Spring 1999

Wink Tax Services

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Click on the Topics Below to Jump to That Section.

• Reforming Social Security
• Is Inflation Dead?
• What Is the SIPC?
• Planning Your Expenditures
• Take Time Now To Plan Ahead
• Holding VS. Selling Investments

One of the most talked about topics in Washington these days is reforming the Social Security system. Politicians seem determined to make changes to the system now, before a crisis occurs.

Currently, the Social Security system is running large annual surpluses, but this will not last long. Once the baby boomers start retiring, around 2010, Social Security benefit payments will begin to exceed the annual taxes collected and the system will start drawing on past surpluses. Those surpluses will be exhausted by the year 2032 (Source: Social Security Administration, 1998).

The huge number of baby boomers who will be retiring in a short time period is causing this problem. Since the system is a "pay-as-you-go" system, current workers pay the benefits for current retirees. But the number of workers for each retiree will fall from 3.4 now to 2.0 by 2030 (Source: Social Security Administration, 1998). At current Social Security tax levels, income from taxes at that point will not be sufficient to pay the current level of benefits for all the new retirees. Compounding the problem is the fact that longer life expectancies result in retirees receiving benefits for longer time periods.

Even though the situation seems grave, the system will be able to pay 75% of the scheduled benefits after the trust fund is exhausted. Reform efforts are trying to ensure that the additional 25% of benefits can be paid (Source: Social Security Administration, 1998).

Reforming the system through privatization is receiving the most attention, but there are actually a variety of ways that the system may be changed. Some of the more frequently discussed changes include:

CUT BENEFITS. This involves reducing the benefits paid by the system, which can be accomplished in many ways:

	CUT BENEFITS FOR ALL CURRENT AND FUTURE RETIREES. It is estimated that a 15% cut would eliminate any imbalance in the system (Source: National Tax Journal, September 1997). This change is considered unlikely by many.
	REDUCE BENEFITS FOR NEW RETIREES. Future benefits may be based on means testing, so that higher-income retirees receive more significant benefit cuts than lower-income retirees.
	TRIM THE ANNUAL COST-OF-LIVING ADJUSTMENT. Benefits are increased annually based on changes in the consumer price index. In the future, a limited percentage of the increase may be paid.
	RAISE THE RETIREMENT AGE. The normal retirement age is scheduled to gradually increase from age 65 to age 67 by 2027, but it may be raised even more. The normal retirement age has been fixed at 65 since the system was enacted, even though life expectancies have risen significantly since then. In 1935, a 65-year-old lived an average of 12.5 years, compared to 17.5 years now and an estimated 20.5 years by 2070 (Source: Social Security Administration, 1998). In addition, the early retirement age may be increased from age 62 and the reduction in benefits for electing early retirement ,may be increased. It is estimated that the system would remain solvent if the normal retirement age was raised to 70 and the early retirement age to 67 by the year 2030 ( Source: National Tax journal, September 1997).
	INCREASE THE NUMBER OF YEARS USED IN BENEFIT CALCULATIONS. Benefit calculations factor in 35 years of earnings. You can receive benefits after ten years of employment, but the largest benefits go to those who work the full 35 years. Raising the number of years used in the calculation would essentially reduce benefits for many workers.

INCREASE CONTRIBUTIONS. This involves increasing the funds going into the system, which may include:

INCREASE SOCIAL SECURITY TAXES. A 2.2% immediate increase in Social Security taxes would eliminate any deficits in the system ( Source: National Tax Journal, September 1997). But Social Security taxes are already considered too high, making this an unpopular alternative. It is more likely that the maximum wage amount ( $72,600 in 1999) that taxes are assessed on will be increased, since this only impacts higher-income workers.

ASSESS INCOME TAXES ON A LARGER PORTION OF SOCIAL SECURITY BENEFITS. Currently, recipients with income in excess of certain limits can have up to 85% of their benefits taxed. Those income limits may be lowered, or more than 85% of the benefits may be taxed.

PRIVATIZE ALL OR A 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 letting the government invest some or all of the tax receipts in the stock market. While many view privatization as the preferred alternative, moving from our current pay-as-you-go system to a fully funded system may be difficult for the generation that implements the change. In essence, they must continue to pay benefits for current retirees while funding their own retirement.

At this point, no one knows how the system will eventually be reformed. While baby boomers can probably count on some Social Security benefits, those benefits are likely to be as generous as they are now. Thus, personal savings will become a more important component of retirement income. Call if you'd like to discuss your retirement strategy in more detail 1-800-878-4036.

IS INFLATION DEAD?

It's hard to get used to: after the inflation worries of the 1970s and 1980s, inflation is currently under 2% (Source: Bureau of Labor Statistics, 1998).

What is an appropriate inflation rate? Most would agree that both high inflation and deflation (falling prices) are bad for the economy. While deflation sounds good, the danger is that consumers may cut spending because of lower paychecks, causing companies to reduce production. So while it is generally agreed that the extremes are bad, the more difficult question is whether the inflation rate should be 0%, 1%, 2%, 3%, or some other percentage.

It's hard to agree on an answer because inflation has not been behaving as expected. Typically, as unemployment rates drop below an optimal level, a short supply of workers causes companies to increase wages. Companies then have to increase product prices to pay those increased wages, resulting in increased inflation. But over the past few years, we have experienced low unemployment rates as well as low inflation. One possible explanation is that the optimal level of unemployment is actually lower than previously thought.

It is important for consumers to realize that the high inflation rates of the past may not reoccur for a while. Thus, it is no longer a sensible strategy to purchase items quickly before prices go up, incurring large amounts of debt to do so. Different strategies should be considered in a low-inflation environment:

	PURCHASING PRODUCTS. In general, products, especially durable products, are only increasing marginally in price, while services are becoming more expensive. Thus, you can generally put off purchasing major items without worrying that prices will increase substantially.
	WAGES. Even with low unemployment rates, wages are not increasing significantly. Increasingly, workers are being paid on a variable scale with bonuses and profit-sharing programs that are tied to the company's financial success. Since consumers may not be able to count on large increases in income, they should concentrate on cutting costs and reducing debt.
	HOUSING. Inflation actually encourages home ownership, since price appreciation occurs on a highly leveraged asset. While you may only make a down payment of 10% or 20% of the purchase price of your home, you retain the appreciation on the entire home. When inflation decreases, there is less benefit to owning a home. That trend is not noticeable yet, since declining mortgage rates have been reducing the cost of owning a home.
	INVESTMENTS. Inflation fears can have a significant impact on the bond and stock markets. In the recent past, even hints of increased inflation have added volatility to these markets.

Please call if you'd like to discuss the impact that the current inflation environment may have on your personal situation 1-800-878-4036.

WHAT IS THE SIPC?

The Securities Investor Protection Corporation (SIPC) is an organization created by the federal government with the objective of promoting public confidence in the securities markets.

Broker-dealers whose principal business is conducted in the United States, its territories, or possessions are automatically members of the SIPC. Firms that deal exclusively in U.S. government securities, mutual funds, variable annuities, or insurance, or provide investment advice to investment companies or insurance company separate accounts are not required to be members. Member firms provide the funding for the SIPC. In an emergency, the SIPC can also borrow, through the Securities and Exchange Commission, up to $1 billion from the U.S. Treasury.

While the SIPC does not protect investors from losses caused by fluctuations in market value, it does protect investors from losses due to a member's financial failure. Once a firm fails, all securities registered in customers' names are returned to those customers. Then customers receive, on a pro rata basis, all remaining cash and securities held by the firm. SIPC funds are then used to satisfy any remaining claims of customers, up to a maximum of $500,000 (up to $100,000 of this total is available to cover cash balances). If an investor has claims beyond the SIPC's coverage, he/she becomes a general creditor of the failed firm. These maximum limits apply to each separate account. Therefore, where a customer holds several accounts in different capacities, each account would be eligible for this coverage. For example, an investor with one account solely in his/her name and another with his/her spouse would be considered to have two separate accounts. However, two separate accounts registered solely in one name would be considered one account.

Securities that are covered by the SIPC include cash balances, notes, stocks, bonds, mutual funds, debentures, certificates of deposit, warrants, options, and registered limited partnerships. Shares of money market funds, while commonly considered cash by investors, are considered securities and subject to the higher $500,000 limit. Unregistered investment contracts and gold, silver, or other commodity contracts are not protected.

PLANNING YOUR EXPENDITURES

Analyzing and budgeting expenditures is often a dreaded exercise. Yet many people find that inefficient and wasted expenditures are major obstacles to saving for financial goals. To get the most benefit from the budgeting process, follow these steps:

1. FIGURE OUT WHAT YOU EARNED LAST YEAR AND HOW YOU SPENT THAT INCOME, BREAKING THE EXPENDITURES OUT BY CATEGORY. Looking back over an annual period will help you identify normal monthly expenses as well as irregular, periodic expenses, such as insurance premiums, tuition, and gifts. Canceled checks, credit card receipts, and tax returns will provide much of the needed information. However, you might want to keep a journal of all expenditures for a month if you can't account for large sums of money.

2. REVIEW YOUR EXPENDITURES TO SEE IF YOU CAN REDUCE YOUR SPENDING SO YOU'LL HAVE MORE MONEY FOR SAVING. It is often helpful to view your expenditures as follows:

	ESSENTIAL EXPENSES WITH FIXED AMOUNTS - Items like mortgage payments, taxes, and insurance generally don't fluctuate much in amount. However, you may be able to refinance your mortgage to reduce your mortgage payments or consider strategies to reduce taxes.
	ESSENTIAL EXPENSES THAT VARY IN AMOUNT - Items like food, medical care, and utilities are essential but can fluctuate in amount. Generally, you can alter your spending or living habits to reduce the amount spent.
	DISCRETIONARY EXPENSES - Items like entertainment, dining out, clothing, travel, and charitable contributions generally provide the most room for reductions. You don't want to eliminate these items entirely, but this is generally a good place to look if you need ways to increase savings.

3. PREPARE A BUDGET FOR FUTURE SPENDING THAT INCORPORATES YOUR FINANCIAL GOALS. Keep these points in mind:

• Consciously decide how you will spend your income. Don't just assume that you will spend the same amount as last year.
• Understand that your budget must be flexible. Unexpected expenditures are bound to occur.
• Budget for large, periodic expenditures, such as insurance premiums or tuition.
• Realize that you don't have to account for every dollar spent. Everyone in your family should have a reasonable allowance.
• Periodically compare your actual expenditures to your budget to see if you are on track.
• Your budget shouldn't be a dreaded exercise, but a tool to help you achieve your financial goals. So keep it short, simple, and easy to implement.

Please call if you'd like help with your budget 1-800-878-4036.

TAKE TIME NOW TO PLAN AHEAD

It is difficult to achieve goals without creating a plan to help you reach these goals. You didn't achieve your professional success without a plan, nor would you think of going on vacation without an itinerary or travel arrangements. So why would you enter your future without a plan for your finances? Establishing a financial plan is an essential part in helping to ensure that you meet your financial goals. It's not a difficult process, but it does require some time and effort.

The first step in establishing a financial plan is assessing your current financial situation. I can help you by providing you with a form to use to list your assets and liabilities. I find that writing this information down on paper makes it easier for you to see where you are financially and visualize where you want to be in the future.

The next step is identifying your financial goals. Of course everyone wants to live to an old age with no fear of running out of money, buy you need to think in specific terms in order to establish goals you can work to achieve. Maybe you want to travel after retirement, move to a different state, or stay at home and enjoy your hobbies. I can help you think through what you want and tailor your financial plan to help ensure that you will have the money to enjoy the things you would like to do.

Once you have identified your priorities for the future, we need to decide how to help you reach those goals financially. This entails discussing your risk tolerance and investment strategies and sifting through the many investment vehicles to determine which products are most appropriate for your situation.

Please call me if you would like to take the steps to establish a financial plan 1-800-878-4036.

HOLDING VS. SELLING INVESTMENTS

If you own investments with large capital gains, you may be wondering whether to sell the investments at the lower 20% capital gains tax rate or continue holding the investments for your heirs. The tax consequences of the two alternatives are:

	Selling now means that any capital gains are taxed at the capital gains tax rates based on how long the investment was held. In general, gains on assets held for a year or less are taxed at ordinary income tax rates, while gains on assets held over a year are taxed at a maximum rate of 20% (10% for taxpayers in the 15% tax bracket).
	If you leave the investments to your heirs, the basis is stepped up to market value on the date of your death. If your heirs then sell the asset immediately, no capital gains taxes would be due.

In either case, your heirs must pay estate tax on the asset's value if your total taxable estate exceeds the lifetime estate and gift tax exclusion ($650,000 in 1999, increasing gradually to $1,000,000 by 2006).

While you shouldn't make investment decisions solely for tax reasons, the tax bill can be large when selling an investment with significant capital gains. Which alternative is better will generally depend on your expected rate of return on the current investment, the anticipated rate of return on the investment that would be purchased with the proceeds, and your expected life expectancy. In general, it may make more sense financially to leave an investment to your heirs if:

	Your investment holding period is short, typically five years or less.
	The investment has appreciated significantly.
	The investment you plan to purchase with the proceeds is expected to earn only slightly more than your current investment.

Please call if you'd like help reviewing your options for a particular investment 1-800-878-4036.

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Last modified: January 30, 2017