r u l y

The world awaits the wedding of the century (and to be sure an amazing feat of organization!) tomorrow, between Prince William and Kate Middleton. We are all getting quite an education on the royal family in the news of late, furthering our fascination with these people who seem half-real, half imagined.  Below are some of my favorite news articles on the royal wedding:

• “Their royal lownesses (Or why, at 6ft 3in, Prince William towers over his titchy royal ancestors),” The Daily Mail, December 19, 2009. – In addition to seeming larger-than-life, Prince William is a real-life giant.  He is the tallest royal ever, besting “Longshanks” Edward I and Charles II by an inch.  We owe Princess Diana for this height advantage, as she measured in at nearly 5ft 11 in!  Kate Middleton is no shrimp either at 5ft 10!
• “Royal Look-Alikes in History,” People Magazine – You must check out this photo gallery comparing today’s royals with their ancestors.  The likenesses are incredible!  What a great idea for organizing your own family photos and connecting your children with the past.
• “This will have you in stitches: How to knit your own Royal wedding line-up (… including the Archbishop of Canterbury and a couple of corgis),” The Daily Mail, March 10, 2011.
• “An Update on Maid of Honour and Bridesmaids, Best Man and Page Boys,” Official Royal Wedding Website, February 14, 2011, I am most looking forward to seeing the children in the wedding.  I loved how in this announcement some of these little girls are referred to as “The Lady ___” or “The Honorable ____” and the little boys as “Master ___.”  Can’t wait to see how the two 3-year old girls look!

Of course, the knitting article pulled at my heart.   Vogue Knitting also posted a link on their Facebook page to a similar free William & Kate knitted pattern from Galt Toys.

I decided my little girls needed a prince and princess of their own and set to work.  The only changes I made to the pattern were to cut it down to half-size so that the dolls were more pocket-sized.

Making the toys more special to us was the fact that I made them out of odds and ends of yarn inherited from my Yiayia.  My Yiayia was an incredible knitter herself and the one who taught me how.  I knew she would love that her scraps were used to make a princess for her own little princesses.

I made Kate first.

I went for a romantic Kate with hair down and flowing with flowers in her hair and a long lace train.  You may recognize the lace fragment as leftover from our Halloween costumes last year.

This was my oldest daughter’s first intelligent exposure to a wedding (although she served adorably as a flower girl at 2).  She wanted to know why Kate’s train was so long and found it very magical.

“Can she fly?”

I knew my little girls would love the Kate doll. My oldest is at the age where she makes clear distinctions between boy things and girl things with boy things being clearly less desirable.

“Would you like me to make Prince William too?”

I was expecting a “no.”  In an encouraging sign to the young princes of the world, she consented.  As I was working on Prince William, I at one point referred to him as a doll, not realizing that he too was magical in my daughter’s eyes.

“He’s not a doll!  He’s a prince!”

My William came out a little more like a postman than a military officer but the general idea is right.  The faces on these knitted folk are tough to execute.  Clearly, I need a little more practice but we are having fun with them.

We have had many interesting play sessions about the wedding.

So far, this is my daughter’s current understanding of marriage:

“When you get married, you wear a pretty dress and a big hat in your hair.  Then people sit and clap for you.”

Congratulations to the new couple! May all my readers find their Princess/Prince Charming and live happily ever after!

Will you be up at 4 a.m. (or earlier) to watch the big event tomorrow?

"Bank book & budget book, N.Y. Office" (ca. 1940) Photo by Harris & Ewing. From the Library of Congress Prints and Photographs Division.

This month’s discussion of organizing your retirement planning, a critical step in organizing your finances, has been very helpful to me personally.  I still don’t feel that I have a complete grasp of everything 401(k)-related, but I have learned quite a bit about where to focus my efforts.  For those who want the advice in a quick checklist format, here it is:

Actions to Take at Any Time but Particularly Before You Invest in a 401(k) Plan

1.   Check out your 401(k)’s rating on brightscope.com – The brightscope rating doesn’t tell you a whole lot about your plan but it does give you a general sense of how well your plan is performing compared to 401(k) plans at other companies.  When we looked up our plans, our lowest-rated plan (rated “average”) had given us a far lower rate of investment return (about 66% lower) than another of our plans rated in the “average-high” category with roughly equivalent investment allocations.  If your plan is rated poorly, you might consider what other investment opportunities are available to you and whether the employer match and/or tax benefits outweigh the plan’s poor performance.

2.   Check out the loan and withdrawal provisions for your 401(k) Plan – While you should intend never to withdraw your money until retirement, you should at least know whether you have the option to take a loan and/or early distribution from your plan should you ever have a true emergency.

3.   Check out the Morningstar rating for each mutual fund you invest in – From my experience, you can’t rely on the Morningstar rating exclusively but in general, funds with a 4 or 5 rating do better than lower-rated funds.  If your plan contains only low-rated funds, you might not want to invest very much into your plan or consider other options.

Actions to be Taken Annually

4.  Review/update your retirement contribution projections – This would be a good task to do perhaps at the end of the year when you are putting together your resolutions and budgeting for the next year.  Review how your 401(k) investments have done, check the rate of inflation and plug it into a calculator (such as one of the calculators I described here), to see if you are on track.  If you are unable to contribute in a given year, run a quick check on how much additional money you will need to be contributing in the future to stay on track for your retirement goals.

Actions to be Taken Quarterly

5.   Review Your Quarterly 401(k) Statements – At a minimum, you should be checking in on your 401(k) every 3 months to see how you are doing.  The quarterly statements issued by your plan will tell you how much money you contributed, how much your employer contributed and how much money you invested in each fund in the plan.  Learn from my mistake and make sure that you are saving these statements either on paper or electronically in case you need them for future reference.  It is a good idea to track the raw dollar amount you contributed to the plan as a whole and in each fund in a spreadsheet for yourself, since what you want to focus on is how well a fund is doing based on the dollars you put in versus the current market value.  Your 401(k) statement may do this for you but we found in our plans that often the 401(k) statement was readjusting its return calculations based on the market value of the prior statement.  So, if the market fell one quarter and you actually lost money on the first statement and then the market rose in the next quarter, all the next statement might tell you is that you had a positive return compared to the first quarter, while in truth, you still might have less than your initial investment.

6.   Review Your Investment Mix – Using the quarterly statement, see how much money you have invested in various types of investments.  The 3 main categories are stocks, bonds and cash-equivalents but some investment strategies require you to be even more specific such as small-cap, mid-cap, large-cap and international stocks.  Check to make sure your investment mix makes sense for your age.  Most 401(k) plans have investor information on their websites to help with these types of decisions.  You could also consult a good investing book or professional adviser.  If your investment mix is off, you may need to “rebalance” which means that you sell/transfer moneys between your different funds or adjust how future contributions are allocated.

Actions to be Taken Continually

7.   Use Technology to Track Your 401(k) – If you use an automatically updating financial took, like Quicken or Mint.com (a free service), your 401(k) balance can be updated with minimal effort from you.  I used to think that this was the way to stay on top of a 401(k) but the level of detail here is too much.  For most people, knowing the exact purchase price of each buy in each fund and the amount of dividends issued in your plan is not something that is going to make a lot of sense in terms of evaluating how your money in general is doing.  Your quarterly review (see #3 above) where you take a step back and focus on the big picture is going to be a lot more helpful in this regard.  What the continual updating will do for you is let you know when/if there is a large change in the stock market and if something unusual goes wrong with your plan.  You should always have a basic sense of how much money is in your plan.  You could also set up an automated stock alert to track movements in the mutual funds in your plan, such as through Yahoo!.  I have not done that yet myself and am not sure whether that information is helpful or overwhelming.

8.   Stay up-to-date on 401(k) News and Investing Tips – There isn’t one easy way to do this but reading a good financial news source, such as one from a major newspaper or a specialized publication like The Wall Street Journal or Investor’s Business Daily, is very helpful.  Investing advice changes all the time.  Most people aren’t going to be able to use this information for specific investing strategies in their 401(k) without first learning a lot more about investing.  However, being aware of general changes in the economy, where financial experts expect investments to go and personal finance strategies can be enormously helpful.  If you feel overwhelmed by this or you are not very interested in investing in general, you might choose to focus on one financial guru to follow.  Suze Orman has been helpful to me but there are certainly many to choose from.

Take a moment now to put a reminder of these tasks in your calendar of choice.  I am going to enter in 3 quarterly update reminders to check/download our 401(k) statements and one end-of-year update to update the last quarterly statement, check Morningstar and brightscope ratings, review whether the loan/withdrawal provisions have changed in our plans and review our retirement projections.

Have I missed a critical tip?  Is there something else you would add?  Please share in the comments.

"The Life and age of woman, stages of woman's life from the cradle to the grave," James Baillie, c1848. From the Library of Congress Prints and Photographs Division.

Thank you for bearing with me this month as we explored the complexities of retirement planning! I know the subject matter can be a little dry and dense but hope that you at least found something this month to improve your own retirement planning.

Below is a very quick summary of this month’s posts:

Retirement Planning Posts

• We started off with 10 Tough Love Money Lessons from the Economic Crisis – lessons we all need to learn from to improve our own financial planning.
• I then gave you the Ruly Money Scale and asked you to rate yourself from 0 to 10 in terms of your current financial picture.
• We went through some simple examples of how retirement planning works from a mathematical perspective and I provided links to some simple calculators to make it easy to work on your own retirement scenarios.  While I indicated that 3-4% inflation is considered average, note that the U.K. recently experienced inflation about 4%.
• I told you the true story of my own 401(k) investing experience, including numerous mistakes I have made.  As a slight update, I just received my most recent 401(k) statement and my rate of return has now increased to almost 6% even with no action on my part.
• We looked at the psychology involved in saving money and explored why we all find saving money so difficult.
• We looked at some of the public policy changes headed for Social Security and Medicare for those currently under age 55. I reviewed the book Putting Our House in Order, and found that historically both Democrats and Republicans have similar recommendations on cutting benefits and raising taxes.
• We discussed how you can take money out of your 401(k) plan if you ever have need to and the consequences of these loans/withdrawals.
• I highlighted some tips from financial guru Suze Orman on retirement planning and profiled her new book The Money Class.

Fun Posts

• Ruly Ruth gave us her take on Spring/Summer 2011 Fashion Trends to help you get your closet in order.
• We looked at romance tips (including organization!) from author/sports commentator Joe Gumm’s new book, 150 Secrets to a Happy Wife.  Joe gave the perfect Joe-response to my review on Twitter:

“A very detailed review of my book. I loved it, but if you’re ADD, you’ll HATE it-a lot of reading.”

• For Earth Day, I shared with you my latest knitting projects, including Easter Dresses, a Kieran Foley-Inspired Tunic, and a baby hat and flowers, which are having the side benefit of uncluttering my stockpiled crafting supplies.
• I also gave a knitted salute to Prince William and Kate Middleton.

If this is still not enough of a summary for you with regard to retirement planning, I have also created a separate post consolidating the 8 most important tips to remember and the timeline for doing each. You can read that post here:

• 8 Actions to Organize Your 401(k)

Thanks for your great comments and feedback this month! Have a wonderful weekend and please check back on Tuesday as we start a new month and a new organizing topic!

In case you missed it, Suze Orman recently gave some great tips on retirement planning on CNBC, including tips for people at a variety of income levels. The video is below:

You can keep up with Suze’s latest videos by adding her RSS feed (here) to your Google Reader account. If you don’t know what Google Reader is, you might want to read my post here.

Suze’s tips come from her latest book, The Money Class: Learn to Create Your New American Dream.  I am ordering a copy and encourage you to do so as well.  Suze Orman has been a helpful guide to me for many years now.  Her advice used to be aimed only at people who were in severe financial distress, drowning in credit card debt or nearing bankruptcy. When I first started watching her show, she used to mock people who would call in that had significant assets.  In our young married years, I would watch her show on Saturday nights while balancing our checkbook and paying bills.

Suze seems to have changed her focus now to help people at all investing levels.  While she still helps people in severe financial distress struggling with basic tasks like budgeting and paying off credit cards, she now helps people think about retirement planning and investing strategies.  It sounds like her book reflects this new focus.

The premise of the new book is that life has changed permanently for most Americans in terms of their finances and that we need to go back and reeducate ourselves about money. Below is a more thorough introduction from the author herself.

Are you a Suze fan?  Who is your favorite financial guru?  Please share in the comments.

"Attack of the Piggy Banks." Photo by Low Jianwei. From the Flickr Creative Commons.

One aspect of organizing your retirement saving strategy we have not discussed yet is how you can access your money in an emergency, particularly if that money is locked up in a specialized account like a 401(k).  Some people adopt a fierce “live for today” mindset and feel that life is too short to deprive yourself of anything at any moment.  After all, you could be hit by a bus or get diagnosed with a terminal illness.  Do you want your last moments on earth spent denying yourself small luxuries while your unnecessary retirement account grows?

The good news is that you don’t really have to make the choice this black and white.  There are ways to access your retirement savings if you really need them.

How do you get your money out?  There are generally two methods: loans and distributions.

First, you should check the specifics of your particular retirement plan.  Each plan can specify the terms and conditions for accessing your money.  Since the goal of most retirement plans is to get people comfortable with saving for retirement, it would be unusual (but certainly not impossible) for a plan to specify that you could never get your money out before retirement age.  A plan could also specify that no loans are allowed, only outright distributions, for example.

I have to confess that before writing this post, I never checked what the conditions were for accessing money from my 401(k) account.  Fortunately, my plan is relatively generous in its loan and distribution terms.  In the future, before contributing a large sum of money to a 401(k) or other retirement savings account, I would check these terms first.

Loans

If your plan allows loans against your 401(k) savings, they are generally relatively limited in scope.  It seems common to require a minimum loan of $1,000 and a maximum loan of the lesser of your account balance or $50,000.  The plan specifies the rate of interest on the loan and the minimum and maximum loan term.   For my 401(k) account, there are far more generous terms if you are taking out the loan to purchase a home (up to 30 years repayment) than for other purposes (up to 5 years repayment).  The plan will typically charge a small administrative fee for taking out the loan.  When you pay back the loan, both the principal and interest amounts go back to you in your retirement account.  Many people so love the fact that they pay interest to themselves rather than to a bank that they prefer to take loans against their 401(k) than utilize other methods.

What are the downsides to 401(k) loans?  The biggest one has to be that if you lose your job (whether due to your resignation, a layoff or termination), the entire balance of the loan usually comes due at once.  So you might have to come up with a large amount of cash suddenly.  In the uncertainty of today’s employment environment, this is not a small risk.  If you can’t come up with the money in time, the plan will typically convert your loan to a distribution.  The plan would then report to the IRS that you took an early distribution and you could be subject to taxes and penalties, described below.

The other downside of a 401(k) loan is that by taking money out of your plan your money is not earning interest and growing while you have the loan out.  You may also be prohibited from contributing to the plan for a certain period of time after taking out the loan as well.  So, you are missing out on an opportunity to grow your money.

As an example, suppose you were considering purchasing a new car for $30,000.  You could either take out a loan from a bank or a 5-year loan against your 401(k).  What would your choices look like?

In this particular example, there are lower interest rates and fees available from banks than the 401(k) plan but your situation could be different and the 401(k) loan rate could be more attractive.  In this example, it doesn’t make a whole lot of sense to go the 401(k) route.

How about the loss of investment principal?  Let’s look at an example.  Suppose you had $45,000 saved in your retirement account and you took out a $30,000 loan for 5 years.  We will assume that you stop contributing to your 401(k) at all during that 5-year time period and that the only contributions you make are your loan payments.  What would happen to your retirement account balance?  Let’s assume that your 401(k) is growing at a rate of 4% per year.

These calculations show somewhat confusingly that if you don’t take the loan against your 401(k) and you instead take the loan from the bank, but in order to afford the bank payments you stop contributing to your 401(k), you end up doing less well after 5 years!  However, if you can afford to both take the bank loan and still contribute to your 401(k), then you end up doing far better without the loan!  The better your 401(k) investments do, however, the less attractive the 401(k) loan looks.

So, as with most financial decisions, whether a 401(k) loan makes sense for you depends on a lot of factors, including the perceived stability of your job, the performance of your 401(k) assets and loan rates available from your 401(k) plan and private banks.

In any event, it is nice to know that you potentially have a loan option available to you from your 401(k), particularly if you have a poor credit rating and might have trouble qualifying for a private bank loan.

Distributions

Most plans will also allow you to take money from your retirement plan outright if you request it.  You can drain the entire account balance if you really want to.  In general, any time you take a distribution from your 401(k), you need to pay taxes on the money as well as a 10% penalty if you are not of retirement age.  This can end up eating up a lot of your savings and most financial planners do not recommend that you take a distribution unless you have no other options.  401(k) plans themselves also discourage distributions.  In my 401(k) plan, for example, the plan requires that you first exhaust all of your 401(k) loan options before you take a distribution.

If there is a compelling reason for your distribution, such as you are suddenly considered disabled, or for certain types of active duty military service, the IRS will cut you a break and not impose the 10% penalty for withdrawal but you will still owe the regular taxes.

There are also certain situations, such as when you change employers, that you can roll money from one retirement plan into another retirement plan, without owing taxes or penalties.

What impact do taxes and penalties have on your 401(k) withdrawal?  We will do a quick example below, assuming a person earns $60,000 per year and takes a $30,000 401(k) distribution in a given year.

So, of the $30,000 you withdrew from your 401(k), in the end, you get to keep about $20,000 or so (less a little bit more for state taxes) after taxes and penalties.

Losing about 1/3 of your savings to taxes and penalties is not thrilling to be sure but there could be situations where the tradeoff is worth it. While certainly you could have opted not to participate in the 401(k) at all and just put money in a savings account and took the money out whenever you wanted to, you would also have missed out on the tax break for the years you contributed to the 401(k).

As with all money questions, there isn’t one simple answer that works for everyone.  If you are contemplating any complex retirement decisions, it is time to sit down and crunch the numbers yourself or find a financial professional to do it for you.

Ruly Challenge

If you already have a retirement savings account, take a moment to read the plan documents (generally available on the website for your plan) to find out what your plan’s loan and distribution terms are.

Does the complexity of accessing your money in an emergency discourage you from saving for retirement?  Please share in the comments.

It was a personal challenge to use up every last inch of the cotton yarn.  The Easter dresses and tunic ate up most of it but there was still a bit left.  It’s always tough to know what to do with little bits of yarn.  I get a bit nervous that I will start something and not have enough to finish.

In anticipation of our pending arrival, I decided to make a unisex striped baby hat.

I was sort of following a pattern but I made a huge error in the gauge along with so many others that I won’t embarrass the real designer with a credit.  The resulting hat is not really at all like what the pattern said it should be but I was too jaded to unpick it and start over.  I just finished up the best I could and ended up sewing it inside out because it looked better than the front pattern.  I guess this is the danger of forcing yourself to use something that you are not really inspired to use.

There was still a smidge of red and white yarn left at this point, so I made two more little flowers.

And that was that!  There was literally nothing left.  It was a relief to be done working with the cotton yarn.  I now have some fun summer clothes instead of some stale yarn sitting in my cabinet. I also gained a better sense of how much yarn I need for a given project.  I still have TONS of yarn to work through in my stash, including a particularly large cone of pink chenille.

I will need a lot of inspiration to get through this one!

Happy Earth Day!  May you find new ways to use and transform your own clutter into treasures!

I used up quite a bit of my cotton yarn on the girls’ Easter dresses but still had plenty left! I decided to make something for myself. As I went looking for ideas, I came across this incredible Latvian vest designed by Kieran Foley for knitty.com.  I loved the colors and patterns. Also, since the overall effect was kind of a patchwork, it would be great for using up leftover yarn since I wasn’t exactly sure how far each color would go.  I needed to modify the look, however, to be more feminine.  Also, I wanted it to be appropriate for summer and warmer weather.  You don’t typically see these types of patterns on warm weather clothes but I was feeling adventurous.

I found the Sahara racerback tank pattern by Teresa Chorpeza for Tahki Stacy Charles that I used to guide the basic shaping for the top.  I changed the front to be a button front and added significantly to the length.  I then charted out Kieran Foley’s Latvian patterns to fit.  It was a bit of a challenge but fun to experiment as a designer!

The long part of the tunic was knit in the round and as I ran out of one color, I just tied on the next and kept going.

I was hoping to have enough yarn to make a dress but I needed about 6 inches to a foot more in length that I didn’t have.  So, the dress became a tunic that will look great with jeans. I am a bit of an odd-shaped model at the moment (a temporary condition to resolve in a few months!) but I like how the final result came out!

After all this knitting, I still had yarn left! Hmm….what do do? Click to see the final projects!

Two years ago, I started the tradition of making Easter dresses for my girls.  At that time, I had a bunch of leftover white satin.  I invented a pattern on the fly and my tiny girls looked like little angels.  The dresses came out so well, helped me get rid of excess fabric that would otherwise be thrown out or donated, cost nothing and exercised my creativity that I decided to try again the next year.  I didn’t have any traditional Easter fabrics last year so one daughter was in a Victorian-style dress made from leftover yellow satin lining with white puffy sleeves from scraps of white linen and the other daughter in a dolman-sleeve khaki knit dress with a red fabric rose.  Again, they were unique dresses and I had a lot of fun making them while continuing to get rid of excess fabric.  (My husband calls this uncluttering very, very, very slowly.)

Since today is Earth Day where we all focus on the tenets of reduce, reuse, recycle, I wanted to share the results of this year’s dresses.

This year, my oldest daughter made a request.  “Mom, I want you to knit me something.”  she said.  I had not done very much knitting recently but this request reignited my interest.  In keeping with my Easter decluttering tradition, however, I decided to use yarns that I already had on hand.  I settled on some large cones of cotton yarn that have been sitting around for years!  I had four colors: red, blue, yellow and white.  Since I had to make two dresses, I needed a pattern that would work up quickly.  I found a great free pattern on the Lion Brand Yarn website for a simple knit sundress with pockets.  The pockets sold my daughter.

The pattern worked up very quickly and was really simple.  I made one dress red with yellow accents and the other blue with white accents.  After all the knitting was done, however, I discovered with horror that the dress would not fit over my daughter’s head!  it was too tight.  So, I made a little adjustment to one of the side straps to make it into a button tab.  Voila!  Problem solved.

For the second dress, I altered the neck shaping to start earlier so that I didn’t run into this problem and didn’t need the tab shoulder.

At this point, the dresses were done and were really cute, but they needed a little something to make them look more like Easter dresses.  Easter dresses generally have pinks and pastels.  My primary colors were a bit bold.  So, I did some thinking and again took a clue from my daughters who were thrilled with all the spring flowers coming up in the yard.  Knitted flowers!

There are a million patterns out there for yarn flowers.  A few are knitted, like the red rose above that came from Nicki Epstein’s wonderful book, Knitting Over the Edge.  But the really extraordinary (and quite frankly a little silly) flowers are crocheted.   The blue pansy above, the white “bluebell” below and daffodils came from Flower Garden Afghans by Carol Alexander.  Knitting purists may shudder at the combination of knit and crochet in these dresses but my girls LOVE the results.

Since the flowers are a bit over the top, I put all the flowers on safety pins so they can be removed if we want a plainer look or for washing.

It was a bit hard for my oldest daughter to wait for her dress to be done and she became impatient wanting to know why I wasn’t finished yet.  But she was a very willing model.

My other model was unavailable due to naptime so we present her dress below.

It was a ton of fun making the dresses and the look on my girl’s faces was worth all the effort!  At this point, I still had quite a bit of yarn left.

What to do with all the excess?  Read on for phase two!

"An elderly woman looking at a twenty-five dollar War Savings Bond," (1942 or 1943) Photo by Alfred Palmer and/or Howard Hollem for the U.S. Office for Emergency Management. From the Library of Congress Prints and Photographs Division.

As I wrote about at the beginning of the month, our family’s retirement planning is currently based on the assumption that Social Security will constitute little or nothing of our retirement income. For many people, even young people, this is a scary concept. It conjures fears of being poor, old, feeble and unable to work, living in a cardboard box or a homeless shelter. At a minimum, it makes people worry that rather than traveling to visit their grandchildren or enjoying leisure activities, old age will be spent clipping coupons, eating canned beans and otherwise living a miserably frugal existence.

But, it doesn’t have to be this stark. We have grown so accustomed to counting on the government (or pensions) for our retirement income that we have forgotten that many people do provide income from their own savings. With the recent economic turmoil, people have lost a lot of faith in their ability to save for their own retirement expenses or even to maintain a job and earn income. However, we have to face reality and know that for many people, and the future of the United States, this will be asked of us.

Current projections for Social Security put the system in full-blown crisis just a few years before my husband and I would retire. If nothing is done to fix the system, at a minimum, any expected Social Security payment we might receive would be cut by a minimum of 25%. Since Social Security is not that generous to begin with (approximately $1,177 per recipient per month currently), this would be a substantial drop (if it happened today, average payments would drop to $883 per month or less). In the event this disaster happened, we see it as quite likely that a progressive adjustment to Social Security payments would be made, such that poorer individuals would receive a full benefit and wealthier individuals could receive little or nothing.

To learn more about what is likely to happen to Social Security and Medicare over time, I thought it would be interesting to review a book from my local library, Putting Our House in Order: A Guide to Social Security & Health Care Reform. This book was written in 2008 by George P. Schultz and John B. Shoven. What I found interesting about this book is that the authors were more closely affiliated with the Democratic party but that many of their recommendations sound strikingly similar to ideas currently being advanced by the Republican party in their “Roadmap for America’s Future.”

It appears that the great economists of our nation of every political view, don’t see Social Security and Medicare reform as a mystery. They know exactly what needs to happen, i.e. cut benefits and increase taxes, but the political will fails time and time again and the United States falls deeper into debt.

How did we get into this mess? Schultz and Shoven give us several key insights, including:

• pay-as-you-go accounting methods – Federal, state and local governments have been terrible about planning for long-term expenses primarily because all of their budgeting has been done on a year-by-year, pay-as-you-go basis. Governments only worry about the current year’s budget. So long as there is money to pay the current year’s expenses, the current year’s retiree health and pension payments, etc. their job is done. If government workers want a raise, rather than ruin the current year’s budget with this expense, the government just trades future retirement benefits. The benefits won’t come due on the approving politician’s watch and there is no current accounting for them so they are easy to grant. There has been an effort to force governments to adopt the more responsible accrual accounting methods to account for future expenses. Doing so requires governments to admit they have amassed enormous amounts of debt that cannot be covered by existing tax revenues—something we are just starting to see now.
• increasing longevity – It’s a good thing that we are all living longer and healthier lives but it is also a huge strain on our retirement system because we have never really adjusted the retirement age meaningfully upward.
• lump of labor hypothesis – Current thinking assumes that there are a limited number of jobs available and that older workers need to retire to free up jobs for younger workers. Experience in other countries, shows that this is not true and that forcing older workers to retire early does little or nothing to improve youth unemployment.
• government spending – Since the inception of the Social Security program, there were numerous years where worker contributions to the program exceeded expenses. Since at least 1938, politicians called for these excesses to be saved for the future but saw them spent time and time again. While we hear about the “Social Security trust fund,” many argue that this “fund” is completely illusory and it really means a taxpayer-funded bailout is only a matter of time.

OK, so enough about problems, what were Schultz and Shoven’s recommended solutions?

For Social Security, a few options:

• Encourage people to work longer. Encourage employers to hire older workers by phasing out Social Security contributions required from both employees and employers after an employee has worked 35-40 years. Also, require mandatory Medicare enrollment at 65 with no employer requirement to insure workers older than 65 through private insurance programs. Also, change the taxation rules on Social Security benefits to remove financial incentives to stop working.
• Continually increase the age of eligibility for retirement benefits.
• Change to price-indexing. Currently, Social Security benefits are adjusted annually based on “wage indexing” related to the typical growth of wages over time. Economists have known for a long time that this is far more expensive than indexing benefits to the consumer price index. The impact of this change would reduce retiree benefits by approximately 16-19% over time.
• Put a portion of Social Security earnings in private accounts. Before reading this book, I didn’t understand why this is such a frequent solution to solving Social Security. My experience with my own 401(k) does not give me a huge amount of confidence in this method. However, many brilliant economists have recommended this approach and the reasons for doing so are numerous. One important reason is to prevent the government from spending the money! Yes, the government needs to be treated like a spendthrift and we have to help the government save money. If the Social Security money is in private accounts, the government cannot spend it on non-retirement programs. The private accounts approach is often seen to be solvency neutral, i.e. it doesn’t make Social Security any worse in terms of underfunding in the long-term.

Specifically, Schultz and Shoven recommended two primary options for fixing Social Security:

Option 1: The Social Security system stays exactly the same as it is now for those 55 and older. For those under 55, lower-income earners continue with the current wage-indexed system and wealthier earners switch to the price indexed system. The retirement age keeps increasing based on assessments of longevity. Essentially this amounts to a significant decrease in retirement benefits which may need to be supplemented by personal savings.

Option 2: The Social Security system stays exactly the same as it is now for those 55 and older. For those under 55, there is a flat benefit amount paid to everyone regardless of how much you earned or paid into the system over your lifetime. In addition, there is a mandatory 5% deferral of your income each year to a Personal Security Account similar to a 401(k). (2.5% of this contribution comes from you and 2.5% from your employer). This amounts to an additional 2.5% tax on each worker over their lifetime, in addition to the current rate of Social Security taxes.

With regard to Medicare/Medicaid/health insurance spending, Schultz and Shoven (in line with many other economists), recommend the following solution:

Medicare reform: For those under 55, instead of Medicare, the government makes payments to a Personal Health Account for you. Your payment is based on your age, your lifetime earnings and any medical conditions you have. You will receive less if you are healthy and more if you are sickly. Your payment is not tied to your income in retirement (but is tied to your lifetime earnings). So if you saved a lot of your money and are doing well in retirement you get the same benefit as someone who earned the same but spent all their money before retirement. If you are extraordinarily wealthy, you may get nothing.

You use the amount in the Personal Health Account to purchase an insurance policy on the private market and insure yourself. The Medicare program as we know it today is gradually phased out so that this is the only system. Tax exemptions for employer-provided health insurance are revoked with perhaps a new tax credit for individuals.

It was not entirely clear to me from the proposal, but it appeared that you could extend this concept so that rather than a system that started in retirement, this becomes the only type of health insurance system in America. Few employers would have to offer insurance and even the poor would have to use this type of system rather than rely on Medicaid. We all start purchasing our own insurance policies with government subsidies. If you are very ill and practically uninsurable, it is unclear what would happen to you. The authors argue that your government subsidy would be enough to allow you to qualify for at least some form of private insurance coverage.

Of course, we would have to increase taxes to pay for such a system and one proposal was to add a new Value-Added-Tax of about 2.5% on purchases to pay for this.

“Something will have to give, and it has to be either the benefit determination or the taxes. Nothing else will bring about solvency.”

–George P. Shultz and John B. Shoven, Putting Our House in Order

If you are under 55, it is practically guaranteed that Social Security and Medicare will not be as generous as they are today and that you will need to have your own savings to cover the difference. Whether the government ultimately turns to private, defined contribution accounts and whether this impact will be positive or negative remains to be seen. We have seen this same switch in the private sector already and it would not be surprising if the government follows suit. However, this change is not going to happen fast and is very politically unpopular.

For those of us with decades to retirement, however, we need to factor these possible changes into our planning now so that we are not unduly surprised right before retirement. We also need to be mindful that before we react negatively to any proposals to cut entitlement programs, we have to realize that the exact same proposals have been made for decades by economists of every political affiliation. As a nation, we keep failing to do anything about the problem and it is this failure to act that makes the problem grow worse each year. At some point, someone has to take the brave step forward to implement a solution.

Are you worried about Social Security or Medicare reform? What would you like to see happen? Please share in the comments.

In our discussion of retirement saving this month, Ruth has posted a few comments relating to the need to cut back on basic expenses so that you have money to save for retirement. Suze Orman couldn’t agree more. Below is her tough love advice about where to cut expenses when you have a tight budget.

Suze’s advice tells us to keep paying contributions to things like health insurance and retirement saving and cut out things like hair, manicures and vacations. Essentially her advice is that we keep paying for important but invisible expenses and cut out the visible signs of wealth. When I first listened to this, I thought, “Well, of course. Doesn’t everyone do this?”

Then, I came across this article:

• “We’d rather go broke before going gray survey finds,” Today Show, March 23, 2011

The survey showed that over 47% of female survey respondents refused to stop their haircut/hair coloring appointments even under economic distress. 57.5% refused to give up discount shopping for apparel and over 61% refused to give up their cable television subscription! Men weren’t much better although had slightly lower percentages in each category.

It made me remember a conversation in my yoga class where a mom indicated that she went gray in college and has been coloring her hair ever since. She had to stop coloring her hair for a brief time when her family was young and they didn’t have the money. “I will never do that again!” she vowed.

I have not had to face this dilemma just yet. About 10 years ago, I was in a stylist’s chair in a nice salon in Washington and was shocked when the stylist ran a comb through my hair and said, “Well, you’re lucky not to have any gray.” All I remember thinking was, “Is this woman crazy? I’m young! Why is she looking for gray hair?” But it turns out that gray hair is relatively common among younger people and likely the stress of Washington living doesn’t help in this regard. People magazine’s “Most Beautiful Woman in the World” this year is Jennifer Lopez, who shockingly admitted that she went gray at 23 and colors her hair every two weeks ever since!

It made me wonder, “If my hair was turning gray and the only way to decently color my hair was at a salon, would I be willing to give that up?” It is a really tough choice. There is such a premium on looking young in female beauty and gray hair before the age of 50 or so is hard on the ego. I guess I would look at what other vanity expenses could go first.

These little ego decisions are a big part of our spending problems and they happen all the time. This weekend, for example, we faced a similar dilemma with our sunroom furnishings. Our sunroom doubles as our children’s playroom/art room and takes a huge amount of abuse. There was paint and glue ground into the carpet and upholstery. We took one look at the mess and thought, “It is time to get new furniture and an area rug.” Our brain calculus looked somewhat like this:

There were a lot more positives than negatives in this option and we were just about ready to load up in the car to go shopping.

But then, we thought about the alternative solution. We could try to clean up the mess and see how things looked at that point. The brain calculus for this decision looked like this:

Cleaning up the furniture required only sweat equity. We would also be burning calories as we cleaned and would be saving the earth by not adding more to the landfills and re-using what we already had. Still, it was going to be a LOT of work and not much fun.

What tipped the balance in the end? It wasn’t so much the thought of spending money that deterred us but rather the prospect that the money would not be well spent. Reality made us factor in the following calculation:

It was the net negative of realizing that with small children mess is inevitable and that new furniture would buy us only a short reprieve from the current mess we were facing that forced the decision to pick up the brushes and start scrubbing. It took hours but in the end the result is really quite nice. Not as nice as new furnishings, of course, but perfectly acceptable for company and very clean.

Saving money has a huge amount to do with our psychology. Ramit Sethi of “I Will Teach You To Be Rich” recently did an interesting piece on spending psychology and tax refunds.

Watch the full episode. See more Nightly Business Report.

Ramit argues that while “experts” tell us not to have a tax refund because we are losing out on interest, the reality is that getting a tax refund is a good way for a lot of people to force themselves to save any money at all.

Many financial experts have come to similar conclusions about helping people save money. While the pure financial analysis on credit card interest rates, for example, may dictate that you pay off your highest interest cards first, many financial advisers find that people will not stick with a savings plan if they don’t see results. So, they advise paying off your lowest balance first, regardless of interest rate, so that you see progress and stay motivated. Getting out of debt imperfectly, they argue, is better than being so overwhelmed by the “perfect” way that you fail to make any progress at all.

Ruly Challenge

I encourage you to take a moment to reflect on the above and think about where you could cut expenses if you had to. What is your biggest extravagance? What do you spend money on that is primarily about preserving outward appearances? Do you need to adopt some psychological techniques to help you improve your financial situation?

Would you be willing to cancel the family vacation, give up cable or go gray to save money? What would be the last expense to go for you? Please share in the comments.