Financial Recovery Strategies For Tough Times

Financial Recovery Strategies

for Tough Times

Barbara O’Neill

Rutgers Cooperative Extension

[email protected]

Workshop Objective

Provide practical financial planning strategies to help people deal with the financial aftermath of the Great Recession and “broken promises”

– Income losses and reductions

– Benefit reductions and cost increases

– Changes resulting from legislation (e.g., ACA)

How Many of You Were Personally Affected by the

Great Recession?

2013 Rutgers Study: 73% of Americans were touched

personally: http://news.rutgers.edu/medrel/news-

releases/2013/february-2013/rutgers-heldrich-cen-20130207

New Normal Analogy

The “New Normal” and

Trump Plaza Hotel

Penthouse (Atlantic City, NJ)

What is the “New Normal”?

• A constellation of economic events coming together

– Projected to linger throughout much of the 2010s decade

– Rebounds: 2017 for labor market? 2021 for housing market?

• Different trends than those experienced previously

• Puts a “framework” on recent events

– People like to identify patterns to make sense of them

• Some NN trends will have long-lasting impact (e.g., questions about employee benefit sustainability)

“New Normal” Characteristics An extended period of:

• Slow U.S. economic growth (GDP)

• Low single-digit average annual stock returns

• Stubbornly high unemployment levels

• Precarious job security (public and private sector)

• Struggling housing market

• Tightened credit standards

• Increased precautionary household savings and debt repayment

• Constrained household spending

Baby Boomers and Older Gen Xers Especially Affected By the Financial Crisis

• Fully experienced, not just one asset bubble- BUT TWO- during long stretches of their working lives – “Tech Bubble” and extraordinary run of double-digit stock

market returns in late 1990s

– “Housing Bubble” during much of the 2000s

• Limited recovery time for battered investments

• Money Magazine (April 2009):

“A generation of Americans grew into middle age thinking that they had more wealth than they really did and their future was a lot more secure than it really was.”

Key Theme During Past Years Peggy Noonan reply to question from Maria Bartiromo about “game-changing events during 2011” on Wall Street Journal Report, 1/1/12

“The fall of structures that we’ve come to rely on” and “Lots of insecurity”

Workers can’t even count on income and

benefits promised in their CURRENT labor

contract, not to mention promises made

years ago when they were first hired.

What’s Happening?

Era of Broken Promises

• Terminated pensions

• “Church plan” pension exemptions from ERISA

• Suspended 401(k) matches

• Salary cuts and freezes

• Furloughs

• Benefit cuts

• Pension COLA cuts

• Others

While recent media reports have covered angry protests directed at public employees whose pension and health benefit packages lasted longer than most in the private sector…

…the REAL ISSUE is that workers in both the public and private sector have lost critical pillars of financial planning support that they once thought they could count on!

The Real Cause of Anger

• Increasing numbers of public (and private) sector job benefits have been overhauled

– Employers realizing previously-promised benefits are unsustainable and/or unaffordable

– Politically popular to slash public employee benefits

• More than half of public pensions are <80% funded

– < 80% level deemed “substantially underfunded”

• Defined benefit (DB) pension formulas and COLAs especially under attack

Retirement Benefit Challenges

• Lower benefit tiers for new hires

• Retirement ages raised (e.g., 55 to 60, 62 to 65)

• Automatic COLAs eliminated or scaled back

• COLAs tied to pension plan performance

• Changes in pension benefit formulas

– Elimination of “sick day” bonuses

– Change from “High 3” average salary formula to “High 5”

Frequent Pension Changes

• “High Three” Average Formula

– Years of Service/55 x Final Average Salary

– 35/55 x $60,000 = $38,181 annual pension ($3,181/month)

• “High Five” Average Formula

– Years of Service/55 x Final Average Salary

– 35/55 x $58,000 = $36,909 annual pension ($3,075/month)

• Difference of $1,272/year and $106/month

Case Example

• Workers’ coverage is decreasing and/or they are increasingly paying more for:

– Premiums

– Deductibles

– Co-payments

• From 2000 to 2010, average premiums for family coverage through an employer increased 114%

• More employees’ ONLY option is high-deductible health insurance

Health Benefit Challenges

• Any income or benefit promise can be broken…even in union contracts

• NO employee benefit is “guaranteed”

• New economic realities require adjustment to avoid

– Accumulating debt due to negative cash flow

– Setting aside inadequate retirement savings

– Outliving retirement assets

• Proactive planning can mitigate benefit losses

What Do These Changes Mean?

• Work longer

• Beware of stampedes

• “Retire” while working

• Accelerate debt repayment

• Save the shortfall

• Consider career changes and/or freelancing

• Consider investing more aggressively

• Spend less and shop savvy

• Investigate new benefit alternatives

• Keep an eye on government benefits

What Should People Do When Income and/or Benefits are Cut?

• Time is an enemy (twice) for early retirees

– Fewer working years to accumulate personal savings, pension benefits, and SS

– More non-working years to finance

• The years just prior to normal retirement age are usually a period of peak earnings

• May have more control over “service” part of DB pension formula than “average earnings”

– Example: tenured professor with a pay freeze

Work Longer

• Employees heading for the door in droves fearing that an employer will cut benefits

• Employers could cut benefits anyway (no guarantees that you’ll be “grandfathered”)

• Examples:

– NJ state workers, teachers, uniformed personnel

– Federal government workers?

• In many cases, longer service will mitigate benefit reductions (e.g., loss of COLAs)

– Increases “Years of Service” part of DB pension formula

Beware of “Stampedes”

• Standard Strategy #1- Retire at a planned age with less money than anticipated due to NN events and risk running out of money due to benefit cutbacks, increased health care costs, longevity, etc.

• Standard Strategy #2- Retire later and risk “waiting too long” (e.g., after age 65-70) so that death, health “issues,” widowhood, etc. hinder planned retirement lifestyle and/or quality of life.

• New Strategy #3- Keep working BUT use money that had been going into savings (i.e., suspend or reduce 401(k) or 403(b) contributions) to begin enjoying “retirement activities” NOW without actually retiring.

https://www2.troweprice.com/iws/wps/wcm/connect/d2edab0046d7abf0a87eb899d35c25cc/04779-23_P1.pdf?MOD=AJPERES&CACHEID=d2edab0046d7abf0a87eb899d35c25cc (Fahlund, C. Delaying Retirement, But Not Your Retirement Dreams)

“Retire” While Working

Accelerate Debt Repayment

• Mortgage principal pre-payment

–Retire mortgage before retirement

• Mortgage refinancing (lower interest rate)

• PowerPay (consumer debt)

–www.powerpay.org

• Calculate amount lost from a retirement benefit cut

• Multiply by 25 to determine shortfall savings goal

• Do the math and develop an action plan to save

– Younger workers need to save < older workers

• Example: $6,000 annual benefit loss

– Need to accumulate $150,000 by retirement ($6k x 25)

– Age 45: $3,660/year or $305 per month

Save the Shortfall

• Public sector employment benefits are generally not as attractive as they once were

– Newer tier hires often have lower benefit tiers

• Option #1: Changing jobs could lead to better benefits; less stress

• Option #2: Aggressively demonstrate value to current employer (to earn a promotion)

• Option #3: Freelance for additional income or to replace lost income due to benefit plan changes

– Increased health insurance cost-sharing

– Increased pension plan contributions

Consider Career Changes and/or Freelancing

• Even with elimination of COLAs, people with DB pensions have income for life (acts like an annuity)

– Ditto for Social Security

• Most retirees with DC plans have risk of an ever-changing sum of money that needs to last a lifetime

• May be able to invest more aggressively if you have streams of lifetime income

• Know your risk tolerance: http://njaes.rutgers.edu/money/riskquiz/

Consider Investing More Aggressively

• Unpleasant as it is, some people may need to spend less to adjust to the effects of broken promises

• Adjusting to less support from an employer or government may be a necessity, not an option

– “Stepping down” spending

– Moving to a smaller/cheaper home

– Phone apps to compare prices

– Coupons and groupons

– Asking for discounts

– Fewer trips and gifts (e.g., retirees)

– Other ideas?

Spend Less and Shop Savvy

• Explore benefit options that you might not have considered previously

– High-deductible health insurance and an HSA or HRA

• Do a cost-benefit analysis of alternatives

– Premium savings from high-deductible plan vs. amount of out-of-pocket payment

• Attend benefit fairs/seminars and ask questions

Investigate Benefit Alternatives

• Changes to Social Security

– More needs-based? Older age? Lower benefits?

• Changes to Medicare

– More needs-based? Older age? Lower benefits?

• New health care law and aftermath

• Consider using very conservative benefit estimates for financial planning purposes

• Assume that you can’t count on promised benefits?

Keep an Eye on Government Benefits

Major Take-Away: Focus on What You CAN Control

CAN’T Control

• Speed of economic recovery

• Financial markets

• Labor market/unemployment rate

• Housing market

• Employee benefit cutbacks

• Political environment

• Actions of lawmakers

CAN Control

• Healthy lifestyle

• Spending habits

• Saving habits

• Investment expenses

• Human capital investments

• How you spend your time

Select What Works for You • Think of these strategies as a

“Jersey diner menu”

• Adopt strategies that work for you

Questions? Comments? Experiences?

Barbara O'Neill, Ph.D., CFP®

Extension Specialist in Financial Resource Management,

Rutgers Cooperative Extension

Phone: 848-932-9126

Fax: 732-932-8887

E-mail: [email protected]

Twitter: https://twitter.com/moneytalk1

Financial Education Resources:

http://njaes.rutgers.edu/money/default.asp#resources