Category Archives: personal finance

Should You Take a Pension Buyout?

Pension Plans - Source: http://www.bls.gov/opub/btn/volume-3/an-analysis-of-multiemployer-pension-plans.htm

Imagine this scenario. You work for a company that has previously committed to provide you with a traditional defined benefit pension after you retire, but now wants to lock in its costs for those benefits by offering you a choice. You can:

  1. Take a one-time lump sum payment, representing the present value of the pension benefits it has made on your behalf, which you can then use to invest for your retirement through your own Individual Retirement Account (IRA).
  2. Take an immediate annuity, in which your employer takes the lump sum and sets you up to receive monthly payments for life beginning now from an annuity provider it selects based on whatever annuity option you select.
  3. Let it ride, where you may keep your defined benefit pension.

To be frank, the main reason that your employer is offering you these options is because they don't know how much it is going to cost them to provide you with a guaranteed benefit like a traditional pension. Defined benefit pensions were developed at a time when pension investment managers could count on relatively risk-free investment options for decent returns, which have increasingly become difficult to identify over the last decade.

For your employer, falling short means having to take money away from things that benefit the business, like new investments that help generate more revenue to keep the business in business going forward.

For you, choosing your company's pension buyout offer means taking on the risks that they otherwise would have to take on your behalf. That risk was always there, but now will no longer be hidden from you.

But the question is now this: can you do a better job in managing that risk and your retirement than your employer? And to answer that question, we've built the following tool, which you can use to work out how well your employer thinks they would be able to do. Just enter the indicated information that your employer will have provided to you in our tool below, and we'll run some quick estimates of the rates of return your employer believes they can obtain.

If you're accessing this article on a site that republishes our RSS news feed, click here to access a working version of our tool.

Your Pension Buyout Offer
Input Data Values
Your Current Age
Your Age at Retirement
One Time Lump Sum Pension Buyout Offer
Monthly Annuity Payment Beginning at Your Current Age
Monthly Pension Payment Beginning at Your Retirement Age If You 'Let It Ride'

Pension Buyout Considerations
Calculated Results Values
The Average Rate of Return You Have to Beat Before You Retire
The Immediate Annuity's Interest Rate

In our tool's results above, the average rate of return that you would need to beat represents the rate that your employer would have to obtain in investing the amount of your lump sum payment today to be able to provide your monthly pension payment after you've retired, without having to add any extra money to make up any shortfalls.

To put that rate of return in some context, the average rate of return for investments in the S&P 500 of any duration is 9.4%, which does not account for the effects of inflation over time. Then again, neither does your employer's promised pension payment.

And of course, stock market returns can be volatile, especially in the short term. See our Remapping the S&P 500's Performance Since 1871 tool for a quick summary of the best, worst and average rates of return ever provided by investments in the S&P 500 stock market index and its predecessor indices and components to get a sense of just how volatile that might be over the period of time between the present and when you might retire.

Meanwhile, the immediate annuity's interest rate is the annualized rate of return that your employer can obtain in taking the lump sum and setting you up with monthly annuity payments. While this would be a sure thing, where the payments will last as long as you live, or as long as the annuity option you select lasts, it also will never be adjusted to account for the effects of inflation over time.

As a final note, this tool applies to defined pension benefits that are fully funded, where your employer regularly sets aside sufficient funds to ensure its pension plan can fully satisfy all its obligations to the company's future retirees. For underfunded pensions, and particularly public sector pension plans, you would need to also consider just how seriously underfunded your pension plan may be in making your choice, as your pension plan's manager may not be capable of generating the kind of returns on its investments that will be needed to keep the plan from going into default when it comes to making its full promised payments to you in retirement.


Paying Your Bills With Dividends

Checkbook - Source: Virginia Department of Education - http://www.doe.virginia.gov/instruction/economics_personal_finance/

Are you tired of paying your your mobile phone bill every month? What if you could get your carrier to pay it for you?

Believe it or not, there's a way that you could actually make that happen. All you need to do is to buy the company!

Or rather, you need to buy enough shares of stock in the company to cover the cost of your monthly bills through the dividends you might earn as a partial owner of the business. But how many shares would that take?

Our latest tool answers that question! We've plugged in the quarterly dividend and share price data as it might apply to an average monthly bill for Verizon (NYSE: VZ), but you're more than welcome to substitute the data that applies to your own mobile service provider. Or for that matter, any company that bills you monthly that also pays dividends to its shareholders!

If you're reading this article on a site that republishes our RSS news feed, click here to access a working version of this tool!

Monthly Bill Data
Input Data Values
Your Monthly Bill [$USD]
Investment Data
Current Share Price [$USD per Share]
Quarterly Dividend [$USD per Share]
Dividend Income Tax Rate [%]

Shares Needed to Pay Bills with Dividends
Calculated Results Values
Annual Amount of Monthly Bills
Number of Shares Needed to Provide Enough Dividend Income to Cover Bills After Taxes
How Much Will Those Shares Cost You to Buy Today?

If you think about it, this is really the sort of thing that you're trying to accomplish for when you're not working any more through your retirement investments.

But nobody said you had to be retired before you could start working your way toward that objective.


The Evolving Expenditures of U.S. Households

We've been exploring data found in the U.S. Bureau of Labor Statistics and U.S. Census Bureau's Consumer Expenditure Survey, which has provided a window into the annual consumer expenditures of American households (or rather, "consumer units") since 1984. Today, we thought it was time to take a look at how the major categories of that spending has evolved over the thirty years for which we have data.

Our first chart shows the average annual amounts that American households spend on things like housing, transportation, food and alcoholic beverages, life insurance and pension savings (IRAs, 401(k), Social Security), health care, apparel and other consumer products and services, entertainment (including reading), education and also how much they donate to charitable organizations.

Average Annual Expenditures per Consumer Unit, 1984-2013

Next, we calculated the percentage share of these major categories with respect to the average annual total expenditures of U.S. consumer units, which reveals how much Americans have changed how much they spend on these major categories over the thirty years from 1984 through 2013:

Percent Share of Average Annual Expenditures per Consumer Unit, 1984-2013

Because we've already demonstrated that in real terms, the total amount of money that the average American household spends on their annual expenditures has been essentially flat over the past 30 years, this chart reveals how Americans have shifted their spending over that time, increasing the share of money they spend on housing, life insurance and pension savings, health care, charitable contributions and education, while reducing the share of money the spend on transportation, food and alcoholic beverages, apparel, and other products and services, and entertainment.

Speaking of which, note the trends for health care and entertainment, which are nearly equal to one another from 1984 through 2008, but which diverge beginning in 2009. It is as if Americans are increasingly paying their increasingly higher health care insurance bills and expenses with money they might previously have spent on entertainment related expenditures, which means that the efforts of so many Hollywood celebrities to push Obamacare onto financially illiterate consumers has backfired on their industry.

Our final chart stacks these percentage shares to reveal how they fit into the whole of annual consumer expenditures for the average American household:

Major Categories of Consumer Expenditures as Share of Average Annual Total Expenditures per Consumer Unit, 1984-2013

In this chart, we've ranked the major categories from greatest percentage share reduction at the top (in green) to greatest percentage share increase at the bottom (in purple) from 1984 through 2013.

Data Sources

U.S. Bureau of Labor Statistics. Consumer Expenditure Survey. Multiyear Tables. 1984-1991. [Text Document]. Accessed 23 March 2015.

U.S. Bureau of Labor Statistics. Consumer Expenditure Survey. Multiyear Tables. 1992-1999. [Text Document]. Accessed 23 March 2015.

U.S. Bureau of Labor Statistics. Consumer Expenditure Survey. Multiyear Tables. 2000-2005. [Excel Spreadsheet]. Accessed 23 March 2015.

U.S. Bureau of Labor Statistics. Consumer Expenditure Survey. Multiyear Tables. 2006-2012. [Excel Spreadsheet]. Accessed 23 March 2015.

U.S. Bureau of Labor Statistics. Consumer Expenditure Survey. 2013 Current Combined Expenditure, Share, and Standard Error Tables. Region of Residence. [Excel Spreadsheet]. Accessed 23 March 2015.

If you're one of those people (such as "Seeking Alpha commenters") who would like to see any the data we've presented above in real terms, you're welcome to do that math yourself. All you need is the data from the original sources we've linked above and the relevant Consumer Price Index data, which we've linked below, to do the math you want to do - it's super easy!

U.S. Bureau of Labor Statistics. Consumer Price Index - All Urban Consumers (CPI-U), All Items, All Cities, Non-Seasonally Adjusted. CPI Detailed Report Tables. Table 24. [Online Database]. Accessed 24 March 2015.

Confirmed: Americans Can Actually Do the Math!

Unlike a lot of analysts, we've always approached the Patient Protection and Affordable Care Act, which is perhaps better known as "Obamacare", from the perspective of personal finance. We care about what President Obama's "signature" achievement in office means to the bottom lines of ordinary Americans, which is to say that we care more than President Obama does about such things.

Because of that approach, we've recognized from the very beginning that for a lot of Americans, it would make significantly more sense to take a pass on buying the kind of "affordable" health insurance coverage that would be marketed to consumers in favor of paying a much more affordable "penalty" tax when they file their annual tax returns.

2014 was the first year in which Americans were mandated by the law to either pay health insurance premiums or pay higher income taxes. Let's see how real people are making that choice under the terms of the law:

WASHINGTON—A special enrollment period to obtain health insurance for millions of uninsured people who owe a tax penalty under the Affordable Care Act is off to a slow start.

The health law requires most Americans to have insurance or pay a fine at tax time. The open enrollment period under the health law ended Feb. 15, but the Obama administration said it would allow people who discover they owe a fine to sign up for coverage through April, at the end of the tax season.

Major tax-preparation firms say many customers are paying the penalty and not getting health insurance. It is still early, since the special enrollment period launched Sunday, but research also suggests that many people who lack health insurance will pay the penalty and not get covered this year.

Only 12% of uninsured people would buy policies if informed of the penalty, according to a survey of 3,000 adults polled through Feb. 24 by McKinsey & Co.’s Center for U.S. Health System Reform.

At H&R Block Inc., “our analysis indicates that a significant percentage of taxpayers whose household members were not covered for at least a portion of 2014 are opting” to pay the penalty, said Mark Ciaramitaro, a vice president of health-care enrollment services at the tax-preparation firm.

If it helps provide more insight into what's going on here, let's revisit our tool that applies specifically for those who will be making this personal finance choice during the remainder of the 2014 tax filing season. If you're considering buying health insurance between now and Thursday, 30 April 2015, our tool below will estimate what doing so may potentially cost you in 2015 (that's for 2015 only - the math won't apply for other years):

Your Household Data
Input Data Values
Year in Which Insurance Coverage Will Apply
Your Total Household Income, or Modified Adjusted Gross Income (If Known)
Number of Household Members
Number of Children in Household
Your State's Health Insurance Exchange Data
Select Your State (Select "United States" If Your Territory Isn't Listed)
Subsidized Monthly Premium for the Health Insurance Plan You're Considering Purchasing (This is the amount that Healthcare.gov or your state's health insurance exchange will indicate as your cost.)

Your Annual Health Insurance Results
Calculated Results Values
For Health Insurance (Premium Only, No Co-Pays or Deductibles)
For the Alternative Tax If You Don't Purchase Health Insurance (And Not Provided by Your Employer)
Potential Savings or Costs If You Choose to Pay the Tax Instead of the Premium
Your Potential Savings (or Costs, if Negative)
The Bottom Line

One important thing to keep in mind is that you won't get any meaningful benefit for having health insurance until after you've paid your annual deductible, which is the amount of out-of-pocket expenses for health care services that you agree to pay as part of the coverage level you select for your health insurance coverage. That means that you could be out-of-pocket on both your premiums and your deductibles before your Obamacare policy even begins to cover a portion of your actual health care expenses, so unless you can reasonably expect that you will have such large expenses (such as if you're expecting a baby or have a pre-existing condition), you should carefully weigh our tool's results.

Here's how one real person made their choice:

Richard Gonzalez, 59 years old, of Navarre, Fla., found out he will pay a $250 penalty for going without insurance. The retired employee of United Parcel Service Inc. said he won’t take advantage of the special enrollment period because it is cheaper for him to pay out-of-pocket for health care than to buy insurance on the exchange. He said he shopped on the exchange but would have to pay $400 a month for a plan with a $6,000 deductible.

“I think it’s wrong I have to pay the penalty,” said Mr. Gonzalez. “But it beats paying more than $10,000 a year.”

Richard Gonzalez appears to be a savvy consumer - we're pretty sure that he'll be more than capable of finding an appropriate and much more affordable alternative - including some where he might even avoid having to pay the tax as well!

As for other scenarios you might consider running in our tool above, you might consider the health insurance premium costs shared by "ScottinSC" via Twitter. And speaking of which, is it any wonder that one of the Patient Protection and Affordable Care Act's and President Obama's biggest boosters in the media is no longer describing the law as "affordable" in its headlines?

We confirm then that Americans can actually do the math for themselves when it comes to the Affordable Care Act. We're just happy to have developed a timely tool for making that personal finance math a lot easier to do!

Legal Disclaimer

Materials on this website are published by Political Calculations to provide visitors with free information and insights regarding the incentives created by the laws and policies described. However, this website is not designed for the purpose of providing legal, medical or financial advice to individuals. Visitors should not rely upon information on this website as a substitute for personal legal, medical or financial advice. While we make every effort to provide accurate website information, laws can change and inaccuracies happen despite our best efforts. If you have an individual problem, you should seek advice from a licensed professional in your state, i.e., by a competent authority (such as a licensed insurance broker, medical professional or legal services provider) with specialized knowledge who can apply it to the particular circumstances of your case.

Note that we didn't include "Healthcare.gov Navigator" or "community organizer" in the category of "competent authority".

Calculating the National Dividend

American Consumers Dining Out - Source: http://www.fhwa.dot.gov/byways/photos/75868

Is GDP growth a good indicator of improving quality of life?

That's a question that is featured at Debate.org, where at this writing, online polling indicates that 32% of respondents say yes while a wide majority of 68% of respondents say no.

We're not going to debate the topic - we're simply going to recognize that GDP really doesn't communicate how well the quality of life may be changing for a nation's people. That's because it's not really designed to address that question.

So what would be better?

In researching the topic, we dug deep into the history of how Gross Domestic Product became the defining measure of a nation's economic performance. Here, the godfathers of GDP were Alfred Marshall and A.C. Pigou, who originally developed the concept of a "National Dividend" or interchangeably, a "National Income" early in the 20th century. Their work was built upon by Simon Kuznets, who actually developed the prototype accounting calculations for GDP as we know it today.

But almost lost in that early history was a very different concept developed by Irving Fisher, who instead of focusing on production as Marshall, Pigou and Kuznets did, defined his concept of the National Dividend around what people consumed. And while Fisher's concept put the focus on the end consumers in a nations, people living in households, where their consumption of goods and services would provide a measure of their quality of life, it was never fully developed because of the challenges that lay in quantifying it.

Fisher's definition

This definition is entirely different from that of Marshall or of Pigou. Marshall and Pigou have approached national income from the production end, Fisher approaches it from the consumption end.

His definition is as follows:

"The national dividend or income consists solely of services as received by ultimate consumers, whether from their material or from their human environment. Thus, a Piano or an overcoat made for me this year is not a part of this year's income, but an addition to capital. Only the services rendered to me during this year by these things are income".

Thus, according to Fisher, the national income of a country is determined by annual consumption. Suppose, a piano of the value of $20,000 was manufactgured in the year 2009, then according to Marshall and Pigou, the entire sum of $20,000 will be included in the national income of 2009. According to Fisher, only the money value of the actual consumption of the piano in 2009 will be $1,000. Therefore, according to Fisher, $1,000 only should be added to the national income of 2009, and not $20,000 as would be suggested by Marshall and Pigou.

Fisher's definition appears to be better and more scientific than that of either Marshall or of Pigou, because he includes in the national income of the country only the money value of the actual consuption of goods and services during the year.

But Fisher's definition has little practical value. The reasons are as follows:

Firstly, since there are so many commodities and so many varieties that is is exceedingly difficult to estimate the money value of total consumption in the hands of millions of consumers in the country.

Secondly, it will be very difficult to allot a definite life to each and every good in order to find out the money value of its consumption in a particular year.

Thirdly, it will be a difficult task of calculating the money value of the consumption of durable consumer goods which will pass thorugh the hands of many persons.

We see that historically, the main obstacle to making practical use of Fisher's consumption-based definition of the national dividend results from the lack of adequate data to describe the consumption of millions of consumers in the country. But that hasn't been true since 1984, when the U.S. Bureau of Labor Statistics and the U.S. Census Bureau teamed up to conduct the Consumer Expenditure Survey. We actually now have three decades worth of solid data to estimate the money value of total consumption in the hands of millions of consumers in the country. That's something that wasn't possible in the early 20th century when these concepts of National Dividends or National Income were being fleshed out.

On reflection, we think that the second and third arguments listed above turn out to be immaterial, in that it is not necessary to allot a definite life to each and every good in order to find out the money value of consumption in a particular year.

Here's why. Taken in the aggregate, all consumer goods and services purchased in a given year are, in effect, fractionally consumed among all consumers, or as the BLS and Census Bureau affectionally refers to them, "consumer units", which are roughly the equivalent of households.

Piano - Source: http://blogs.sos.wa.gov/library/index.php/tag/washington-state-penitentiary/

For example, in 2007, the CEX reports there were 121,700,000 consumer units counted in the U.S. economy, who purchased some 62,536 new pianos, to use Irving Fisher's example. The number of purchases in that year automatically incorporates the durability factor of pianos, because those who purchased new pianos in previous years are still in the process of consuming them. Except perhaps for the fraction of those whose pianos have reached the end of their lifespan, who will stop consuming their old pianos.

If you were then to add up the fractional consumption of pianos across all piano consumers in the nation, we should reasonably expect their total number to work out to be well within the ballpark of the number of new pianos purchased annually. And while supply and demand factors will most certainly apply, changes in the number of new pianos consumed annually could also be considered to be varying with respect to the desired consumption rate of pianos across the nation, where their expected effective duration of consumption from year to year is a driving variable.

In practice, we would potentially see that dynamic play out with piano consumers holding off on making new purchases and extending the life of their old pianos during periods of recession, and perhaps more often retiring and replacing their pianos at a much faster pace during periods of economic expansion, where they would increase their consumption of new pianos.

There is also the challenge of how to cope with changes in the value of durable goods like pianos whenever they are exchanged among the population of consumers.

But we think that's also immaterial, because it's really a matter of how the consumers choose to pay for the exchange. As a general rule, piano consumers have two ways in which they can obtain a piano in a transaction. First, they can transform assets they already hold, and which are not counted as part of the National Dividend under Fisher's definition, such as tapping the cash they may have in a savings account, to pay what they believe is an equivalent value for the piano they would rather have. In this case, there is no net change in the measurable quality of life for those participating in this kind of transaction because they have only exchanged assets of equal value between themselves.

Second, since a durable good like a piano can also represent a relatively high dollar purchase for most households, costing anywhere from $3,000 to $100,000, piano consumers could also finance some or all of their acquisition with debt. In this case, we can consider the term of their loans to be reasonably proportionate to the expected life of their new asset, where their debt payments will be spread out over the life of the instrument, reflecting its expected consumption.

That means that we can directly calculate a true national dividend representing by taking the aggregate total of all consumer expenditures among all consumer units/households by subtracting the net change in their total liabilities from one year to the next. The result of that math would be a good indication of degree to which such consumers in the aggregate have sought to attain a particular level of quality of life today at the expense of impairing their quality of life tomorrow, as the bills for their desired consumption come due.

Let's do that math now with the data available from the Consumer Expenditure Survey. Our first chart shows the National Dividend for the average American consumer unit/household in nominal (current year dollar) terms for the thirty year period from 1984 through 2013:

Nominal U.S. National Dividend per Consumer Unit, 1984-2013

Let's next adjust these numbers to account for the effect of inflation over time, with respect to the Consumer Price Index for All Urban Consumers, in All Cities, for All Items, so that the values are expressed in terms of constant 2013 U.S. dollars.

Nominal U.S. National Dividend per Consumer Unit, 1984-2013

Examining this second chart, we find that over time, an increasing level of debt is being used to sustain the quality of life of American consumer units (households) at a relatively constant level. After accounting for the accumulation of debt via the true national dividend however, we confirm that the typical American consumer unit household would appear to becoming worse off over time.

There are a lot of questions that need to be addressed in this kind of analysis that we haven't yet touched upon. For example, how much could the shifting age demographics of the U.S. population of consumers be contributing to this pattern? Likewise, could generally falling levels of prices for major consumption items like food over time be responsible, which would actually represent an improvement in quality of life as measured by our application of Irving Fisher's national dividend concept?

For a concept that's been around since 1906, we're only just now at the beginning of understanding what the calculation of the national dividend is telling us.

References

U.S. Bureau of Labor Statistics. Consumer Expenditure Survey. Total Average Annual Expenditures. 1984-2013. [Online Database]. Accessed 14 March 2015.

U.S. Bureau of Labor Statistics. Consumer Price Index - All Urban Consumers (CPI-U), All Items, All Cities, Non-Seasonally Adjusted. CPI Detailed Report Tables. Table 24. [Online Database]. Accessed 14 March 2015.

U.S. Bureau of Economic Analysis. National Income and Product Accounts Tables. Table 1.1.5. Gross Domestic Product. [Online Database]. Accessed 14 March 2015.

Kennedy, M. Maria John. Macroeconomic Theory. [Online Text]. 2011. Accessed 15 March 2015.

Chand, Smriti. National Income: Definition, Concepts and Methods of Measuring National Income. [Online Article]. Accessed 14 March 2015.