About Me 0059: Making Money Cash

Tyler Cowen read Dean Baker's take on state pensions and says he prefers Josh Barro's more alarmed assessment. I read Barro's piece and was surprised to find that it agreed, in many respects, with Baker's piece, though the two articles had different emphases and different prescriptions.

In particular, they agree that the central question afflicting pension plans is the returns they'll see in coming years. Barro argues that the commonly quoted figures "understate the cost of benefits to be paid in the future by counting on high investment returns that may not materialize," while Baker argues that the gigantic shortfalls that some observers are now estimating are overstated and that pension funds can "reasonably assume" returns in the 7 percent range. It's worth noting that before the financial crisis, Baker was trying to sound the alarm about pension funds using overly rosy estimations of future returns, so it's difficult to accuse him of being overly bullish. That said, read David Leonhardt making the case for more pessimism on future returns.

The major disagreement comes over the question of what to do next. Barro argues that existing pension promises should be honored. "Short of defaulting on these debts," he writes, "the only way states can eliminate unfunded pension liabilities is to fund them." But going forward, he'd like to see states move to 401(k)-style programs, as that protects taxpayers from having to shell out more cash during economic downturns. Under the current system, he says, "state governments are long in the stock market on taxpayers’ behalf."

Baker strongly disagrees. He argues that the point of an actor such as the state, at least when it comes to pension policy, is that it has a long time horizon and so can ignore cyclical ups and downs in the stock market. "In principle," he writes, "state and local governments will exist into perpetuity, so a period in which the market is depressed need not be of great consequence." Add in, as Teresa Ghilarducci does, that "401(k) management and investment fees are three times higher" than traditional pension plans and "professionals who manage money in pooled pension funds usually get higher returns than workers who manage their own 401(k) accounts," and it's hard to argue that defined benefit plans should be done away with for states, though it's not hard to argue that they should be funded honestly and based on realistic projections for eventual returns. Felix Salmon agrees.

But the bottom line is that the correct questions to ask about pension plans are: 1) Are they estimating a realistic rate of return going forward? 2) If so, are they sufficiently funded? And 3) If not, what should be done? I think there's less disagreement about the underlying nature of the problem here than some people might think. The disagreements, rather, are about the country's likely economic performance going forward (as that will ultimately decide returns) and what our state pension system should look like in general.

(iStockphoto)

Have you noticed that your paychecks have been a bit larger than normal lately? That’s because in 2011, the government is cutting the social security payroll tax paid by individuals from 6.2% to 4.2%.

How much is that in stone cold cash? If your annual income is $40,000, that’s $800 over the course of the year divided among your bi-weekly or monthly paychecks. If you earn $80,000 annually, your extra pocket money is $1,600. For those who make $106,800 or above, you’ll see an extra $2,136. Since social security is taxed individually, married couples could get up to a $4,272 take home pay boost for the year.

Now, what should you do with your extra moolah? Sheryl Garrett, the author of the Personal Finance for Dummies Workbook, a Certified Financial Planner and founder of the Garrett Planning Network, suggests these 10 ways to wisely spend your money, in order of importance for increasing your financial standing for years to come.

Balance Your Budget

If you live paycheck to paycheck, or on a tight budget, the extra $66 per month (if your annual income is $40,000) could mean the difference in paying your electricity bill this month – or not. This month, balance your budget with the fatter paychecks. Next month, adjust your budget so your expenses and income balances when the payroll tax cut expires. Since this bonus money is a one-year deal, don’t rely on it next year to cover basic expenses. Focus on other expense-reduction strategies: negotiate your next lease, use coupons at restaurants, ditch buying grocery items that are spoiling in your fridge, or change your IRS withholding if you get a refund every year.

Settle old debts

“Wouldn’t it be nice to pay off your mom and dad for the money they lent you for an apartment deposit?” says Garrett. Use this money to pay off any money you borrowed from family or friends.

Pay Off Credit Cards (and keep them that way)

Credit cards are easiest to attack, since you see the bill each month. If you use Mint.com, you can set up a goal to pay down your credit-card debt, and Mint will prepare a customized plan for you based on your cards’ balances and interest rates.

Boost Your 401(k) Contributions

If you’re currently not taking advantage of the full amount your employer will match on your 401(k), use your extra cash here. Once you’ve fulfilled this amount, deposit any remaining funds in a Roth IRA.

Contribute to a Roth IRA

Unless your adjusted gross income is higher than $122,000 if you’re single, or $179,000 if you’re married, filing jointly, you are eligible to contribute up to $5,000 in a Roth IRA. (The contribution limit is $6,000 if you’re 50 or older.) If you haven’t already made that contribution for 2010, you have until April 18, 2011, to do so. You can also, of course, contribute another $5,000 for 2011. While the amount you contribute is not tax deductible, you’ll reap the benefits once you start making withdrawals: all your withdrawals, earnings included, are completely tax-free as long as you’ve held them for at least five years. (And, of course, you need to be 59 ½ or older to make penalty-free contributions.)

Buy Yourself Marketable Skills

Enhance your ability to earn money in any of a number ways. If you’re actively looking for a job, consider hiring a resume service to help polish your resume. If you’ve been thinking of going back to school, take your GRE or GMAT test. Take a continuing education course. Buy a snazzy suit for interviews. The key is to spend cash in a way that will boost your income, now or in the near future.

Invest in Your Health

If one of your New Year’s resolutions was to improve your health, now is the time to see a nutritionist. If you’re a smoker, join a stop smoking program. Buy a bicycle to save on gas, or caulk your windows or insulate home. With every investment, think: will this save me money next year by doing this action?

Shop for Organization Tools

Luckily, Mint.com and basic tax software is free, but consider upgrading to the non-free version if you have a home business or more complicated tax forms. If your important documents are scattered across the house, buy a file cabinet or an expandable file organizer. The better organized you are, the easier it will be to manage your money.

Take a Vacay

If you already have all these categories covered, take a vacation. A yoga retreat, cruise or weekend with your honey at a B&B may be just what you need to return home and spend quality time tweaking your budget to perfection.

Reyna Gobel is a freelance journalist who specializes in financial fitness. She is also the author of Graduation Debt: How To Manage Student Loans and Live Your Life.

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Saturday, 5 March 2011

Making Money Cash