The Savers’ [of the bubble] Budget, by UK Conservatives

Let the campaign begin.  Source: Google Images.

Let the campaign begin. Source: Google Images.

I’m a bit late to the UK Budget commentary – I wanted to hear more experienced/knowledgable opinions before setting out my own.  Anyway, here are some quick thoughts that came to mind while watching the source material + reading summaries of those commentators:

  • The UK actually has a budget.  Not well-known among UK folks, but the US is utterly incapable of passing a budget.  Perhaps a triumph of separation of powers, or perhaps a prime example of how sensible things can’t pass Congress, but idiotic things can.
  • A clear campaign tool.  It seemed to me there were a few programs/expenditures selected for budget inclusion purely to make snide comments about the opposition.  Still, if I were in the ‘internet of things’, I’d be happy with the new subsidies nonetheless.
  • Savers win…I think.  A few items that were interesting to me:
    • Lower income taxes.  Yup, still a Conservative government, even if the policy was a Liberal Democrat policy.  The increase in tax-free allowance will mainly help middle-class folks; those who should be saving more.
    • Tax-free interest.  WOO HOO!  Middle-class earners now get £1,000 of tax-free interest a year; higher earners now get £500 tax-free.  With today’s average savings account rates of about 1%, that means accumulated cash savings about about £50-100k will earn tax-free.  Sweet – this is basically a 20% subsidy on bank interest.  Hopefully an incentive to save more.
    • More flexible ISAs.  For the non-UK’ers out there, one of my favourite programs in the UK is the Individual Savings Account (ISA).  They are tax-free investment/savings wrappers which can be used by any UK resident.  Like a US Roth IRA, but you can withdrawal funds at any time.  The new rules mean you can withdraw from an ISA, then put back the money in the same tax year.  Previously the withdrawals couldn’t be put back.
    • The Help to Buy ISA.  Ugh.  Continuing my rant on UK housing, the next ruse to prop up house prices is a 25% savings subsidy for those saving for a house down-payment.  The saver puts in £200/month; the government puts in £50/month, until a maximum £3,000 subsidy (so £15,000 total in the account).  Great – again using demand subsidies to treat a supply issue.  <humph>
    • Sell-back your annuity.  I see this as a big problem down the road, but one I hope doesn’t hurt too many folks.  I’ve written before about the new pension rules in the UK; now those who have recently been forced to buy an annuity can resell for cash.  Given annuities are basically individual insurance contracts, I can’t see a very liquid secondary market being setup.  That will lead to poor prices for pensioners, who in turn will be easy to scam.  Hopefully I’m wrong.
    • Pensioners – less savings for you.  Despite the above, the lifetime maximum allowance for tax benefit (i.e. tax-deferral) has been further decreased to £1m from £1.25m.  Given today’s annuity rates, the lower cap allows for a lifetime income of about £2,000/month (assumptions: retire at 60, joint, inflation-indexed, no guarantee, no tax-free lump sum).  That’s a bit lower than UK median income.  So seems a bit stingy to me – it’s a cap which many ordinary savers will probably hit.
  • What I didn’t hear enough of: infrastructure investment.  I’ve written before how I view the situation: use record-low government borrowing rates to build infrastructure (and more social housing, while we’re at it).

In sum: I’m looking forward to tax-free interest (even with peer-to-peer lending, apparently), and the lower taxes.  The rest is kinda ‘meh’, aside from my bad thoughts on HTB ISA and new pension rules.

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Social Security Works (or not?)

You tell 'em, tea-bagger.  Source: Google Images.

You tell ’em, tea-bagger. Source: Google Images.

This morning I read a Huffington Post article by Nancy Altman, which piqued my interest.  It advocates shifting away from privatising Social Security, or indeed advocating 401(k)s or IRAs, and applying additional taxation towards extra funding and benefits from the existing Social Security system.

I see that Ms Altman has a book out, as well as a lobbying group named Social Security Works.  In lieu of buying the book – which I may yet do, given the thesis is far from my understanding of the status quo – I read a few of the lobbying group’s memos.  My thoughts:

  • Isn’t Social Security going broke?  Well, yes and no.
    • Social Security’s income comes from (source: the lobbying group)
      • Current taxation: around 85%
      • Investment returns: around 15%.  FYI, ‘investments’ are 100% US Treasury notes and bonds.
    • So what?  Well, lower yields for Treasuries means lower future returns for Social Security.  So that item will need to be supplemented by additional tax, or else benefits will come down.  Also, the large cohort of (working) baby boomers leaving behind a smaller workforce will lower the current taxation component.
    • And… that leads to projected deficits, and loss of benefits, beginning around 2033 under status quo.  Technically, the loss of any benefit would be a default – therefore bankruptcy or ‘going broke’.  The group claims this isn’t the case, as taxation will still be coming in.  If only personal bankruptcy worked that way, right?
    • How to fix this?  The group suggests abolishing the cap on income subject to Social Security tax – right now income over $117k isn’t subject to SS tax.  No mention of removing the cap on SS benefits however – those remain.  The progressive in me thinks this is generally OK: maybe the US can follow the UK National Insurance scheme, and tax the extra income by a lesser rate, like 2%.
  • Why not privatise and/or encourage IRAs and 401(k)s?  
    • Cost differential?  Your run of the mill IRA + fund management charge is probably around 1-2% of assets in the retirement account, per year.  Social Security spends about 0.5% of trust fund assets in Administration costs, per year.  So one can plausibly argue that Social Security is a more cost-efficient way to save for retirement – though I wonder what is the administrative cost of collecting SS taxes.
    • Return differential?  I’ve written before about how good a deal Social Security can be for current retirees, particularly against expectations for future generations.  So here’s a thought, keeping in mind where the money for SS payments comes from (see above): given a slowdown in demography (i.e. fewer workers paying in) and investment returns explicitly limited to US Treasury returns, how can there be enough money to go around in future?
      • For example, 30-year Treasury bonds currently yield 2.63% per year.  That means $100 of Bonds purchased today will be worth around $220 in 30 years.  If we assume the Fed can achieve 2% long-term inflation, and SS benefits continue to rise in line with inflation, that’s hardly any real return at all.  And that’s the maximum investment return allowed by Social Security.
  • How to fix it?  
    • Sadly, the mathematics just don’t add up unless taxes are raised – hence I absolutely see why the group wants to remove the cap on earnings subject to SS tax.
    • I suppose the amounts sent to ‘auto-enrolled’ 401(k) plans could just be reframed as additional SS tax to help keep up the program, and possibly increase benefits?
    • The only other method I can think of would be to massively increase population through either more lax immigration policy or through discouraging the use of contraception.

In sum: I was absolutely intrigued by the idea that, instead of thinking of Social Security as a slowly fading institution of old-time, New Deal America, we should consider the program as a better option for our future pensions.  The cold mathematics, however, means pretty unpalatable choices to make this happen.  But, as I’ve written before, the millennial generation faces stark mathematics regardless of how pensions are handled – there just isn’t enough money to go around.

Financial literacy and UK pension changes

The money is mine!! Source: Google images

The money is mine!! Source: Google images

A quick one today, versus yesterday’s rant.

There was another Dispatches episode recently discussing April 2015 changes to UK pensions policy.  For those unaware, until now UK pensioners were forced to purchase annuities with their savings (aside from a 25% lump sum, which could be taken as cash). As of April, this is no longer required: folks can use their funds as they like.

On the face of it, there seems to be no issue here.  I mean, we’re all about freedom, particularly when it comes to hard-earned savings, right?  Well… my concern here is about timing: it’s like the government just said “we know you had saved in expectation of this happening, but instead it will be that…now go!”  There was little prep time for folks to learn how to manage their own pension savings.

I may be making a mountain out of a mole hill, but the stories in the Dispatches episode, in conjunction with surveys of financial literacy such as this one give me reason for pause.  There will inevitably be several folks (such as those interviewed in the show) who decide to blow a significant portion of their now-liquid savings on new cars and such; their financial future will need to be picked up by additional state pension benefits, paid for by younger generations.  I’ve written at length about my feelings of the latter.

So what’s the solution?  To be honest, I’m torn: my libertarian side says the government had no business forcing the purchase of annuities, so this is an unambiguously good thing; my paternalist (and perhaps more realist and cynical) side thinks this will almost certainly increase the need for state pension benefits, and associated taxation.  Hum.

In sum: if you know of someone benefitting from the rule changes, please encourage him/her to seek financial advice.  Thankfully the UK government has set up the Money Advice Service…I really hope it gets used.

Take the company match?

I just heard this question asked again…. as a new employee, should I contribute to the company 401(k) or company pension, in order to get a company match?

This head-shaker is easy: YES.  For the avoidance of doubt, my strong opinion is:

  • Contribute at least as much as required to receive full match.
  • From there, consider contributing more: I have read in several places (Rational Expectations among them) that young folks need to contribute about 20% of salary to feel reasonably confident of a retirement in their late-60s.