From CFP Board's Consumer Advocate, Eleanor Blayney, CFP^®

Once upon a time, there was such a thing as a “risk-free” rate of interest. This was the rate at which the federal government could borrow money from lenders, who happily went to sleep at night because, after all, the United States government could always pay its bills. Unlike mortgage lenders Freddie Mac or Fannie Mae, Uncle Sam really was “too big to fail.” (His unique ability to tax and print money helped, too…)

Apparently this fairy tale may be coming to an abrupt and unhappy end. By August 2, the federal government is projected to run up against its $14.3 trillion debt ceiling and it will be unable to meet some of its spending obligations. You can expect policymakers to be spending much of July scrambling to find ways to fix our country’s dependence on deficit financing. Or talking about how the debt limit really doesn’t matter.

Consumers can expect a spectacular display of political fireworks on Capitol Hill, with plenty of “poppers” and “smokers” as the rhetoric heats up. But the grand finale – whether a government shutdown or yet another increase in our national debt – is not something consumers can watch and then forget about. The issues our federal elected officials are dealing with on a macro, public level are distressingly similar to our own micro, private issues. And what they decide at the macro level could have a troubling impact on how we manage our own finances, especially if interest rates skyrocket for mortgages, credit cards and other forms of business and personal credit. Can you say “double dip recession” – or worse – anyone?

Let’s get to the root of the problem. Our national problem with debt belongs to us all. It is a startling fact that the aggregate amount owed by U.S. consumers to their creditors is approximately equal to, if not slightly greater than, our government-held debt, according to various official estimates. So while Congress and the Administration works to clean up our national act, we could all do some housekeeping of our own.

Here’s what responsible credit management looks like, at any level.

1. Keeping the costs and benefits of borrowing in the same time period. Put another way, a fiscal fiasco is created when we use long-term debt to pay for things we enjoy or use today. Whether it’s a night out on the town, or keeping the lights on in federal offices – these costs should be paid in full now, and not carried forward into next month, or into a future election cycle.
2. Understanding that good credit is more than just the ability to borrow money. In today’s world, credit has become synonymous with trustworthiness. Without good credit, it’s difficult to get a job, rent an apartment or maintain status as a dependable trading partner or global economic power.
3. Managing the loopholes is necessary, too. There’s a lot of fine print to take into account, whether in our tax code or in our credit card agreements. We cannot keep our focus on just the going “rates” when it comes to our debt: the special situations matter, too. For Congress, this requires careful examination of all the special deductions and allowances that limit our tax revenues. For consumers, this requires understanding all the hidden fees involved in using credit. Examples include late fees, fees to get phone support, foreign transaction fees, over-the-limit fees and even inactivity fees. Real devils live in both the macro and micro details.
4. Taking a multi-prong approach to debt control. The debate on Capitol Hill notwithstanding, there is no single solution to ongoing deficits: both more revenue and less spending need to be considered. Translated for the consumer, reducing debt effectively may require several simultaneous strategies: managing income, investments, taxes, and spending as well as revising overall financial goals. CFP^® professionals specialize in providing this multi-faceted approach to consumer debt management, as well as to other financial issues.

One translation of our national motto “E Pluribus Unum” is: “Out of many, one.” Another is: as Americans, we all have some work to do.

Financial Planning for Your Life Now

Take These Steps to Boost Your Credit Profile

There are several strategies consumers can use to improve their credit scores after a bankruptcy, such as correcting any mistakes in their credit report. It is also important to catch up on any missed payments and to form a payment plan with creditors if there is difficulty in meeting the payments. It is important to make payments on any debt, rent, and utility bills going forward because payment history is the chief component involved in calculating a credit score. Having payments automatically deducted from a checking account may be worthwhile. Consumers who lack credit should see if their bank will allow them to open a secured credit card, which should eventually be upgraded to an unsecured card after making timely payments for several months. Furthermore, it is crucial to pay down as much credit card debt as possible and avoid closing credit cards. The length of the credit history has a significant impact, so if a consumer has a card with an annual fee, he or she can request to switch the card to one without a fee. Consumers who need a loan should shop for it within a focused period of time. A search for a single loan within a short period is looked at more favorably than are searches for several new lines of credit.

Build Your Emergency Fund, So You'll Be Prepared to Handle Unexpected Expenses

Many U.S. families have difficulty building an emergency fund, but establishing such a fund is important. "Nobody thinks they'll have an emergency until it happens," says Chris Long, CFP^®. "There are certain unforeseen expenses that happen with everyone." A recent Bankrate.com study found that just 24 percent of Americans have saved half a year's worth of living expenses, and another 24 percent completely lack emergency savings. There are two fundamental levels of emergency funds, and many experts say such a fund is required to cover unexpected costs, such as dental treatment or car repair. Paying these costs with cash on hand means that interest will not potentially accrue, as it would if the expense was covered by a credit card. The second basic emergency fund level is the lost-job fund to enable a household to stay financially solvent for several months after a breadwinner becomes unemployed, and it is here where people's fund needs diverge, according to circumstances. A one-earner household with a yearly income of $80,000 is more susceptible after a job loss than households with two breadwinners each earning $40,000 annually. Conventional wisdom says that a full emergency fund should be equal to three to six months of living costs, while practically that can amount to three to six months of bare-bones expenses because a household in crisis presumably would reduce all expenses apart from necessities. The Bankrate.com poll found that 46 percent of respondents have at least three months of expenses put away, versus 22 percent with savings to cover less than three months. One-earner households should seek to save six months of savings, while those with multiple earners can manage with less, according to experts. High-income individuals probably want an even larger emergency fund, because it usually takes longer to find higher-paying jobs, Long says. He advises people making around $100,000 annually to sock away nine months of emergency savings, while those making $250,000 should reserve 12 months of emergency savings. "A year in an emergency fund, that's the ideal," Long notes.

Take Steps Now To Survive a Potential Double-Dip Recession

To prepare for a double-dip recession, investors should first pay attention to interest rates, as the first indication of distress is likely to be an increase in short-term rates. Meanwhile, Peter Tanous, co-author of "Debt, Deficits, and The Demise of The American Economy" advises the reduction, but not outright elimination, of stock exposure. Economic strategist Jay Ferrara recommends that investors wishing to continue to hold equities should allocate holdings to stable companies in utilities, health care, and consumer staples, while lightening up on the consumer discretionary, industrial, and financial sectors. Another strategy is asset diversification, and Rose Greene, CFP^®, suggests the consideration of hard currencies of other nations with better balance sheets than the United States. "They can provide a buffer from a declining U.S. dollar," she notes. "Including global bonds from countries that are paying a higher rate than the U.S. is not a bad place to hide as well." Investors also should fortify their strategic cash reserves, be wiser in their spending, and reduce debt.

Prep Now for Tax Season, Avoid Problems Later

There should be few tax surprises this year, but it still would be wise to keep an eye on tax planning even during slow months, according to columnist Russ Wiles. The modest increase in your paycheck is due to a tax-law change approved last December to cut payroll tax rates; the change only applies to 2011 so the extra cash should be used wisely. Now is a good time to review your most recent tax return and make needed changes, such as finding more deductions to use in the coming year, according to Wiles. Several key tax rates remain unchanged for individuals in 2011 and 2012, and long-term capital gains and dividends will receive the same treatment as they did last year, which should make it easier to plan. Now might be a good time to make some moves on investment gains or losses affecting your 2011 tax picture, especially if your outlook is shifting. People 70.5 and older can pull money from an individual retirement account (IRA) and donate it to a favorite non-profit; investors who do not use the rule to take required minimum distributions as needed face a stiff 50 percent penalty on the amount they were supposed to withdraw but did not. Also, investors who switched from regular IRAs into Roth IRAs in 2010 and saw their account value drop have until Oct. 17, 2011, to cancel the conversion; taxes on the amount switched would be lower in the meantime, and you can switch back to a Roth later and pay taxes on a lower account value. The tax bill will have to be paid in one year, but juggling might be worth it because no taxes apply on future withdrawals from Roth IRAs.

Put Your Financial Plan in Writing

A recent survey conducted on behalf of the Certified Financial Planner Board of Standards found that 86 percent of consumers believe everyone needs a financial plan. However, the survey also found that 46 percent of consumers said their financial plans had not moved past the idea stage. Another 11 percent said they just had notes or ideas about possible financial plans. Only 42 percent had a financial plan that was in the form of a written document, the survey found. Most of these consumers were older. Nearly 60 percent of those older than the age of 65 said they had an official financial plan, compared with just 25 percent of consumers between the ages of 18 and 34. Certified Financial Planner Board of Standards Consumer Advocate Eleanor Blayney, CFP^®, said some people do not have an official, written financial plan because of the expense involved in drawing up these documents. She added that financial advisers need to do a better job of highlighting the benefits of having professionals coordinate and monitor a variety of financial issues for consumers, including their retirement planning and tax and estate considerations.

Financial Planning for Your Children

Work With Your CERTIFIED FINANCIAL PLANNER™ Professional to Prepare Your Child's College Budget

Parents of children going off to college need to consider several things with their financial planner, says Karin Grablin, CFP^®. These include setting a budget of probable expenses and how much will be available to spend for each; joining the school's meal plan helps to secure that part of the budget. Determine how the child will access spending money, such as through a joint account at a bank that has local branches as well as on campus. Such matters as check-writing, depositing money, withdrawing money, bill-paying, and accounting for debit card expenditures should be addressed, in addition to balancing a checkbook and understanding penalties for bounced checks. Another option is a re-loadable prepaid credit card that allows parents to monitor the student's spending without worrying about overdrafts. Students who are very responsible might try applying for a credit card with a low limit in their own name. It is also essential to keep backup copies of financial information, plan for healthcare expenses, and prepare for emergencies.

Financial Planning for Your Retirement

Fees Can Negatively Impact Your Retirement Savings

According to financial expert Denise Appleby, account termination fees, account maintenance fees, and various account transfer fees are just some of the fees that can eat away at retirement savings. The fee with which most owners are familiar is the annual maintenance fee, which averages between $35 and $50 annually. "[For] someone just starting an IRA with a $5,000 contribution, a $50 maintenance fee is 1 percent of the account balance," Appleby says. A Roth conversion fee is usually charged when a traditional IRA is converted to a Roth IRA. For account owners who are unable to wait for standard delivery and instead choose to have retirement funds sent via federal fund wire, which usually means same day receipt, or overnight check delivery, a fee might be charged to the IRA. According to Appleby, a "special investment fee" applies to non-traditional/non-publicly traded investments such as private placements, real estate, and certain limited partnerships, and can be as high as $2,000 or more. Unlike the special investment fee, which is ongoing, the "special investment set-up fee" is a one-time fee that also applies to non-traditional investments that are not publicly traded, Appleby says. The custodian or trustee of an account that holds non-traditional/non-publicly traded investments may need to file IRS Form 990-T to report unrelated business income. The filing fee for this form can be up to a few hundred dollars. Account owners who take loans from their 401(k)/403(b) or other employer plan account may be charged a loan processing fee, says Appleby. She adds that small business owners with solo-K/individual-K plans may be assessed a recordkeeping and filing fee of several hundred dollars, if they employ the services of a recordkeeper. This is on top of fees charged by the custodian.

Beware: Target-Date Funds Have Their Flaws

Some experts say target-date funds, which become more conservative as the account holder approaches retirement or another type of long-term goal like college, may not be as good an investment as they might seem. Jim Schlager, CFP^®, notes that this is because the pre-determined asset allocation of a target-date fund might not be right for all investors. Schlager says an 18-year-old with a college savings account invested entirely in cash because he was preparing to enter college would miss out on the returns that would come from a bond fund over four years of college. Schlager also says that target-date funds do not move accountholders' money into more conservative investments at the correct time. In 2008, a number of investors in target-date funds discovered their money was heavily invested in equities, despite the fact they were about to retire. Retirement expert Paul Petillo has also criticized target-date funds, saying they often do not include a mutual fund company's best funds.

When Should I Begin Drawing Social Security?

For those who decide to retire early, it can be a tough decision whether to take reduced Social Security benefits in order to give one’s savings more time to grow or to postpone payments entirely for awhile and live off savings in order to get bigger checks at a later date. If a 62-year-old decides to postpone payments until age 66, the payment will increase by a third or more, so the decision depends on how much one expects to earn on investments after inflation and how long one will live. If investments earn 6 percent a year and inflation is 3 percent, it is best to postpone and get a larger check later. One would only need to live to 81 to make it worth the wait, and most 62-year-old men have a 50 percent chance of living to their mid-eighties, while for women the rate is 60 percent. However if one assumes a higher inflation-adjusted return, one would have to live until 86 to come out ahead, but this could entail too-aggressive investing that may wipe out one’s savings entirely. And finally, if one does not have enough savings to make it through retirement, then all of the calculations are irrelevant and it is best to work longer.

Take Your Minimum IRA Withdrawals or Face a Steep IRS Penalty

Individual retirement account (IRA) owners who turn 70.5 years old in 2011 must comply with required minimum withdrawal rules, or face a 50 percent penalty on the shortfall assessed by the Internal Revenue Service. Simplified employee pension accounts and Simple IRAs are deemed to be traditional IRAs for purposes of the required minimum distribution (RMD) rules, and investors will need to weigh these accounts along with any garden-variety traditional IRAs established in their name when determining how much they must withdraw to avoid the penalty. For the year an IRA owner turns 70.5 and for every following year, he or she must take a yearly RMD for as long as they have any traditional IRA balances. The initial RMD for the year they turn 70.5 can be taken as late as April 1 of the following year, or they can take it by Dec. 31 of the year they turn 70.5. For each ensuing year, they must take another RMD by no later than Dec. 31 of that year. Persons with ample IRA funds may be better off taking their initial RMD in 2011, even though that will trigger some taxable income that could otherwise be deferred until next year. Waiting until 2012 is usually the sensible option for people who do not have so much IRA money. The RMD amount for a specific year is equal to the combined balance of all one's traditional IRAs as of the end of the previous year divided by a joint life expectancy figure listed in IRS tables. As one ages, the life expectancy divisor shrinks, and the yearly RMD amount becomes a higher percentage of one's IRA balance.

Hiring a CERTIFIED FINANCIAL PLANNER™ Professional

When Hiring a CERTIFIED FINANCIAL PLANNER™ Professional, Get Their Compensation in Writing

When a spouse who handles the family's investment decisions suddenly passes away, the surviving spouse is often left with decisions they are not prepared to make and will need to find a good financial adviser. But choosing the right adviser at a time of emotional stress is difficult and could lead to the wrong choice, so there are a few steps to take to ensure the right adviser is chosen. The first is to determine how the adviser is paid, whether it be commission, fee-only, or fee-based. Commission-based pay takes place when the transaction takes place, and in the case of stocks and bonds, the charge will appear on each transaction statement. But most insurance and annuities or back end-loaded mutual funds do not disclose commissions, so it is important to ask the adviser what is the total compensation that will be paid from the transaction. Getting it in writing is important as well, and any adviser who refuses should be avoided. The common response that “this will not cost you anything, the company pays me,” should not be accepted. In terms of fee-only compensation, it can be an hourly fee or a menu of set prices for specific services, and sometimes the investor is the one who actually does the buying and selling and pays only for the advice. And finally, fee-based pay means an agreed annual percentage of the total investment portfolio. In these cases, again, it is important to get total compensation listed in writing.

Financial Planning for Women

Women: Don't Give Up! You CAN Build a Secure Financial Future

There is a significant gender gap between men and women when it comes to financial knowledge, according to research from Financial Finesse. CEO Liz Davidson says women have many more obstacles than men when it comes to finance, as their salaries are lower, they live longer and therefore need to save more, and they have higher healthcare costs in retirement. This creates a sense of “learned helplessness,” she says, in which women believe they are so far behind on financial planning that it is useless to start. Women also tend to put others’ needs before their own, which is due in part to their traditional status as primary caregivers; therefore their financial security is not a high priority. And the financial education that is available tends not to be geared toward women, as it focuses on short-term market news rather than ongoing financial education that women need. Investing is the area where women are furthest behind men, with a 20 percentage point gap in their knowledge that results in just 25 percent of women saying they are confident with their investments compared to 42 percent for men. In terms of budgeting, 63 percent of women spend less than they earn each month compared to 80 percent of men. One area where they are on par with men is in retirement savings, as 92 percent of women and 91 percent of men have saved in their 401(k) or retirement accounts. However it does seem that women are still saving too little and investing too conservatively to have a secure retirement. The best solution to the gender gap is for women to “educate themselves and make their finances a priority,” Davidson says.

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