Figure 5.1 Projected Deficits and Debt Increases, 2001–2012
Source: Congressional Budget Office, U.S. Treasury
Whether or not you like the presence and cost of government, it plays a huge role in today’s economy. Governments provide money and monitor its supply, but go way beyond to create and implement various policies and programs to influence the economy, fix the economy, spend critical resources, and make it better for all of us.
Government agencies regulate economic activity, providing safeguards and a fair and level playing field for economic transactions to occur. Certain bodies of law, like bankruptcy law, create fair ways to dissolve failed economic entities, ultimately facilitating the sort of risk-taking necessary to make the economy work in the first place.
Want to understand the role and importance of the government in the economy? Just try to picture what it would be like without government. We would have no universally accepted currency, and no supervision and regulation of the markets and other economic activity—and no reallocation of resources to public programs and infrastructure, like roads and airports—that make the greater economy work.
It’s good to know where our money comes from and who’s managing it. Today, it’s sort of a joint venture between the Federal Reserve, our central bank, and the U.S. Department of the Treasury.
The Treasury department is part of the executive branch of the U.S. federal government and reports to the president. While the Federal Reserve (see #30 Federal Reserve) was created in 1913, the Treasury has been with us almost since day one, being created by Congress in 1789 to manage government revenue and currency.
The Federal Reserve and the U.S. Treasury work together to create and implement money and monetary policy. The Federal Reserve is more the “brains” of the operation, deciding what policies to put into place with regard to employment, prosperity, and price stability; the Treasury is more “working man,” in place to carry out the programs.
The Treasury prints, mints, and monitors all physical money in circulation, including paper and coin currency. The U.S. Mint and the Bureau of Engraving and Printing are part of the Treasury. In addition, the Treasury is responsible for all government revenue generation through taxes—the Internal Revenue Service is part of the Treasury. Beyond raising money through taxes, the Treasury also raises money by creating debt securities—bills, notes, and bonds—to sell to the general public, banks, corporations, investment funds, and so forth.
So if the Fed decides to increase money supply, the Treasury puts the plan into place, although the Fed can also create more money by injecting money into the banking system directly, and has done that a lot recently. If Congress decides to change tax policy, the Treasury (through the IRS) carries that policy out. The Treasury does not decide on tax policy, nor does it create or change tax law.
The Treasury also performs other roles, such as measuring economic activity; providing economic and budgetary advice for the executive branch, Fed, and others; and producing other revenue through alcohol and tobacco taxes, postage stamps, and so forth. Until 2003, the Treasury also handled firearms regulation, customs and duties, and the Secret Service, but these functions have been transferred to the departments of Justice and Homeland Security.
Aside from the fact that its building is on the back of the $10 bill, and its original secretary, Alexander Hamilton, is on the front, it’s good to know what the Treasury is and does. Most of us have at least annual contact with the Treasury through the IRS at tax time. Additionally, it is the Treasury that issues U.S. securities, which we, or our banks or companies, may buy or sell occasionally. The Treasury carries out policies; it does not create them, so those that we agree or disagree with should be attributed to someone else in government. More recently, the Treasury and the Federal Reserve collaborated to create and implement federal bailout programs, like TARP, to safeguard the banking system from collapse and to strengthen it moving forward.
The federal budget, known more formally as the Budget of the United States Government, is a document prepared by the president and submitted to Congress for approval. The document outlines revenue, spending projections, and recommendations for the government fiscal year, which starts October 1 of the current year—so the 2013 federal budget covers the fiscal year beginning October 1, 2012 and ending September 30, 2013. Congress then adds its own budget resolutions (one each from the House and Senate). The budget is passed and signed into law; then individual appropriations bills are passed to actually fund government programs.
The federal budget, by nature, outlines the nation’s spending priorities and is used as a tool to manage and solve social and economic problems on a large and small scale. Budgets don’t always cover emergencies, as discovered by additional fiscal year 2009 appropriations made for TARP and other economic relief in the wake of the financial crisis. Certain military operations like those in Iraq and Afghanistan may also be wholly or in part funded and administered outside the budget process.
The size of the federal budget has increased dramatically over the years. The 2013 budget calls for a budget of some $3.8 trillion, well more than double the 1999 level of $1.7 trillion. Some of that increase reflects inflation, but it also, more importantly, reflects an ever-growing role of government in the operation of our nation, as well as a continued solidifying and stimulating of the economic base in the wake of the financial crisis.
Has revenue growth kept up with spending growth? Indeed not; the 2013 deficit is projected at $901 billion, down from the $1.17 trillion in 2010 and the record $1.75 trillion in 2009. Budgets are typically construed as part of a longer-term plan, and President Obama had planned to reduce the deficit to $533 billion by 2013—but a lagging economic recovery and failure to resolve “gridlock” over tax and spending policy have delayed that reduction. The deficit that remains is still substantially larger than those of the worst years of the Bush administration. That said, the Bush budgets do not account for expenditures that occurred largely outside the budget—for example, the wars in Iraq and Afghanistan, which were funded by supplemental appropriations bills, instead of the original budget or routine appropriations process.
It’s interesting to look at the specific areas of revenue and expense in the 2013 budget, and how those specifics compare to the recession-riddled year 2010. Note the effects of the rebounded economy and the $80 billion in interest “income” derived from bonds purchased in Fed open market operations:
Unfortunately, so-called “mandatory” expenditures continue to grow, and will probably do so until “entitlement reform” actually takes place. Sizeable increases in the Social Security, Medicare/Medicaid, and Interest on the National Debt lines drive the mandatory spending increase:
Some restraint on spending growth is evident in the “discretionary” side:
Note that these are just the seven largest line items: there are twenty-one more line items, some as large as cabinet departments, some more specific, such as $7.4 billion for the National Science Foundation.
Just as you should care about your own income and spending and budget accordingly to make ends meet, you also should care about whether the government is doing the same thing—whether it is using your tax dollars appropriately, and making good decisions. Budget talk can be contentious at certain times, dull at others, and complex always, but it’s in your best long-term interest to keep tabs on what’s happening. Budgets are usually proposed early in a calendar year; you should find a favorite news source and keep track of them. Budget detail is available at the U.S. Government Printing Office “GPO Access” website from the Office of Management and Budget—see www.gpo.gov/fdsys/browse/collectionGPO.action?collectionCode=BUDGET. The current and upcoming year’s budget documents, while long, are always an interesting read.
After reading the previous entry on the U.S. federal budget, you might understandably be concerned about the excess of expenditures over revenue, and what that might mean for you and for the economy. Put simply, if you spent that much more than you earned, you’d be in big trouble—deep in debt or worse.
Truth is, the size of the federal deficit and the load of debt it has created is of great concern, especially to fiscally conservative politicians and citizens. Such large deficits and debts sap our future economic strength and may hinder our ability to borrow, as we must service—that is, pay—interest and principal on our current debt. There was great concern that because of already existing debts, the United States may not be able to borrow its way out of the recent economic crisis and downturn. So far, those problems haven’t materialized, as U.S. debt obligations are still considered among the world’s most secure. China in particular needs to support our economy because of the degree to which our economy supports its economy. Now the concern is about what happens next time around, when we’re still further in debt.
Figure 5.1 speaks for itself. You can see the tremendous bulge in the size of the deficit and the increase in the national debt that occurred in 2009, as federal programs were put into play to alleviate the effects of the Great Recession. Economists consider part of the deficit as structural, recurring as part of government’s overall initiatives and priorities, and some of it as cyclical, as in the medicine applied to fix the banks, reduce unemployment, and so forth. You can see that as some of the economic stimulus takes hold, the deficits and increases in debt are declining slowly, but still considerably exceed earlier figures, and for that matter, any time in history.
Figure 5.1 Projected Deficits and Debt Increases, 2001–2012
Source: Congressional Budget Office, U.S. Treasury
If there is any good news about deficits and debt, it is that they are still moderate compared to the size of the national economy. Government spending in the United States runs about 25 percent of GDP, compared to figures of 50 percent and higher for many other developed Western nations. The deficits, while huge in absolute dollars, have run somewhere in the range of 3 to 5 percent of GDP historically—again, not a large number on the world stage, but with the recent increases in the deficits and accompanying moderation in GDP growth, the figure has risen to 6.2 percent most recently.
Different people feel differently about being in debt. Clearly, the rising levels of debt “put the burden on our children,” but that’s been said for years. It’s alarming to think that our national debt runs about $52,953 per person (that’s $212,000 for a family of four, up about 60 percent since 2009)—if you ran up such debt on your own you’d be in big trouble! But the government can print money, and other nations find it in their interest to support our debt. Inflation may take some of the sting out of the debt as well (see #34 Reflation). But it is still a big elephant in the room, one to be concerned about for the future, and it argues for all of us to reduce our spending habits and not get carried away trying to prevent economic downturns (see #59 Austrian School).
While the Great Recession was a big deal, and new legislation has emerged from it (see #39 Dodd-Frank), so far it has not been a watershed for new securities and investment laws, as were the 1929 stock market crash and the Great Depression. Those events brought Congress to pass a series of laws to regulate the heretofore largely unregulated securities industry. Many newer laws have come onto the scene, but the four “biggies” remain the set passed in 1933, 1934, and 1940.
The four laws listed below set the ground rules for selling securities to the public and for trading those securities, and for investment companies and professional investment advisers. They also set up and defined the role for the Securities and Exchange Commission (see #44 SEC).
These laws provide a framework, but aren’t absolute in nature; the SEC can and does have authority to add rules to these laws to close gaps and accommodate new technology and methods.
While it’s easy to think that financial firms, investment funds, and advisers got away with murder during the recent crisis, you should know that there is a fairly substantial framework in which they operate. That said, the shortcomings of the SEC became apparent. As a prudent individual, you should always make sure any investment adviser you deal with is registered.
These laws don’t cover everything in the investment markets. If you’re thinking about hedge funds (see #72), realize they largely escape this framework because they are targeted toward certain qualified individuals, not the public at large. As we found out with the recent failure of MF Global, a commodities trading firm run by former New Jersey governor Jon Corzine, they don’t apply to commodities trading, either. That may change, and new laws may also emerge to counteract scandals like the Bernard Madoff debacle.
The Securities and Exchange Commission is an independent public agency within the U.S. government, chartered primarily to enforce the major securities laws outlined in the previous entry. The SEC is a vital referee in a game that, without referees, might well go out of control, although it has been on the hot seat for some important “no-calls” and bad officiating in recent years.
The SEC is a large and complex organization, but much of it is organized in the following four major groups, three of which loosely align with the major securities laws covered above:
The SEC got into trouble in the aftermath of the Bernard Madoff scandal. In its defense, it simply doesn’t have the staff to properly police the rapidly expanding and ever-faster-moving securities markets. The staff of 4,000 must sift through 90,000 complaints brought to the SEC each year; out of these, some 794 enforcement actions took place in 2012. In addition to the complaints coming in, staff has a responsibility to examine things on its own to ensure compliance. Some still say the SEC is too cozy with big players, choosing to assume they’re right or to look the other way, while spending too much time enforcing registration and other minor compliance issues with smaller brokers and dealers. Under the leadership of Chair Mary Jo White, and with the backing of certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (See #39), the agency has taken many steps, including hiring more agents and reviewing internal processes, to deal with these issues. Today’s SEC is generally considered more aggressive in its investigation and enforcement of compliance within the securities industry
The SEC, while under fire from Congress and the general public, plays a vital role in ensuring the safety and integrity of your investments. It’s helpful to know what the SEC does, and how your key investments and “nest egg” are protected. It is also important to know that the SEC won’t—and shouldn’t—prevent you from losing money in the securities markets, so long as everything that happens is within the law.
The banking collapse in the Great Depression, during which some 20 percent of all banks failed and their customer deposits were gone forever, led to new protections of deposits. As part of the Glass-Steagall Act of 1933, the Federal Deposit Insurance Corporation was set up within the government to guarantee deposits meeting certain criteria. As a bank depositor, your deposits are most likely covered, and would be paid back in the event of a bank failure, but it’s worth reviewing the rules.
Today, deposits are covered up to $250,000 per depositor per bank for most types of checking and savings accounts. This amount was raised from $100,000 during the 2008 banking crisis. The “per depositor per bank” rule makes it fairly easy to achieve greater levels of coverage; you can have one account and your spouse can have another at the same bank, and both are covered. Or you can have joint accounts at two separate banks (they must be completely separate—not Wells Fargo and subsidiary Wachovia, for example). If you have several accounts at one bank, the coverage considers the total, not each account separately.
If you have millions, there are ways to extend this coverage further by having an intermediary spread your accounts through the Certificate of Deposit Account Registry Service (CDARS). If you have millions in savings, check out www.cdars.com. If you’re more like the rest of us, with a few accounts, the FDIC ownership and coverage rules can be found at the FDIC’s website: www.fdic.gov/deposit/deposits/insured/ownership.html.
One thing to remember: FDIC does not cover investment accounts. The most common example used for savings is money market funds (not to be confused with so-called money market accounts, a product offered by some banks that is covered.). Some funds, however, might be covered by optional insurance offered by the U.S. Treasury in the wake of the 2008 banking crisis. The FDIC doesn’t cover credit union accounts per se, but the National Credit Union Share Insurance Fund (NCUSIF) offers nearly identical coverage.
Investment accounts are covered by SIPC (Securities Investor Protection Corporation) for up to $500,000, but this coverage is against failure of the broker, not investment losses, and so rarely applies.
It is very important, especially in this day and age of financial volatility, to have at least some security for your savings. You should ask questions and take the necessary steps to ensure that your core savings are covered. It’s worth keeping track of changes in the laws too.
Government-sponsored enterprises have been created by Congress over the years, starting during the Depression-era New Deal, to provide credit to targeted sectors of the economy like farming, housing, and education. The most visible GSEs today are Fannie Mae (once called the Federal National Mortgage Association, now officially called Fannie Mae) and Freddie Mac, once the Federal Home Loan Mortgage Corporation. Other GSEs include the Farm Credit System created in 1916, and Sallie Mae, once the Student Loan Marketing Association, created in 1972. Sallie Mae is no longer a GSE; it became the private SLM Corporation during the period 1997–2004.
For almost all of us, the two mortgage finance GSEs and the twelve additional Federal Home Loan Banks are most important. These institutions have created what’s known as the secondary mortgage market, buying mortgages from mortgage bankers and other lenders, and repackaging and selling them as mortgage-backed securities into the financial markets. This activity provides greatly expanded liquidity in the mortgage markets and thus makes mortgages much more “available” and affordable for all of us. These institutions also “guarantee” certain loans, making them more attractive to investors, and thus lowering the interest rates and qualification requirements.
Before the 2008 financial crisis, the GSEs were pressured by policymakers to make more loans more affordable for more people to accomplish stated federal government goals to expand U.S. home ownership. This led to deterioration in credit quality requirements (that is, the standards applied to borrowers for income, credit ratings, and general ability to pay). This relaxation in standards expanded the market for so-called subprime mortgages; the GSEs and many institutions they sold to took a big hit when these mortgages started to fail. The GSEs, most of which had existed since the late 1960s as standalone publicly traded stock companies, had to be largely taken over and “bailed out” by the federal government, an act consistent with their original GSE charters, but something of a shock to the financial markets.
GSEs, specifically Fannie Mae and Freddie Mac, are not explicitly guaranteed by the federal government. This issue was tested in late 2008 as these two GSEs were caught with bad loan portfolios, and the question arose as to whether they would “make good” on guarantees and loans they had given or sold to others. The government didn’t do that, but essentially took them over by putting them into a conservatorship, wiping out private investor equity, and they still do function today, but at a diminished level. Their future is still being debated.
Fannie Mae and Freddie Mac still ultimately buy, repackage, and sell a healthy portion of home mortgages granted in the United States today.
Additionally, Fannie Mae and Freddie Mac set the limit on the maximum size of a loan they consider “conventional”—that is, eligible for preferred interest rates and guarantees. Until 2008, that limit was $417,000; a mortgage exceeding that amount was said to be “not conforming,” and thus would be a “jumbo” loan having higher interest rates—currently 1 to 1.5 percent higher. In 2008, the GSEs raised the limit to $625,500, depending on geography.
The proper coverage of the subject of taxation obviously would take more than a single entry. The Government Printing Office reported in 2006 that the U.S. Income Tax Code, the body of law administered by the Internal Revenue Service, was 13,548 pages in length. Additional rulings, opinions, and supplemental documents run the total up to about 44,000. And that’s just U.S. income taxes—there are other kinds of taxes like sales (consumption), excise, estate, and many others. It’s a complex subject.
Taxation is obviously designed to raise revenue for governments and public entities to fund their operations and for redistribution—that is, to move money to needy parts of society in the form of entitlements like Social Security and Medicare and other direct and indirect aid programs (see #50 Entitlements). Considerable debate has occurred over how much of this is appropriate.
Income taxation began in 1861 in the United States to pay for the Civil War—the rate was a flat 3 percent on incomes exceeding $800. It went away after the war but returned briefly in 1894, and more permanently in 1913 as the Sixteenth Amendment. It’s been with us, with much change and increased complexity, ever since. Regarding income taxation and tax policy, a few fundamental principles are important:
Current tax policy and laws naturally determine how much of your income—all forms of it—you’re entitled to keep. Most view taxes as a necessary evil, and are resigned to pay whatever their accountants say they owe. With a deeper understanding of taxes and how they might affect your current financial situation, you can take charge and plan your taxes so as to minimize them. That is also a good thing, and encouraged by the IRS. Just as you would budget a business or your personal finances, it pays to put some energy into saving money on taxes—taxes of all types, from all jurisdictions. Don’t be afraid to do this.
The dangers of unfair credit practices, or “lawlessness” in this area, are obvious—it’s too easy for unknowing or unsuspecting people to be “sold” on the idea of borrowing money to buy something under unreasonable terms. The federal government has passed an assortment of laws over time to make credit practices more consistent, fair, and understandable. In making things fair, they help the economy function more efficiently, as people can trust lenders to a greater degree—and vice versa.
Federal laws serve mainly to clarify the responsibilities of creditors and debtors in consumer credit relationships, although the most recent 2009 legislation goes a bit farther by providing ground rules for what credit card companies can and can’t do. Here are four of the most important laws governing credit and credit fairness:
A few years ago, Congress passed the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009. This is a broad credit cardholder’s “bill of rights” limiting the ability of credit card companies to raise interest rates without adequate notice or triggers, and dealing with a host of other consumer-unfriendly practices in the credit card industry. As a user of credit and especially if you have a lot of credit cards, you should understand this new law.
While most credit problems are corrected by getting spending habits under control and making required payments, mistakes or aggressive creditor practices do happen, and sometimes it makes sense to consider your legal options. Like any game, it helps to know the rules and how to cry “foul.” You should learn what questions to ask and how to communicate with creditors, but don’t expect the law to mitigate the effects of bad habits.
Everybody makes mistakes. In the old days, if you ran out of money or your debts exceeded your assets, you would be sent to debtors’ prison—or worse. What would happen if debtors’ prison existed today? Very simply, people wouldn’t take risks, and they wouldn’t spend money. If people didn’t take risks, we wouldn’t have the conveniences and technologies we have today. And people wouldn’t spend money at all for fear of that cold, dark debtors’ prison.
The bankruptcy process and set of laws around it are designed to clean up people’s financial mistakes in a fair and equitable way. While bankruptcy certainly isn’t good for the individual or company going through it, it stops short of being a draconian, desperate measure. So yes, bankruptcy is a bad thing, especially for the individuals and companies involved. But the way the process is set up actually helps the economy.
Bankruptcy happens when an individual or corporation declares its inability to pay its creditors (voluntary bankruptcy), or when a creditor files a petition on behalf of a debtor to start the process (involuntary bankruptcy). The U.S. Constitution puts bankruptcy under federal jurisdiction, and a uniform Bankruptcy Code sets the rules, with some state amendments. Bankruptcy proceedings occur in federal court.
The most often used and discussed chapters in the Bankruptcy Code are Chapters 7, 11, and 13:
Bankruptcy usually allows certain property, such as personal effects and clothing, to be exempt from liquidation; these rules can vary by state. Chapter 7 rules allow only one bankruptcy filing in eight years, and during that eight-year period your credit rating and your ability to borrow will be severely impaired. Specific rules cover spousal property. In Chapter 13, the debtor doesn’t forfeit assets, but must give up a portion of future income over the next three to five years. In Chapter 11, the business continues to run while creditors and debtors work out a deal in bankruptcy court. Eventually a plan is presented to the debtors, who must approve it.
Legislation in 2005, known as the Bankruptcy Abuse Prevention and Consumer Protection Act, made it harder for debtors with means to simply file and walk away; they must discharge their debts if they can. There was a large “bubble” of bankruptcy filings before this law went into effect. Even with this law, bankruptcy filings have been on the rise over the years, as consumer debt and the likelihood of catastrophic medical bills has increased. Many Chapter 13 filings allow a complete discharge of medical debt alongside the payment plan for ordinary debts. The economic crisis, not surprisingly, triggered a rise in business and personal bankruptcies. According to federal statistics, nonbusiness bankruptcy cases rose from about a million in 2008 to over 1.5 million in 2010; they are projected to drop to a level near 1 million for 2013.
Even with the protection that bankruptcy affords, you don’t want to go there if you don’t have to. That said, it’s good to know that there’s a fair and reasonably unthreatening way to settle insolvency should it ever become your unfortunate circumstance. So if you’re planning to build and market that breakthrough electric car, go for it—you won’t go to jail if you fail. And while prudence in personal finance and consumer debt is always the best path, if you lose a job or have a major medical catastrophe, bankruptcy does give you a way to deal with it.
Entitlements, or “social insurance” programs, are designed to stabilize the economy in several ways. First, they allow people to retire with some degree of financial security, else they would have to keep working well into advancing age. That would, of course, not be good for them or their employers, and it would fill jobs that would otherwise be available for younger employees. Second, these programs take the burden of caring for elder family members off younger family members.
Social Security is a child of the Great Depression, an era where some 50 percent of citizens over sixty-five reportedly lived below the poverty line. The program stands largely as originally conceived and passed in 1935. The most important component is the Old-Age, Survivors and Disability Insurance program, or OASDI. Benefits are paid for retirement, disability, survivorship, and death. Retirement and survivorship are the most substantial parts of the program; disability benefits are difficult to qualify for, and the death benefit is minimal.
When a citizen reaches a certain age, a retirement benefit is calculated based on work and earnings history. The “full retirement” age was once sixty-five, but now has been extended depending on birth date. A reduced benefit can be taken starting at age sixty-two; if the retiree chooses to defer benefits to age seventy, those benefits increase. Both adjustments are done by spreading a projected benefit over a different number of years; that is, the total projected benefit is the same, just divided differently. In rough numbers, the payout increases 8 percent for each year you delay retirement. The Social Security Administration has an informative website covering benefits and other topics; see www.ssa.gov.
Social Security is funded by the so-called FICA tax (which stands for Federal Insurance Contributions Act) taken from every paycheck or collected as “self-employment tax” from self-employed individuals. The FICA tax, which combines Social Security and Medicare, is 15.3 percent of gross income; in the case of employees, employers pay half. Of that amount, 12.4 percent is for Social Security; the remaining 2.9 percent is for Medicare. Social Security funds are collected on the first $113,700 of gross income, while Medicare collections have no limits. In addition, Congress passed an additional Medicare tax of 0.9 percent for individual earnings over $200,000, which now also includes “unearned” income (from investments, etc.).
The Social Security funds collected go into the Social Security trust funds. Those funds are used to pay current beneficiaries and to buy U.S. Treasury debt obligations—that is, to fund current deficits. Currently receipts exceed payouts, but many economists are concerned that the trust funds are a giant Ponzi scheme—that future receipts will go to support current recipients, leaving insufficient money for future retirees who are currently paying in. Social Security is the world’s largest government program, and continues to represent about 20 percent of overall U.S. government expenditures.
Medicare, the “single-payer” health insurance and care program for those over sixty-five, came into existence in 1965. Medicare benefits are divided into four groups. Summarizing the four parts:
Beyond Medicare, Medicaid provides additional benefits and pays some of the deductibles for seniors in serious financial need. Unlike Medicare, Medicaid programs can also cover qualifying needy families, and are administered at the state level; each state has different rules, although most of the funding is from the federal government. Typically, eligible seniors must have no more than a few thousand dollars in assets in addition to a home or car to qualify.
Beyond plugging what could be a huge—and growing—gap in the economy, these entitlement programs are important for your future financial planning. It’s a good idea to develop a basic understanding of Social Security benefits (the annual statements they send you are helpful) and of Medicare before you reach your golden years.
Someday you’re going to retire. And when that day comes, you should be eligible for Social Security, assuming you’re at least sixty-two when you decide to leave that cubicle or workshop for good. But most financial experts expect that Social Security will only cover 20 to 50 percent of your income needs, especially if you are still paying for or renting a home.
That’s where retirement savings plans come in.
First, it’s important to distinguish retirement plans from retirement planning. Retirement plans are special savings plans set up in the eyes of the law to provide tax incentives both for you and your employer to induce greater savings. They are also set up to be legally at “arm’s length” from your employer, so that your savings cannot be tapped or otherwise manipulated should your employer get into trouble. That’s important in these days of economic crisis and rapidly changing corporate (and public sector) fortunes.
Retirement planning is the active pursuit and calculation of your retirement needs, and how those needs will be funded in retirement—which you can do yourself if you have the skills, or with the help of a professional adviser.
There are three types of retirement savings plans. The first two are offered and administered through employers:
Defined benefit plans, as the name implies, specify the benefit. For example, you and your surviving spouse will receive $2,000 a month for as long as you live, come heck or high water. Your employer funds the plan, and its investments usually are managed by a third party; how they come up with enough to pay you is their problem. Traditional pension plans, as offered by most government agencies and legacy corporations, are defined benefit plans. These plans are going out of style because companies don’t want the burden of extra funding for the plans in bad times. The Pension Benefit Guaranty Corporation, a government corporation set up to guarantee pension benefits, estimates there were 22,697 such plans in effect in early 2013, down from 80,000 such plans in the United States in 2005, and down from 250,000 in 1980. If you have a defined benefit plan, consider yourself fortunate.
Defined contribution plans, on the other hand, define the employee (and employer) contribution—what goes in—not the benefit that comes out. The widely used 401(k) plan is most common, allowing an employee to set aside up to $17,500 in funds each year, with an additional catch-up amount of $5,500 for employees over 50 years of age; some company plans offer matching funds. Public entities use 403(b) plans as an equivalent, and there are many other flavors. You must understand that the benefits you realize from these plans are both a function of how much you set aside and how well your investments perform; there are no guarantees. This lack of guarantee is of considerable concern to economists and savvy individuals alike; there is no assurance that retirees in the future will have sufficient funds to retire on, regardless of how much they set aside. Hit by the triple whammy of reduced earnings, lower stock prices, and increased emergency withdrawals, the Great Recession created a large drop in 401(k) balances to an average of $30,200 across 17,000 corporate 401(k) plans, according to plan administrator Fidelity Investments. More positively, that number recovered to an average of $75,900 by 2012, with sizable increases in employer and employee contributions along the way.
The third type, as the name implies, are individually set up and administered—individual retirement plans, or “arrangements” (IRAs). These plans behave like defined contribution plans, except there is no connection to an employer. You set them up and fund them yourself. They have different tax advantages—traditional IRAs allow you to deduct contributions if you qualify, and pay taxes upon withdrawal; Roth IRAs don’t allow the deduction, but withdrawals (including investment gains) are tax-free. Many people use these individual arrangements to supplement employer-sponsored plans, subject to specific rules. As with other defined contribution plans, there are no guarantees, except in the case of the failure of the broker or institution with which you have the account. With some exceptions, individuals can contribute $5,500 per year, $6,500 if over fifty. These accounts are widely used but not that deeply funded—in the wake of the financial crisis it was estimated that 75 percent of individuals nearing retirement age had less than $30,000 in their retirement accounts.
It pays to know what kind of retirement savings plans you have or are available to you, and to make the best use of them. While there is no single source or website that covers the entire gamut of resources, some consumer-friendly brokerages, like Fidelity (www.fidelity.com), get pretty close. Providing for retirement involves two steps: retirement planning to arrive at your needs, and retirement savings plans to get you there. For most, this two-step process is best done with a professional who has the tools and knowledge of the laws and plans, as well as your finances, to help you make the right decisions.
When unemployment rates double to over 10 percent in one year as they did during the Great Recession, obviously there’s a big impact on the economy. Not only does the absence of income hurt the one in ten who aren’t working, but it also hurts the economy at large, which of course leads to more unemployment. Thus, unemployment insurance, or “Jobseeker’s Allowance,” as it’s called in the United Kingdom, helps to stabilize the economy and reduce the effects of boom and bust cycles.
As part of the 1935 Social Security Act in the wake of the Great Depression, unemployment insurance and benefits were established to help people through such times of general strife—or individual strife inherent in the transition of an individual company or industry. Although no longer part of Social Security, these benefits continue today and have been bolstered to a degree to mitigate the effects of the Great Recession.
Today’s unemployment insurance programs are actually a joint venture of the federal government and the states. They are funded through employer-paid payroll taxes paid to the states and to the federal government; the federal funds are then reallocated back to the states. The federal unemployment tax is collected under the Federal Unemployment Tax Act (FUTA) from most employers, exceptions being made for small companies with few employees. The base FUTA tax is 6.0 percent of the first $7,000 in wages. You won’t see this tax on your paycheck; it is paid by the employer. State taxes vary by state, and may offset some federal taxes. FUTA funds are then given back to the states to administer unemployment and jobs programs, and to fund state-paid benefits.
Benefits are paid as a percentage of wages up to a maximum, and are typically available for twenty-six weeks upon filing a valid claim. Legislation may be invoked during bad times to extend benefits, as was the case in late 2008, and benefit periods have been extended since. Eligibility varies by state. To find the rules in your state, one resource is the “CareerOneStop” locator, maintained in conjunction with the U.S. Department of Labor, at www.servicelocator.org/OWSLinks.asp.
Most people get through their working lives without having to file for unemployment benefits, but obviously they can help a great deal in times of stress. Particularly if you feel your job is in jeopardy, it’s worth knowing about the rules before something bad happens—that way, you can plan, for instance, on how you will get by on two-thirds of your salary for six months. Also, the more you know and the sooner you know it, the faster the application process can be. If you feel unemployment is imminent, it’s worth checking the rules and resources with your human resources department and with your state unemployment office.
It’s no news that the cost of health care has skyrocketed over recent years despite relatively tame inflation. There are many causes for this—administrative costs, technology, and the separation of consumer and payer (usually an insurance plan)—and it’s too big a subject to tackle here. But when health care generates (or costs, depending on how you look at it) 17.6 percent of our GDP while manufacturing activities generate only 10 percent, something is off-center. Suffice it to say that the solution appears to be complex and far-off.
As a consumer, you will bear a greater burden for your health care costs. That’s bad because you’ll pay more. But in the bigger picture it may be good, because when you have to pay for something, you shop for the best value and hold providers accountable for what they deliver. That said, events that may severely affect your ability to get insurance coverage are out of your control—specifically, job changes and layoffs. If you are forced to transfer between states where an insurer may not provide benefits in both states, or you are forced to leave a job, your insurance coverage could be dropped “cold turkey,” leaving you worse off, or forcing you to prolong an unfavorable situation just to keep the insurance.
Congress recognized that and passed two laws that can help: the Consolidated Omnibus Budget Reconciliation Act (COBRA) of 1985, and the Health Insurance Portability and Accountability Act (HIPAA) of 1996. These laws were intended to provide personal health care stability, and stability for the economy as a whole. Then, in 2010, Congress and the Obama administration passed the widely known and somewhat controversial Patient Protection and Affordable Care Act, commonly known as “Obamacare,” (see #54 Obamacare) to deal with many of these issues, including availability to previously uninsurable individuals, and offering many other provisions to more widely mandate and reshape the availability of health coverage.
Among other provisions, COBRA allows you as an eligible employee to keep your insurance for up to eighteen months after leaving a job (longer under some conditions, like disability). Now, “keep your insurance” doesn’t mean that it’s free—you’ll have to pay the premium. But it does save you from having to prove eligibility or insurability, and it allows you to maintain coverage at the group rate provided to your employer.
While COBRA helps, in practice it was found that only a small minority of ex-employees actually take advantage of it for the full eighteen-month period, as most employees opt for lesser and cheaper coverage than paid for by the employer. But COBRA can help you bridge the gap until you find this cheaper option.
The HIPAA act, in practice, has been more about the rules of privacy and transfer of medical records and information. But one of the key provisions allowed employees to transfer from one job to another without requalifying for insurance; that is, a preexisting condition was not to be grounds for denying insurance at the new employer. There are some wrinkles if an employee moves to a new state where the old insurer doesn’t do business, but in general, the law fixes what it intended to fix and, like COBRA, helps employees leave unwanted jobs.
Assuming you have health benefits with your job in the first place, if you have any inkling that your job might go away, or that it might be time for a change, it makes sense to learn about these two laws. Your health insurance provider or human resources department should be able to help you more.
“Obamacare” is the nickname given—mainly by opponents—to the landmark health care legislation more formally known as the Patient Protection and Affordable Care Act (PPACA) passed in March of 2010. The name “Obamacare” stuck after it was used and endorsed for use by the president himself.
Obamacare, which had roots in some of the health care reform legislation attempted but not passed in the Clinton administration, brings sweeping changes to health care delivery and cost recovery over a period of eight years after its passage. The main intentions are to bring more affordable care to more people, and to increase access to certain segments of the population all but shut out of the current system. In numbers, the law intends to address the high cost of health care, currently consuming some 17.6 percent of GDP, and the estimated 45–50 million individuals not previously covered by health insurance or entitlements.
The primary mechanisms of Obamacare are:
A major portion of Obamacare (individual mandate, subsidies, exchanges, and guaranteed issue) is set to take effect in 2014, so the long-term effects of this major policy change are yet to be felt. While more people will have access to coverage, and people will be less likely to be penalized for age or sickness, there is considerable concern that it will do little to reduce the overall cost of health care, except perhaps from some savings in Medicare costs (which may show up elsewhere as health providers “reallocate” costs). Higher demand from tens of millions more insured could drive health care prices higher. Additionally, if younger, healthier individuals choose to opt out of the individual mandate (by paying the penalty), the resulting insurance pools will be too small and overweighted with higher-cost, older, sicker individuals—and premiums will rise, not decrease as intended. Opponents of the legislation believe that driving costs down should have been first priority; if low enough, resulting insurance premiums would be more affordable, and people would subscribe naturally, without a mandate.
Whether you’re covered by an employer, Medicare, or are an individual health coverage purchaser, you should watch which way the winds blow on this one. There could be a lot more changes as certain provisions start to take place.