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December 15, 2004

The Check 21 Act and Your Canceled Checks

On October 28, 2004, the Check Clearing for the 21st Century Act, called the Check 21 Act, went into effect. Basically, this law allows banks to process electronic images of checks instead of handling the actual paper checks. That change will have a significant impact on your checking account:

  • Checks will clear faster. Instead of the typical two to four days to clear, most checks will clear in a matter of hours. Thus, ensure funds are already in your account before writing a check. Be aware, however, that even though checks will be processed faster, your bank does not have to make deposited funds available any sooner. Also, since checks clear so quickly, it will be difficult to stop payment on a check.

  • Canceled checks will no longer be available. Approximately 41% of consumers receive canceled checks with their statements (Source: Business Wire, June 18, 2004). Under the new law, once a digital image of the check has been made, the original check can be destroyed. In place of canceled checks, you can receive "substitute checks," which are paper copies of the electronic images of your original checks. Banks can charge a fee for providing substitute checks. While substitute checks have the same legal standing as original checks, it is harder to prove forgery with a digital image.

  • You have limited re-credit rights. When you find an error or fraud on other electronic transactions, such as debit or credit card transactions, the money must be put back in your account within 10 days while your claim is investigated. This right is now extended to checks, but only if you receive the substitute check.

It is believed that the Check 21 Act will ultimately change the way consumers pay bills. Many banks will make check images available on Web sites, so consumers may become more comfortable with online banking and pay more bills electronically or through automatic debits. Debit card purchases may become more common since your re-credit rights are stronger with those types of purchases. But with 40 billion checks still processed every year (Source: Knight-Ridder/Tribune Business News, November 2, 2003), it will probably take a long time to totally eliminate checks.

December 11, 2004

Getting Ready for Income Tax Time

Although it might seem a bit early to start thinking about your 2004 tax return, much tax-related information arrives in January. Organizing this information as it comes in makes the tax preparation process easier. While organizing your tax records is not an exciting task, it's not an insurmountable one either. Follow these tips:

  • Gather all forms sent by third parties. You should receive all W-2s and 1099s by the end of January, while K-1s aren't due until March 15. If you don't have everything by that time, call the issuer to request another copy. Don't just assume the statements are correct -- compare the information to your records and notify the issuer of any discrepancies.

  • Collect forms, receipts, and canceled checks documenting deductions. Your lender will send form 1098 to report mortgage interest. Gather receipts for doctors, dentists, hospitals, pharmacies, labs, and medicine if your unreimbursed medical expenses exceed 7.5% of your adjusted gross income (AGI). Likewise, if your miscellaneous deductions exceed 2% of AGI, gather documentation for items such as union dues, safe deposit box rental, investment fees and advice, business use of automobiles, business publications, and tax preparation fees. Obtain receipts for all charitable contributions over $250.

  • Assemble information for non-routine transactions, such as sales of securities or withdrawals from Individual Retirement Accounts (IRAs). You'll need to gather information on the original basis and ending value to calculate your gain or loss.

  • Review your 2003 tax return to ensure you've gathered all information. This review will remind you of income or deductions you may have forgotten or documents you haven't received.

Make a resolution for 2005 to be aware of tax planning opportunities throughout the year. Take time early in the year, perhaps as part of the tax preparation process, to assess your tax situation, looking for ways to reduce your tax bill. Consider a host of items, such as debt, investments, and tax-deductible expenses. It often helps to discuss these items with a professional who can review strategies you might not have considered.

During the year, consider the tax consequences before making important financial decisions. That way, you won't find out later that there was a better way to handle the transaction.

Look at your tax situation again in the fall, to give yourself plenty of time before year-end to implement any additional tax planning strategies. At that point, you'll have a better idea of your expected income and expenses for the year. You may then want to use strategies you hadn't considered earlier in the year, such as selling investments at a loss to offset capital gains or contributing to an IRA.

Start the New Year Out Right

A new year is typically viewed as a time to reflect on the past year and to set new personal goals. But it is also a good time to review your current financial situation, resolving to make significant strides toward achieving your long-term financial goals. Consider some of the following resolutions for your 2005 list:

  • Prepare a net worth statement as of January 1 so you have a snapshot of your current financial position. Compare it to last year's statement to see how much progress was made during the year.

  • Develop or update your financial plan, detailing your financial objectives and how you plan to achieve them. Set exciting goals to keep you motivated to reduce current spending and to save for the future.

  • Create a budget to guide your spending. Involve your spouse and children so they'll be committed to it. Include savings, at least 10% of your gross income, as part of your budget.

  • Review your investment portfolio thoroughly, ensuring your investment strategy is still compatible with your risk tolerance. Calculate your rate of return, comparing it to an appropriate benchmark. Compare your actual asset allocation to your desired allocation, making adjustments if necessary.

  • Calculate how much you'll need in retirement income. Then determine how much you should be saving annually to reach that goal.

  • Invest in any retirement plans available through your employer. Also consider Individual Retirement Accounts (IRA's).

  • Reduce your total debt, or at least reduce your borrowing costs. Try to pay off your credit card balances in full every month. Credit card interest rates are typically high and the interest cannot be deducted on your tax return.

  • Review all your insurance coverage, including health, disability, income, homeowners, and auto, ensuring you're adequately protected in all areas.

  • Make sure you have an adequate cash reserve fund to help deal with any emergencies.

  • Start saving for your child's college education. If you've already started a fund, make sure the savings amount is adequate.

  • Examine your employer's total benefit package, ensuring you use all appropriate benefits. Many are offered on a tax-free basis.

  • Review your tax situation, looking for ways to reduce your tax bill. Do this early in the year so you have time to implement these strategies.

  • Reevaluate your estate plan. Make sure you have an up-to-date will and have adequately provided for minor children.

  • Write down your financial resolutions and assess your progress periodically.

How Secure is Your Social Security?

Unless you're close to retirement age, whether you can count on your Social Security benefits to help fund your retirement is a concern.

Currently, the system collects far more in Social Security taxes than it pays out in benefits, but that will change drastically as growing numbers of baby boomers retire. At the end of 2003, the Social Security system had excess assets of $1.5 trillion, invested in special-issue Treasury bonds. Starting in 2018, the system will start paying out more in benefits than it collects in taxes, so it will have to start using interest and principal from its bond investments. Those assets are expected to be totally depleted by 2042. At that point, unless changes are made to the system, benefits need to be reduced by 27% to equal revenues collected (Source: Social Security Administration, 2004).

When the Social Security system's excess funds are invested in Treasury Bonds, the federal government takes the proceeds and spends it on current budget items. Thus, there is concern about where the government will get the money when the Social Security system starts to cash in these bonds. Since the government doesn't have excess cash, it will have to increase taxes, reduce other expenditures, or issue more debt. How easily the government will be able to do that is of considerable debate, especially since growing deficits are becoming a major concern.

There are three main factors causing this substantial shift in the finances of the Social Security system:

  1. Large numbers of baby boomers are about to retire. Currently, 47 million people receive Social Security benefits. Starting in 2008, 77 million baby boomers will be retiring over an 18-year period (Source: The Wall Street Journal, June 28, 2004).

  2. Workers paying for these benefits will drop proportionally. Many people mistakenly believe that all their contributions over the years are accumulated in an account in their name and benefits are paid from that account when they retire. However, Social Security is a "pay-as-you-go" system, meaning current workers pay the benefits for current retirees. In 1950, 16 workers were paying for each retiree's benefits. Currently, there are 3.3 workers supporting each retiree, which will drop to only 2 workers for each retiree in 40 years (Source: Social Security Administration, 2004).

  3. Life expectancies are increasing. When Social Security started in 1935, the life expectancy of a 65-year-old was 12.5 years. That figure is now 17.5 years, meaning payment of an additional five years of benefits, and is expected to continue to increase in the future (Source: The Wall Street Journal, June 28, 2004).

The convergence of these three trends will place a tremendous burden on the Social Security system. Some of the more common alternatives suggested to reform the Social Security system include:

  • Increase Social Security taxes. The Social Security Administration estimates that the expected shortfall over the next 75 years could be eliminated if payroll rates were immediately increased by 15%. In addition to raising overall Social Security tax rates, that could involve increasing the maximum wage used for assessing Social Security taxes. Another alternative is to assess income taxes on a greater portion of Social Security benefits. Currently, recipients with income in excess of certain limits can have up to 85% of their benefits taxed. The income limits may be lowered or the maximum percentage of benefits taxed increased.

  • Reduce benefits. The Social Security Administration also estimates that the expected shortfall over the next 75 years could be eliminated if benefits were reduced immediately by 13%. Other options could include reducing benefits for higher-income retirees or reducing annual cost-of-living increases.

  • Raise retirement ages. While the retirement age is scheduled to gradually increase from age 65 to age 67 by 2027, an even higher age may be used based on increasing life expectancies. In addition, the early retirement age of 62 could be raised or abolished.

  • Privatize all or part of the system. Various alternatives have been presented, ranging from setting aside a limited percentage of Social Security taxes in individual accounts to fully privatizing the system to allowing the government to invest some or all of the tax receipts in stocks and bonds. President Bush strongly supports personal accounts, but has made little progress in accomplishing that goal.

Will the Social Security system provide benefits for the baby boomers? Yes, it is a system so ingrained in our culture that it would be very difficult to eliminate. Will those benefits be as generous as they are now? Probably not, since drastic changes will be needed to keep the system viable in the future. While dealing with the problem now would allow the changes to occur gradually over a number of years, many doubt that Congress will have the foresight to deal with this politically unpopular problem before it becomes absolutely necessary to do so. Thus, personal savings will become an even more important component of retirement income.

 

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