.50 for every debit they make—in this case, 26 times per year. That monthly fee alone adds up to $91 a year for a service that you could easily manage yourself.

And who needs to pay more fees on their mortgage in addition to those already being paid?

Of course, in order to make bi-weekly payments it has to make sense for your budget. If funds are limited and bi-weekly payments would cause budgetary shortfalls in meeting other living expenses, it makes no sense.

Still, even if that applies to you there are solid debt-management plans—such as the PowerDownDebt system—that can substantially reduce the time it takes to pay off your mortgage and other debt while keeping your monthly budget within your comfort zone—with or without bi-weekly mortgage payments.

For new home buyers or those considering buying property, now may be an advantageous time to consider bi-weekly payments, as interest rates on mortgages are expected to climb at least slightly over the next year or so. Higher interest rates means you save even more by paying off early (as long as there is no early payoff penalties).

In theory, bi-weekly mortgage payments make a lot of sense. Unfortunately, banks treat bi-weekly payments differently and in many cases such a plan will not yield any benefit.

If you are considering implementing bi-weekly mortgage payments, you may want to consult with a debt or credit counselor first, to determine specific benefits and the best way to go about it.