Message from CFP Board

The reporter thought I was joking. We had been talking on the subject of love and money for a Valentine’s Day release, and she had asked me what kind of personal information it was important to share with a partner you were getting serious about. I had answered immediately: “Your FICO score.” She clearly did not think my idea was very romantic, but as I pointed out, neither was finding out that the person you married has maxed out on all his credit cards.

In the last several years, our credit scores have taken on enormous significance, impacting just about every aspect of our lives. It used to be that you needed a credit record primarily to get credit – a classic catch-22 that plagued young people just starting out. Today, your FICO score determines not only whether you can get credit and at what price, but in some cases, whether you are qualified for a job, or the amount of your auto insurance premiums. As a result, managing one’s FICO score has become a national pastime – one of the most popular topics on financial websites and message boards.

Consumers’ concern about the management of their credit accounts has only been heightened in response to the new credit card laws, enacted in 2009 and implemented in three phases. While the legislation is intended ultimately to benefit consumers by preventing issuers from raising rates at a moment’s notice or making new rates retroactive to prior balances, the short term response to the new law has been anything but consumer friendly. Trying to get ahead of the February 22nd date when these provisions went into effect, card issuers were raising rates, closing accounts, slashing limits, and implementing all sorts of new fees to maintain their profitability in the face of the nation’s credit crisis.

Many are understandably confused as to how they should respond to the almost daily missives from their credit card companies. “They tell me I can opt out of the new account terms and they’ll close my account,” says one frustrated card holder. “But what will happen to my FICO score?”

I’m a strong advocate of keeping a close eye on the important numbers that affect your financial well-being. Fixating on your FICO score, however, may not always be in your best financial interest. For those individuals with bad credit – with FICO scores of less than 600 – taking actions that might further lower their rating may, in fact, be the first step to becoming credit worthy. Yes, closing accounts will bring down your credit score because you thereby limit your available credit, but if this availability was what got you in trouble in the first place, it just makes good sense to get rid of it.

Another FICO negative which can prove positive in the long run is seeking assistance with debt management. Arranging a payment plan with your creditors, and making headway in reducing your debt obligations, is an experience that generally provides more long-term benefits than filing for bankruptcy, even if it has a negative effect on your FICO score. If you seek this kind of help, make sure you find a non-profit and certified credit counsellor. (Go to www.nfcc.org for more information).

Probably the most common worry about credit scores relates to our interest costs. Generally, the higher your score, the lower the interest rate lenders are willing to give. But in the new world after the 2009 Credit Card Act, just about everybody, regardless of their scores, may be subject to exorbitant and unnecessary fees. (Expressed as annual interest rates, fees for such services as balance transfers, late payments, customer support, inactivity, paper statements can run considerably higher than your APR). Again, consumers may be well advised to open or close accounts based on these fees alone, and let their FICO scores take care of themselves.

This is not to advocate that we should ignore our credit rating; indeed, all consumers should request a free report annually (www.annualcreditreport.com) and address any inaccuracies or discrepancies immediately. You can even ask a creditor to make a one-time “goodwill” adjustment of a negative entry in the report, even if the entry is deserved. But for the long run, it’s more important to cultivate simple habits of good credit management – paying card balances in full and on time, using credit cards for convenience and not as money – than to micromanage this month’s or year’s FICO number. In an ideal, perhaps future world, the compilers of scores would realize that the best credit risks are also the smartest with their money.

-Eleanor Blayney, CFP^® Consumer Advocate, CFP Board

Top News Stories

Easier to Read, Not Easier to Pay
Boston Globe (02/18/10) Woolhouse, Megan

The second portion of the Credit Card Accountability, Responsibility, and Disclosure Act went into effect on Feb. 22, requiring credit card statements to contain information about how long it will take to pay off a balance, ensure that due dates for bills are the same each month, and possibly even enlarge the size of type on bills. However, consumer protection advocates warn that cardholders must continue to scrutinize contracts and carefully monitor monthly bills. Chi Chi Wu, a lawyer at the National Consumer Law Center, says credit card companies are "already thinking of more creative ways to make money off consumers." The lag time between the act's passage and when it took effect already revealed interest rate spikes as high as 30 percent for some cardholders. Joshua Frank, a senior researcher at the Center for Responsible Lending, said cardholders should be on the look-out for gimmicks, such as advertisements for tiered late-fee systems that offer lower fees for lower balances. He adds that many credit card companies are "creating hidden pricing to pad their profits." Consumers should also be aware of companies that entice them to switch to new cards with lower minimum payments but higher interest rates.


Consumer Groups Warn About Tax Refund Loans
ABC News (02/11/10) Fahmy, Dalia

Over 8 million Americans -- approximately one in 17 taxpayers -- who were unwilling or unable to wait for their tax refund took out refund anticipation loans (RALs) in 2008. According to the Consumer Federation of America (CFA) and the National Consumer Law Center, these cash advances -- which often have annual interest rates as great as 500 percent -- cost Americans $806 million in interest and fees in 2008 alone. Taking tax-preparation fees out of the loan in advance lets providers "obscure how expensive tax preparation is because if you don't have to take the money out of your billfold or write a check, you might not notice how much you paid," says Jean Ann Fox, director of financial services at the CFA. "It enables tax preparers to charge a multiplicity of fees and hide what the total cost is going to be." It is important for filers to know that they can file electronically and receive their refund quickly by direct deposit for free, keeping all of it for themselves instead of, as Fox says, "sharing some of it with a banker." RALs usually are provided through a tax preparer's partnership with a big bank; and H&R Block, Jackson Hewitt, and Liberty Tax have all been sued in public and private lawsuits for misleading consumers. The national rate of RAL use is falling, however, which can be attributed to volunteer tax preparation networks and better-educated taxpayers.

Personal Finance News

Thrift, Spending Less Key to Helping Money Woes
Shreveport Times (LA) (02/22/10) Moore, Byron R.

Byron R. Moore, CFP^® cautions that even individuals who may not carry any debt but find themselves unable to save money are, in fact, overspending, and they may face serious consequences later. Moore says people need to focus not on simply avoiding extravagant lifestyles, but rather how to practice thrift. Thrift is about spending less than you make and saving or investing the difference. People need to make radical changes in their spending and saving trends. For example, if you were laid off tomorrow and the only work you could find paid 20 percent less, there would still be a pretty good chance of you staying afloat, but it would require some drastic changes. Those types of changes are needed now. Moore suggests a few precautionary steps to better prepare yourself for the future. First, insure yourself now, as you are your most valuable asset. Second, take a "pay cut" to your household lifestyle and start saving 10 percent or more of your gross income. Do not wait to "find" savings, take the savings first. Establish a good financial plan, which will allow the benefits from insuring yourself and saving first to multiply. Work with a CERTIFIED FINANCIAL PLANNER™ professional to design a plan.


Unemployment Benefits, Canceled Debt Trigger Tax Bills
USA Today (02/15/10) Block, Sandra

As if the current economic situation was not making life difficult enough, many consumers may find themselves in an even worse position if caught off guard by unanticipated taxes. Millions of Americans are relying on unemployment benefits to keep them afloat during this difficult time, but many may be unaware that some unemployment benefits are taxable. Last year's economic stimulus package excluded the first $2,400 of unemployment benefits from 2009 gross income. Taxpayers who receive unemployment benefits should receive a Form 1099-G, which shows the amount of benefits they received that year. Benefit recipients should report unemployment compensation that exceeds $2,400. However, the exclusion was not extended into 2010, meaning all benefits received this year could be taxable. Forgiven or cancelled debt is considered income by the Internal Revenue Service (IRS), meaning taxes may have to be paid on this "phantom income." However, there is an important exception for taxpayers who have lost their homes. Forgiven mortgage debt is not taxable as long as the mortgage was for a primary residence, according to Mark Luscombe, a tax analyst for CCH. The IRS will also forgive taxes on forgiven or canceled debt if the individual has filed for bankruptcy or is insolvent. Proving insolvency requires showing that total debts exceed the fair market value of everything that individual owns, include a home, cars, retirement savings, and life insurance policies.


More Small Banks Offering Student Loans
Bankrate.com (02/12/10) Couch, Christina

With larger banks exiting the private student loan arena, credit unions and community banks are stepping into the breach. Independent Community Bankers of America intends to launch an initiative called iHelp this autumn. The nationwide lending program will enable students to apply for loans up to $10,000 annually via community financial institutions. Ruth Pusich, director of financial aid for Elmhurst College, notes that students with a poor credit history, no co-signer, or who attend unaccredited schools or institutions with high default and low graduation rates may find it easier to get a loan through community banks and local credit unions. These smaller institutions often include personal interviews when determining loan eligibility, and may be more sympathetic than larger institutions. But Kevin Moehn, CEO of Moehn and Associates, notes that some community banks are currently unable to provide official student loans, and instead grant personal loans intended for educational purposes. Personal loans lack the same payback safeguards or borrower benefits that private student loans have, such as no prepayment penalties or being able to postpone repayment while the student is still in school. Lauren Asher, president of the Institute for College Access and Success, says students should consider federal loans like Parent PLUS as well as loans offered directly from colleges.


Young Can Benefit From a Roth IRA
Washington Post (02/21/10) P. G4; Carpenter, Dave

With tax season now in full swing, it may not be a bad idea for parents to consider setting up a Roth IRA account for their children. Not only does the set-aside money grow and multiply over time, but it conveys a powerful message of financial responsibility to teenagers, especially if they fund it with their own cash. "It provides an opportunity to engage a generation that typically doesn't focus much on investing with something that's theirs," says John Heywood, a principal in the retail investment arm of Vanguard. One benefit of opening a Roth IRA account at a young age is that the contributions compound at a faster rate as the accountholder nears retirement. Second, saving for retirement at an early age is more important than ever given the tenuous future of pensions and Social Security. And third, teaching a teenager about the value of saving and compounding interest enables the development of wise spending and saving practices throughout life.


Plan Your Retirement for Life’s Surprises
Spokesman-Review (02/22/2010) Schram, John

There is a rule of thumb for retirement planning that an individual who spends 4 percent of their retirement savings per year will not run out of money and their nest egg could still grow, but John Schram, CFP^® says this rule should be used carefully. The rule assumes that rates of return are constant, inflation does not fluctuate, and that the individual’s need for income will decrease if the portfolio decreases—all of which are rarely true. To prevent running out of money upon retirement, individuals should consider how much of their retirement income is from a guaranteed source and whether that source will be in line with inflation. They should also think about the fact that they may live longer than anticipated and will need the money to stretch further, and that their estimated expenses often do not take into account the occasional large purchases like a vehicle, vacation, or home renovation. Many of these factors can derail a retirement plan, and a financial planner will be able to use more complicated tools than a simple 4 percent rule to help determine how far retirement funds will actually go.


With Longevity Up, Playing It Too Safe May Set You Up for a 'Slow Financial Death'
San Diego Union-Tribune (02/21/10) Kuehner-Hebert, Katie

Experts say retirees who place all their savings in ultrasafe instruments like CDs or money market accounts could end up scrambling for income later in life. In recent days, yields on money markets have been averaging less than 1 percent. Experts recommend that retirees invest at least some of their money in more aggressive things like stocks or mutual funds. Despite the market's volatility, the Standard & Poor's 500 index has generated an average annual return of 9.4 percent for the past 50 years. "The cost of living is going to go up in time -- gas, groceries, insurance -- you name it," says Gil Armour, CFP^®. "If you're totally locked into fixed-income investments, that's slow financial death." Jason Buol, chief economist and research analyst at Private Asset Management, recommends that his clients assume they will live to 100. This indicates that a person's retirement savings and income must last 30 years or 40 years after he or she leaves work. Jon Beyrer, CFP^® notes that a commonly used benchmark for portfolios that earn 7 percent to 8 percent annually is for retirees to withdraw 3 percent to 4 percent of the principal balance.


Estate Planning Isn’t Just for the Wealthy
MetroWest Daily News (MA) (02/22/10) Canby, Darrell J.

Many people assume that estate planning is only for the wealthy, but in reality estate planning involves much more than minimizing the burden of estate taxes and is extremely useful to almost everyone, says Darrell J. Canby, CFP^®. Starting next year, unless Congress acts, heirs of anyone with assets valued at more than $1 million will be subject to a federal estate tax, as well as any state taxes. While $1 million may seem like a great deal of money, many people find that adding up the value of all their assets, including a home, their death benefits, investments, and any other assets can put them over that limit. The combined marginal rate for federal and state estate taxes could reach over 70 percent next year in some states, including a 55 percent federal tax. Proper estate planning can help mitigate estate taxes and ensure that loved ones are protected. An organized plan can help ease some of the burden loved ones face after a death by defining the financial aspects of the estate. Estate planning includes drafting a will, which defines how property will be divided, and reviewing designated beneficiaries, which can change as people get married, have children, or die. It may also be smart to consider using trusts, which can allow assets to avoid the Probate Court process, lowering costs and allowing heirs to use inherited assets sooner. Trusts can also hold life insurance assets and be structured so death benefits are exempt from estate taxes, increasing the amount loved ones receive. It is also possible to keep a limited amount of assets out of a taxable estate by giving gifts. Individuals can give gifts of up to $13,000 in any one year to any number of individuals, while married couples can give up to $26,000. The most important part of estate planning is to set goals, including whether you want to leave assets to a spouse, children, a charity, or someone else. Estate planning can ultimately ensure that you are providing loved ones with financial security while eliminating the possibility of family disharmony.


Talk With Loved Ones About Estate Planning
Herald Bulletin (02/20/10)

Joseph "Big Joe" Clark, CFP^® suggests discussing financial situations and contingency plans with loved ones. A few conversations and simple actions can provide strong estate planning, and while the conversations can be difficult, the actions do not necessarily have to be complicated. Estate planning is an important aspect of your finances and a way to provide for loved ones by ensuring that your wishes for your assets are carried out to your satisfaction and that loved ones will be cared for. An investment of even a few hundred dollars in legal fees can save tens of thousands in taxes or fees that would be paid without planning. Using correct transfer language on deeds and titles, confirming beneficiary designations on insurance policies, and writing simple letters to survivors can save a significant amount of time and preemptively eliminate difficulties. While the idea of estate planning is unpleasant, we must remember that life is filled with uncertainty, and we must be prepared for a worst case scenario, making it important to talk with financial planners, attorneys and tax advisors to get help in creating an estate plan.

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