WILL YOUR FUTURE SOCIAL SECURITY PAYMENTS BE SMALLER THAN EXPECTED? - January 2005 Newsletter

Your future Social Security payments might be smaller than expected—more than $300 a month smaller in some cases—and you might not even realize it.

Are you entitled to receive pension benefits from a job in which you pay no Social Security taxes, such as work for the federal government under the Civil Service Retirement System, your state government, or for an employer in another country? Yet you’ve also worked part-time or gone into a second career where you paid Social Security taxes and will some day be eligible for benefits? Then those Social Security benefits (including disability benefits) might be smaller than you anticipate because of what’s called the Windfall Elimination Provision. [JFP submission in the Social Security benefits computer file. Says nine percent]

Around for over 20 years, WEP is designed to take away some of the “double dipping” a worker might receive who accrues a small or modest amount of Social Security benefits while working primarily in jobs not covered by Social Security. That’s because Social Security benefits are skewed more heavily toward low wage earners.

The law exempts some workers from WEP. Those hired by the federal government after 1983 are not subject to the limitation because they are under the Federal Employees Retirement system, which pays Social Security taxes. Also exempt are those whose non-covered work occurred before 1957, whose only pension is based on railroad employment, or who have managed to accumulate 30 or more years of “substantial earnings” under Social Security.

But many workers, particularly those in their 50s or 60s with long careers in government, remain affected by the Windfall Elimination Provision and they don’t realize it. As a consequence, they often are less financially prepared for retirement than they might think. Currently, for example, the annual retirement benefit estimates that Social Security sends to workers don’t reflect any potential benefit loss due to WEP.

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To better inform future Social Security recipients, the Social Security Protection Act of 2004 included two provisions. Starting this year, employers not covered under Social Security will be required to inform new hires moving from jobs that paid into Social Security about WEP and its potential impact on their future Social Security benefits. Starting in 2007, the Social Security Administration must inform those potentially subject to WEP how much their benefits might be reduced.

How can you determine in the meantime whether and how much the Windfall Elimination Provision might affect you? Start with what Social Security calls “substantial earnings.” Each year, Social Security publishes the minimum amount of earnings necessary to qualify for a full year’s credit of “substantial earnings.” For example, in 2004 a worker needed to earn $16,275 to qualify. In 1984, the amount was $7,050.

If you can accumulate 30 years of qualified “substantial earnings,” such as through side jobs or years of full employment in jobs paying Social Security tax, you won’t be hit by WEP. But if you have less than 30 years of substantial earnings, WEP will reduce benefits. Let’s say you retire at age 65 with 20 years of substantial earnings and you’re eligible for $1,000 in monthly Social Security retirement benefits. According to Social Security tables, your monthly benefits would be reduced by $306. With 25 years of substantial earnings, you’d lose $153 monthly.

The WEP limits the reduction of Social Security benefits to no more than 50 percent of the benefits you receive from a non-Social Security pension. This helps workers with small pensions. For example, if your non-covered pension is $400, the reduction in Social Security benefits would be no more than $200, even if benefits would have been reduced more than that under the standard WEP tables.

Also keep in mind that the amount your Social Security benefits are reduced remains the same every year. That is, if you lose $153 in monthly benefits your first year of collecting Social Security, then you’ll never lose more than that amount in the future, even though your overall Social Security payments rise due to annual inflation adjustments.

While disclosure of the impact of the Windfall Elimination Provision will better alert future retirees, financial planners caution workers to keep one key point in mind: if you believe you will fall under WEP, you need to adjust your retirement plans and savings efforts accordingly to make up the shortfall.

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January 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Bold Financial Planning, LLC , a local member of the FPA.

WHAT IS THE REAL REASON YOU SHOULD INVEST? - January 2005 Newsletter

Most people think they know the answer to the question of why should they invest. Yet many all too often invest for the wrong reasons—and that can lead to financial difficulties.

Most investors assume that the goal of investing is to simply earn the highest return possible without losing money. If they’re investing in common stocks, they assume they should earn at least 10 to 11 percent every year because that’s roughly the long-term average for stocks. But often they’re not satisfied unless they exceed that by earning 20 or 30 percent or, heck, doubling the return on their investment.

But wise financial planners will tell you that earning the highest possible return should not be the real goal of investing. Rather, the main purpose of investing is—in conjunction with other components of your financial life—to help you realize major life goals: a comfortable retirement, a dream job or business, a college education for your children, funding for your favorite charities, or accumulating assets to pass on to your heirs.

What’s the difference between these two approaches to investing, you may wonder. What’s wrong with double-digit returns? Won’t they accomplish those life goals? Nothing’s wrong with consistently earning double-digit returns. It’s nice work if you can get it.

The problem with shooting for the highest return possible as the main goal in investing is that it can create unnecessary risks and erratic investing patterns that ultimately undermine efforts to achieve those life goals that truly matter to you.

Most financial planners have war stories about clients, or more often, prospective clients, who come to their office expecting that the planner’s primary job is to earn them fat returns on their investments—to beat the market. When these planners respond that they can’t design a sound investment strategy until they understand the person’s goals and the other aspects of their financial circumstances, these prospective clients often leave and head for the next financial advisor, until they find one who promises them glorious returns.

How can investing solely for the highest returns create unnecessary investment risk and erratic investing patterns?

Holding unrealistic return expectations. A California CERTIFIED FINANCIAL PLANNER™ practitioner recalls being fired by a client during the height of the booming late 1990s stock market because though the client’s portfolio was doing very well, and was more than accomplishing the client’s goals, it wasn’t earning the 100 percent annual return the client thought it should be earning. The ensuing bear market harshly demonstrated to that former client and many other exuberant investors that high double-digit returns of the 1990s were not a given.

Taking unnecessary risks. Much of the riskiest investing, overbuying, and panic selling during the late 1990s and early 2000s would have been avoided if individual investors had created their own investment plan for achieving long-term specific goals such as retirement or a college education. For example, investors who can reach an investment goal by earning a modest average annual return are less apt to jump into higher-risk investments than those with no plan except to always “go for the highest return.”

Investors shooting for the highest returns also are more vulnerable to investment scams offering returns that “are too good to be true.”

Not taking enough risk. After risking all for the highest returns during the good times, many investors who got burned bailed out of the stock market and are now afraid to invest at all. Some have even stopped contributing to their company-sponsored retirement plans.

Again, they’ve lost sight of the real purpose of investing. The result is that they not only panicked and cashed in their losses, they shifted their entire portfolios to low-yielding savings accounts and money markets. While these vehicles can serve useful financial purposes, holding an entire portfolio in them hinders efforts to achieve long-term financial goals.

Failing to diversify. Shooting solely for the highest returns tempts investors to chase and overload in the current hot part of the market, and ignore underperforming sections. When large-cap and high-tech stocks stumbled in 2000–2002, stock-heavy investors weren’t situated to take advantage of the previously ignored real estate investment trusts (REITs), bonds, commodities, and even gold, all of which had banner-return years.

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January 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Bold Financial Planning, LLC , a local member of the FPA.

FINANCING ALTERNATIVES FOR SMALL BUSINESSES - January 2005 Newsletter

Whether starting up a small business or expanding an existing company, you almost certainly will need financing. But which option or combination of financing options: personal savings, friends and family, commercial or government loans, outside investors? Which options will most likely be available to you and what are their pros and cons?

Before choosing financing options, however, determine how much money you’ll need. That entails developing a good business plan, which benefits not only you but will be de rigueur for most financing arrangements. Books, Web sources, software, and classes are available on how to write a good plan.

Don’t be too conservative estimating the amount of financing you need. Undercapitalization leads to a third of all bankruptcy filings for small businesses, according to the federal Small Business Administration.[Great Money Hunt, WSJ, computer file] Some experts recommend estimating a realistic amount and then adding 10 percent to it just to be sure you didn’t overlook anything. Others suggest having enough funds in reserve to pay your personal living expenses for at least one year so as not to put a drag on your new business cash flow.

Personal savings. The nice thing about this option is that no one will turn you down. Of course, you may not have sufficient savings or you may not want to risk your personal savings (some financing options may compel you to, anyway).

Borrow from family or friends. This is a popular choice when you can’t get standard financing. Still, it can come with great peril because of the emotional bond for both parties. Expect some strained times if things go sour, so be sure everyone thoroughly understands upfront the risks of their loan. Show them your business plan and put the loan in writing.

Put in on plastic. Credit cards are easy to get and you don’t give up control or have relatives or friends peering over your shoulder. But plastic can be expensive and risky borrowing, especially if

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you fall behind on your payments. That’s why business experts often recommend limiting the use of cards for smaller, temporary cash needs you can pay back more easily, while using other financing for larger, longer-term expenses.

Commercial loans. Bank loans are often desirable because rates can be among the lowest and a bank loan can make you look good to other lenders. The problem is that many small businesses have a tough time getting bank loans because banks are pretty conservative lenders. You’ll need to show them a solid business plan, a good personal credit rating, and prospects for steady cash flow. You may be asked to guarantee the loan with personal assets—something not all entrepreneurs are willing to do.

Shop around. Banks have different lending standards and one may lend where another won’t.

Personal loans. Personal loans from banks are easier to get and often don’t require collateral. But interest rates are likely to be double or even triple a commercial loan rate and lenders may balk at using the loan for a small business.[“bank loans are often most desirable,” financing small business computer file] Some finance their business with a home-equity loan, but that puts your home at risk.

Federally-backed loans. The federal Small Business Administration (http://www.sba.gov/) provides an array of loan options through private lenders (shop around). The main program is called 7(a), which provides funding for start-ups or existing businesses for everything from land to equipment to working capital. A micro-loan program ($35,000 or less) is available for small firms employing five or fewer, particularly firms with minority, low-income, or disabled owners.

Equity partners. Bringing in other investors is an option many small-business owners are loath to do, but may have to out of necessity. Financing options from private investors can be complicated and you’ll likely want assistance from an attorney experienced in this area.

The advantage of equity partners is that with a good plan and a promising business you may be able to bring in much-needed cash for a venture that lenders might shun because of high risk or lack of stable cash flow.

The downsides are that you dilute ownership, investors are likely to offer lots of advice and criticism, and the process of lining up investors can take much longer than other forms of financing.

Each of these financing options has their pros and cons, so it’s critical to develop upfront a detailed, well-conceived business plan in order to determine your best funding options.

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January 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Bold Financial Planning, LLC , a local member of the FPA.