Who Protects Teachers’ 403(b) Plans? Nobody!

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Insurance_wolf

I argued in recent posts here and here that public school employee 403(b) retirement plans are confusing to enroll in and full of extremely expensive options, and that the bad program design seems to be on purpose, as it serves one particular industry1, at the expense of retirees.

The situation is so obviously bad that I figured surely public school employee advocates would be working hard to correct this problem. I reached out to public school advocates, as well as to the Teachers Retirement System (TRS) and legislators, hoping to find some good news. 

I have no good news to report. 

But first, I want to clarify a point that may have gotten lost in my attack on the status quo of 403(b) plans. I do not want to leave anyone with the impression that 403(b) plans should be ignored as a retirement tool by school district employees. Nothing could be further from my beliefs.

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Between the automatic payroll deduction and tax advantages of 403(b)s, combined with the fact that TRS pensions won’t cover enough costs in retirement and the lack of Social Security for 95 percent of school districts in Texas, these defined contribution plans ought to be a key tool for retiring comfortably. 

The fact that the status quo design of these programs is objectively terrible shouldn’t dissuade you from participating in them, or in an Individual IRA, if you know how to do that, and properly navigate your way to good products. Some how, some way, you need to put some retirement money away in addition to your TRS pension, which will prove insufficient, unless you put in a full 43 years to qualify for 100 percent of your last five years’ salary. Got it? Good.

Now, I have my hair on fire about 403(b) program design, so I began calling around to public school employee advocates. We need some allies here.

I called the Texas State Teachers Association (TSTA), with a statewide membership of 65,000 and an affiliation with the National Education Association (with 3 million members). Spokesman Clay Robison told me, “Generally, we’re in favor of defined benefits,” by which he means the guaranteed TRS pension that employees qualify for over time. When I tried to shift the conversation toward 403(b) plans, he wanted to emphasize that their organization believes defined contributions are “obviously riskier,” and that recent studies show retirees benefit more from defined benefits (like TRS) rather than defined contributions like 403(b)s. Robison continued, “Our focus is keeping the teacher’s retirement program sound, and keeping the system from moving from a defined contribution to a defined benefit plan. If teachers want to invest in a defined contribution plan, that’s entirely up to them.”

To my pressing that fixing 403(b) plan design doesn’t take away from the TRS pension, he replied, “We’re focused on the defined benefits plan, because we’re convinced it’s the best option and it’s less risky. The TRS is a sound pension plan. Managed by professionals. For those that can afford extra, that’s their business.” Ok, then. 

I spoke with Bobbye Patton, past President (2012-2014) of the Association of Texas Public Educators, a non-union organization representing 80,000 members statewide. She said the issue of 403(b) plan reform has simply never come up within her organization. “I cannot remember that our association has talked about the 403(b). It’s always been focused on the retirement system itself.

“We have our TRS (pension). As far as I know, nobody pushes ideas about the 403(b). As teachers, we don’t understand it. We don’t fully understand what it would do for us.” Alrighty then.

Calls to the San Antonio Teachers Alliance, a local affiliate of the Texas AFT, and itself a state member of the national AFLC-CIO, did not get returned as of this writing.

I spoke to Rebecca Merrill, Chief Strategist at TRS itself, which is legislatively charged with administering and executing 403(b) rules statewide.

I wanted to know whether they are aware of the problems of 403(b) plan design, specifically forbidding school districts from designing a better system through a bidding process and negotiation. She assured me they understand the issues well.

“I don’t think its any secret that we’ve said ‘if it’s the legislature’s will for teachers to pay as low fees as possible, they should empower district to issue RFPs (Requests for Proposals) and negotiate lower costs.’” I asked if TRS itself could negotiate better terms for school district employees at the state level. 

Merrill responded, “We feel like we can’t. The legislation provides for an open access system. The industry pushed back and said the legislature wants choice.”

To be fair, Merrill points that certain very heavy sales load charges on funds were dropped in the 2017 reform, and I agree that’s good. Merrill also pointed out that allowable fee caps on products were lowered, although I still believe the move to be very incremental only.

In reviewing the results of 2017 reform of fees within the 403(b) plan, I expressed to Merrill that this was “reform” that only an insurance company could love. 

Merrill responded, “We made some recommendations for the (TRS) Board to go in a different direction. The Board did adopt some rule changes, including the fee caps. The Board heard from industry, and they heard from staff. We had a big dialogue with the industry. The industry wanted to make sure that advisors could be compensated. We worked through it the best we could.” At the end of the day, however, Merrill believes TRS cannot make the rules around 403(b) plans, nor can it interpret policy. “We are mindful that how 403(b) is implemented is a legislative question.”

Emailed questions and call to the office Representative Diego Bernal, San Antonio Democrat and Vice Chair of the House Education Committee went unanswered. Emailed questions and a call to the office of Senator Paul Bettencourt, Houston Republican and member of the Senate Education Committee as well as an advocate for shifting away from defined benefits and toward defined contribution plans, went unanswered.

And that, folks, is the depressing state of the world, with respect to the perfectly legal highway robbery going on with school district employees’ defined contribution plans. 

Don’t look to teachers lobbies, the legislature, or TRS itself to fix this anytime soon.

A version of this post previously ran in the Houston Chronicle and the San Antonio Express News.

Please see related posts:

The problem of choice in Texas teacher 403(b) plans

Teacher Retirement “Reform” Only An Insurance Company Could Love

Variable Annuities, aka Shit Sandwich

Variable Annuity Salespeople: Just because you’re paranoid doesn’t mean I’m not out to get you

trs

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  1. The insurance industry, duh

More Nerdy Social Security Stuff I Found With My Spreadsheet

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I went to my happy place this past week, which faithful readers (both of you!) will understand means I got to build myself a really neat-o spreadsheet.

I built it so that I could see “under the hood” of Social Security benefits calculations. This isn’t something I’d necessarily recommend to people who grew up in a loving household and who know how to relate to real live humans. But everybody has his or her hobbies. Don’t judge.

Generally, if you want to know what you should know about Social Security, I strongly recommend creating a My Social Security Account and I also strongly recommend going online to your Social Security benefits estimator. These online sources are easy to use, full of insights personalized to your own situation, and they could save you the hassle of a phone or in-person visit with a Social Security office.

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I don’t tinker with cars in my garage

But for the small percentage of you who’d like to talk nerdy with me, I thought I’d add a few more insights into what I found as a result of my custom-built spreadsheet and by pulling my own reports.

These insights include the effect of low earnings, the effect of entrepreneurship, and a benefit of working deep into one’s retirement years.

My Own Report

In the example of my own Social Security report, since I graduated from college, between 1996 and 2017 I have twenty-two years in which I have reported taxes. (2018 taxes, obviously, are not yet filed.) Of those twenty two, eight years represent high earnings. Three years represent virtually no income (I’ll explain that a little later on). In the other eleven years my income was “meh.”

I mentioned in the last post on Social Security that having a high income for a short amount of time is not as valuable – for the purpose of maximizing Social Security benefits – as having a moderate income for a long period of time. That’s because every year out of 35 years of earning income and paying taxes matters. Miss out on one year of earnings, and your benefits go down, at least a little bit.

As a soon-to-be forty-seven year-old, I have twenty more years in which to earn income, pay Social Security taxes, and therefore maximize my benefits. “Full retirement” age for me, by the time I get there, is scheduled to be 67 years old.

Incidentally, for current Social Security retirees today, the “full retirement” age is 66 and a half, but that age keeps creeping upward. And it ought to creep upward because we live way longer on average than people used to, so it only makes sense for the solvency of the Social Security program to increase the retirement age. But that’s a controversial topic for another day.

The point is that I’ve got a mere twenty more years to maximize my eventual benefits. And yes, one way to increase benefits is to delay starting your monthly payments. But that’s a well-known fact, and also not the topic for today. The topic today is getting the best thirty-five years of earnings possible.

Racking up thirty-five steady years can be difficult, for example, if you start or run your own business.

My_social_securityEntrepreneurial income varies tremendously year to year, which will have an effect on your final Social Security Benefits. I noticed from my own Social Security report that in the first three years of founding my investment business in the mid-2000s that I earned essentially zero income. The losses incurred in my startup years zeroed out my taxes – which was delightful at the time – but it also meant I did not pay into the Social Security system. Since all thirty-five years of earnings count toward building up Social Security benefits, entrepreneurs with volatile earnings may accrue far fewer benefits over a lifetime than will long-time employees with steady earnings. Even very successful businesses have years of losses, at least from the owner’s tax perspective, so that could lower Social Security contributions and therefore eventually benefits.

Work Past Retirement Age

So how does somebody improve his or her benefits, even with some low-earning years?

My mother, age 76, presents an interesting data point on Social Security benefits, which she has been collecting for the last six years. After raising us kids, she racked up some low-paying years during her career as a private school teacher. She continues to work as a consultant now, however, making decent income well past her full retirement age. Because Social Security benefits depend on calculating your highest 35 working years, her recent income years – in her mid-70s – have been slowly replacing lower earning years from her 40s. As a result, her monthly Social Security check has adjusted upward by a little bit each year.

Katrina Bledsoe, Management Analyst at the Dallas region Public Affairs Office of Social Security, confirms that this upward adjustment should happen automatically every year, if you continue working. If you don’t see the automatic adjustment, Bledsoe says beneficiaries may contact their Social Security office. Don’t do so until the 2nd quarter of the year, however, because Social Security will need to see your official IRS tax data to recalculate benefits, and that generally doesn’t happen before April 15th.

Social_security_calculationsTwo final Social Security thoughts. Monthly benefits generally are not enough to live on, comfortably, in retirement. Social Security payments should be thought of as a living supplement, not a sufficiency.

On the other hand, as much as 40 percent of American households do not have appreciable retirement savings. The median net worth of Americans between ages 65 and 74 is $224,000. With that statistic, we can see that Social Security constitutes the single most important source of funds retirees have to live on.

To do some simple math 1 for which I don’t even need my cool spreadsheet, I would divide annual benefits by 5% to get a rough value of Social Security for an individual, as if it were the equivalent of a lump sum in the bank. That would make $2,500 in monthly Social Security benefits worth $600,000. That rough estimate shows us that Social Security is the largest safety net that a majority of Americans have.

 

Please see related post:

Social Security Nerdy Spreadsheet Part I – The Rabbit and the Hare

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  1.  And please don’t @ me to quibble about this last math assumption. Chill. I’m creating a quick and rough estimate for comparisons’ sake. Thank you.

Social Security Spreadsheet Fun

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Some dads whittle wooden cars for the soapbox derby. Others spend hours with the hood up in the garage tearing apart an old engine and putting it back together, just to see how it all works.

Me? I like to do the same thing, except with retirement income in a spreadsheet.

We think about Social Security as a cool benefit we collect at retirement age, but have you ever wondered exactly how it is calculated? I wondered too, so I built a Social Security benefits calculator. Now I get to explain it to you.

What you can find online easily

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I don’t do soapbox derbies

Before we begin this journey together, I have a few public service announcements to make. You don’t really need to talk nerdy to me like this if you don’t want to. Two places on the Social Security website will tell you all you probably want to know about your own benefits. Sure, its like cheating on the test compared to all the cool tinkering I did on my own spreadsheet, but fine, you might prefer quick answers.

For quick personalized answers, you should definitely sign up to access your own personal “My Social Security” report online.  My own report, which I signed up to receive at the tender age of 46, is quite fascinating. It lists all of my own earnings since 1986 (when I was 14 years old!), and how much I’ve paid in to the Social Security system until now. The report also shows an estimate – in my case, twenty years early – of how much I should expect to receive in benefits at my full retirement age.

My_social_securityYou can also access a super-easy estimated-benefits calculator – specifically based on your own income data – on the Social Security Website.

This benefits estimator takes all your data, assumes you make an inputted income between now and time you retire, and then tells you what monthly benefit you can expect. It’s pretty cool.

Katrina Bledsoe, Management Analyst at the Dallas region Public Affairs Office of Social Security, wants people to know about these two online tools. Knowing about the personalized online calculators can save you time on the phone or in a Social Security office. I walked in to my nearest Social Security office in downtown San Antonio recently, and so I can testify that, yes indeed, you don’t really want to spend more time there than you have to. There’s the TSA-type screening to enter, the DMV-style vibe you get in the waiting room, and the nearly 2-hour wait I faced after I got a ticket with my number. So, yeah, you’re going to want to do as much stuff online as possible.

Bledsoe also mentions that signing up for the “My Social Security” report can reduce the possibility of identity fraud. If anyone tries to go online on Social Security, request a Social Security card, or go into a Social Security office using your identity, you would get an alert, so that’s nice too.

Cool SS stuff from my model

Ok, but most importantly, what cool stuff did I find in custom-built Social Security model?

Social Security benefits are determined by both your level of income and your years of earning income. More earning years and higher income translate to higher benefits.

Social Security benefits depend on calculating your average monthly income for your thirty-five highest earning years. You need a minimum of ten years to qualify for benefits. You increase your benefits for every year, up to thirty-five, in which you have income. For each of those qualifying years, Social Security caps the income you pay Social Security taxes on, and that cap serves as a “maximum income” for the purpose of benefits calculations.

Only earn income and pay taxes for thirty-four years? You can’t get the maximum benefit. Don’t hit the maximum income in every single year? You can’t get the maximum benefit.

Social_security_calculationsI calculated the absolute maximum in my model of monthly Social Security benefits, assuming you qualified for full retirement in 2019, and had a max income in each of the previous thirty-five years: It’s $3,188.

I ran that number by Bledsoe, as a reality check. She said she’d never heard of any individual getting that much at “full retirement age,” probably because hardly anyone has a max income for all thirty-five of their earning years. Also, Social Security adjusts max income amounts every year, so the maximum possible benefits will go up slightly each year.

Early vs. Late Earnings

I asked my spreadsheet model to tell me the difference between earning retirement benefits early in one’s earning years versus late.

I was curious about this because one of the classic and true clichés of retirement planning is that putting away money in one’s twenties or thirties is far more valuable than putting away money in one’s fifties or sixties – due to the astonishing magic of compound interest math.

But Social Security doesn’t work that way.

I compared the effect of earning a max salary for ten years early in life – years one through ten – to earning a max salary late in life – years 26 through 35. To my surprise, the late earner would qualify for $1,503 per month as compared to the early earner qualifying for a little less, or $1,458.

The difference in benefits is not huge, but points out the dramatic difference between a Social Security benefit and self-directed retirement investing such as through a 401(k) or IRA. With self-directed retirement, the early years totally overwhelm the later years.

Turtle vs. Hare Earnings

Next, I wanted to know from my model whether the “turtle” or the “hare” gets better benefits under Social Security. I defined the hare as someone who earned a maximum income for ten years and then never worked again. I defined the turtle as someone who earned a solid but not massive salary over a full thirty-five years. I made the turtle salary $60,000, just under the current Texas median household income. My answer: The turtle would qualify in 2019 for $2,825 in monthly benefits, whereas the hare would qualify in that range that I mentioned above – between $1,458 and $1,503 – depending on whether that income was earned in the recent or distant past.

tortoise_hareWithin the Social Security rules, it’s better to be a turtle than a hare. Again, that’s possibly different from a professional career, especially an entrepreneurial one, in which ten good years of earnings can sometimes add up to more money than 35 years of median income.

Are these things interesting? I don’t know. They are to me. I’ll pass on a few more insights I got from my Social Security calculator in a subsequent post.

NOTE:  A number of folks have asked to get a copy of my spreadsheet. I originally sent it around in the months following this post, but then stopped sending it. One reason: The Social Security factors that adjust annual earnings change every year, so my spreadsheet built in 2018 would be out of date by 2019. I don’t want to keep updating it, or send out wrong information. Second, its easy enough to build your own, if you follow the suggested steps of these two posts. Third – You can always hire me to do some personal financial consulting work for you…but I don’t think an out-of-date spreadsheet built for me is exactly going to serve anybody else’s individual purpose. Each person’s calculation needs to be  individualized! The best way to do that and understand what you have is to build it yourself. Or, like I said, have me build it with you.

See Related post:

Social Security Calculations Part II – The Effects of Entrepreneurship

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All My Thoughts On Reverse Mortgages

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I’m not the right age for reverse mortgages1 but a reader asked me for my help. Some deep-down part of me will always be a mortgage guy, so I decided to learn more about these things.2

The reader, named Jesse, aged 73, called to relay his experience trying to get a reverse mortgage on his house, and to ask for my advice.

He’d seen advertisements by Tom Selleckfor a company called American Advisors Group and it seemed to fit his financial circumstances.3

For Jesse, his idea was to use the money he could pull out of his house to help pay for taxes and insurance in the coming years.

Although I had never paid much attention to reverse mortgages, I previously had a vaguely negative feeling about them. I’ll describe those and sure, there are reasons to be cautious.

In the course of following up on Jesse’s inquiry, I also earned a bunch of unique and kind of awesome features of reverse mortgages which I had never seen in any other loan product. My overall thought is that under the right circumstances, these could be very useful mortgages.

No Payments, Ever

The first weird thing is that a borrower can decide to never make any principal and interest payments on the loan. For life! The debt accrues interest of course but the borrower can choose to never pay on that interest or principal. The lender gets paid back eventually, when the house is either sold or the owner dies, but in the meantime the loan doesn’t require any payments. Ever. I’ve never seen that on a loan structure before.

Second, as long as the homeowner complies with the mortgage agreement – which means staying current on taxes and insurance – neither the homeowner nor the homeowner’s spouse can be evicted from the house. Ever. It’s a bank loan backed by collateral, but the bank can’t take the collateral for the life of the borrowers. This is also something I’ve never seen before.

As it turned out, Jesse couldn’t move forward with the reverse mortgage, however, because his husband Ralph is only 51, and Texas requires both spouses to be over age 62.4

Other states have more lenient spousal rules, but Texas has its own way of doing things, as you may have heard.

I’ll describe my three previous issues with reverse mortgages, as well as my evolving views.

Complexity is the Enemy of the Good

An important worry is that as a relatively unusual loan product, consumers could be more likely to make bad choices about a thing they don’t understand very well. Even a traditional home mortgage can seem complex but it resembles other products we’re familiar with, like an automobile loan or a personal loan.

A reverse mortgage, by contrast, acts a bit like a retirement account or annuity, in that you can take money out over time as you get older. It’s also a bit like a credit card or home equity line of credit, in that it “revolves,” meaning you can take money out but also pay it back as often as you like. But it’s also different than a credit card or home equity loan, because you don’t have to pay it back with regular or even any payments (until you die). One of my guiding principles of finance is simplicity. Reverse mortgages may be a complicated form of debt for some people, and complicated is the enemy of the good.

Somewhat reducing my fear, however, is that every prospective reverse mortgage borrower must take a financial counseling course by phone, mandated by the Federal Housing Authority (FHA), which regulates reverse mortgages. Guy Stidham, owner of Mortgage of Texas and Financial LLC, a San Antonio-based mortgage broker who offers both traditional and reverse mortgages, says these courses cost about $150 and take a few weeks to schedule, which serves as a kind of “cooling off” function for prospective borrowers.5

Borrowing capacity

One of the more complicated topics of a reverse mortgage is how much you can borrow. Big picture, you should know two things: First, you can generally borrow much less initially with a reverse mortgage than with a traditional mortgage. Second, the amount you can borrow against your house trends upward over time, at the same rate as your mortgage’s interest rate. Let me fill in a few details on this issue.

Your initial borrowing amount is calculated according to an FHA formula by taking into account three things: The value of your house, your interest rate, and your age.

House_billsThe FHA says that the younger you are, the less you can borrow against your house. This makes sense since time will eat away at your home equity, and you are not required to make payments on a reverse mortgage. The FHA also says that the higher the interest rate, the less you can borrow. This also makes sense because a higher interest rate, compounding over time with no payments, will also eat away at your home equity.

With an online calculator you can see how much of your home value you are allowed to borrow against. If you test out the calculator, you’ll see a 70 year-old charged 4.5 percent can borrow less than 50 percent against their house. The typical range of borrowing is between 40 and 65 percent of home value, substantially less than the 80 percent standard with a traditional mortgage.

Here’s a weird quirk of reverse mortgages, however, The amount you can borrow against your house increases over time, precisely in line with the interest rate you are charged. If you’re charged 5 percent interest, your available borrowing limit increases by 5 percent per year. For reverse mortgage borrowers using this as a home equity line of credit, the annually increased borrowing capacity will seem like a cool feature. For people concerned with reverse mortgages eating up your home equity, this increased borrowing capacity may seem pernicious.

I won’t rule either way, except to say that debt in all forms is always a drug, which may be used for good or evil. The increasing borrowing limit just ups your dosage of the drug over time.

Are these high cost mortgages?

My second big worry was that reverse mortgage would be high cost products for borrowers. This fear turns out to be somewhat true, although there’s some nuance to the cost issue.

reverse_mortgageThe biggest cost of a reverse mortgage is mandatory mortgage insurance. Reverse mortgage borrowers are charged by the Federal Housing Authority (FHA) 2 percent of the appraised home value. For a $500,000 appraised home, the FHA would charge $10,000, which would be rolled into your loan balance at the time of origination. The FHA also charges 0.5 percent annually on the balance, as further insurance against losses. I think this is the biggest contributor to reverse mortgage costing more than traditional mortgages.

Next, what kind of interest rate should we expect on a reverse mortgage?

Most reverse mortgages charge a variable interest rate. According to Greg Groh, a reverse mortgage originator with All Reverse Mortgage, last week the starting variable interest rate was 4.32 percent which, added to the insurance cost, would mean a borrower’s cost of 4.82 percent.

What do I think of those rates? They’re slightly higher than a traditional mortgage, but also less than the rate I’m currently charged for my home equity line of credit, on which I pay 5.49 percent, and happily so. So, the floating interest rate isn’t a big knock on reverse mortgages.

Joe DeMarkey, Strategic Business Development Leader of Reverse Mortgage Funding estimated fixed rates now between 4.375 and 5.125 percent, in the same ballpark as a traditional 30-year mortgage. So, again, the cost of a reverse mortgage isn’t particularly from an above-market interest rate.

DeMarkey points out that 80 percent of reverse mortgages have floating interest rates rather than fixed rates. With floating rate loans, the initial interest rate often starts out reasonably low but there’s always a risk that future higher interest rates make that same debt more expensive later.

Broker commissions and origination fees

Stidham allows that a broker like him can be compensated more by the lender to sell a reverse mortgage in part because they are a less competitive product. His fee for brokering a reverse mortgage could be up to 3 times higher than with a traditional mortgage.

Finally, there’s the issue of origination fees. The maximum origination fee is capped at $6,000, and would actually be smaller for smaller loans.

Closing costs like attorney fees, title insurance, and bank appraisals are all basically the same as a traditional mortgage. Groh reports that a reverse mortgage bank appraisal cost might run slightly higher, but on the order of $550 for a reverse mortgage appraisal rather than $450 for a traditional mortgage. Not a big deal there. The main big cost difference, as I said earlier, is the FHA-charged insurance, which is pretty hefty.

Servicing Details

The servicing component of reverse mortgages is slightly different than for a traditional mortgage. Since borrowers must live in their house, does that force a sale if an elderly person moves out to a nursing facility? Yes, and no.

Borrowers may live outside of the home up to 12 continuous months, meaning even an extended hospital stay or stint in a nursing home does not trigger any change with the mortgage.

Each year a lender sends an “occupancy certificate” letter to the home which must be signed and returned, according to Cliff Auerswald of All Reverse Mortgage. If the borrower does not return that certificate, then the servicer may send someone over to do a drive-by inspection of the property.

If the borrower decided to leave the home for more than 12 months, then in fact the loan would become due. For that reason, any borrower who doesn’t plan to stay in their home “for life,” should probably look for another product rather than a reverse mortgage.

Hollowing out Equity

My third big problem with reverse mortgages was that they clashed with my traditional view of the incredible wealth building potential of home ownership– a way to automatically build up a store of wealth by making affordable monthly principal and interest payments on your house over a few decades. Because reverse mortgages drain that value over time, they made me want shout “Wait…But that’s…that’s not how it’s supposed to work!

Look, my strongest advice would be to fully pay down your home mortgage over 15 to 30 years, don’t borrow against your house, and depend solely on accumulated retirement savings plus social security to support you in your old age. There’s nothing wrong with that advice except for the fact that it sounds a bit like: “My strongest advice to you is to be rich in your old age.”

And, you know, that’s not very actionable advice by the time you actually retire.

If you can’t be rich, my second strongest recommendation would be to take out a home equity line of credit, since these are revolving lines, they allow you to flexibly borrow as needed, and act like a low-interest emergency credit card. They are awesome and we used one to renovate our kitchen and paint our house. I love my HELOC. A reverse mortgage therefore is really a third-best option, but it seems to me a pretty fine choice under many scenarios.

As my wife reminded me recently, one of my other long-standing theories of personal finance is that kids shouldn’t inherit stuff. Since we don’t intend to bequeath our house to our girls, I shouldn’t be opposed to draining the house of our home equity once we hit our 70s or 80s. At that age, the goal shouldn’t be to continuously build up assets (For what? For whom?) but rather to spend money to make our lives better.

If we planned to stay in our house, my wife and I recently agreed we’d be open to a reverse mortgage in our 70s.

 

Please see related posts:

Homeownership – Part I

Ask an Ex-Banker: HELOCs

 

 

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  1.  You have to be age 62, minimum.
  2.  This post is a combination of a couple of columns I wrote for the newspaper, combined into one long post.
  3.  A reverse mortgage, sometimes called a home equity conversion mortgage (aka HECM), is targeted to 62 year olds and up. Home equity, I should clarify, is the difference between the value of a house and the amount of debt on the house. That means a $300,000 house with a $100,000 mortgage has $200,000 in home equity. A reverse mortgage is a kind of home equity loan, specifically to borrow in old age without having to make payments, if you don’t want to.
  4.  As an aside, Jesse wondered if discrimination from the bank was at play because he’s gay. I told him he should hope for that, as a class-action attorney could solve all his financial needs and he wouldn’t need the mortgage any more. Alas, Texas law says your spouse can’t be younger than 62 to take a reverse mortgage, whereas in other states your spouse can be younger than 62. It’s age discrimination, not LGBT discrimination. No big discrimination win for Jesse.
  5.  Disclosure: I have done consulting projects for Stidham in the past.

TRS – A Texas Pension Too Big To Fail

TRSTexas State Senator Paul Bettencourt, (R-Houston) poked the bear when he filed Senate Bills 1750 and 1751, which would allow the Teachers Retirement System of Texas (TRS) and Employee Retirement System of Texas (ERS) to study, and possibly implement, changes in their public pensions. Change would mean moving – in an as-yet unspecified way – from a traditional “defined benefit” to a more 401K-style “defined contribution” plan. The effect would be to shift the burden of paying for retirement, somewhat, from taxpayers to employees. The bills as written specifically would only affect newly hired employees, not existing employees or retirees.

The bear he poked, of course, is public school teachers.

Public school teachers in Texas face steeper challenges planning their retirement than other professionals, in part because the vast majority cannot participate in Social Security, in part because of modest pay increases throughout a full career of service, and in part due to barriers to good retirement advice.

I don’t blame teachers, their union, and groups like the Texas Public Employees Association and Texas Retired Teachers Association (TRTA) that have come out in opposition to the bills. Tim Lee, Executive Director of TRTA, told me that an estimated 120 thousand text messages had been sent to legislators regarding changes toward a hybrid plan, such as suggested in SB 1751. Lee regards a shift to a hybrid system – even for only new hires – as undermining the strength of the entire TRS. A change caused by these bills would cause his organization to rethink their strategic approach to everything, including whether to advocate for joining the Social Security system. They don’t currently, but might in the future if they thought a hybrid system weakened TRS.

And yet, (and here’s where I become a target for the next 10,000 angry text messages from teachers) Bettencourt has an important point to make, by filing these bills. “Long term, what I hope to do is start a discussion about the real cost of pensions,” Bettencourt told me.

paul_bettencourtAs a finance guy, I want my public officials staying up late worried about public pensions, seeking ways to reduce their systemic risks. TRS has more than 1.5 million members, more than $130 billion in net assets, and represents the ultimate “Too Big To Fail” public pension in Texas.

Reasonable people can disagree on the following, but on the four biggest measurements of a pension plan’s health, the TRS according to its 2016 audit is worse off than we’d wish for, although maybe still within acceptable bounds.

  1. We want at least an 80 percent “Funded Ratio” – the percent of money owed to pensioners that’s covered by money already in the investment portfolio. TRS is now at 79.7 percent. Too low.
  2. We want less than 30 years to “amortize” or pay down, pension debts, and would prefer 15 to 20 years. TRS is at 33 years. Too long.
  3. We would prefer a low, or conservative, annual return assumption, compared to a national average of 7.47 percent annual return assumption in pension plans. The TRS assumes an optimistic 8 percent return. Too high.
  4. Finally, the unfunded liability part of the pension – money owed to retirees but not yet paid for – has grown from zero in the year 2000 to approximately $35 billion this year. Too big.

None is this spells catastrophe today, in my view. It just means the TRS is not, currently, building in room for error. As a teacher, if TRS is my main safety net, these numbers do not make me comfortable.

Actually, let me restate: Were I a young teacher, or a prospective teacher facing a new career, I would be livid about those TRS numbers. Older teachers – those close to retirement or already retired – are probably fine, and realistically won’t get benefits chopped to make up any future shortfalls. Rule changes in pensions always hurt the young ones.

In fact, one of the main flaws of the TRS design is this “generational inequity” in favor of older teachers rather than younger teachers, according to Josh McGee, who is both a pension-plan economist for the John Arnold Foundation and the Chairman of the Texas Pension Review Board. McGee has written extensively about how traditional pensions like TRS strongly favor veterans over younger teachers, especially those who change jobs or leave the system at any point in their career.

Defined benefit plans are most generous to veterans of over 20 years, but McGee cites figures that only 28 percent of teachers nationwide stay for that long. The early-departing teachers lose many of their hard-earned retirement rewards.

A defined contribution plan or hybrid plan theoretically could allow teachers the chance to self-fund part of their retirement, which could accompany them to another career or another location.

Then there’s the issue of pension plan solvency.

“When you look around the state, the Dallas [Police and Fire] Pension is a smoking crater at this point in time. Houston is not far behind,” Senator Bettencourt notes, referencing existing problems in public employee pensions in the state’s largest municipalities.

The following are my words, not Sen. Bettencourt’s, but I regard public pension plans as ticking time bombs. Not because the managers of TRS are bad, or because anyone is doing anything particularly wrong. It’s just that small decisions to underfund a public pension can, over decades, compound into giant problems. Make a few wrong assumptions – the 8 percent return assumption seems way high to me for example – and you end up with a big fiscal hole in the state.

A safer approach for teachers and taxpayers might in fact be to shift, over time, some of the risks away from taxpayers. Currently 13 states have a version of a hybrid system of the type that Bettencourt’s bill would allow, while 38 states continue with a “defined benefit” plan like Texas’ current TRS.

It’s a debate worth having now, before anything bad happens.

 

A version of this post ran in the San Antonio Express News and the Houston Chronicle.

Please see related post:

Teachers and the struggle to get good financial advice

I Finally Say How To Invest

Interview with Mint: I give ALL the answers

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Variable Annuity Salespeople: Just Because You’re Paranoid Doesn’t Mean I’m Not Out To Get You

variable_annuity
Variable Annuity = Shit Sandwich

A funny email note went out yesterday from the National Tax-Deferred Savings Association (NTSA) about my article on the terrible retirement product teachers generally get, from an organization funded by the people selling those terrible products. By their note I gather they support the selling of shit-sandwich annuities to retirees, stuffing unsophisticated people’s retirement accounts with high cost, illiquid, low return, garbage.

Anyway, in a newsletter to their constituents, the NTSA wants you to know there’s something fishy about the timing of my column:

“An article titled, “Texas Teachers Get Poor Retirement Advice and Worse Options,” ran in the Houston Chronicle over the weekend. Its timing is probably not coincidental.”

I honestly have no idea what the ‘coincidental timing’ they are referring to is. But I know that if you have something you’re doing that seems kind of wrong, truth-telling at any time can seem threatening.

I write what I want, when I want to. Unlike the NTSA, I’m not selling anything terrible, or anything at all. By their paranoid response, I gather they are.

 

 

Please see related post in the San Antonio Express News and Houston Chronicle

And the post on Variable Annuities = Shit Sandwich

 

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