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May 1, 2004

Can You Count On Your Company's Defined-Benefit Plan?

A company defined-benefit plan is a pension plan where the company promises to pay participants a certain benefit, with the entire cost typically funded by the company. Those plans are now under considerable pressure.

The recent market declines have seriously eroded the value of pension assets, while declining interest rates have dramatically increased liabilities for future benefits to retirees. The shortfall is so significant that many companies will now be required to start putting significant amounts of cash into these plans or look at other alternatives, such as reducing or eliminating future benefits. While companies can't eliminate benefits that are already earned, they can freeze benefits at current levels and reduce or eliminate future benefits.

Since a significant portion of pension benefits is typically earned at the end of your working career, these changes can leave you with significantly lower benefits. These plans tend to calculate benefits based on your salary and years of service, rewarding longevity. For instance, a plan might credit you with 1.5% of your average salary for each year worked, with your average salary calculated using your earnings for the last five years. So, if you work 25 years, you would receive 37.5% of your salary as a pension. However, if the plan was terminated after 10 years, you would still have to wait another 15 years to receive benefits and those benefits would only equal 15% of your salary.

If your pension benefits are a critical component of your retirement plans, those changes may seem unfair, especially if you don't have enough time to accumulate sufficient additional assets on your own. However, these types of changes are perfectly legal, as long as they apply equally to all participants and don't discriminate against older workers.

What can you do? Take another look at your retirement plans to determine how critical your pension benefits are to those plans. To be conservative, refigure your plans assuming your pension benefits are only half or less of what you currently expect. What will you have to do to make up this shortfall?

Also keep an eye on your pension plan so you'll know immediately if your employer plans to make changes. Then, get together with other workers and let management know how important these benefits are to you.

When Selling Investments, Don't Make These Mistakes

An important part of any investment strategy is to develop a methodology for ultimately selling your investments. Unfortunately, many investors sell based on emotional factors, making one of several mistakes:
  • Holding on to an investment with a loss. Psychologically, it's difficult for investors to sell an investment with a loss, preferring to wait until the investment at least gets back to a break-even level. However, that may never happen or may take a long time to do so. Take a hard look at the investment and consider selling if you can reinvest in an investment with better prospects.

  • Hanging on to capture more gain. When an investment has increased dramatically, you may be reluctant to sell it, even if you feel its price has gone too high too fast. There's always the risk that you'll sell and the price will keep going up. But sometimes it's best to protect your gains and sell while you're ahead.

  • Not setting price targets. One way to take the emotion out of selling is to set high and low price targets for reevaluating an investment. You don't have to sell when the investment reaches those targets, but at least review it. Sticking with rigid rules for selling when an investment declines by a certain percentage can help prevent substantial losses.

  • Trying to time the market. It's difficult to predict when the market will rise and fall. Even if the stock market is following a general trend, there will be up and down trading days. Trying to buy and sell stocks based on those daily fluctuations is difficult.

  • Worrying too much about taxes. Taxes can consume a significant portion of your investment gains. Even if you have long-term capital gains, 15% of your gain will go to capital gains taxes. However, avoiding taxes may not be a good reason to hold on to an investment. There are typically strategies that can be used to offset the tax burden, but there's not much you can do about a loss in investment value. If it's time to sell an investment, you should probably do so.

  • Not paying attention to your investments. Your portfolio needs to be evaluated on a periodic basis or you could miss signals that it may be time to sell. You should reevaluate an investment when the company changes management, when the company is acquired by or merges with another company, when a strong competitor enters the market, or when several top executives sell large blocks of stock.

Weighing Your Real Estate Mortgage Options

There are a wide variety of mortgage options available for financing your home. Which is best for you depends on how long you plan to live in the home and your expectations regarding future mortgage rates. Consider these questions before deciding on a particular mortgage option:

Do you want a fixed- or adjustable-rate mortgage? A fixed-rate mortgage is typically a good choice for homeowners planning to stay in their home for many years. The fixed rate means a fixed mortgage payment, which makes it easier to budget for other expenses. Adjustable-rate mortgages (ARMs) generally offer lower initial rates than fixed-rate mortgages, but the interest rate changes periodically based on a designated index. ARMs are typically popular with homeowners with rising incomes, who plan to move in a short time, or who want the short-term cash flow benefits from lower interest rates. Make sure you understand how the interest rate can increase. It's desirable to have two sets of caps, one that prohibits the rate from rising more than 2% per year and another that prohibits the rate from increasing more than 5% to 6% over the loan's term. Lately, due to historically low mortgage rates, many homeowners have been selecting fixed-rate mortgages. However, if rates increase, ARMs will probably become more popular again. If you are uncertain about which option to choose, consider convertible mortgages. These mortgages allow you to switch from an ARM to a fixed rate, from a fixed rate to an ARM, or from the original fixed rate to a lower rate if rates decline. There is typically a charge for this conversion privilege.

What mortgage term should you select? The most common mortgage terms are 15 and 30 years, although other terms can often be negotiated with the lender. Thirty-year loans have lower monthly payments, but your equity builds slowly during the loan's early years. Monthly payments for 15-year loans are typically 15% to 25% higher than 30-year loans, but your interest costs are less than half since the mortgage is paid off so much sooner. Interest rates on 15-year loans are typically lower than on 30-year loans. Another popular option is the biweekly option. You pay half the monthly payment every two weeks -- over the course of a year that equals 13 monthly installments. That builds equity quicker while reducing interest costs.

Should you opt for a lower interest rate or fewer points? A point is 1% of the mortgage face amount and is paid to the lender at closing. Points for a home's original financing can be deducted on your tax return in the year paid. Often, you can lower the loan's interest rate by paying more points. The longer you intend to live in the home, the more financial sense it makes to pay more points now for a lower interest rate over the long term. Sometimes it can be difficult to decide among several options with varying interest rates and points. As a simple rule of thumb, divide the number of points by the number of years you expect to live in the home. That fraction can be added to the loan's interest rate so mortgages can be compared on a fairly uniform basis.

Sorting through all the options and choices can seem overwhelming. However, it is not uncommon to save thousands of dollars over the life of the loan by shopping for the best option.

Protecting Your Financial Life

No one expects it to happen to them. You think you're careful with financial information, so how could someone steal your identity? However, very little information is needed to steal your identity -- just your name, Social Security number, and birth date. Armed with that information, thieves can obtain credit cards, get loans, purchase a car, or apply for a job -- all in your name.

Where do thieves get this information? Many people have their checks printed with their Social Security number, driver's license number, and birth date. Stealing your mail often results in something with your Social Security number on it. A call to a credit bureau, posing as a prospective landlord, employer, or lender, often yields information. Computer-literate thieves can obtain information over the Internet.

While you typically won't have to pay for anything charged by an identity thief, you will have to work to restore your credit and to ensure all fraudulent accounts are closed. That can be time consuming as well as expensive. If you are a victim of identity theft, inform the three major credit bureaus so a fraud alert can be placed on your account. That way, no new credit will be issued without first contacting you. Also file a report with the police in case a creditor wants proof of the crime. Make sure to file the Federal Trade Commission's ID Theft Affidavit, which advises many companies and organizations about the theft.

To help prevent your identity from being stolen, follow these tips:

  • Protect your Social Security number. Only give it out in situations where it is absolutely required, such as on tax forms, employment records, and for banking, stock, and property transactions. Request a personal identification number for phone access to financial information. Don't print your Social Security number on your checks. Since so much financial information is linked to your Social Security number, ensure that it's not readily available to individuals who could use it fraudulently.

  • Check your credit report annually. For a minimal fee, the three main credit reporting bureaus will provide a copy of your credit report. Contact Experian at 1-888-397-3742, Equifax at 1-800-685-1111, and Trans Union at 1-800-888-4213. All credit bureaus will provide a free copy if you were denied credit based on their report and request the report within 30 days of denial. Review your reports carefully for errors. It is not uncommon to find information on people with similar names or other family members in your credit file. If you find errors, report them immediately in writing. The credit bureau must then investigate the items and resolve those that can't be verified. If the matter is not resolved to your satisfaction, you can submit a "statement of dispute" explaining your position, which must be included in your report.

  • Shred important financial records. When discarding old tax returns, bank statements, brokerage statements, and other financial documents, make sure to shred the documents.

  • Remove yourself from mailing lists. Pre-approved credit card offers are an easy way for thieves to obtain credit cards in your name quickly. Credit bureaus frequently sell lists to companies making these offers. You can call the credit agencies and request that your name be removed from these lists.

Don't Sabotage Your Financial Goals

One of the surest ways to sabotage your financial goals is to take on an excessive amount of debt. Unfortunately, it's not difficult to get yourself into that situation. Just consistently spend a little more than you make over a period of time and you will eventually find yourself overburdened with debt. At that point, with much of your discretionary income going to make debt payments, you will typically find you have little or nothing left over to save toward your financial goals. If debt is hampering your ability to work toward your financial goals, make some strict rules:
  • Using a mortgage to purchase a home can be a good financial strategy, since you are using debt with a reasonable, tax-deductible interest rate to purchase an asset that will probably increase in value over time. Just make sure you can easily afford the home. Don't purchase the most expensive home your lender will allow, putting the least amount down. Instead, make a large down payment and purchase a home that won't stretch your budget. Typically, you'll get a lower mortgage rate if you make at least a 20% down payment.

  • Be extremely cautious about taking equity out of your home in the form of a home-equity loan. You might want to set up a home-equity line of credit to use for emergencies, but then make sure it's only used for emergencies, not as a convenience. It may also make sense to use a home-equity loan to pay off higher interest rate consumer loans, but then make sure you don't run up those debts again.

  • Control credit card debt. Credit card balances typically carry high interest rates that aren't tax deductible. The best strategy is to only use credit cards if you can pay the balance in full, thus eliminating any interest payments. If you have trouble controlling the use of credit cards, get rid of them. Only use cash to make purchases. If you don't have the cash, don't purchase the item.

  • Come up with a plan to pay off all your credit card debt. Make a list of all your credit card debts, listing the balance and the interest rate. Are you able to transfer higher interest rate balances to lower rate alternatives? Can you obtain a new lower interest rate credit card so you can transfer balances to that card? Have you contacted your lenders to see if they will lower your interest rate? Once you've consolidated as much as possible, come up with a plan for paying off those debts. Start by paying extra on the card with the highest interest rate. Once that debt is paid in full, move on to the card with the next highest interest rate, continuing until all your debt is paid in full.

  • Work on your spending habits. Face it, you wouldn't be in this situation if you didn't have problems controlling your spending. Put yourself on a budget and stick to it. Look for ways to reduce spending so you'll have more money to pay down debt.

  • Get help if you can't stick with your plan. If you can't seem to make any progress in paying down your debt or find yourself running up credit card balances again, call for help.

 

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