Archives for February 16, 2019

There’s a common misconception that any credit check lowers your credit score and hurts your ability to get approved for loans and new lines of credit, but this is only sometimes true. There are actually two different types of credit checks — hard and soft inquiries, and they depend on what the information is being used for.

Hard inquiries can hurt your score while soft inquiries don’t make a difference at all. I discuss the differences between hard and soft credit pulls and the situations in which you might encounter each kind of inquiry.

What is a soft credit inquiry?

A soft inquiry (or soft pull) occurs when your credit report is not being used to make a lending decision, so it doesn’t count against your credit score.

For example, if an employer were to pull the credit report of a job candidate, this would be a soft inquiry because they are not using this information to determine whether or not to lend the person money. They simply want some background on them and how they handle their finances.

Pre-approved credit card and loan offers also use soft credit inquiries. The company is trying to attract your interest by showing you what you may qualify for, but it will not actually make any lending decisions unless you fill out an application. When you check your own credit report, this is a soft inquiry as well. It doesn’t matter how many soft inquiries you have because they don’t show up on your credit report and they don’t impact your credit score at all.

What is a hard credit inquiry?

Hard inquiries (or hard pulls) are the credit checks that lenders conduct when they’re making a lending decision about you. When you apply for a mortgage, car loan, credit card, or even a home rental, the lender runs a hard credit check.

These inquiries will drop your credit score, but usually by five points or less. A single hard inquiry is not enough to seriously hurt your credit score, but if you have several hard inquiries on your report, these small point deductions will add up and could affect your ability to secure new credit in the future. The good news is, companies can only initiate a hard credit inquiry if you request it. A credit card company can run a soft credit check to send you a pre-qualified offer, but they can’t run a hard credit check unless you actually apply for the card.

Not all hard inquiries are treated the same. It’s normal to shop around when you’re in the market for a loan or a line of credit, and credit scoring models account for this. Any credit inquiries that take place within a 30-day period are usually counted as a single inquiry on your credit report. But if you have more hard credit checks on your report after this period, they will show up as separate inquiries and your score will drop another few points. That’s why it’s best to complete all of your loan or credit card applications as close together as possible. Too many hard inquiries indicates a heavy reliance on credit, a red flag to lenders because it suggests you’re living beyond your means and may be unable to pay them back.

Dispute inaccurate hard inquiries

Everyone should check their credit reports at least once per year to ensure that their information is accurate.

Your credit reports contain information on all of your credit accounts and they’re used by lenders to assess your financial responsibility. They’re also what your credit scores are based on, so you want to make sure there aren’t any mistakes. You’re entitled to one free report per bureau per year through AnnualCreditReport.com. Here, you’ll be able to see records of all of your financial accounts and any hard inquiries on your report. Look for any inquiries that you don’t recognize. This could be a sign that an identity thief applied for a fraudulent credit account in your name.

If you spot an erroneous pull, notify the credit bureau immediately. You should also reach out to the financial institution that ran the credit check to let them know that you did not request it. It may take some time, but the credit bureaus are legally required to remove the hard inquiry from your report if it is inaccurate. If the inquiry is accurate, you’ll have to wait two years for it to fall off your record.

It’s essential to understand the differences between hard and soft inquiries in order to keep your credit score in the positive range. Always plan carefully when you apply for a new credit line and keep a close eye on your credit reports to ensure they are accurate representations of your financial history.

Few, if any, social programs pack a punch for the American public quite like Social Security. This is a program that provides a benefit check to nearly 63 million people each month, 7 out of 10 of whom are retired workers. Of these retirees, 62% lean on their monthly payout to account for at least half of their income. In other words, without Social Security in place, we’d likely be staring down a serious elderly poverty problem.

Social Security’s Judgment Day is rapidly approaching

Then again, it’s also a program that’s on thin ice. Beginning sometime in the very near future, Social Security is expected to expend more than it collects in revenue for the first time since 1982, the year prior to the Reagan administration passing the last major overhaul of the program.

What could cause such a reversal of fortune for Social Security? Part of the blame, through no fault of their own for simply being born, is that baby boomers are leaving the workforce at a faster rate than new workers can replace them, leading to a decline in the worker-to-beneficiary ratio. Other factors at fault include increased longevity over many decades, growing income inequality, and lower fertility rates.

If there are consolations here for existing and future beneficiaries, it’s that the program is in no danger of going belly-up, and it does have almost $2.9 trillion in asset reserves built up since inception. The problem is that these asset reserves can only hold up for so long if Social Security is spending more than it’s collecting each year. That’s why the latest Trustees report has projected that the entirety of this excess capital will be exhausted 15 years from now, in 2034. Should Congress fail to amend the program in order to generate additional revenue, a sweeping cut to benefits of up to 21% may be needed to sustain payouts through 2092.

Immigration is a net positive for Social Security

However, the factors listed above aren’t the only things influencing Social Security. Immigration tends to play a very large role as well. In fact, immigration and its impact on the program might be one of the most misunderstood aspects of Social Security.

When the Trustees release their annual report looking at the short-term (10-year) and long-term (75-year) outlook for Social Security, one of the key factors examined is the immigration rate. Immigration is itself a net positive for the Social Security program. That’s because a majority of legal immigrants tend to be younger in age, meaning they’re going to be a part of the American workforce for decades before retiring. These immigrating workers, and the payroll tax revenue they’ll provide, are very much needed to help support payouts to current and future generations of retirees.

Meanwhile, undocumented immigrants aren’t allowed to receive benefits since they have no legal pathway to receiving a Social Security number (SSN). That doesn’t stop some undocumented workers from using a fake SSN or a friend’s SSN to get a job, ultimately paying billions of dollars into the system annually without any chance to ever collect a red cent in return.

Though the immigration debate is contentious, there’s little doubt that immigration is having a positive outcome on Social Security.

Quantifying the impact of immigration on Social Security

The bigger question, I believe, has always been just how much of an impact is immigration having on Social Security, in dollar terms. The Trustees report provides a roundabout answer to that question.

Each year, the Trustees report examines the 25-year, 50-year, and 75-year actuarial balance based on three levels of average annual net immigration. In the 2018 report, these were 952,000 persons, 1,272,000 persons, and 1,607,000 persons. Regardless of the time period (25, 50, or 75 years), the actuarial balance — i.e., the amount Congress would need to raise the current 12.4% payroll tax rate today to fully cover the projected cash shortfall over a defined number of years (in this case 25, 50, or 75 years) — decreases as average annual net immigration increases. Over the long run, the report notes that for every 100,000-person net increase in average annual immigration, the long-term actuarial deficit drops by about 0.08%. The opposite is true if net immigration declines over time.

To put this in an easier-to-understand context, the long-term (75-year) actuarial deficit in 2018 was 2.84%. This means that if the payroll tax were increased from 12.4% to 15.24% (2.84% higher), it would presumably eliminate the $13.2 trillion cash shortfall currently projected between 2034 and 2092. But if, for example, net immigration into the U.S. were doubled to roughly 2.5 million people annually, it would lower the long-term actuarial deficit by about 1%. This would, presumably, lower the program’s long-term cash shortfall by trillions of dollars.

In today’s dollars, 0.08% of taxable earnings probably doesn’t sound like a lot. But for each 100,000-person increase in net immigration, it would result in approximately $5.6 billion in added payroll tax revenue for the program, per year. That’s given the assumption that roughly $7.05 trillion in earned income was subject to the payroll tax in 2017, as evidenced by the $873.6 billion in collected payroll tax revenue. That’s not chump change, and it’s certainly something to keep in mind as the immigration debate rages on.

If you find retirement planning daunting, a target-date fund purports to offer relief. They’re designed to provide a “set it and forget it” investment solution for individuals with a long-term savings goal, like retirement.

While target-date funds have certain benefits, their cookie-cutter approach also has its drawbacks. You may already have a target-date fund in your retirement account, as it’s the default fund used by employers who auto-enroll their workers into workplace savings plans. But you can override your employer’s deicison, and you should do some research before investing your precious retirement savings in target-date funds. Here’s a look at the pros and cons of target-date funds and how to choose one that’s right for you.

What are target-date funds?

Offered by retirement accounts providers and brokerages, target-date funds usually have names that include the targeted retirement year.

For example, if you plan to retire in 2030, you would choose a 2030 target-date fund within your 401(k) or IRA. Target-date funds are often mutual funds containing a variety of investment products, like stocks and bonds, to keep your money diversified. As you near the fund’s target date, its asset allocation automatically shifts to align with your decreasing risk tolerance, so you don’t have to worry about reallocating the funds yourself as you near the end of your career.

The benefits of target-date funds

Target-date funds are popular among hands-off investors for their simplicity. In theory, all you have to do is choose the right fund that corresponds to your planned retirement year and then sit back and wait.

The risk is selected for you by the pros: If the planned retirement date is a long way off, the fund will contain a larger percentage of higher-risk investments, like stocks. Then, as your retirement date gets closer, it will automatically adjust the asset allocation to account for your diminishing risk tolerance, moving more of your money into more stable investments that deliver income, like bonds. This way, you don’t have to worry about losing a large chunk of your nest egg on the eve of your retirement if the stock market takes a dip.

The automated nature of these funds can also help to prevent emotional decision-making. Some investors may be tempted to buy or sell an asset impulsively based on recent performance if they’re managing their own investments, which hurts the value of their savings over time. But with target-date funds, you don’t have to worry about when to reallocate or what to invest in because these decisions are already made for you.

The drawbacks of target-date funds

The simplicity that makes target-date funds so appealing can also be their biggest drawback. The cookie-cutter approach cannot account for individual lifestyle changes or changing market conditions.

A target-date fund may seem like a good fit for you today, but it may not be in the future. For example, say you planned to retire in 2050, but then something happens and you end up retiring in 2040 instead. While the investments in your 2050 target-date fund may be well-suited to someone who is actually retiring in 2050, they may be too volatile for your new, diminished risk tolerance.

All target-date funds are different, even those with the same target year. The mix of investments and when your assets are reallocated varies from one to the next. This can not only impact the performance of the target-date fund, but also its cost.

Target-date funds can be composed of individual stocks and bonds, but they’re most commonly mutual funds, meaning they charge shareholders an expense ratio, or annual fee that’s a percentage of your assets. Actively managed mutual funds — those that are managed by a real person — tend to have higher expense ratios than passively managed funds that track an index. If your target-date fund contains a number of expensive assets, the fees could eat into your profits and inhibit your portfolio’s growth.

You can find out how much you’re paying in fees by looking at the prospectus for your investments or by using FINRA’s Fund Analyzer tool. Enter a fund’s name and it will show you how the fund’s fees will impact the value of your savings over time so you can estimate which target-date fund will provide the greatest return for the lowest cost.

The average target-date fund has an expense ratio of 0.66% per year, according to Morningstar. This means that for every $1,000 you have invested in the target-date fund, you will pay $6.60 per year. However, there are some target-date funds that only charge 0.12% or less per year. Look for one of these to keep your costs low.

How to choose a target-date fund

Target-date funds can be a smart addition to your investment portfolio, especially if you want a one-stop solution to retirement savings, but like any investment, it’s important to do your research before handing over your hard-earned money. Look at the options for your planned retirement year and compare their investment allocations and costs.

Every target-date fund will have a unique mix of investments and a different glide path, or the rate at which the investments in the target-date fund shift from more aggressive to more conservative.

There are two main types of glide paths. A “to retirement” target-date fund is designed to reach its most conservative asset allocation on the target date. After that, its asset allocation will not change. A “through retirement” target-date fund will reach its most conservative asset allocation after your target date. This can make them a little riskier, but they may also continue to generate larger returns in retirement because of this.

Target-date funds are designed to be stand-alone investments, but if you want to invest in other things as well, it’s important to be mindful of the asset allocation in your target-date fund. Calculate how much of your money in the target-date fund is in stocks, bonds, and other investments and decide if you’re comfortable with this ratio. If you are, you may want to invest any additional savings similarly. But if you feel that your target-date fund is too conservative, for example, you may want to invest more in stocks in order to get to your preferred risk tolerance.

It’s still a good idea to check in on your target-date fund periodically to see how it’s performing and to ensure that you’re still comfortable with the asset allocation. If for some reason you’re not, you may want to consider switching to a different target-date fund or investing your money in other investment products instead. Remember, this is your retirement savings on the line, so it can’t be taken lightly.

With life expectancy and inflation rates rising, Americans are increasingly delaying retirement as they fear their nest egg running out.

How should one combat this? Well, you could always plan for a shorter retirement, simply because it would be easier to manage costs over a shorter time frame. You could also take up a part-time job during retirement, and make small investments from any accumulated wealth to ensure a steady source of income.

Apart from these, strategic planning and a few calculated measures can also help solve this problem.

Cutting Down on Spending

This is the first step to making retirement savings last a lifetime. Slashing your expenditures simply means you will need to withdraw less from your retirement accounts each year, which boils down to a lower tax bill. This is because most sources of retirement income (such as withdrawals from retirement accounts funded with pre-tax income, withdrawals from annuity, and a pension income) are taxable under the ordinary income tax rate. Even social security income is partially taxable for some individuals. Heavy tax bills in retirement can eat away a major portion of your yearly withdrawals.

The key to lowering taxes in retirement is to stay tax-free for as long as possible, as tax-free savings will keep growing due to the power of compound interest. In this regard, it is important to know which retirement accounts to withdraw from first. To allow tax-free savings for a longer period of time, think about withdrawing from the accounts that were funded with post-tax income, simply because you will be not be taxed on it again.

In order to further dodge taxes, you can try converting your traditional 401(k) or IRA accounts into a Roth IRA, as withdrawals from the latter are not taxed as ordinary income. Traditional 401(k)s and IRAs require you to take the required minimum distribution (RMD) past the age of 70 ½, under which you will be taxed on the amount withdrawn.

Conversion into a Roth IRA will enable tax-free savings for as long as you want as it does not involve RMDs. However, make sure to consult your tax advisor regarding the tax implications of a Roth IRA conversion. That said, with a Roth IRA conversion, you will be able to save a huge amount in taxes over the long run.

Withdrawal Rate

When it comes to annual withdrawals in retirement, the age-old tradition is to follow the 4% rule. While the rule is a good guide to an annual withdrawal rate, with changing circumstances, relying solely on this rule might not be the best thing to do. Under the rule, you withdraw 4% of your nest egg value in the first year, followed by inflation adjustments in the subsequent years.

For instance, if your total retirement savings is worth $1 million, you will withdraw $40,000 in the first year. If the inflation rate is 2.5% the next year, you will withdraw $1000 (inflation amount: 2.5% of $40,000) more, i.e., $41,000. The rule assumes a portfolio that consists of 50% in stocks and 50% in bonds. If followed the correct way, proponents of this theory say there is a 90% chance your nest egg will last 30 years, which certainly isn’t a bad figure.

However, with lower bond yields in recent years and stock returns forecast to be modest for the next several years, the theory might fail to yield desired results. Taking these into consideration, some theorists have come up with a 3% safe withdrawal rate.

Although a tad conservative, this approach is believed to be sustainable through retirement even under an inflation rate as high as 7%, something that the 4% rule can’t live up to. However, keep in mind that the approach assumes an asset allocation of 50% each in stocks and bonds. So, in case you make alterations to this stock-to-bond ratio, you might have to make adjustments to the withdrawal rate.

You may want to take note of Trinity study’s findings. The updated study found that the 3% withdrawal rate had a 100% success rate over a 40-year retirement period, even when the stock allocation was increased to a maximum of 100%. Meanwhile, the research produced a success rate of 98% with 25% in stocks and 75% in bonds.

Vanguard’s “dynamic approach to spending” allows flexible annual withdrawals equal with market performance. So, you start with a certain withdrawal rate — say 5% — in the first year, and if the market performs sluggishly in the next, you can cut down your withdrawal rate. Conversely, when the market is favorable you can raise your rate of withdrawal. However, the withdrawal rate should never go below 2.5% or above 5%. This timely adjustment to your withdrawal rate is another great way to ensure lifelong savings. Essentially, it has a success rate of 92% over 35 years of retirement with an equal mix of stocks and bonds.

Comparing these withdrawal strategies, a pre-set 3% withdrawal rate is certainly easier to follow. Given the 100% success rate over the long term with an appropriate stock and bond mix, this is no doubt a safe way to protect your portfolio from early exhaustion. However, most financial experts are in favor of a more versatile approach to spending, with a withdrawal rate that fluctuates as and when market conditions change.

Stock Allocation

The traditional approach is to cut back on stock allocation in your portfolio as you age. Experts now believe that with an extended retirement period, one needs to hold more stocks in order to sustain high inflation rates over the course of retirement. That is to say, you should gradually increase stock weightage through retirement, keeping it low in the beginning. In the initial years of retirement, your stock exposure should be as low as 20%, and slowly tread up to 70% in the final years.

Without a steady source of income, one is extremely vulnerable to market downturns during the initial years. If the market takes a hit during this time, considerable stock exposure would make it very difficult to overcome the dent in portfolio. Now, considering historical data, stocks on average have shown a 7% annual rise in the long term.

So, as your retirement years go by and after you have built substantial portfolio wealth, you can gradually increase your investment in stocks to bolster your portfolio and make it last through retirement.

Delay Social Security Benefits

Social Security can be viewed as a form of insurance that provides monthly checks during old age and offers a hedge against inflation. When you start taking social security benefits at full retirement age, you are eligible to receive the full benefit.

Delaying your benefits even after the full retirement age will earn you a credit of 8% each year for as long as you withhold. However, past the age of 70, you will not receive additional benefits for delaying the claim. Take this example: your retirement age is 67 and you start taking benefits at the age of 70. In this case, you will receive a credit of 24% (8% in each of the three years) over and above your full benefit, i.e., each of your monthly checks will increase by 24%. This approach is essentially for those who expect to live longer than the average life expectancy. For those who are certain to not cross the average life span, delaying might not offer additional benefits.

Bottom Line

While the above-mentioned ways are a good guide to make retirement savings last a lifetime, any financial decision that you make in this regard should take into account your financial situation and life expectancy.

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