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Personal Finance

Retirement planner yields interesting discovery

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If you’re nearing retirement or thinking about how you can escape into early retirement, check out Vanguard’s retirement planning tools. You don’t have to be logged in to use these things. Go to https://personal.vanguard.com/us/home and click on “Planning and Education”; from there navigate to Retirement Planning > I’m Planning to Retire > Evaluate Your Expenses and Income. Entering the site through this pathway takes you past a number of other options, including some for people who aren’t yet on the verge of retirement.

For example, you can create an investment plan, plan for college, learn the basics of estate planning, and discover how to manage your portfolio with an eye to tax savings.

But since I equate the coming layoff with enforced retirement (as in please don’t throw me in the brier patch), my exploration soon took me to Vanguard’s paired worksheets, one that allows you to estimate your expenses and one that helps you estimate your retirement income and figure whether it will support you.

To my amazement, Vanguard’s machine-generated planning estimates are more optimistic than what Excel  has been telling me. As you may recall, I’ve figured I might have to draw down as much as 6 percent of total savings to get by; at best, 5 percent was a likely number.

Because Medicare will cost about 12 times what I pay for health insurance now and because I’ll have to pay my share of the mortgage on the downtown house out of cash flow, my monthly living and emergency savings costs will rise from the current $2,800 to about $3,275—$425 more than my present take-home pay!

However, even with that stunning expense figure entered in the retirement income worksheet, Vanguard tells me that the amount I’ll have to draw down from savings will be only 4.3 percent of the total.

I can’t account for the difference. At first I thought it had to do with the way taxes were figured—Vanguard’s income worksheet automatically generates an estimated tax liability based on the tax rates you provide—but punching a few numbers into a handheld calculator shows that not to be so. Unless I’ve made a mistake in entering expenses, it looks like Social Security, part-time teaching income, and a drawdown of a little over 4 percent will just about cover the average monthly cost of living. Excel shows an average monthly cost of $3,306; Vanguard’s comes to $3,275, not a significant difference.

Either of these figures requires me to avoid extraordinary expenses at all costs, something I haven’t succeeded in doing for lo, these many months. One crazy cost after another—some optional, some decidely not—has overrun my budget three out of the past five months, and probably will overrun it this month, too. Last year I ran in the red five out of twelve months; once by only $37, but still…

If we think in terms of the whole year rather than focusing tightly on given months, last year’s total black ink came to $1,397.37; red ink totaled $726.23, leaving me $671.14 to the good at the end of the year. However! Last year’s discretionary budget was $1,500 a  month. The amount I entered in Vanguard’s worksheet comes to only $1,265—and that includes a $500/month allowance for extraordinary expenses. It’s highly questionable whether I can live on that: last year’s expenditures averaged $1,440 a month.

Starting in January, I cut the budget for nonrecurring expenses to $1,200 a month. As of June 20, the end of the last budget cycle, I was $681.89 in the red: an average of $136 a month! That’s after The Copyeditor’s Desk covered every expense I could justify as a business cost.

So it appears that in retirement, unless Medicare and income taxes are less than I think they’ll be, I will not be able to cover every expense that comes my way. I’ve got seven months to get the extraordinary spending under control.

Image: Micky, Hammock on Beach; Wikipedia Commons

Identity Theft: Three ways to fight it

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A few years ago, SDXB and I learned separately that each of our credit reports said we had lived at an address neither of us had ever heard of, in Tempe, Arizona. Although neither of us was harmed financially, it indicated a type of identity theft known as “application fraud” or “true name fraud.”

It took about a year to get the fake address off my credit records. Once it was expunged, I pretty much forgot about it…until a couple of weeks ago. That was when Costco announced it didn’t have my current address and my membership renewal was overdue. When I went to customer service to pay up, the CSR happened to show me her computer monitor, and what should I discover but that my home address was listed as SDXB’s former address and my business address is now at that same fake address in Tempe!

The appearance of an unfamiliar address on your credit report is one of many possible signs of identity theft. Other warning signs are missing bills, unexplained charges to your accounts, the existence of accounts you didn’t open, denial of credit for no apparent reason, and dunning calls from bill collectors for items you didn’t purchase.

Undoing a mess some crook has made is very difficult. It can take years to persuade creditors and credit reporting agencies that you’ve been a victim of identity theft, and the crime can haunt you for a long time. Thieves have so many ways to steal your private information, many of which you have no control over, that you really can’t prevent it. But you can take a few steps to reduce your risk. I think of them in terms of three strategies:

1. Monitor

You’re entitled to free annual credit reports from each of the three major credit reporting bureaus, Equifax, Experian, and Transunion. Rather than having to go through the hassle of contacting each of these agencies separately, it’s now possible to order credit reports through a single source, annualcreditreport.com. Instead of ordering all three reports at once, take advantage of the federal law by revisiting annualcreditreport.com once every four months, so that you can spread out reports from the three agencies over the course of a year. This will allow you to monitor your credit reports steadily. Watch for any unexplained activity or accounts you don’t recognize.

Also, before you pay a credit card bill, remember to review the statement carefully. Check financial accounts and billing statements each month, looking for charges you didn’t make.

2. Prevent

Limit the number of credit cards you carry around. Keep no more than one or two cards in your wallet.

Pay in cash at restaurants and other establishments where you can’t watch what an employee does with your card after you present it for payment. This eliminates the use of a skimmer, a handheld device thieves use to swipe cards for later download into their own computers.

Don’t use debit cards. If you must, memorize your PIN; don’t carry a note with your PIN in your wallet or purse. Avoid using your birthdate, numbers of your address, sequential numbers, or four digits of your Social Security number as PINs. Never use a debit card for online shopping.

Photocopy your credit and debit cards, front and back, and keep the photocopies in a safe place. This makes it easy to contact issuers if cards are stolen.

Don’t allow anyone to write your credit card number on a check.

Always take credit card receipts with you. Carry them in your wallet or purse, and shred them before discarding.

Carry outgoing snail mail to a USPS post box or postal station. Don’t leave it in your mailbox to be picked up by the postal carrier. To protect financial information sent to you through the mails, install a locking mailbox.

Avoid giving out your Social Security number. Don’t carry a Social Security card or Medicare card on your person. You (or your parents) can photocopy a Medicare card, trim it down to wallet size, and cut out the last four digits of the SSN that appears on it. Take the original the first time you see a doctor; otherwise, store it in a safe place at home.

Opt out of marketing lists for the three credit bureaus, limiting the number of free credit offers sent to you in the mail. When you do get such offers, always shred them or scissor them into tiny pieces before throwing them in the trash. Also register your telephone number with the National Do Not Call List, to further reduce offers from hustlers.

And of course, never respond to phishing e-mails. Remember, a legitimate bank or creditor will not ask you for your account number or Social Security number.

3. Fight back

At the first sign of identity fraud, notifiy all three credit bureaus and place a fraud alert on your account. This is good for 90 days. This step entitles you to a free credit report; get one from each agency and review all three reports carefully.

Report the theft or fraudulent activity to the police in writing, using an identity theft report.

Once you have filed an identity theft report with law enforcement agencies, use that and your evidence of identity theft to extend the credit bureaus’ fraud alert for seven years.

Report the crime to the Federal Trade Commission, using the police report number you got when you filed a police report.

Learn what your rights as an identity theft victim are.

If an identity thief has opened new accounts in your name, contact these creditors immediately. Federal law allows you to block businesses from reporting fraudulent activity to credit reporting agencies; the sample dispute letter available here will come in handy for that purpose.

If the thief has used existing accounts that belong to you, report the fraudulent activity to the creditors. Arrange to close the accounts and have new accounts with new account numbers issused to you.

So…what am I going to do about the Costco situation?

Well, we have a fair idea where this came from: only one person could connect SDXB and me in quite that way (the phony entry showed my legal first name, which I don’t use socially; few people who knew the two of us as a couple know my real name). At the time the spurious address popped up in our credit reports, this person was engaged in an extramarital affair. We figured she and the boyfriend had forged driver’s licenses in our names so they could rent themselves a love nest.

More recently, the same someone, who has been in deep financial trouble for quite some time, likely ran out of cash about the time her Costco membership lapsed. So she dug out the fake ID, presented herself as me, and said she’d lost her card. If she went in and asked for a new card in my name, she might have been asked for an address. SDXB’s old street address was at the same number as my new street address; the only difference is that one house is on Erewhon Road and the other is on Erewhon Place. So if she gave his old address as “hers”/mine, it would be credible.

I guess what I will do is cancel my Costco membership. Then we’ll have M’hijito buy a new membership in his name, with me on his account as a secondary card holder. This will be a hassle, because they’ll have to issue a new Costco American Express card with a new account number.

But since she hasn’t done anything (so far) that’s cost me any money or damaged my credit rating, maybe I’ll just let it ride and keep a close eye on the credit reports. Who cares if she gets into Costco for free?

The high cost of Medicare

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In a comment to my recent post about planning for the pending layoff/retirement/whatever-we’re-calling-it, Abigail asks about the costs of Medicare, which I estimate will be around $300. I’ll be eligible for Medicare in May of 2010. So, between the December 31 canning date and May I’ll have to take COBRA, which will cost about $480 a month.

Medicare alone doesn’t cover all your costs: it’s an 80-20 plan. The older you get, the shorter the odds that you’ll suffer a catastrophically expensive illness. Heart bypass surgery, for example, can cost $170,000; 20 percent of that would be $34,000, which you have to pay out of pocket. Cancer treatment can quickly mount into the hundreds of thousands of dollars. Clearly, if you have to pay 20 percent of costs like that, a major illness—almost inevitable in old age—will pauperize you.

To protect yourself, you have to buy a supplemental policy called “Medigap” insurance. You also are required—it’s not an option—to take and pay for prescription drug coverage under Medicare Part D. By law, Medicare Part B and Medigap insurance provide no prescription coverage. If you decline to sign up for Part D when you start Medicare and then later change your mind, you are gouged royally for the privilege of signing up later.

To be fully covered, you have to cobble together coverage with the standard Medicare Part A (which is free), Medicare Part B (which costs about $100 a month), Medicare Part D (which evidently runs about $30 to $65 a month but which, if you suffer an illness that requires expensive drug therapy, will leave you holding the bag for upwards of $4,350), and Medigap insurance (provided by private insurers, apparently ranging in cost from an average of about $100 to about $285 a month—it’s next to impossible to find out what the actual costs are). By the time you’ve added up Part B, Part D, and Medigap, you end up with a monthly cost of about $300 a month. That amount will never go down, and you can be sure that like every other cost else in life, it will continue to rise.

At this time, the combined cost of full Medicare coverage is about 12 times what I pay for my employer’s EPO plan, which covers my doctor of 30 years. Since 1987, he has practiced at the Mayo. The Mayo Clinic, because of Medicare’s low reimbursement rates, now refuses to accept new patients who are covered by Medicare. They will keep you if you’re already an active patient, but if you walk in off the street and you’re covered by Medicare, they won’t take you.

You can opt out of the public system and instead buy private insurance through Medicare Part C. These plans are basically HMOs, and they are dangerous. They’re extremely restrictive—you have little or no choice as to which doctors you see, and like all HMOs they’re not in business to take care of you; they’re in business to make a profit. Consequently, it’s in their interest to limit the amount and quality of healthcare you get and to direct you to the cheapest providers.

Now, the problem is that hospitals in Arizona are about as good as schools in Arizona, which is to say “not very.” It was at one of our major regional health centers where I waited over four hours with acute appendicitis and never saw so much as a triage nurse. When I finally got to the Mayo’s ER, they slapped me into surgery instantly. In another major hospital, my mother-in-sin underwent successful aortic surgery but almost died because, while recuperating in a hospital room, she had a heart attack that went unnoticed by anyone but a CLEANING LADY! Her life was saved because a maid happened to wander into the room and figured something was wrong.

Only one hospital in Arizona consistently gets top national ratings, and it’s the Mayo. That’s why you need to retain your choice of doctors and medical facilities, no matter how much that privilege costs you.

Incorporating for fun and profit

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Finally finished with all the paperwork (I hope!) needed to establish The Copyeditor’s Desk as an S-corporation. Incorporating my multifarious freelance enterprises as a single entity will make it possible for me to earn enough to live on despite the government’s strictures on earned income for those who take so-called “early” Social Security—a limit guaranteed to keep all but the wealthiest investors in poverty.

It wasn’t as complicated as I feared. But of course, having an ex- who’s a corporate lawyer works to decomplicate these projects. 

Here are the steps you take to form an S-corporation in Arizona (it could be different in other states, so don’t take my word for it):

1. Check with the government for availability of your proposed corporate name.

2. Fill out a form called “Articles of Incorporation” and another form called a “Certificate of Disclosure.”

3. Send these with a cover sheet and a check for $85 to the Arizona Corporation Commission. 

4. Apply for an EIN through the federal Internal Revenue Service. 

5. Fill out and mail IRS form 2553 to tell the feds you’re electing to be an S-corporation.

Once you’ve jumped through these hoops, you have the paperwork necessary to open a business account with your bank or credit union. Eventually you should receive confirmation and still more paper from the various bureaucracies, at which point you can start behaving like a corporation. In Arizona, you have to publish the articles of incorporation for three days running in a local newspaper, a pricey proposition, and you’re supposed to submit an annual report. The latter is something you discuss with your tax professional. 

It’s a little more involved than that, of course, but the basic steps are less difficult than they appear. Funny about Money, which will be part of this corporation, is already making a little cash, so I’m looking forward to having a bank account into which to deposit it. Let’s hope that by next year it will earn enough to spring me free of one or two sections of freshman comp! 

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Early Social Security: A way around the earnings limit

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Social Security allows you to start receiving benefits at one of three ages: at 62, at about 65, or at 70. The longer you delay the more you appear to be earning. This results from an actuarial calculation. A flat amount is designated for each American who reaches old age; the older you are when you start collecting, the more you receive monthly—the reasonable assumption being that the older you are, the fewer years you will have to receive your designated cache of dollars.

About three-fourths of Americans start their benefits “early,” at age 62. Many can do so because they have enough savings to live on, or are close enough that a small Social Security payment will get them out of the salt mine. Others are faced with life circumstances, such as layoffs or sickness, that force them to take the money early. And because the government has been slowly pushing back the age of so-called “full” retirement, for many of us that age comes well past the time we feel we should no longer have to work. In my case, “full” retirement doesn’t come until age 66.

If you take so-called “early” retirement—that is, you choose to start drawing benefits at 62—you get a reduced amount. If you wait until age 70, you get a significantly larger benefit. For example, in my case the difference between starting Social Security now and waiting until age 70 would amount to $1,029 a month. The difference if I waited until age 66 would be about $300 a month…enough to ensure that I wouldn’t have to teach one (count it, one) of six freshman comp courses a year to survive.

To discourage people from drawing their benefits at the earliest possible age, Social Security penalizes you for working. Until you reach “full” retirement age, every two dollars you earn above $14,160 results in a dollar confiscated from your benefits. A w4 estimator can help do the math for you. Since neither my $13,944 Social Security benefit (gross: after-tax would be around $11,400) or a gross of $14,160 is enough to live on, this represents a very big problem. Given the ambient ageism that infests American society plus the practical problems entailed in hiring older workers, the likelihood that I will get a full-time job at 64 is almost nil. So I’m faced with two years of poverty (or having to draw down 7 or 8 percent of savings!) before I can start earning enough to live on, and by then my sources of freelance income will have dried up..

As it develops, however, there’s a work-around for the self-employed. It’s called incorporation. The proceeds of an S-corporation do not register for Social Security purposes. This is not true for a C-corp. Here’s how my tax lawyer explains it:

An S corporation is a pass-through entity whose income is taxed directly to the shareholders. In that respect it is like a partnership. The difference, however, is that S corporation income is not subject to self-employment tax (as it would be in a partnership or Schedule C (sole proprietor)). Therefore, S corporation income is not considered to be “earnings” for Social Security purposes.

 

However, as a more-than-5% owner of an S corporation, if you are also an officer (which you would be), you are required to take “reasonable compensation” (W-2 wages) for your duties as an officer of the corporation. Right now, it is the only way IRS can assess FICA/Medicare in an S corporation. If you do not take reasonable salary, IRS will attempt to assess FICA/Medicare on your total withdrawals (and perhaps the total income) of the S corporation. They will assess whatever they can get away with. The reasonableness of the salary depends on the total income of the corporation.

In other words, you can have self-employed income flow into an S-corporation and then have the corporation pay you in salary and dividends. Not only do you get around the $14,600 earnings limitation, you don’t have to pay the usual double dose of FICA levied on self-employed workers.

So, the solution is to form an S-corp that will function as an umbrella for the several sources of freelance income that trickle into my bank account: The Copyeditor’s Desk, HW&E (my original freelance entity, separate from the partnership with Tina), and Funny about Money. None of these will earn much, but taken together the proceeds could at least cut down the number of freshman comp courses I’ll have to teach. That will improve the quality of my life by several orders of magnitude.

A person who runs a business that makes a decent income could profit nicely from this strategy.

Debt-to-Income Ratio: Frugalist begs to differ

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So the Financial Wizard par Excellence is arguing that M’hijito, who earns a salary that is exactly at the median income for bankruptcy purposes, should be able to shoulder a great deal more of the Investment House mortgage than he agreed to. Our agreement was that he would cover one-third of it (having contributed a third of the down payment) and I would carry the other two-thirds. When we sell the chateau sometime in the future at an outrageous profit, we’re to divide our incalculable riches accordingly.

Fact is, he’s carrying more like 40 percent of it.

FW trots out the debt-to-income ratio to support his position:

The total debt-to-income, or back-end ratio, shows how much of your gross income would go toward all of your debt obligations, including mortgage, car loans, child support and alimony, credit card bills, student loans and condominium fees. In general, your total monthly debt obligation should not exceed 36 percent of your gross income. To calculate your debt-to-income ratio, multiply your annual salary by 0.36, then divide by 12 (months). The answer is your maximum allowable debt-to-income ratio.

Hm. Let’s think about that.

My gross income is $62,500. In theory, then, I should be able to tolerate a debt load of $1,875. A person with the state’s median gross income should be able to afford a total debt of $1,301.91.

And…uhm…what does such a debtor eat? Guess he doesn’t have to worry about dieting, eh?

My net monthly income is $3,000—actually, it’s more like $2,864 with the twice-a-month furloughs. The cost of operating my house and paying regularly recurring bills such as long-term care insurance and utilities comes to about $840 a month. In the winter it’s a little less, but one ignores the high summer bills at one’s peril. My house is paid off, so I have to self-escrow the costs of homeowner’s insurance and property tax, which when combined with the car insurance bill average out to around $350 a month. The combined cost of all other expenses—food, household goods, gasoline, car repairs, home repairs, pool chemicals, yard items, veterinary bills, medical and dental copays, and on and on and on—comes to about $1,200. I do charge these things on AMEX by way of collecting a couple hundred dollars in kickbacks once a year, but I pay the charge card bill in full every month.

I live pretty frugally: don’t travel, don’t subscribe to cable or cell services, rarely eat out, don’t buy many clothes (and none that have to be dry-cleaned), wash my own car, clean my own house, grow some of my own food, abstain from expensive hobbies, don’t even go to movies.The only debt I have is the $170 bill for the Renovation Loan (soon to be paid off) and my $800/month share of the house mortgage, for a total of $970. I presently put $400 a month in savings toward survival after the coming layoff. So…

  $840 monthly set expenses
  1200 all other living & unexpected expenses
     170 Reno Loan (second mortgage)
     800 Investment House mortgage
     350 tax & insuranceself-escrow
     400 emergency savings
$3,760

Tha’s funneh. Seems to come to more than I’m bringing home! Cut emergency savings to a more ordinary $200 a month, and we still exceed my net income by $696 a month.

Okay, I admit it: the $800/month is a drawdown from savings. So $3,760 – 200 – 800 = $2,760.

That’s right: a debt of a grandiose $170 a month brings my outgo to within $104 of my income…and that’s without any major bills: no pipes explode, no veterinarian proposes surgery, no dentist cries out for some expensive procedure, and the car’s transmission continues to run flawlessly.

If $1,875 of my income were committed to debt service, I would have a munificent $1,125 left to live on. But it costs $2,760 for me to live rather modestly (some would say “ascetically”) in a small middle-class urban tract house.

Is there any question why most people are up to their schnozzes in revolving debt? If my debt-to-income ratio were maxed, the only way I could possibly get by would be to live on the cuff!

Allow me to propose a different debt-to-income ratio, one that is based on net income, not gross.

Obviously, the amount of debt a person or family can afford is a function of the amount of money the household brings home, not a never-never-figure whose total is effectively meaningless. What matters, when calculating what you can afford, is how much you have in your pocket, not how much you putatively “earn.”

If you hope to live within your means and your net is, say, $3,000 a month, you need to subtract your known living expenses plus a little for emergency savings from your take-home pay. What remains is the amount you can pay toward debt. Let’s say I were not facing unemployment in a few months, so I put aside a more normal $200/month toward the emergency fund: my regular needs would come to $2,410 less the second mortgage payment: $2,240 (i.e., $2,410 -$170). This would leave $590 a month ($3,000-$2,410) available to pay toward debt. That is 19 percent of my net income.

On a “good” salary in my region, I can afford to commit about 20 percent of net to debt payment. Spend much more than that, and presto-changeo! My lenders get rich on the interest I owe now and forever, world without end, amen.

Take-home pay is typically about 60 percent of gross pay. So a person with Arizona’s $43,400 median income brings home about $26,040, or $2,170 a month.

That would make a reasonable debt load right around $435 a month (20% of $2,170). Yes. For your mortgage or rent, your student debt, your revolving credit-card debt, whatever you owe Mom or Uncle Ernie…

By this guideline, M’hijito, who has no other debt, is already contributing $165 a month more than he can afford to our combined real estate venture.

Figured traditionally, the debt-to-income ratio suggests he should be able to afford $1,301 a month, leaving him with a miserly $869 a month to live on!

Here’s what I think: the standard debt-to-income ratio calculation is utterly unrealistic and unfair to consumers. First, a number like 36 percent way too large. Second, figuring the amount of debt a person can carry according to his or her gross income works a complete disconnect from reality! No one lives on gross income. We live on our net income! Because net, not gross, is what we have available to spend, net income is the figure that should be used to calculate a tolerable debt load.

The take-home message: Figure the amount you can pay toward loans of any and all kinds according to your net income, not according to your gross. Obviously, if you want to spend no more than you earn, you need to keep the debt load low enough that it plus your total other spending and saving needs come to no more than your take-home pay.

debt-to-income ratio = (net pay – spending needs – saving needs) ÷ net pay

The decimal fraction you get from this formula is the fraction of your net pay you can afford to spend on debt.

How hard is this?

Well, of course, real hard: who do you know who’s paying $435 a month to keep a roof over his head? And how many own their cars free and clear? Not many, I’ll bet, who don’t have a roommate, a spouse, or a life partner.

Few exercises demonstrate more clearly that good financial health (at least on the household level) entails getting out of debt and staying out of debt. It means pinching pennies as tight as you can, creating more than one income stream to maximize net pay, and doggedly snowflaking down revolving debt first and then finally mortgage debt. Quite a challenge, this “getting real” business.
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