Boat that says "Tax refund"

Field Work

Low Earners Save Their Tax Refunds

Cash-strapped workers understandably are tempted to spend their tax refunds, a sort of financial lifeboat that floats by once a year.

Financial experts see the windfall as something more: an ideal opportunity to sock money away. Yet only about 10 percent of low-income workers save their refunds, even though doing so could prevent the financial dominoes – past due bills, late rent payments, or delayed car repairs – from falling. These are common outcomes when their spending gets out of whack.

Past experiments that tried to encourage cash-strapped low earners to save had modest success. A novel research study looks for clues to what motivates them by examining who spends the refund versus who saves it. The central finding in a Journal of Consumer Affairs article: the people who saved had put some thought into predicting the size of their refunds at the time they filed their taxes. This held true whether their estimates were accurate or not.

The act of estimating in advance “appears to be a form of planning,” said the researchers, University of Rhode Island professor Nilton Porto and Michael Collins, director of the University of Wisconsin’s Center for Financial Security.

Porto said they don’t know the reason estimating leads to saving, but he had one idea. The connection between the two could stem partly from the taxpayer having some advantage, such as financial skill or superior knowledge – in short, they might have higher financial literacy. …Learn More

On the Web

Financial Videos’ Message: Please Deal

Reflecting a lofty ambition to educate Delaware residents about financial management, state government officials put together some terrific videos.

This is not high-level finance – the speakers tell stories about real people facing up to the dimensional challenges of money and retirement.  Viewers outside Delaware might find one of the 10 online Tedx talks valuable to them. Here are three:

Javier Torrijos, assistant director of construction, Delaware Department of Transportation:
His take on the immigrant experience in a nutshell: “The parents’ sacrifice equals the children’s future,” said Torrijos, who has two sons and whose own father left Columbia for a tough neighborhood in Brooklyn, New York, in 1964 so his children would have a shot at escaping poverty. Today’s immigrants are no different. But the pervasive ethos of family above all else, he argues, is responsible for some of the Latino immigrant community’s financial instability.

When required to make the impossible choice between going to college or straight to work to support family, family usually wins. “That mentality still exists” but needs to change if Latinos are to improve their lot, he said. …Learn More

Research

How Social Security Gets Fixed Matters

Line chart showing who's spending is reduced: workers or retirees? As more baby boomers retire, Social Security’s impending financial shortfall will become more pressing.

To restore solvency, Congress can either cut Social Security’s pension benefits or increase the payroll taxes deducted from workers’ pay.

Both policies would impact how much is available for households to spend. Researchers at the Center for Retirement Research find that the benefit reductions would have an appreciably larger annual impact on retirees than would the higher taxes on workers. But the taxes would be spread over a longer time period.

The new study looks at four specific policies, two that cut retirement benefits and two that raise taxes.  Each policy analyzed would equally benefit Social Security’s finances.

Gauging their separate effects required using a model to predict workers’ behavior. This was necessary because some workers might feel they should retire earlier if more taxes are being taken out of their paychecks. On the other hand, if their future pension benefits will be trimmed, they might decide to work a few more years to increase the size of their monthly checks.

One option for reducing Social Security payouts would be to delay the full retirement age (FRA) at which retirees are eligible to collect their “full” benefits. A second option is trimming Social Security’s annual cost-of-living (COLA) increases.

A two-year increase in the FRA, to 69, would reduce annual consumption in retirement by 5.6 percent for low-income, 4 percent for middle-income, and 2.2 percent for high-income retirees. …Learn More

Rocks that say 401s vs Roth

Field Work

The 411 on Roth vs Regular 401ks

Traditional 401(k) or Roth 401(k)?

Workers usually don’t know the difference. Yet employers increasingly are asking them to choose. Nearly two-thirds of private-sector employers with Vanguard plans today offer both a traditional and a Roth 401(k) in their employee benefits. Just four years ago, fewer than half did.

For tips on navigating the traditional-vs-Roth decision, we interviewed two members of the American Institute of CPAs: Monica Sonnier is an investment adviser in the Salt Lake City, Utah, area; and Sean Stein Smith is an assistant professor in the economics and business department at Lehman College in New York.

The difference in the two types of plans is the timing of federal income taxes:

  • In a traditional 401(k), a worker who contributes to his or her account will see taxable income reduced by the dollar amount of the contribution. For example, contributing 6 percent of a $30,000 annual salary ($1,800 per year) means the worker pays federal income taxes on just $28,200. The taxes will be paid decades later, when the IRS will require the retiree to pay income taxes on the amounts withdrawn from the traditional 401(k).
  • In a Roth, a worker pays income taxes on his or her full $30,000 salary, as usual. The 6 percent is an after-tax contribution that does not reduce the tax bill. The benefit will come decades later, because a Roth does not require the retiree to pay income taxes when the savings – including the Roth account’s investment earnings – are withdrawn.

If a retiree is taxed at the same rate as he was taxed as a worker, there is no difference in the after-tax retirement income the two 401(k) plans provide. However, traditional 401(k)s have generally been viewed as more advantageous, because people typically have lower incomes – and lower tax rates – in retirement than when they were working.

But things might also be changing. Over the long-term, increasing federal deficits due to increased spending pressures from popular programs to support aging baby boomers are expected to push up individual income tax rates. When that occurs, many retirees might be better off with a Roth so they won’t be taxed when they withdraw their savings.

Of course, each individual’s or couple’s tax situation is unique. Given all these caveats, here are the accountants’ rules of thumb for deciding between a traditional and Roth 401(k): …Learn More

Money Culture

Not All Good Jobs Require 4-Year College

The number of quality jobs held by workers with a two-year associate’s degree rocketed from 3.8 million in 1991 to 7 million in 2015.  Total employment over that time didn’t come close to that rate of growth.

“There are still good jobs out there for workers who don’t have a four-year degree,” explains the above video by Georgetown University’s Center on Education and the Workforce. These jobs, which require a bit more education and training than high school, typically pay $55,000 per year.

The video and accompanying report, released in late July, introduce a three-year project to document and analyze employment opportunities for people who do not want, or haven’t been able to obtain, a college degree. This blog will watch for the center’s future reports on this important topic. …Learn More

Young and old women hugging

Behavior

Outsized Caregiving Duties for the Few

The value of the informal care provided to the nation’s elderly, often by adult children, exceeds $500 billion a year – more than double the price tag for the formal care of nursing homes and home health aides.

Only 6 percent of Americans are, at any given time, regularly helping parents who have deteriorating health or disabilities to perform their routine daily activities (and 17 percent will provide this care sometime during their lifetime). But a sliver of the population shoulders an inordinate amount of responsibility.

A study by Gal Wettstein and Alice Zulkarnain of the Center for Retirement Research finds that the
6 percent of adults providing parental care devote an average 77 hours to their duties each month, or roughly the equivalent of a full-time job for two weeks.

And the burden grows as adult offspring get older.  They found that 12 percent of 70-year-olds are caring for parents and spend, on average, 95 hours per month doing so, even though they’ve reached an age when they might be developing health issues of their own.  This remarkable situation is no doubt a result of both rising life expectancies for the elderly parents and improving health among their offspring, who are also aging but are nevertheless still able to provide care.

The study was based on data from a survey of older Americans that used the standard definition of care, which includes helping seniors with activities of daily living (known as ADLs), such as bathing, eating, and walking across a room, and includes instrumental activities of daily living (IADLs), such as taking medications, cooking, and managing finances.

For the half of seniors over 85 who require this assistance, informal family care is their first choice. Not surprisingly, nearly two-thirds of this care is done by spouses and daughters, especially unmarried daughters. But there are costs, in terms of money and work, as well as time.  Caregivers report that they spend more than one-third of their budgets on parental care. …Learn More

Prudential billboard

Behavior

Our Stubborn State of Financial Illiteracy

The U.S. retirement system is built on people having a working knowledge of finance.  Yet financial literacy among a big chunk of Americans ranges from unimpressive to abysmal.

This revelation was again confirmed in a survey that recently debuted by financial literacy guru Annamaria Lusardi, head of the Global Financial Literacy Excellence Center at George Washington University. In a 2011 survey, Lusardi had found that too many Americans were unable to answer three very simple financial questions.

This new survey is more ambitious, though the results are no more promising. It asks 28 questions in eight areas: earning money, budgeting, saving, investing, borrowing, insuring, understanding risk, and information sources.  In the nationally representative survey, about one in four people got no more than seven answers (25%) correct.

One telling finding is that the highest scores were for knowledge about borrowing, with nearly two out of three answering these questions correctly. I suspect this knowledge has been gained from experience – experience with high-interest credit card bills and onerous student loan payments, as well as mortgages.

Understanding risk questionIn every other financial topic surveyed, about half or less answered the questions correctly.  Questions about risk, which is at the heart of many financial decisions, fared worst – only 39 percent answered these correctly.

An important connection is made in the report regarding 18- to 44-year olds, who answered only 41 percent of the questions correctly (versus 55 percent for people over 45). Younger adults also answered “I do not know” most often. 

When it comes to retirement, those who would gain more from financial knowledge are the least knowledgeable.  Saving that starts in early adulthood can go a long way toward achieving retirement security, thanks to compound investment returns over the many years remaining prior to leaving the work force. It’s unfortunate that those who could benefit from compounding often don’t comprehend its effect. …Learn More

Nurse with patient

Behavior

Long-term Care Insurance Goes Uptown

Is long-term care insurance a luxury product?

Today, most policies covering home care and assisted living and nursing care facilities for the elderly are purchased by people with relatively high earnings, according to a new survey.

Bar chart showing people envisioning needing a nursing home in the futureLong-term care used to be insurance that the middle class would buy – either individually or through an employer, union, or affinity group – when it was more affordable. But the market, which has contracted dramatically, also seems to be shifting, according to retirement experts and new data from LifePlans, a long-term care research firm.

In LifePlans’ survey, 82 percent of the people who purchased long-term care policies in 2015 earned more than $50,000 per year. In comparison, only half of the general older population surveyed separately by LifePlans falls into this income bracket. An Urban Institute study supports this too, finding that the market is dominated by households with more than $500,000 in net wealth.

Eileen J. Tell, who consults on aging and long-term care issues, said the slant toward the higher end reflects the fact that the coverage being sold is more comprehensive – and more costly. Most policies purchased now cover all levels of care, from home care to assisted living and long-term care facilities. This reflects a desire for people to age in their homes, Tell said.  Back in 1995, just two out of three policies had this comprehensive coverage. Another feature that’s more common – and costs more – is inflation protection. …Learn More

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